HANGER, INC. - Quarter Report: 2012 June (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

 

FORM 10-Q

(Mark One)

 

 

For the quarterly period ended June 30, 2012

 

OR

 

 

For the transition period from           to           

 

Commission file number 1-10670

 

HANGER, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Registrant’s telephone number, including area code: (512) 777-3800

 

 

Formerly Hanger Orthopedic Group, Inc.

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.) Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one).

 

 

Indicate by check mark whether the registrant is a shell company as defined in Rule 12b-2 of the Exchange Act. Yes o No x

 

As of July 27, 2012 34,199,023 shares of common stock, $.01 par value per share, were outstanding.

 

 

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HANGER, INC.

 

INDEX

 

		Page No.
Part I.	FINANCIAL INFORMATION
Item 1.	Consolidated Financial Statements (unaudited)
	Consolidated Balance Sheets — June 30, 2012 and December 31, 2011	1
	Consolidated Statements of Income and Comprehensive Income for the Three and Six Months ended June 30, 2012 and 2011	3
	Consolidated Statements of Cash Flows for the Six Months ended June 30, 2012 and 2011	4
	Notes to Consolidated Financial Statements	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	30
Item 4.	Controls and Procedures	30
Part II.	OTHER INFORMATION
Item 1A.	Risk Factors	30
Item 6.	Exhibits	33
SIGNATURES		34

 

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HANGER, INC.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

(Unaudited)

 

		June 30,			December 31,
		2012			2011
ASSETS
CURRENT ASSETS
Cash and cash equivalents		$	41,613		$	42,896
Restricted cash		3,120			—
Accounts receivable, less allowance for doubtful accounts of $24,382 and $22,028 in 2012 and 2011, respectively		142,551			138,826
Inventories		124,815			114,086
Prepaid expenses, other assets, and income taxes receivable		18,273			17,015
Deferred income taxes		20,652			20,648
Total current assets		351,024			333,471
PROPERTY, PLANT AND EQUIPMENT
Land		794			794
Buildings		7,302			4,400
Furniture and fixtures		17,991			17,281
Machinery and equipment		58,264			56,137
Equipment leased to third parties under operating leases		34,314			33,830
Leasehold improvements		67,801			65,245
Computer and software		91,107			81,775
Total property, plant and equipment, gross		277,573			259,462
Less accumulated depreciation		168,262			154,690
Total property, plant and equipment, net		109,311			104,772
INTANGIBLE ASSETS
Goodwill		615,732			609,484
Patents and other intangible assets, net		54,732			54,894
Total intangible assets, net		670,464			664,378
OTHER ASSETS
Debt issuance costs, net		15,759			17,485
Other assets		8,623			8,394
Total other assets		24,382			25,879
TOTAL ASSETS		$	1,155,181		$	1,128,500

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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HANGER, INC.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

(Unaudited)

 

		June 30,			December 31,
		2012			2011
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES
Current portion of long-term debt		$	6,115		$	8,065
Accounts payable		29,116			26,561
Accrued expenses		22,915			18,247
Accrued interest payable		3,034			3,040
Accrued compensation related costs		23,990			35,829
Total current liabilities		85,170			91,742
LONG-TERM LIABILITIES
Long-term debt, less current portion		498,311			499,968
Deferred income taxes		74,257			74,309
Other liabilities		37,025			32,818
Total liabilities		694,763			698,837
COMMITMENTS AND CONTINGENCIES (Note H)
SHAREHOLDERS’ EQUITY
Common stock, $.01 par value; 60,000,000 shares authorized, 35,504,100 and 35,127,230 shares issued and outstanding at 2012 and 2011, respectively		355			351
Additional paid-in capital		274,345			268,535
Accumulated other comprehensive loss		(1,185		)	(1,185		)
Retained earnings		187,559			162,618
		461,074			430,319
Treasury stock at cost (141,154 shares)		(656		)	(656		)
Total shareholders’ equity		460,418			429,663
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY		$	1,155,181		$	1,128,500

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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HANGER, INC.

