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

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

 

FORM 10-Q

 

(Mark One)

 

 

For the transition period from           to           

 

Commission file number 1-10670

 

HANGER ORTHOPEDIC GROUP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

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

 

 

Former name, former address and former fiscal year, if changed since last report.

 

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 April 27, 2012 34,117,244 shares of common stock, $.01 par value per share, were outstanding.

 

 

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HANGER ORTHOPEDIC GROUP, INC.

 

INDEX

 

			Page No.
Part I.		FINANCIAL INFORMATION
Item 1.		Consolidated Financial Statements (unaudited)
		Consolidated Balance Sheets — March 31, 2012 and December 31, 2011	1
		Consolidated Statements of Income and Comprehensive Income for the Three Months ended March 31, 2012 and 2011	3
		Consolidated Statements of Cash Flows for the Three Months ended March 31, 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	29
Item 4.		Controls and Procedures	30
Part II.		OTHER INFORMATION
Item 1A.		Risk Factors	31
Item 6.		Exhibits	33
SIGNATURES			34

 

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HANGER ORTHOPEDIC GROUP, INC.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

(Unaudited)

 

		March 31,			December 31,
		2012			2011
ASSETS
CURRENT ASSETS
Cash and cash equivalents		$	32,248		$	42,896
Restricted cash		3,120			—
Accounts receivable, less allowance for doubtful accounts of $22,022 and $22,028 in 2012 and 2011, respectively		133,308			138,826
Inventories		120,485			114,086
Prepaid expenses, other assets, and income taxes receivable		20,106			17,015
Deferred income taxes		20,652			20,648
Total current assets		329,919			333,471
PROPERTY, PLANT AND EQUIPMENT
Land		794			794
Buildings		7,294			4,400
Furniture and fixtures		17,464			17,281
Machinery and equipment		57,314			56,137
Equipment leased to third parties under operating leases		34,186			33,830
Leasehold improvements		66,410			65,245
Computer and software		84,216			81,775
Total property, plant and equipment, gross		267,678			259,462
Less accumulated depreciation		161,538			154,690
Total property, plant and equipment, net		106,140			104,772
INTANGIBLE ASSETS
Goodwill		611,147			609,484
Patents and other intangible assets, net		53,958			54,894
Total intangible assets, net		665,105			664,378
OTHER ASSETS
Debt issuance costs, net		16,622			17,485
Other assets		8,661			8,394
Total other assets		25,283			25,879
TOTAL ASSETS		$	1,126,447		$	1,128,500

 

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

 

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HANGER ORTHOPEDIC GROUP, INC.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

(Unaudited)

 

		March 31,			December 31,
		2012			2011
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES
Current portion of long-term debt		$	7,927		$	8,065
Accounts payable		26,105			26,561
Accrued expenses		19,325			18,247
Accrued interest payable		6,615			3,040
Accrued compensation related costs		19,031			35,829
Total current liabilities		79,003			91,742
LONG-TERM LIABILITIES
Long-term debt, less current portion		498,168			499,968
Deferred income taxes		74,257			74,309
Other liabilities		35,183			32,818
Total liabilities		686,611			698,837
COMMITMENTS AND CONTINGENCIES (Note H)
SHAREHOLDERS’ EQUITY
Common stock, $.01 par value; 60,000,000 shares authorized, 35,588,485 and 35,127,230 shares issued and outstanding at 2012 and 2011, respectively		356			351
Additional paid-in capital		271,149			268,535
Accumulated other comprehensive loss		(1,185		)	(1,185		)
Retained earnings		170,172			162,618
		440,492			430,319
Treasury stock at cost (141,154 shares)		(656		)	(656		)
Total shareholders’ equity		439,836			429,663
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY		$	1,126,447		$	1,128,500

 

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

 

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HANGER ORTHOPEDIC GROUP, INC.

CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME

For the Three Months Ended March 31,

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

(Unaudited)

 

		Three Months Ended
		March 31,
		2012			2011
Net sales		$	218,091		$	200,439
Cost of goods sold - materials		64,098			58,108
Personnel costs		83,619			78,889
Other operating expenses		42,133			37,390
Relocation expenses		—			376
Depreciation and amortization		8,285			7,292
Income from operations		19,956			18,384
Interest expense		7,777			8,379
Income before taxes		12,179			10,005
Provision for income taxes		4,624			3,792
Net income		$	7,555		$	6,213
Other comprehensive income		—			—
Comprehensive income			7,555			6,213
Basic Per Common Share Data
Net income		$	0.22		$	0.19
Shares used to compute basic per common share amounts		34,036,539			33,360,840
Diluted Per Common Share Data
Net income		$	0.22		$	0.18
Shares used to compute diluted per common share amounts		34,639,660			34,134,067

 

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

 

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HANGER ORTHOPEDIC GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Three Months Ended March 31,

(Dollars in thousands)

(Unaudited)

 

		2012			2011
Cash flows from operating activities:
Net income		$	7,555		$	6,213
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Loss on disposal of assets		—			5
Reduction of seller notes and earnouts		(177		)	(257		)
Provision for bad debts		4,723			4,078
Provision for deferred income taxes		—			(343		)
Depreciation and amortization		8,285			7,292
Amortization of debt issuance costs		863			748
Compensation expense on restricted stock		1,971			1,658
Excess tax benefit from stock-based compensation		(209		)	(816		)
Changes in operating assets and liabilities, net of effects of acquired companies:
Accounts receivable		851			5,483
Inventories		(6,087		)	(1,368		)
Prepaid expenses, other current assets, and income taxes		(2,234		)	(3,010		)
Accounts payable		(522		)	(6,339		)
Accrued expenses and accrued interest payable		3,594			1,670
Accrued compensation related costs		(17,504		)	(25,531		)
Other		183			(1,794		)
Net cash provided by (used in) operating activities		1,292			(12,311		)
Cash flows from investing activities:
Purchase of property, plant and equipment (net of acquisitions)		(4,777		)	(5,437		)
Purchase of equipment leased to third parties under operating leases		(539		)	—
Acquisitions and contingent purchase price (net of cash acquired)		(2,402		)	(4,941		)
Proceeds from sale of property, plant and equipment		—			3
Restricted cash		(3,120		)	—
Net cash used in investing activities		(10,838		)	(10,375		)
Cash flows from financing activities:
Borrowings under revolving credit agreement		—			10,000
Repayment of term loan		(1,450		)	(750		)
Scheduled repayment of seller’s notes		(488		)	(406		)
Deferred financing costs		—			(4,189		)
Excess tax benefit from stock-based compensation		209			816
Proceeds from issuance of common stock		627			573
Net cash (used in) provided by financing activities		(1,102		)	6,044
Decrease in cash and cash equivalents		(10,648		)	(16,642		)
Cash and cash equivalents, at beginning of period		42,896			36,308
Cash and cash equivalents, at end of period		$	32,248		$	19,666

 

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

 

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HANGER ORTHOPEDIC GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE A — BASIS OF PRESENTATION

 

The unaudited interim consolidated financial statements as of and for the three months ended March 31, 2012 and 2011 have been prepared by Hanger Orthopedic Group, 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 months ended March 31, 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.

 

Revision of Previously Reported Statement of Cash Flow Information

 

During the second quarter of 2011, the Company identified a misclassification within the consolidated statements of cash flows, resulting in the overstatement of the net cash provided by operating activities in prior periods. The offsetting understatement was to net cash provided by financing activities. The misclassification had no impact on total reported decrease in cash and cash equivalents for any period, and therefore had no impact on operating or net income. The Company assessed the materiality of this item on previously reported periods and concluded the misclassification was not material. Accordingly, the three month period ended March 31, 2011 has been revised.

 

The impact of the reclassification on the statement of cash flows for the three month period ended March 31, 2011 is shown in the table below:

 

		As Previously
(in thousands)		Reported			Adjustment		As Revised
Net cash used in operating activities		$	(11,495	)	(816	)	$	(12,311	)
Net cash (used in) provided by financing activities		$	5,228		816		$	6,044

 

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NOTE B — SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

 

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. 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 March 31, 2012 was $210.5 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

 

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NOTE B — SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

 

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 outsourced 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.

