Hanger Inc (HNGR) 2005 Q4 法說會逐字稿

At this time I'd like to welcome everyone to the Hanger Orthopedic Group fourth quarter year end results conference call. [OPERATOR INSTRUCTIONS]

Mr. Sabel, you may begin your conference.

Thank you, Melanie. And good morning to everyone. Today's call contains forward looking statements relating to the Company's results of operations. The United States Private Securities Litigation Reform Act of 1995 provides a Safe Harbor for certain forward looking statements. Statements relating to future results of operations in this call reflect the current views of Management.

However, various risks, uncertainties and contingencies could cause actual results or performance to differ materially from those expressed in or implied by these statements, including the Company's ability to enter into and derive benefit from managed care contracts, the demand for the Company's orthotic and prosthetic services and products, and the other factors identified in the Company's periodic reports on form 10K, and form 10Q filed with the Securities and Exchange Commission under the Securities Exchange act of 1934. The Company disclaims any intent or obligation to update publicly these forward looking statements whether as a result of new information, future events, or otherwise.

Again, good morning, and welcome to our fourth quarter year end results conference call. As you know, we reported $.30 for the quarter and $0.53 for the year, ended December 31st, 2005. Those results were favorably impacted by a tax benefit that George will go into detail with in his presentation. However, on a normalized basis, without this benefit, we still reported $0.14 for the quarter, which has met analyst consensus, and is in fact a 17% improvement over fourth quarter last year, and EPS was $0.37 for the year.

2005 was a pivotal year for our Company. We were able to stabilize what had been a negative sales trend, caused primarily by the continued pressure on the overall reimbursement environment. We were able to continue to show growth at our SPS Distribution Division and at our Patient Care Division, we turned a 1.7% same-store sales decline in 2004, to a .2% gain in comparable store sales in 2005. That resulted in almost a 2% turn in our results. During 2005, we have started to see the benefits of many of the initiatives that we started in 2004, specifically, we were able to sign a major Linkia contract with [Cigna] that we are currently in the process of executing.

Our business development manager program continues to have a positive impact on our the sales growth. The information that we are sourcing from our OPS system continues to help us manage our business operations more effectively. And the roll-out of our Insignia, proprietary laser imaging system, continues to provide efficiencies and most importantly, a superior clinical outcome.

And finally, we are launching the WalkAide product from our Innovative Neurotronics Division at the end of March. Tom Kirk will fill you in on the specifics of all of these initiatives during his presentation.

In summary, we are quite pleased with the results that we have just--that we have achieved, despite a difficult operating environment. We were able to increase our sales, EBITDA, collections, and we saw improvements in all, in the overall management of our expenses. We also managed to reduce our debt by $15 million. I would now like to turn the call over to George McHenry who will give you the specifics as to the financial results for the quarter and the year. George?

Thank you, Ivan. Good morning, everyone. First I will talk about the quarter's results and the year and then I will turn my comments to the balance sheet and the cash flow. For the quarter, sales increased by $3.3 million, or 2.3%, comp sales in our Patient Care Centers increased by .6% or $900,000 for the quarter and then the balance of the increase was realized at SPS where they had a $2.2 million increase or 22.3% of sales. Cost of sales as a percentage of sales was essentially flat. Labor costs decreased by 1.2 million, and decreased as a percentage of sales from 21.1% in '04 to 19.8 in the current quarter. The decrease was attributable to a reduction in labor and our practices as well as a leveling off of our health care costs.

Material costs increased by $2.6 million, to 40.2 million, or 27% of sales, compared to 23.8% in 2004. $1.6 million of that change was the result of the fourth quarter of '04 benefiting by a $1.6 million income item related to our book-to-physical adjustment in that--in 2004. The other remaining $1million increase was a result of an inflationary cost increases, a slight mix change and the impact of a small decline in reimbursement. In the current year, I would like to report that we had no book-to-physical adjustment. The inventory came in exactly where we had pegged it in the books.