CONSOLIDATED STATEMENTS OF INCOME

AND COMPREHENSIVE INCOME

For the Three and Six Months Ended June 30,

(Dollars in thousands, except share and per share amounts)

(Unaudited)

 

		Three Months Ended						Six Months Ended
		June 30,						June 30,
		2012			2011			2012			2011
Net sales		$	251,754		$	234,751		$	469,846		$	435,190
Cost of goods sold - materials		72,899			68,514			136,998			126,622
Personnel costs		83,435			81,014			167,054			159,903
Other operating expenses		51,256			44,603			93,389			81,993
Relocation expenses		—			42			—			417
Depreciation and amortization		8,438			7,696			16,723			14,988
Income from operations		35,726			32,882			55,682			51,267
Interest expense		7,684			7,791			15,461			16,170
Income before taxes		28,042			25,091			40,221			35,097
Provision for income taxes		10,656			9,660			15,280			13,453
Net income		$	17,386		$	15,431		$	24,941		$	21,644
Other comprehensive income		—			—			—			—
Comprehensive income		$	17,386		$	15,431		$	24,941		$	21,644
Basic Per Common Share Data
Net income		$	0.51		$	0.46		$	0.73		$	0.65
Shares used to compute basic per common share amounts		34,268,941			33,499,268			34,110,820			33,429,502
Diluted Per Common Share Data
Net income		$	0.50		$	0.45		$	0.72		$	0.63
Shares used to compute diluted per common share amounts		34,720,489			34,365,395			34,637,769			34,284,513

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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HANGER, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Six Months Ended June 30,

(Dollars in thousands)

(Unaudited)

 

		2012			2011
Cash flows from operating activities:
Net income		$	24,941		$	21,644
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Loss (gain) on disposal of assets		1			(45		)
Reduction of seller notes and earnouts		(870		)	(281		)
Provision for bad debts		12,925			10,891
Provision for deferred income taxes		—			(343		)
Depreciation and amortization		16,723			14,988
Amortization of debt issuance costs		1,726			1,607
Compensation expense on restricted stock		4,014			3,874
Excess tax benefit from stock-based compensation		(448		)	(1,095		)
Changes in operating assets and liabilities, net of effects of acquired companies:
Accounts receivable		(16,190		)	(12,779		)
Inventories		(10,272		)	(4,181		)
Prepaid expenses, other current assets, and income taxes		1,915			5,021
Accounts payable		2,327			(7,583		)
Accrued expenses and accrued interest payable		501			(1,854		)
Accrued compensation related costs		(12,562		)	(19,332		)
Other		2,270			106
Net cash provided by operating activities		27,001			10,638
Cash flows from investing activities:
Purchase of property, plant and equipment (net of acquisitions)		(14,907		)	(13,630		)
Purchase of equipment leased to third parties under operating leases		(1,063		)	(1,639		)
Acquisitions and contingent purchase price (net of cash acquired)		(6,395		)	(6,064		)
Proceeds from sale of property, plant and equipment		—			94
Restricted cash		(3,120		)	—
Net cash used in investing activities		(25,485		)	(21,239		)
Cash flows from financing activities:
Borrowings under revolving credit agreement		—			10,000
Repayment under revolving credit agreement		—			(10,000		)
Repayment of term loan		(2,200		)	(1,500		)
Repayment of long-term debt		(2,451		)	(2,119		)
Repayment of capital lease obligations		(168		)	—
Deferred financing costs		—			(4,230		)
Excess tax benefit from stock-based compensation		448			1,095
Proceeds from issuance of common stock		1,572			573
Net cash used in financing activities		(2,799		)	(6,181		)
Decrease in cash and cash equivalents		(1,283		)	(16,782		)
Cash and cash equivalents, at beginning of period		42,896			36,308
Cash and cash equivalents, at end of period		$	41,613		$	19,526

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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HANGER, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE A — BASIS OF PRESENTATION

 

The unaudited interim consolidated financial statements as of June 30, 2012, and for the three and six months ended June 30, 2012 and 2011 have been prepared by Hanger, Inc. (the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim financial reporting. These consolidated statements are unaudited and, in the opinion of management, include all adjustments (consisting of normal recurring adjustments and accruals) considered necessary for a fair statement of the Company’s financial position, results of operations and cash flows for such periods. The year-end consolidated data was derived from audited financial statements but does not include all disclosures required by accounting principles generally accepted in the United States of America (“GAAP”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted. The results of operations for the three and six months ended June 30, 2012 are not necessarily indicative of the results to be expected for the full fiscal year.

 

These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements of the Company and notes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2011, filed by the Company with the SEC.

 

NOTE B — SIGNIFICANT ACCOUNTING POLICIES

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated in the accompanying financial statements.

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Cash and Cash Equivalents

 

The Company considers all highly liquid investments with original maturities of three months or less at the date of purchase to be cash equivalents.  At various times throughout the year, the Company maintains cash balances in excess of Federal Deposit Insurance Corporation limits.