 

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.

 

New Accounting Guidance

 

In May 2011, the FASB issued Accounting Standards Update (“ASU”) 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs,” which amends ASC 820, “Fair Value Measurement.” The amended guidance changes the wording used to describe many requirements in U.S. GAAP for measuring fair value and for disclosing information about

 

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NOTE B — SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

 

fair value measurements. Additionally, the amendments clarify the FASB’s intent about the application of existing fair value measurement requirements. The guidance provided in ASU No. 2011-04 is effective for interim and annual periods beginning after December 15, 2011 and is applied prospectively. The Company adopted the amendments of this ASU effective January 1, 2012, and the initial adoption of the amendments in this ASU did not have a material impact on our condensed consolidated financial statements.

 

In June 2011, the FASB issued ASU No. 2011-05, “Comprehensive Income (Topic 220),” which changes the presentation of comprehensive income. The amended guidance gives companies the option to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The guidance provided in ASU No. 2011-05 is effective for interim and annual periods beginning after December 15, 2011 and is applied prospectively. The Company adopted the amendments of this ASU effective January 1, 2012, and the initial adoption of the amendments in this ASU did not have a material impact on our condensed consolidated financial statements.

 

In July 2011, the FASB issued ASU No. 2011-07 “Presentation and Disclosures of Patient Service Revenue, Provision for Bad Debts and the Allowance for Doubtful Accounts for Certain Health Care Entities.”  The objective of this update is to provide financial statement users with greater transparency about a health care entity’s net patient service revenue and the related allowance for doubtful accounts. This update provides information to assist financial statement users in assessing an entity’s sources of net patient service revenue and related changes in its allowance for doubtful accounts. The amendments require health care entities that recognize significant amounts of patient service revenue at the time the services are rendered even though they do not assess the patient’s ability to pay to present the provision for bad debts related to patient service revenue as a deduction from patient service revenue (net of contractual allowances and discounts) on their statement of operations. The amendments in this update require certain health care entities to change the presentation of their statement of operations by reclassifying the provision for bad debts associated with patient service revenue from an operating expense to a deduction from patient service revenue (net of contractual allowances and discounts). Additionally, those health care entities are required to provide enhanced disclosure about their policies for recognizing revenue and assessing bad debts. The amendments also require disclosures of patient service revenue (net of contractual allowances and discounts) as well as qualitative and quantitative information about changes in the allowance for doubtful accounts. The guidance provided in ASU No. 2011-07 is effective for interim and annual periods beginning after December 15, 2011 and is applied prospectively. The Company has determined that ASU No. 2011-07 has no impact on its financial statements.

 

In September 2011, FASB issued ASU 2011-08, “Intangibles — Goodwill and Other (Topic 350):  Testing Goodwill for Impairment”, which provides entities the option to perform a qualitative assessment in order to determine whether additional quantitative impairment testing is necessary. This amendment is effective for reporting periods beginning after December 15, 2011. This amendment does not impact the quantitative testing methodology, should it be necessary. The Company adopted this standard on January 1, 2012 and the initial adoption of the amendments in this ASU did not have a material impact on our condensed consolidated financial statements.

 

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NOTE C - SUPPLEMENTAL CASH FLOW FINANCIAL INFORMATION

 

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

 

		Three Months Ended
		March 31,
(In thousands)		2012			2011
		(Unaudited)			(Unaudited)
Cash paid during the period for:
Interest		$	3,278		$	3,789
Income taxes (net of refunds)		1,566			1,030
Non-cash financing and investing activities:
Non-cash property, plant and equipment purchases		1,028			2,628
Earnouts payable on acquisitions		—			321
Issuance of notes in connection with acquistions		—			693
Issuance of restricted shares of common stock		8,419			11,566

 

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.