SG&A increased by only $200,000 compared to 2004. Our normal annual salary increases, scheduled rent changes, effective energy cost on our travel costs, and increased professional fees caused our expenses to increase by 6.4 million. Those increases were offset by a $6.2 million reduction in bonus. We improved our bad debt, and other expenses were also lower than the prior year. As a result of all these changes, our EBITDA increased by $1.7 million, to $21 million, versus 19.3 million in the prior year.

Our interest was $600,000 higher despite an overall reduction in borrowings due to increased variable interest rates. Our depreciation was only $19,000 higher than the prior year, because of the low level of additions during the year, we ended up the year at $8.8 million, in terms of CapEx. As Ivan mentioned, the--our income tax provision benefited by $3.7 million in the quarter due-- principally to the realization of $4.6 million in state NOL carry-forwards that previously were fully reserved. We'll be able to realize these NOL's through more effective tax planning that was developed in the fourth quarter. And in fact, we will realize $1.3 million of this benefit in the -- when we file our 2005 tax returns. The benefit was somewhat offset by other items including an increase in our tax reserves and true-up of the state tax rate used to calculate the deferred taxes.

For the year, our sales increased by $9.5 million, SPS reported a $5.5 million increase, or a 13.7% improvement. Comp sales in our Patient Care Centers as Ivan mentioned were $1.2 million or .2%. Cost of sales year-over-year increased by 0.5% from 48.5 in 2004 to 49% in 2005. This increase was due to the same factors I had mentioned in the quarter. It was material costs, and it was basically the effect of the reduced reimbursement, a slight change in mix, and some inflationary impact on our material costs.

SG&A increased by 800,000 compared to 2004. The principal reason for that change was $5.1 million in higher labor costs, including health care cost increases. $1.7 million associated with our growth initiatives at Linkia and Innovative Neurotronics. And $1.9 million related to inflationary pressure on fixed operating costs such as rent, travel, and other operating expense, all of which were offset by a $7.9 million decrease in our bonus expense. As a result, we will--we reported $75.2 million in EBITDA, which is a $1.1 million increase over the 74.1that we reported in 2004. Depreciation again was relatively flat, up $400,000, due to the low level of additions. And our interest for the year increased by 26 million--$2.6 million again because of the increase in variable interest rates.

On the balance sheet, our AR decreased by $6 million despite the [inaudible] the $9.5 million sales increase. Our DSOs improved to 64 days, that's a five day improvement over the end of '04, when we reported 69 days. I'd like to highlight that $5.6 million of that $6 million reduction in AR was in our receivable category of 120 days and older, which was reduced to $22.6 million, or 20.4% of sales compared to $28.2 million, or 23.8% of sales in 2004. So we're pretty proud of that improvement as we continue to work on our systems and our work flow and our practices.

Inventory increased by $9 million, to 76.7 million, compared to 67.7 in the prior year. The support-to-sales increase both in our practices and our distribution segment, to support our new in-house shoe line and to meet a purchase requirements that SPS has that is now fully satisfied. CapEx for the quarter was 2.3 million and 8.8 million for the year. Which is significantly below our budget of 17.5 as we concentrated on [equiting] cash flow that we could use to pay down debt.

Cash flow from operations for the quarter was 12.2 million compared to 16.5 in the prior year. The -- that's a $4.3 million decrease. The decrease was principally due to the increase in deferred taxes related to the NOL--NOL's that were recognized that I mentioned previously. For the year, we were $25.7 million compared to 49.1 in the prior year. That is a $23.4 million decrease. The decrease was principally due to a $12.7 million build in working capital, due principally to the reduced bonus expense which also reduced the liability by $8.8 million in the $8 million inventory build that I just discussed.

Most of the remaining difference was due to the fact that working capital in '04 was benefited by the collection of an $8 million tax refund. Keep in mind that last year, our working capital decreased by $17 million to 126.2 million, which was an historic low point, so we feel we're continuing to manage our working capital well.

My last comment, we just want to reaffirm the guidance we gave at the end of Q3, relative to 2006. We expect sales in the range of 600 to 605 million, and EBITDA of between 78 and 79 million. That's all I have on the financials. I am going to turn the call over to Tom Kirk then.