 

Restricted Cash

 

Restricted cash has statutory or contractual restrictions that prevent it from being used in the Company’s operations.  The Company agreed to restrict $3.1 million of cash to eliminate letters of credit obligations used as collateral under the revolving credit facility.

 

Inventories

 

Inventories, which consist principally of raw materials, work in process and finished goods, are stated at the lower of cost or market using the first-in, first-out method. For its Patient-Care Services segment, the Company calculates cost of goods sold—materials in accordance with the gross profit method for all reporting periods.

 

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NOTE B — SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

 

The Company bases the estimates used in applying the gross profit method on the actual results of the most recently completed fiscal year and other factors, such as a change in the sales mix or changes in the trend of purchases. Cost of goods sold—materials during the interim periods are reconciled and adjusted when the annual physical inventory is taken. The Company treats these adjustments as changes in accounting estimates.

 

Fair Value of Financial Instruments

 

The carrying value of the Company’s short-term financial instruments, such as receivables and payables, approximate their fair values based on the short-term maturities of these instruments. The carrying value of the Company’s long-term debt, excluding the Senior Notes, approximates fair value based on rates currently available to the Company for debt with similar terms and remaining maturities (level 2). The fair value of the Senior Notes, based on quoted market prices (level 1), as of June 30, 2012 was $206.0 million, as compared to the carrying value of $200.0 million as of that date.

 

Revenue Recognition

 

Revenues in the Company’s patient-care centers are derived from the sale of O&P devices and the maintenance and repair of existing devices and are recorded net of all contractual adjustments and discounts. The sale of O&P devices includes the design, fabrication, assembly, fitting and delivery of a wide range of braces, limbs and other devices. Revenues from the sale of these devices are recorded when (i) acceptance by and delivery to the patient has occurred; (ii) persuasive evidence of an arrangement exists and there are no further obligations to the patient; (iii) the sales price is fixed or determinable; and (iv) collectability is reasonably assured. Revenues from maintenance and repairs are recognized when the service is provided. Revenues on the sale of O&P devices to customers by the Distribution segment are recorded upon the shipment of products, in accordance with the terms of the invoice, net of merchandise returns received and the amount established for anticipated returns. Discounted sales are recorded at net realizable value. Revenues in the Therapeutic Solutions segment are primarily derived from leasing rehabilitation technology combined with clinical therapy programs and education and training. The revenue is recorded on a monthly basis according to terms of the contracts with our customers.

 

Certain accounts receivable may be uncollectible, even if properly pre-authorized and billed. Regardless of the balance, accounts receivable amounts are periodically evaluated to assess collectability. In addition to the actual bad debt expense recognized during collection activities, the Company estimates the amount of potential bad debt expense that may occur in the future. This estimate is based upon historical experience as well as a review of the receivable balances.

 

On a quarterly basis, the Company evaluates cash collections, accounts receivable balances and write-off activity to assess the adequacy of the allowance for doubtful accounts. Additionally, a company-wide evaluation of collectability of receivable balances older than 180 days is performed at least semi-annually, the results of which are used in the next allowance analysis. In these detailed reviews, the account’s net realizable value is estimated after considering the customer’s payment history, past efforts to collect on the balance and the outstanding balance, and a specific reserve is recorded if needed. From time to time, the Company may outsource the collection of such accounts to collection agencies after internal collection efforts are exhausted. In the cases when valid accounts receivable cannot be collected, the uncollectible account is written off to bad debt expense.

 

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NOTE B — SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

 

Income Taxes

 

The Company recognizes deferred income tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Deferred income tax liabilities and assets are determined based on the difference between the financial statement and the tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The Company recognizes a valuation allowance on the deferred tax assets if it is more likely than not that the assets will not be realized in future years. Significant accounting judgment is required in determining the provision for income taxes and related accruals, deferred tax assets and liabilities. The Company believes that its tax positions are consistent with applicable tax law, but certain positions may be challenged by taxing authorities. In the ordinary course of business, there are transactions and calculations where the ultimate tax outcome is uncertain. In addition, the Company is subject to periodic audits and examinations by the Internal Revenue Service and other state and local taxing authorities. Although the Company believes that its estimates are reasonable, actual results could differ from these estimates.

 

Segment Information

 

The Company applies a “management” approach to disclosure of segment information. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the basis of the Company’s reportable segments. The description of the Company’s reportable segments and the disclosure of segment information are presented in Note L.