 

The activity related to goodwill for the three months ended March 31, 2012 and 2011 is as follows:

 

		Patient-Care Services									Distribution			Therapeutic Solutions
(In thousands)		Goodwill			Accumulated 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		1,536			—			1,536			—			—			1,536
Additions due to contingent considerations		127			—			127			—			—			127
Balance at March 31, 2012 (unaudited)		$	521,637		$	(45,808	)	$	475,829		$	38,388		$	96,930		$	611,147

 

		Patient-Care Services									Distribution			Therapeutic Solutions
(In thousands)		Goodwill			Accumulated 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		3,552			—			3,552			—			423			3,975
Additions due to contingent considerations		341			—			341			—			—			341
Balance at March 31, 2011 (unaudited)		$	505,933		$	(45,808	)	$	460,125		$	38,388		$	96,502		$	595,015

 

NOTE E — INVENTORIES

 

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

 

		March 31,			December 31,
(In thousands)		2012			2011
		(Unaudited)			(Unaudited)
Raw materials		$	39,488		$	39,121
Work-in-process		52,970			45,735
Finished goods		28,027			29,230
		$	120,485		$	114,086

 

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NOTE F — ACQUISITIONS

 

During the three months ended March 31, 2012, the Company acquired one O&P company, operating a total of 2 patient-care centers. The aggregate purchase price for this O&P business was $2.0 million paid in cash. The Company recorded approximately $1.3 million of goodwill related to this acquisition, and the expenses incurred related to this acquisition were insignificant and are included in other operating expenses. During the three months ended March 31, 2011, the Company acquired one O&P company, operating a total of one patient care center. The aggregate purchase price for this O&P business was $5.8 million. Of this aggregate purchase price, $0.7 million consisted of promissory notes and $0.6 million is made up of contingent consideration payable within the next two years. Contingent consideration is reported as other liabilities on the Company’s consolidated balance sheet. The Company recorded approximately $3.6 million of goodwill related to this acquisition and the expenses incurred related to this acquisition 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 this acquisition as an asset acquisition for tax purposes which will result in the goodwill being amortizable for tax purposes.

 

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 $0.1 million and $0.4 million during the three months ended March 31, 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 $0.4 million in the first three months of 2012 and $0.1 million in the same period 2011. The Company estimates that it may pay up to a total of $6.6 million related to contingent consideration provisions of acquisitions in future periods.

 

NOTE G — LONG TERM DEBT

 

Long-term debt consists of the following:

 

		March 31,			December 31,
(In thousands)		2012			2011
		(Unaudited)			(Unaudited)
Revolving Credit Facility		$	—		$	—
Term Loan		295,550			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		10,545			11,033
		506,095			508,033
Less current portion		(7,927		)	(8,065		)
		$	498,168		$	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

 

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NOTE G — LONG TERM DEBT (CONTINUED)

 

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 March 31, 2012, the Company had $99.5 million available under the Revolving Credit Facility. Availability under the Revolving Credit Facility as of March 31, 2012 was net of standby letters of credit of approximately $0.5 million. As of March 31, 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 Company’s subsidiaries’ shares, all of the Company’s assets, and all the assets of the Company’s subsidiaries.

 

Term Loan

 

The $300.0 million Term Loan Facility matures on December 1, 2016 and requires quarterly principal payments which commenced 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. There were no mandatory prepayments required during the first three months of 2012 or 2011. As of March 31, 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 Company’s subsidiaries’ shares, 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.

 

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NOTE G — LONG TERM DEBT (CONTINUED)

 

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 March 31, 2012, the Company was in compliance with all covenants under these debt agreements.

 

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.

 

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NOTE I — NET INCOME PER COMMON SHARE (CONTINUED)

 

Net income per share is computed as follows:

 

		Three Months Ended
		March 31,
(In thousands, except share and per share data)		2012			2011
		(Unaudited)			(Unaudited)
Net income		$	7,555		$	6,213
Shares of common stock outstanding used to compute basic per common share amounts		34,036,539			33,360,840
Effect of dilutive restricted stock and options (1)		603,121			773,227
Shares used to compute dilutive per common share amounts		34,639,660			34,134,067
Basic income per share		$	0.22		$	0.19
Diluted income per share		$	0.22		$	0.18

 

(1) There were no anti-dilutive options for the three months ended March 31, 2012 and 2011.