Thank you, George. I will take a few moments to review the events impacting our operations for this past quarter and then I will update you on some of our growth initiatives. First let's take a look at the SPS and the HPO story in more detail. SPS's growth rate of 22.3% for the fourth quarter compared to the comparable quarter last year, continues to be above the level we forecast and we discussed with you during our last call. Much of their growth came from increasing sales and market share with existing customers. In addition, throughout the year, they added 172 new accounts, which resulted in an extra $1 million of sales. They've also continued their sales strategy of creating regional buying groups and working with these groups, give them most favored nations clauses for a substantial portion of their volume.

SPS continues to be very successful in differentiating themselves from the other distributors in the market, by expanding the number of manufacturers and products as well as the amount of inventory that they have. They've added many smaller new manufacturers to their portfolio, which is a distinct selling advantage because our customers can purchase many more products from SPS compared to anybody else. Finally, SPS derives sales from their new catalog which they put out in mid-year, had a continuing impact through the end of the year, and they continued to make progress on their e-commerce.

Let's turn our attention now to HPO, our Patient Care Division. We achieved same-store sales growth of .6% for the quarter, and .2% for the year. And this was in the face of continuing difficult reimbursement challenges from the government and the private pay sectors. In the past, we've discussed these, and I'm not going to review all of these items with you again. However, I would like to comment on one of these areas where we're working with some other associations, specifically the Amputee Coalition of America, to try and educate state legislators on the issues involved in reimbursement caps, and how these caps deprive our patients of quality care. The good news is they are listening and we're beginning to have a positive impact in seeing some of these efforts overturned at the state level.

You also remember last quarter, we discussed the market's performance based upon various regions. We told you that we had 14 markets throughout the United States and that one of the reasons for our quarterly improvement was the ebb and flow within these regions. Well, one of the reasons that we've had improved performance during this quarter is that we made significant progress in improving the performance in two of these regions of the four that were underperforming last time, and we've made some modest improvements in the other two. We still have more work to do, but it is a priority with us, and we are tackling these issues through a combination of management changes which we've already made, and sales and profit improvement projects.

Also, during the fourth quarter, we made a concentrated effort to drive the sales of our microprocessor needs so that we could push up our prosthetic product mix. During the fourth quarter, we grew our sales by over 50% compared to the level we achieved in the third quarter, which brought us close to the performance that we saw in the fourth quarter of last year. This is an accomplishment when you consider that our unit reimbursement for these products have actually decreased on a year-over-year basis.

Let's talk about some of the other operating activities that we had under way during the quarter. The sales of our upper extremity products and services increased substantially over the sales in the fourth quarter of last year. We believe Hanger is the largest single provider of these service--these services, and this puts us in a position to really utilize our market scope to work with case managers and other referral sources to be the provider of choice and to bring new advanced products to the segment, and that's the strategy that we've been employing.

Also, we have increased the number of our lower extremity patient evaluation clinics from 168 in 2004 to 261 in 2005. We've mentioned these in the past, and they are very effective methods to bring patients back into our Patient Care Centers for a checkup, and it usually results in our identifying some services or maintenance that they require. Primarily, this is good patient care. It keeps them healthy. At the same time, it's a good source of revenue. This year, 2006, we intend to increase this even further to over 400.

Next point. Our sales organization which we've talked to you about in the past is gaining traction in the promotion of our services. We've been studying this issue, and we've determined that those territories that were covered by a business development manager, actually achieved higher same-store sales growth by several percentage points compared to those that did not have a business development manager. This is a work in progress and we'll continue to evaluate this program, but we're pleased with the results that we achieved in '05.

Also, we brought to market a new line of high quality shoes branded as answer two. These shoes have product features that bring benefits to our patients and we promote them through multiple channels, primarily through our own practitioners but SPS sell them through independent orthotists and physical therapists and now we're taking the shoes out to the podiatry market as well.