 

NOTE C - SUPPLEMENTAL CASH FLOW FINANCIAL INFORMATION

 

The supplemental disclosure requirements for the statements of cash flows are as follows:

 

		Six Months Ended
		June 30,
(In thousands)		2012			2011
		(Unaudited)			(Unaudited)
Cash paid during the period for:
Interest		$	13,444		$	13,885
Income taxes (net of refunds)		8,818			3,077
Non-cash financing and investing activities:
Non-cash property, plant and equipment purchases		615			218
Earnouts payable on acquisitions		1,842			647
Issuance of notes in connection with acquistions		1,250			1,100
Issuance of restricted shares of common stock		5,478			12,963

 

NOTE D - GOODWILL

 

The Company determined that it has three reporting units with goodwill to be evaluated, which are the same as its reportable segments: (i) Patient-Care Services; (ii) Distribution; and (iii) Therapeutic Solutions. The Company completes its annual goodwill impairment analysis in October of each year. The fair value of the Company’s reporting units is primarily determined based on the income approach and considers the market and cost approach.

 

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NOTE D — GOODWILL (CONTINUED)

 

The activity related to goodwill for the six months ended June 30, 2012 and 2011 is as follows:

 

		Patient-Care Services												Therapeutic
					Accumulated						Distribution			Solutions
(In thousands)		Goodwill			Impairment Loss			Net			Goodwill			Goodwill			Total
Balance at December 31, 2011		$	519,974		$	(45,808	)	$	474,166		$	38,388		$	96,930		$	609,484
Additions due to acquisitions		4,807			—			4,807			—			964			5,771
Additions due to contingent considerations		477			—			477			—			—			477
Balance at June 30, 2012 (unaudited)		$	525,258		$	(45,808	)	$	479,450		$	38,388		$	97,894		$	615,732

 

		Patient-Care Services												Therapeutic
					Accumulated						Distribution			Solutions
(In thousands)		Goodwill			Impairment Loss			Net			Goodwill			Goodwill			Total
Balance at December 31, 2010		$	502,040		$	(45,808	)	$	456,232		$	38,388		$	96,079		$	590,699
Additions due to acquisitions		4,910			—			4,910			—			423			5,333
Additions due to contingent considerations		741			—			741			—			—			741
Balance at June 30, 2011 (unaudited)		$	507,691		$	(45,808	)	$	461,883		$	38,388		$	96,502		$	596,773

 

NOTE E — INVENTORIES

 

Inventories, which are recorded at the lower of cost or market using the first-in, first-out method, were as follows:

 

		June 30,			December 31,
(In thousands)		2012			2011
		(Unaudited)			(Unaudited)
Raw materials		$	39,627		$	39,121
Work-in-process		56,636			45,735
Finished goods		28,551			29,230
		$	124,815		$	114,086

 

NOTE F — ACQUISITIONS

 

During the six months ended June 30, 2012, the Company acquired five O&P companies, operating a total of eight patient-care centers. The aggregate purchase price for these O&P businesses was $8.6 million. Of this aggregate purchase price, $1.2 million consisted of promissory notes, $1.8 million is made up of contingent consideration payable within the next five years, and $5.6 million was paid in cash. Contingent consideration is reported as other liabilities on the Company’s consolidated balance sheet. The Company recorded approximately $5.5 million of goodwill related to these acquisitions, and the expenses incurred related to this acquisition were insignificant and are included in other operating expenses. During the six months ended June 30, 2011, the Company acquired three O&P companies, operating a total of four patient care centers. The aggregate purchase price for these O&P businesses was $7.3 million. Of this aggregate purchase price, $1.1 million consisted of promissory notes and $0.9 million is made up of contingent consideration payable within the next two years and $5.3 million was paid in cash. The Company recorded approximately $4.9 million of goodwill related to these acquisitions and the expenses incurred related to these acquisitions were insignificant and are included in other operating expenses.

 

The results of operations for these acquisitions are included in the Company’s results of operations from the date of acquisition. Pro forma results would not be materially different. The Company intends to make an election to treat the acquisitions in 2012 as asset acquisitions for tax purposes which will result in the goodwill being amortizable for tax purposes.

 

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NOTE F — ACQUISITIONS (CONTINUED)

 

In connection with contingent consideration agreements with acquisitions completed prior to adoption of the revised authoritative guidance effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, the Company made payments of $0.5 million and $0.7 million during the six months ended June 30, 2012 and 2011, respectively. The Company has accounted for these amounts as additional purchase price, resulting in an increase in goodwill. In connection with contingent consideration agreements with acquisitions completed subsequent to adoption of revised authoritative guidance, the Company made payments of $0.8 million in the first six months of 2012 and $0.6 million in the same period 2011. The Company estimates that it may pay up to a total of $7.9 million related to contingent consideration provisions of acquisitions in future periods.