 

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 March 31, 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 three months ended March 31, 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

 

		(in thousands)
Net benefit cost accrued at December 31, 2010 (unaudited)		$	17,510
Service cost		247
Interest cost		202
Net benefit cost accrued at March 31, 2011 (unaudited)		$	17,959

 

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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 stockholders 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.

 

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 stockholders, 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 March 31, 2012, of the 2.5 million shares of common stock authorized for issuance under the Company’s 2010 Plan, approximately 1,061,000 shares have been issued. During the first three months of 2012, the Company issued approximately 448,000 shares of restricted stock under the 2010 Plan. The total fair value of these grants is $9.0 million. Total unrecognized share-based compensation cost related to unvested restricted stock awards was approximately $19.1 million as of March 31, 2012 and is expected to be expensed as compensation expense over approximately four years.

 

During the three months ended March 31, 2012 and 2011, no options were cancelled under either the 2002 Plan or the 2003 Plan.

 

For the three months ended March 31, 2012 and 2011, the Company has included approximately $2.0 million and $1.7 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. The Company calculates the fair value of stock options using the Black-Scholes model. The total value of the stock option awards is expensed ratably over the requisite service period of the employees receiving the awards. The Company had no unrecognized expense related to its stock option grants for the periods ended March 31, 2012 and 2011.

 

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

 

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NOTE L — SEGMENT AND RELATED INFORMATION (CONTINUED)

 

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;

 

·                  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 41.2% and 40.4%, of the Company’s net sales for the three months ended March 31, 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 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 March 31, 2012
Net sales
Customers		$	176,369		$	26,241		$	15,333		$	148		$	—		$	218,091
Intersegments		—			47,569			844			—			(48,413		)	—
Depreciation and amortization		3,417			324			2,673			1,871			—			8,285
Income (loss) from operations		24,870			8,542			268			(13,447		)	(277		)	19,956
Interest (income) expense		7,582			832			1,440			(2,077		)	—			7,777
Income (loss) before taxes		17,288			7,710			(1,172		)	(11,370		)	(277		)	12,179
Capital Expenditures		2,541			90			624			2,061			—			5,316
Three Months Ended March 31, 2011
Net sales
Customers		$	160,551		$	23,461		$	16,257		$	170		$	—		$	200,439
Intersegments		—			41,627			745			—			(42,372		)	—
Depreciation and amortization		2,961			284			2,474			1,573			—			7,292
Income (loss) from operations		22,373			6,887			751			(11,728		)	101			18,384
Interest (income) expense		7,116			849			1,440			(1,026		)	—			8,379
Income (loss) before taxes		15,257			6,038			(689		)	(10,702		)	101			10,005
Capital Expenditures		3,082			168			90			2,047			—			5,387
Total Assets
March 31, 2012		1,292,294			178,481			134,733			(479,061		)	—			1,126,447
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 1/1/2012 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:

 

(in thousands)		Employee Separation			Other Relocation			Lease Termination			Total
Balance as of December 31, 2011		$	226		$	—		$	3,085		$	3,311
Expenses incurred		—			—			—			—
Amounts paid		(35		)	—			(104		)	(139		)
Balance as of March 31, 2012		$	191		$	—		$	2,981		$	3,172

 

		Employee Separation			Other Relocation			Lease Termination			Total
Balance as of December 31, 2010		$	1,895		$	—		$	5,206		$	7,101
Expenses incurred		36			340			—			376
Amounts paid		(926		)	(340		)	(641		)	(1,907		)
Balance as of March 31, 2011		$	1,005		$	—		$	4,565		$	5,570

 

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Overview

 

The following is a discussion of our results of operations and financial condition for the periods described below. This discussion should be read in conjunction with the Consolidated Financial Statements included in this report. Our discussion of our results of operations and financial condition includes various forward-looking statements about our markets, the demand for our products and services and our future results. These statements are based on our current expectations, which are inherently subject to risks and uncertainties. Refer to risk factors disclosed in Part II, Item 1A of this filing as well as the risk factors disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 for further discussion of risks and uncertainties. Our actual results and the timing of certain events may differ materially from those indicated in the forward looking statements.