Next point, through the enhanced capabilities that we now have with OPS, which is our common billing platform, we have improved visibility into our business. We're using this visibility to understand how our practitioners bill for specific procedures. What we're doing is developing clinical pathways which relate one type of procedure to another. Let me give you an example of that. When we provide an ankle foot orthosis, we also can offer the patient a high quality shoe that will accommodate that device so he doesn't have to go outside and buy an ordinary shoe from a retail outlet. We helped the patient with this one-stop shopping, while ensuring good patient care. We are going to extend this concept to several other related pathways and substitute products, and monitor this performance through OPS. This has the added benefit of producing additional revenue.

We've also seen increased sales from the new applications for Insignia. We've mentioned these in the past and this past year we brought to market the areas of sports and burn mass, as well as an increased number of cranial helmets, all driven by the new technology Insignia.

Finally, we've experienced increased volume from the existing health care client service by our Linkia subsidiary. For example one of the major clients in the Linkia system increased their volume by 50% over the year on a beginning versus a year-end run-rate basis. And I'll say a few more words about Linkia in just a minute. But that's sort of the capsule -- encapsulated version of what we have done during the fourth quarter and the latter half of 2005.

Now let me give you a brief update of some of the other projects that we have underway. Primarily to leverage our fixed cost model in patient care in building sales in addition to continue the activities that I just reviewed. Also I would like to add a little color on some of our new business development activities that that we are driving to add new sources of revenue and diversification of cash flow to our core business. Some of these are, first, within Linkia. We are continuing our discussions and negotiations with the key National Healthcare Management companies. We've expanded the field of potential clients to include the large regionals as well as the nationals. There continues to be interest in the concept by all that we meet, and we're in various stages of working with these entities to show them the value that a Linkia contract can bring.

Also during the fourth quarter, we made substantial progress on building Linkia's infrastructure to accommodate the business that will be coming from the Cigna contract that we announced in '05. Specifically, we developed and Cigna has approved the network of providers. Shortly, the existing provider network will be dismantled and it will be replaced with the new contracts. At the same time, our EDI file management tool for electronic interface management and the auto reconciliation functionality has been installed and it's ready on both sides. These capabilities are scalable, and they have the capability of handling Linkia's longer term needs. And finally, the Linkia network credentialing process for all of the providers within the network was completed in December.

Another area, one that we've talked about in the past, Insignia. A major portion of the Insignia laser scanning system has been completed. We now have almost 675 trained users and almost 400 scanning systems in place. The regional carvers now stand at 30 and we're seeing a significant ramp-up on the number of scans coming in from our practitioners. To accommodate the inflow of scans, we have implemented a lean manufacturing process within our national Fabs. As a matter of fact, the Fab in Orlando won an award for manufacturing excellence based upon their improvement in certain metrics. In 2006, we will optimize that footprint of what we have in place setting the stage for further productivity improvements. And at the same time, we're continuing the development of other applications for Insignia because they represent new sources of revenue and cash flow diversification.

In 2006, we are going to focus on burn garments, and custom and diabetic footwear product. We've completed the software for both of these and are evaluating other pieces of technology to complete that package. Business plans have been drafted, and field testing is going to be undertaken this year.

Let's switch to another side of our business, the product side, we're making a conscious effort to supplement our service capability with a line of devices that can satisfy our existing and potential patient needs. For example, we signed a nonexclusive agreement with a major supplier to market their line of bone stimulation products. Another exciting opportunity on the product side is the WalkAide which is being brought to market by Innovative Neurotronics our subsidiary. We signed an exclusive license from the scientists at the university of Alberta and over the last two years, we've modified their product in terms of design and functionality to yield the finished product unlike anything that's on the market for the treatment of drop foot.

Recently, we've added world class clinicians, marketing and sales, information technology, and medical personnel to the team of the existing manufacturing and design engineering in order to launch this product. Last year, we received approvals from the FDA and the FCC. Our early clinical trials have shown remarkable improvement in patient conditions. We introduced this product during our Ed Fair which was held in early February and now we've scheduled 21 training seminars throughout the country between now and the end of July, focused primarily on our practitioners, but we will be evaluating other distribution channels as well. Both of these products, the bone stimulation products and the WalkAide serve as potential patient populations that number in the hundreds of thousands. We are very optimistic about their commercial potential and the associated revenue for our Company.