 

NOTE G — LONG TERM DEBT

 

Long-term debt consists of the following:

 

		June 30,			December 31,
(In thousands)		2012			2011
		(Unaudited)			(Unaudited)
Revolving Credit Facility		$	—		$	—
Term Loan		294,800			297,000
7 1/8% Senior Notes due 2018		200,000			200,000
Subordinated seller notes, non-collateralized, net of unamortized discount with principal and interest payable in either monthly, quarterly or annual installments at effective interest rates ranging from 3.00% to 7.00%, maturing through November 2016		9,627			11,033
		504,427			508,033
Less current portion		(6,115		)	(8,065		)
		$	498,311		$	499,968

 

Amendment to Credit Agreement

 

On March 11, 2011, the Company entered into an amendment to its Credit Agreement dated as of December 1, 2010 (as amended, the “Credit Agreement”). The amendment (i) reduced the interest rate margin applicable to the Term Loans under the Credit Agreement by 0.75% to 3.0% and (ii) reduced the LIBOR floor applicable to the Term Loans under the Credit Agreement from 1.5% to 1.0%. The Company incurred $4.1 million of fees related to this amendment, which will be amortized into interest expense over the remaining term of the debt.

 

Revolving Credit Facility

 

The $100.0 million Revolving Credit Facility matures on December 1, 2015 and bears interest at LIBOR plus 3.75%, or the applicable rate (as defined in the Credit Agreement). The Revolving Credit Facility requires compliance with various covenants including but not limited to (i) minimum consolidated interest coverage ratio of 3.25:1.00 from October 1, 2011 to September 30, 2012, and 3.50:1.00 thereafter until maturity; (ii) maximum total leverage ratio of 5.00:1.00 until December 31, 2011, 4.50:1.00 from January 1, 2012 to September 30, 2012, and 4.00:1.00 from October 1, 2012 thereafter until maturity; and (iii) maximum annual capital expenditures of 7.5% of consolidated net revenues of the preceding fiscal year with an additional maximum rollover of $15.0 million from the prior year’s allowance if not expended in the fiscal year for which it is permitted. As of June 30, 2012, the Company had $99.5 million available under the Revolving Credit Facility. Availability under the Revolving Credit Facility as of June 30, 2012 was net of standby letters of credit of approximately $0.5 million. As of June 30, 2012, the Company had no funds drawn on the Revolving Credit Facility. The obligations under the Revolving Credit Facility are senior obligations, are guaranteed by the Company’s subsidiaries, and are secured by a first priority perfected interest in the equity interests of the Company’s subsidiaries, all of the Company’s assets, and all the assets of the Company’s subsidiaries.

 

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NOTE G — LONG TERM DEBT (CONTINUED)

 

Term Loan

 

The $300.0 million Term Loan Facility matures on December 1, 2016 and requires quarterly principal payments of $750,000 that commenced on March 31, 2011. From time to time, mandatory prepayments may be required as a result of excess free cash flow as defined in the Credit Agreement, certain additional debt incurrences, certain asset sales, or other events as defined in the Credit Agreement. The Term Loan Facility bears interest at LIBOR plus 3.0%, or applicable rate (as defined in the Credit Agreement), and includes a 1.0% LIBOR floor. During the first six months of 2012 the Company made a mandatory prepayment on its Term Loan Facility of $700,000.  There were no mandatory prepayments made during the first six months of 2011. As of June 30, 2012, the interest rate on the Term Loan Facility was 4.0%. The obligations under the Term Loan Facility are senior obligations, are guaranteed by the Company’s subsidiaries, and are secured by a first priority perfected interest in the equity interests of the Company’s subsidiaries, all of the Company’s assets, and all the assets of the Company’s subsidiaries.

 

71/8% Senior Notes

 

The 71/8% Senior Notes mature November 15, 2018 and are senior indebtness which is guaranteed on a senior unsecured basis by all of the Company’s current and future subsidiaries. Interest is payable semi-annually on May 15 and November 15 of each year, commencing May 15, 2011.

 

On or prior to November 15, 2013, the Company may redeem up to 35% of the aggregate principal amount of the notes at a redemption price of 107.125% of the principal amount thereof, plus accrued and unpaid interest and additional interest to the redemption date with the proceeds of a public offering of its equity securities. On or after November 15, 2014, the Company may redeem all or from time to time a part of the notes, upon not less than 30 days and not more than 60 days’ notice, for the twelve month period beginning on November 15, of the indicated years at (i) 103.563% during 2014; (ii) 101.781% during 2015; and (iii) 100.00% during 2016 and thereafter through November 15, 2018.