 

Business Overview

 

General

 

The goal of Hanger Orthopedic Group, Inc. (the “Company”) is to be the world’s premier provider of services and products that enhance human physical capabilities. We provide orthotic and prosthetic patient-care services, distribute O&P devices and components, manage O&P networks, and provide therapeutic solutions to the broader post acute market. We are the largest owner and operator of orthotic and prosthetic patient-care centers in the United States and, through our distribution subsidiary, Southern Prosthetic Supply, Inc. (“SPS”), the largest dedicated distributor of O&P products in the United States. We operate in excess of 700 O&P patient-care centers located in 45 states and the District of Columbia and six strategically located distribution facilities. In addition to providing O&P services and products we, through our subsidiary, Linkia LLC (“Linkia”), manage an O&P provider network and develop programs to manage all aspects of O&P patient care for insurance companies. We also provide therapeutic solutions through our subsidiaries Innovative Neurotronics (“IN, Inc.”) and Accelerated Care Plus Corp (“ACP”). IN, Inc. introduces emerging neuromuscular technologies developed through independent research in a collaborative effort with industry suppliers worldwide. ACP is a developer of specialized rehabilitation technologies and a leading provider of evidence-based clinical programs for post-acute rehabilitation serving more than 4,200 long-term care facilities and other sub-acute rehabilitation providers throughout the U.S.

 

For the three months ended March 31, 2012, our net sales were $218.1 million and we recorded net income of $7.6 million. For the three months ended March 31, 2011, our net sales were $200.4 million and we recorded net income of $6.2 million.

 

We have three segments—Patient-Care Services, Distribution and Therapeutic Solutions. For the three months ended March 31, 2012, net sales attributable to our Patient-Care Services, Distribution and Therapeutic Solutions segments were $176.5 million, $26.3 million and $15.3 million, respectively.  See Note L to our consolidated financial statements contained herein for further information related to our segments.

 

Industry Overview

 

We provide goods and services to the O&P, post-acute, and other rehabilitation markets. We estimate that the O&P patient-care market in the United States is approximately $2.6 billion, of which we account for approximately 29%, and the post-acute rehabilitation and other rehabilitation markets, combined, are approximately $1.3 billion, of which we account for 5%. We commissioned a study in the past which identified additional opportunities to leverage our expertise beyond the traditional O&P market, and we

 

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believe these additional opportunities could potentially expand our available O&P market by an additional $1.4 billion to $4.0 billion.

 

The O&P patient-care services market is highly fragmented and is characterized by local, independent O&P businesses, with the majority of these businesses generally having a single facility with annual revenues of less than $1.0 million. We do not believe that any single competitor accounts for more than 2% of the country’s total estimated O&P patient-care services revenue.

 

The O&P services industry is characterized by stable, recurring revenues, primarily resulting from new patients as well as the need for periodic replacement and modification of O&P devices. Based on our experience, the average replacement time for orthotic devices is one to three years, while the average replacement time for prosthetic devices is three to five years. There is also an attendant need for continuing O&P patient-care services. In addition to the inherent need for periodic replacement and modification of O&P devices and continuing care, we expect the demand for O&P services to continue to grow as a result of several key trends, including the aging of the U.S. population, resulting in an increase in incidence of disease, and the demands for new and advanced devices.

 

We estimate the post-acute rehabilitation market to include approximately 15,000 skilled nursing facilities (“SNFs”) and to have a market potential of approximately $200 million. We provide technologically advanced rehabilitation equipment and clinical programs to approximately 31% of the post-acute market. We estimate the broader rehabilitation markets, which include independent rehabilitation providers and providers in other post-acute settings, to be approximately $1.1 billion. We currently provide goods and services to very few customers in this portion of the market, however, we believe this market would benefit from our products and services.