And finally, we're progressing on the new delivery models that we've talked to you about in the past, which provide a bundled orthopedic rehab solution package to our patients. Our pilot operations performed very well in 2005, demonstrating substantial sales increases. In 2006, we will roll out the concept of this alternative delivery model. An added benefit to this entire area and this concept, is the natural capability of cross-selling between the new delivery model and our custom core business.

This enables us to provide a comprehensive total care package to our patients while giving assurance to their doctors that they're in good hands with the single source responsibility in a continuum of high quality care. In closing, 2005 was difficult and we continue to see challenges ahead. Feel good about reversing the negative trends, and we belive that we've got a portfolio of projects to continue revenue, and cost control improvements in our patient care business, as well as to open new opportunities for additional revenue growth and diversification. Thank you, and with this I'll turn it back over to Ivan.

Thank you Tom. Melanie, we can now open it up for questions and answers.

[OPERATOR INSTRUCTIONS] Your first question comes from Arnie Ursaner with CJS Securities.

Good morning, gentlemen. This is actually [Joe Geomichael] standing in for Arnie.

Hi, Joe.

Quick-- couple of quick questions for you. You mentioned that the microprocessor need demand was up 50%. I know that the Neurotronics products was something you were very positive about. Can you give us some more color on the balance of those products lines and the demand you're seeing there?

Tom do you want to take that question?

Sure, good morning, Joe. Our demand for the microprocessor knees was relative to the third quarter so I wanted to give you a little time series visibility into that. We see strong demand for that product as a product category. Because we have supplemented the original microprocessor knee with several others. So that gives us the capability to expand the range of patients from high level functionality down to a little lower level functionality. So it gives us a product so that we can more closely match the needs of the patient and that's one of the reasons that we feel that we can continue to drive these,at approximately the same or maybe slightly increasing levels as we go into the future.

And so we think that the kind of performance that we experienced in 2005 will be comparable to what we'll see in 2006. Ther're some very interesting new products coming on the market that you'll be hearing about, and we're preparing even a higher-end device right now by working with one of the manufacturers. So we think the success to this product is to have a full product line that can range from low-end functionality patients all the way up to the very, very high-end functional patients. Obviously some price elasticity with the kind of product that we see. The comparable overall levels to this year, and if you keep in mind, we're really out into our fifth or sixth year which means that some of the patients that we serviced in the early years, Joe, will be coming back to probably get -- we refurbished them once a year by bringing them back but after a period of about five or so years we're going to start to see some product turnover there.

In case of the WalkAide, brand new product. A lot of excitement around it from our practitioners, we've had some patients wearing it as during--we trained 80 people during our Education Fair. Remarkable accomplishments relative to the patient's functionality improvement. As it is a new product, we can look at the market segment size. We don't have any specifics on how it's yet being received into the market, 'cause all of this just is really kicking off as we speak. However, it's a big market.

For example, we know that there is 500,000 stroke patients a year. This has been going on for a number of years. So there is a very large legacy pool. Not all of the 500,000 will qualify, but a significant percentage will. Also, just to give you some flavor of how that translates down to the Hanger level. Last year, we fit about 120,000 AFO's, Ankle Foot Othosis, for the drop foot condition. Not all of those were the direct result of stroke but a significant number were. We look at that as really a potential patient flow, many of these people could qualify for this device. So the numbers just in the segment make us feel very optimistic and then when we look at the performance of the device on our tests and on some of our patient advocates, we're quite optimistic about this.

Got it. And you mentioned some of the price elasticity there, can-- I'm not as familiar as I probably should be, but can you talk about the magnitude of the decrease you've seen in reimbursement?