 

Subsidiary Guarantees

 

The Revolving and Term Loan Facilities and the 71/8% Senior Notes are guaranteed by all of the Company’s subsidiaries. Separate condensed consolidating information is not included as the Company does not have independent assets or operations. The Guarantees are full and unconditional and joint and several, and any subsidiaries of the Company other than the Guarantor Subsidiaries are minor. There are no restrictions on the ability of our subsidiaries to transfer cash to the Company or to co-guarantors. All consolidated amounts in the Company’s financial statements are representative of the combined guarantors.

 

Debt Covenants

 

The terms of the Senior Notes, the Revolving Credit Facility, and the Term Loan Facility limit the Company’s ability to, among other things, incur additional indebtedness, create liens, pay dividends on or redeem capital stock, make certain investments, make restricted payments, make certain dispositions of assets, engage in transactions with affiliates, engage in certain business activities and engage in mergers, consolidations and certain sales of assets. At June 30, 2012, the Company was in compliance with all covenants under these debt agreements.

 

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NOTE H — COMMITMENTS AND CONTINGENT LIABILITIES

 

Contingencies

 

The Company is subject to legal proceedings and claims which arise from time to time in the ordinary course of its business, including additional payments under business purchase agreements.  In the opinion of management, the amount of ultimate liability, if any, with respect to these actions will not have a materially adverse effect on the financial position, liquidity or results of operations of the Company.

 

The Company is in a highly regulated industry and receives regulatory agency inquiries from time to time in the ordinary course of its business, including inquiries relating to the Company’s billing activities. To date these inquiries have not resulted in material liabilities, but no assurance can be given that future regulatory agencies’ inquiries will be consistent with the results to date or that any discrepancies identified during a regulatory review will not have a material adverse effect on the Company’s consolidated financial statements.

 

Guarantees and Indemnifications

 

In the ordinary course of its business, the Company may enter into service agreements with service providers in which it agrees to indemnify or limit the service provider against certain losses and liabilities arising from the service provider’s performance of the agreement. The Company has reviewed its existing contracts containing indemnification or clauses of guarantees and does not believe that its liability under such agreements is material to the Company’s operations.

 

NOTE I — NET INCOME PER COMMON SHARE

 

Basic per common share amounts are computed using the weighted average number of common shares outstanding during the year. Diluted per common share amounts are computed using the weighted average number of common shares outstanding during the year and dilutive potential common shares. Dilutive potential common shares consist of stock options and restricted shares and are calculated using the treasury stock method.

 

Net income per share is computed as follows:

 

		Three Months Ended						Six Months Ended
		June 30,						June 30,
(In thousands, except share and per share data)		2012			2011			2012			2011
		(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Net income		$	17,386		$	15,431		$	24,941		$	21,644
Shares of common stock outstanding used to compute basic per common share amounts		34,268,941			33,499,268			34,110,820			33,429,502
Effect of dilutive restricted stock and options (1)		451,548			866,127			526,949			855,011
Shares used to compute dilutive per common share amounts		34,720,489			34,365,395			34,637,769			34,284,513
Basic income per share		$	0.51		$	0.46		$	0.73		$	0.65
Diluted income per share		$	0.50		$	0.45		$	0.72		$	0.63

 

(1) There were no anti-dilutive options for the three or six months ended June 30, 2012 and 2011.

 

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NOTE J — SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN

 

The Company’s unfunded noncontributory defined benefit plan (the “Plan”) covers certain senior executives, is administered by the Company and calls for annual payments upon retirement based on years of service and final average salary. Benefit costs and liabilities balances are calculated based on certain assumptions including benefits earned, discount rates, interest costs, mortality rates and other factors. Actual results that differ from the assumptions are accumulated and amortized over future periods, affecting the recorded obligation and expense in future periods.