 

Business Description

 

Patient-Care Services

 

As of March 31, 2012, we provided O&P patient-care services through over 700 patient-care centers and over 1,180 clinicians in 45 states and the District of Columbia. Substantially all of our clinicians are certified, or are candidates for formal certification, by the O&P industry certifying boards. A clinician manages each of our patient-care centers. Our patient-care centers also employ highly trained technical personnel who assist in the provision of services to patients and who fabricate various O&P devices, as well as office administrators who schedule patient visits, obtain approvals from payors and bill and collect for services rendered.

 

In our orthotics business, we design, fabricate, fit and maintain a wide range of custom-made braces and other devices (such as spinal, knee and sports-medicine braces) that provide external support to patients suffering from musculoskeletal disorders, such as ailments of the back, extremities or joints and injuries from sports or other activities. In our prosthetics business, we design, fabricate, fit and maintain custom-made artificial limbs for patients who are without limbs as a result of traumatic injuries, vascular diseases, diabetes, cancer or congenital disorders. O&P devices are increasingly technologically advanced and are custom-designed to add functionality and comfort to patients’ lives, shorten the rehabilitation process and lower the cost of rehabilitation. Patients are referred to Hanger by an attending physician who determines a patient’s treatment and writes a prescription. Our clinicians then consult with both the referring physician and the patient with a view toward assisting in the design of an orthotic or prosthetic device to meet the patient’s needs.

 

The fitting process often involves several stages in order to successfully achieve desired functional and cosmetic results. The clinician creates a cast and takes detailed measurements, frequently using our digital imaging system (Insignia), of the patient’s residual limb to ensure an anatomically correct fit. Prosthetic

 

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devices are custom fabricated and fit by skilled clinicians. The majority of the orthotic devices provided by us are custom designed, fabricated and fit; the remainder are prefabricated but custom fit.

 

Custom devices are fabricated by our skilled technicians using plaster castings, measurements and designs made by our clinicians and by utilization of our proprietary Insignia system. The Insignia system replaces plaster casting of a patient’s residual limb with a computer generated image. Insignia provides a very accurate image, faster turnaround for the patient, and a more professional overall experience. Technicians use advanced materials and technologies to fabricate a custom device under quality assurance guidelines. Custom designed devices that cannot be fabricated at the patient-care centers are fabricated at one of several central fabrication facilities.

 

To provide timely service to our patients, we employ technical personnel and maintain laboratories at many of our patient-care centers. We have earned a strong reputation within the O&P industry for the development and use of innovative technology in our products, which has increased patient comfort and capability, and can significantly enhance the rehabilitation process. The quality of our services and the success of our technological advances have generated broad media coverage, building our brand equity among payors, patients and referring physicians.

 

The principal reimbursement sources for our 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;

 

·                  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.

 

We estimate that government reimbursement, comprised of Medicare, Medicaid and the U.S. Department of Veterans Affairs, in the aggregate, accounted for approximately 41.2% and 40.4% of our net sales for the three months ended March 31, 2012 and 2011, respectively. These payors have set maximum reimbursement levels for O&P services and products. Medicare prices are adjusted each year based on the Consumer Price Index-Urban (“CPIU”) unless congress acts to change or eliminate the adjustment. The Medicare price (decreases)/increases for 2012, 2011, 2010, 2009, and 2008 were 2.4%, (0.1%), 0.0%, 5.0%, and 2.7%, respectively. There can be no assurance that future changes will not reduce reimbursements for O&P services and products from these sources.

 

We enter into contracts with third-party payors that allow us to perform O&P services for a referred patient and be paid under the contract with the third- party payor. These contracts typically have a stated term of one to three years. These contracts generally may be terminated without cause by either party on 60 to 90 days’ notice or on 30 days’ notice if we have not complied with certain licensing, certification, program standards, Medicare or Medicaid requirements or other regulatory requirements. Reimbursement for services is typically based on a fee schedule negotiated with the third-party payor that reflects various factors, including geographic area and number of persons covered.

 

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