Typically 5% maybe. Something like that. The range of these product prices can range from the mid teens, perhaps, all the way up to the real high functionality, could go as high as 60 or $70,000. With the middle ground in the mid-30s. And so as they come out and obviously, we're getting a little more experience, manufacturers are getting more experience, and those that are writing the checks are looking for a little bit of that flow back in terms of experience based pricing back to them.

Got it. I know the prior quarter had some impacts on the hurricanes, is there anything in this quarter?

George?

No, the fourth quarter was largely unaffected by any weather concerns.

The hurricane that hit in the fourth quarter swept across lower Florida, and we had some temporary outages, but nothing long-term.

Got it. And I know you reiterated guidance. When the guidance had been initially given, it was basically communicated that this was sort of in hand, yet high visibility on this. You talk about a number of new business activities. Are we to assume that these are sort of longer term, and we're not going to see any benefit in '06 from these?

Yes, I think that's a fair assumption. The guidance we gave in the third quarter and reiterated today is based off of what we know we have in hand, in terms of contracts, and product rollout.

Got it. Thank you very much. I will jump back in the queue.

Your next question comes from Kevin Fischbeck with Lehman Brothers.

Thanks. Good morning, guys.

Good morning, Kevin.

I was wondering if you could provide I guess a little bit more color on Linkia in the quarter. It sounds like you're pretty far rolling out the Cigna contract but we probably didn't see any real benefit in revenue here in the quarter. We're probably not going to really see it until Q2, I guess I just want to make sure I have that right. And then I know you sent a lot of money in G&A kind of preparing for. Are we at a point where we're, making money on this business yet? Or is that something that happens in 2006?

Tom?

Well, keep in mind, Kevin, that Linkia really is a Network Management Company. It derives some benefit by operating the network and collecting a small fee for processing all of the electronic processing and then the remittance back to the providers, so we don't look at Linkia persae as a big profit center. Having said that, what we have seen and what we think is essential is really the flow of dollars through Linkia. And the 50% that I mentioned in the case of one large healthcare company was a substantial increase in the volume of business, and if we keep in mind that that particular provider does not have the full Linkia contracts so is not obligated to give us volume, they're giving us that volume because of the service that they're getting and their satisfaction with the Linkia model. So we view that as a very positive trend and it's really a proof of concept here that's working out.

So we have seen a substantial increase in the volume. Of course, that volume is primarily being handled by the Hanger Patient Care Division. And where we do not have coverage then, some of it goes to the outside, and of course then Linkia collects a fee to offset their expenditures but you're exactly right we spent a little G&A to put this enhanced electronic capability in place. The network for the Cigna contract which is a full Linkia play has been approved. And they will shortly begin, as we have said, dismantling their network, and going with the new provider network, which will probably shrink the range of providers by about 50%.

Okay. And what's the timing on that? Is that kind of a Q2 and a Q3 type --

We'll begin to see some of that revenue report in, perhaps at the tail end of Q2. But then it's really going to be a Q3 and Q4 ramp-up.

And then I guess just to clarify something that you had said earlier, Tom, the 172 clients on the distribution business, adding about a $1 million, is that in revenue in the quarter or is that for the year?

That was for the year.

That was for the year. Okay. And then you know, I guess the revenue guidance that you outlined, what kind of same-store growth does that imply on that O&P business, on the HPO business?

George?

Well, the growth that's coming from Cigna contract, that's coming from the sale of the WalkAide, it's all going to be coming through our practices. It's going to be reported as comp sales growth and we should end up the year somewhere in the 4% range, albeit we're heavily weighted towards the second half of the year.

Okay. And then I guess you had outlined a number of cost-cutting initiatives last year. I wonder if you can just kind of provide an update on the status of all of that. And that's--that's my last question.

Sure. If you recall, we had talked about four major initiatives. The first one was review all the staff, and make appropriate changes. That was completed, and we logged in the full benefit that we had planned which was about 2.5 million. Our G&A exercise was designed to reduce another 2.5. Some of the cost escalating factors in that area, primarily associated with utilities and rent directly related to energy prevented us from achieving the full 2.5, but we did get about 80, 75% of that, or so.