 

The following assumptions were used in the calculation of the net benefit cost and obligation at June 30, 2012:

 

Discount rate		3.90	%
Average rate of increase in compensation		3.00	%

 

The Company believes the assumptions used are appropriate; however, changes in assumptions or differences in actual experience may affect our benefit obligation and future expenses. The change in the Plan’s net benefit obligation for the six months ended June 30, 2012 and 2011 is as follows:

 

		(in thousands)
Net benefit cost accrued at December 31, 2011 (unaudited)		$	20,230
Service cost		230
Interest cost		190
Payments		(525		)
Net benefit cost accrued at March 31, 2012 (unaudited)		$	20,125
Service cost		230
Interest cost		190
Payments		(180		)
Net benefit cost accrued at June 30, 2012 (unaudited)		$	20,365

 

		(in thousands)
Net benefit cost accrued at December 31, 2010 (unaudited)		$	17,510
Service cost		247
Interest cost		202
Payments		(526		)
Net benefit cost accrued at March 31, 2011 (unaudited)		$	17,433
Service cost		247
Interest cost		202
Net benefit cost accrued at June 30, 2011 (unaudited)		$	17,882

 

NOTE K - STOCK-BASED COMPENSATION

 

The Company utilizes the authoritative guidance using the modified prospective method. Compensation expense for all awards granted is calculated according to the provisions of such guidance.

 

On May 13, 2010, the shareholders of the Company approved the 2010 Omnibus Incentive Plan (the “2010 Plan”) and terminated the Amended and Restated 2002 Stock Incentive and Bonus Plan (the “2002 Plan”) and the 2003 Non-Employee Directors’ Stock Incentive Plan (the “2003 Plan”). No new awards will be granted under the 2002 Plan or the 2003 Plan; however, awards granted under either the 2002 Plan or the 2003 Plan that were outstanding on May 13, 2010 remain outstanding and continue to be subject to all of the terms and conditions of the 2002 Plan or the 2003 Plan, as applicable.

 

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NOTE K - STOCK-BASED COMPENSATION (CONTINUED)

 

The 2010 Plan provides that 2.5 million shares of Common Stock are reserved for issuance, subject to adjustment as set forth in the 2010 Plan; provided, however, that only 1.5 million shares may be issued pursuant to the exercise of incentive stock options. Of these 2.5 million shares, 2.0 million are shares that are newly authorized for issuance under the 2010 Plan and 0.5 million are unissued shares not subject to awards that have been carried over from the shares previously authorized for issuance under the terms of the 2002 Plan and the 2003 Plan. Unless earlier terminated by the Board of Directors, the 2010 Plan will remain in effect until the earlier of (i) the date that is ten years from the date the plan is approved by the Company’s shareholders, which is the effective date for the 2010 plan, namely May 13, 2020, or (ii) the date all shares reserved for issuance have been issued.

 

As of June 30, 2012, of the 2.5 million shares of common stock authorized for issuance under the Company’s 2010 Plan, approximately 1,122,000 shares have been issued. During the first six months of 2012, the Company issued approximately 509,000 shares of restricted stock under the 2010 Plan. The total fair value of these grants is $10.4 million. Total unrecognized share-based compensation cost related to unvested restricted stock awards was approximately $14.5 million as of June 30, 2012 and is expected to be expensed as compensation expense over approximately four years.

 

During the six months ended June 30, 2012 and 2011, no options were cancelled under either the 2002 Plan or the 2003 Plan.

 

For the six months ended June 30, 2012 and 2011, the Company has included approximately $4.0 million and $3.9 million, respectively, for share-based compensation cost in the accompanying condensed consolidated statements of income for the 2002, 2003 and 2010 Plans. Compensation expense relates to restricted share grants.

 

NOTE L — SEGMENT AND RELATED INFORMATION

 

The Company has identified three reportable segments in which it operates based on the products and services it provides. The Company evaluates segment performance and allocates resources based on the segments’ income from operations. The reportable segments are: (i) Patient-Care Services (ii) Distribution, and (iii) Therapeutic solutions. The reportable segments are described further below:

 

Patient-Care Services—This segment consists of the Company’s owned and operated patient-care centers. The patient-care centers provide services to design and fit O&P devices to patients. These centers also instruct patients in the use, care and maintenance of the devices. The principal reimbursement sources for the Company’s services are:

 

·                  Commercial and other, which consist of individuals, rehabilitation providers, private insurance companies, HMOs, PPOs, hospitals, vocational rehabilitation, workers’ compensation programs and similar sources;

 

·                  Medicare, a federally funded health insurance program providing health insurance coverage for persons aged 65 or older and certain disabled persons, which provides reimbursement for O&P products and services based on prices set forth in fee schedules for 10 regional service areas;

 

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NOTE L — SEGMENT AND RELATED INFORMATION (CONTINUED)

 

·                  Medicaid, a health insurance program jointly funded by federal and state governments providing health insurance coverage for certain persons in financial need, regardless of age, which may supplement Medicare benefits for financially needy persons aged 65 or older; and

 

·                  U.S. Department of Veterans Affairs.