Materials, we had budgeted roughly $4 million in material savings. This is one that really turned upside down on us. We think that we were successful in stemming some of the major increases that we would have seen, but we didn't book the reductions that we had hoped to. We had budgeted about four. We were able to directly draw hard lines to about a 1.6 million in terms of overall savings. But at the same time, got to be perfectly candid and say anything having to do with metals or polymers, went up substantially, in some cases, some of the titanium prices went up over 50%. So we actually felt pretty good about our ability to try and hold that where we finally came in, but we didn't get the full benefit of that.

Last but not least was we had budgeted roughly $4 million for a reduction in bad debt. We think that some of the statistics, as we've reported them, in terms of reduction of AR, and the aging of debt, that AR, was what enabled George and Tom to go back to PWC and make the statistical arguments so that as we go forward, on a going forward basis, our percentage of bad debt will be slightly lower. So we didn't see an immediate impact on our P&L this year, from that, but it did set us up for strengthening our position on a go forward basis.

And then Kevin, I'd also like to reiterate that although you didn't see the cumulative effect, within the EBITDA benefit, every year, when we march into a new year, we face an inflation number that's in the neighborhood of 7 to $9 million, and we were able to achieve modest improvement in our EBITDA, on very little sales increase. And we did that through cost containment.

Okay. Great. Thanks.

Our next question comes from [Casey Playgar] with [Loackia Swan].

Good morning. I may have missed this on the call so I apologize. But can you give us a little bit more color on-- I think you -- in answer to one of the questions said that Medicare reimbursement may be down 5%. I don't want to misquote that. Does private payer also follow that trend? And if so, how do you offset that potential revenue decrease? I can maybe expect the other initiatives but I know there are costs associated with that so I'm just trying to flush out sort of the trend in reimbursement, versus potential growth in EBITDA.

[Casey], let me just clarify for you. There was no reduction in the Medicare reimbursements. Medicare starting in '04 froze all of the O&P reimbursements for a three-year period. We are in the third year and entering in obviously to the latter half of the third year freeze. And there's been no other additional reductions in Medicare.

What Tom was referring to, and he can comment on this, after I comment on it, was the reduction in the reimbursement for microprocessor needs. Those started out five years ago, as a very high reimbursed item, and that now that they've become more universally accepted, the pricing of that has become somewhat lower, and that's what I believe Tom is referring to. Tom?

That--that's exactly right, Ivan. Specifically, with some of the private payers, what we've seen is they're buying more of them, so they're looking for a bit of a volume discount and we also know that those private payers are consolidating so they're bringing more volume to the table, and negotiating in aggressive fashion on trying to get some of those reductions for the obvious reasons, their attempts to make sure that they can go to the employers that they sell their programs to with an attractive package. But you have summarized there, [Casey], the essence of the issues that in the face of some of these declining reimbursements that are going across the whole medical field, not just O&P, how do we survive, and how do we grow our sales and our EBITDA.

And that's why we put so much emphasis on trying to take care of the patients we have as best as possible, making sure that while they are in our patient care centers, that we don't overlook an opportunity to not only provide good patient care, but to give them the complete array of services and products. And at the same time, we want to make sure we get them back in on a routine basis. That's why the emphasis on our patient evaluation clinics.

But we know that as we go forward in the future, we're going to see continuing pressures in the healthcare field, and that's why we've got such a strong emphasis on trying to bring out some of these new products and new services, so that we continuously augment, and as we look at the patients, we know that we're the world's premiere company in orthotics and prosthetics, so we challenge ourselves each day to say what else can we bring to this whole continuum of care, this whole sort of rehabilitation. So we're looking at alternative delivery items, we're looking at alternative products, so we're really trying to think creatively to get around that beast of the continual pressure on the reimbursement of the standardized fee schedules.

Right. That helps clarify it a lot. One follow-up question from that, when does the freeze end? And what do you guys think the trend is thereafter, I guess, what happens?