 

The Company estimates that government reimbursement, comprised of Medicare, Medicaid and the U.S. Department of Veterans Affairs, in the aggregate, accounted for approximately 41.3% and 40.6%, of the Company’s net sales for the six months ended June 30, 2012 and 2011, respectively.

 

Distribution—This segment distributes O&P products and components to both the O&P industry and the Company’s own patient-care practices. This segment also includes the Company’s Fabrication centers which are involved in the fabrication of O&P components for both the O&P industry and the Company’s own patient-care centers.

 

Therapeutic Solutions—This segment consists of the leasing of rehabilitation equipment from, and the provision of clinical program by, ACP as well the operations of IN, Inc. ACP is a developer of specialized rehabilitation technologies and provides evidence-based clinical programs for post-acute rehabilitation. IN, Inc. specializes in bringing emerging neuromuscular technologies to the O&P market.

 

Other—This segment consists of Hanger corporate and Linkia. Linkia is a national managed-care agent for O&P services and a patient referral clearing house.

 

The accounting policies of the segments are the same as those described in the summary of “Significant Accounting Policies” in Note B to the consolidated financial statements.

 

Summarized financial information concerning the Company’s reportable segments is shown in the following table. Intersegment sales mainly include sales of O&P components from the Distribution segment to the Patient-Care Services segment and were made at prices which approximate market values.

 

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NOTE L — SEGMENT AND RELATED INFORMATION (CONTINUED)

 

(In thousands)		Patient-Care Services			Distribution			Therapeutic Solutions			Other			Consolidating Adjustments			Total
		(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Three Months Ended June 30, 2012
Net sales
Customers		$	207,791		$	27,413		$	16,356		$	194		$	—		$	251,754
Intersegments		—			53,147			1,000			—			(54,147		)	—
Depreciation and amortization		3,381			324			2,712			2,021			—			8,438
Income (loss) from operations		40,454			9,473			941			(14,974		)	(168		)	35,726
Interest (income) expense		7,552			830			1,435			(2,133		)	—			7,684
Income (loss) before taxes		32,902			8,643			(494		)	(12,841		)	(168		)	28,042
Three Months Ended June 30, 2011
Net sales
Customers		$	192,976		$	25,578		$	16,067		$	130		$	—		$	234,751
Intersegments		—			48,940			986			—			(49,926		)	—
Depreciation and amortization		3,029			299			2,575			1,793			—			7,696
Income (loss) from operations		39,005			7,479			811			(14,371		)	(42		)	32,882
Interest (income) expense		7,094			848			1,440			(1,591		)	—			7,791
Income (loss) before taxes		31,911			6,631			(628		)	(12,781		)	(42		)	25,091
Six Months Ended June 30, 2012
Net sales
Customers		$	384,163		$	53,653		$	31,688		$	342		$	—		$	469,846
Intersegments		—			100,716			1,844			—			(102,560		)	—
Depreciation and amortization		6,797			648			5,386			3,892			—			16,723
Income (loss) from operations		65,324			18,015			1,208			(28,420		)	(445		)	55,682
Interest (income) expense		15,135			1,662			2,875			(4,211		)	—			15,461
Income (loss) before taxes		50,189			16,353			(1,667		)	(24,209		)	(445		)	40,221
Capital expenditures		4,677			220			1,359			9,714			—			15,970
Six Months Ended June 30, 2011
Net sales
Customers		$	353,527		$	49,038		$	32,323		$	302		$	—		$	435,190
Intersegments		—			90,567			1,732			—			(92,299		)	—
Depreciation and amortization		5,990			583			5,077			3,338			—			14,988
Income (loss) from operations		61,378			14,366			1,562			(26,099		)	60			51,267
Interest (income) expense		14,210			1,697			2,880			(2,617		)	—			16,170
Income (loss) before taxes		47,168			12,669			(1,318		)	(23,482		)	60			35,097
Capital Expenditures		7,058			630			2,006			5,575			—			15,269
Total Assets
March 31, 2012		1,335,910			188,321			135,350			(504,400		)	—			1,155,181
December 31, 2011		1,279,481			170,077			135,781			(456,839		)	—			1,128,500

 

NOTE M — CORPORATE OFFICE RELOCATION

 

The Company moved its corporate headquarters from Bethesda, Maryland to Austin, Texas in 2010.  As of January 1, 2012 the relocation of the corporate office was complete.  The following is a summary of the costs of the relocation incurred and to be paid in future periods:

 

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