Well, we know the freeze expires at the end of '06. In terms of what the future is, it could be anything from obviously some sort of an increase which if history is any harbinger of the future, that's what's happened when we've been frozen for periods of time in the past, we have received increases. Whether that will happen or not obviously I cannot predict. We could go into a competitive bidding situation. Although that seems to have lost some of its momentum of what it had a couple of years ago, and if in fact we do go into competitive bidding, it is for a rather narrow corridor of products in the over-the-counter orthotic area.

Or there could be an extension of the freeze. And at this point there's really not been any kind of substantive forecasting on anyone's part as to what that may be. I can tell that you -- not that this means a whole lot, but in the President's Medicare reform proposals, in the-- that he proposed a couple of weeks ago, there was no mention of orthotics or prosthetic, obviously.

Okay, thank you.

Your next question comes from [Henry Rakes] with Deutsche Bank.

Good morning, guys.

Good morning, Henry.

Just a couple of questions on maybe the -- broadly the industry and then also your practitioners. It's tough all over. I think is a good way to explain it. You guys are doing a pretty good job of controlling things. How does it look outside your business for the other practitioner, independent guys? Or are some of them falling out of the market. Or are they continuing to accept below, below profit level pricing? Or are they -- how are they doing?

Well, it's hard to tell, because they're all private small operations. Mom and Pop operations.

But anecdotally, from what --

Anecdotally, this year we had about a half dozen small practitioners literally close their doors and walk their businesses over to Hanger and come to work for us. You know, there's a half a dozen--portend a trend? I'm not sure. I can tell that you we continue to hear -- they're facing the same, the same reimbursement pressures that we are. We're just a reflection of the entire industry. And I suspect that depending upon where the reimbursements ultimately go, you'll see probably more difficulty on the side of the smaller player, because they don't have the same leveraging capability that we have in terms of purchasing, in terms of systems, et cetera.

Okay. And then I was -- jumped on a little late, but the bonus payments to the practitioners I think were down year-over-year, and --

That's correct.

And one, I think that is is a function of the fact that, the bonus payments are based on cash collections, and inventory control and that sort of thing, but down just because the business is tougher. And what's the, what's the tone from the practitioners about that, are they under -- do they understand the condition, or are they up in arms, are they, what's their feeling?

I think we just came off of our annual Education Fair in Reno, we had close to 1,000 people out there, and I can tell that you the spirit and the tone in my mind was probably at its high point. I think everybody understands, and that's not to say that there aren't some people that may leave or be unhappy over the bonus pay-outs. But generally speaking, everyone understands what the current environment is, and let's just -- to keep it in perspective, there are still very, very healthy bonus payouts in the variable compensation program. Much more so than they can find out in the independent world.

Did the six guys who closed their doors come back and at the conference say "boy, I'm glad I'm part of Hanger, I'm tired of that stuff out there on my own"?

Well I didn't speak, I didn't speak to each one of them personally but the fact that they moved their businesses over us to and came to work for us I think speaks volumes.

Okay. Thanks a lot.

Thanks, Henry.

Your next question comes from Mike Petusky with Thompson, Davis, Company.

Good morning, fellas.

Good morning, Mike.

A couple things. Can you guys put some -- give me some clarity on the sales organization efforts as far as the territories with business managers? I mean can you kind of put some hard numbers to that and talk about how many territories are actually covered with the business manager, how many facilities a business manager covers, and, what part of your network is not really covered by business manager?

Sure, Tom?

Sure, Mike. How are you this morning?

Doing great.

What we have is 23 business development managers out there organized and under three regional VP's that then report in to a Vice President of Overall Sales and Marketing. Those 23 people encompass on doing it on a revenue basis, encompass roughly about $150 million of sales. The concept here is to not make them so small that they don't matter, but to give them a territory where they can make frequent calls and we can really test the concept of repeat visits of going back into the face of new people, of analyzing the territory in sufficient detail, that they know where we're getting the work they can break our referrals into A, which are great referrals, all the way down to C, which is don't even see them or hardly refer at all.

What we have seen is that they were able to add roughly 3.7% within those territories of additional volume, compared to the territories that don't. They are not necessarily in the big major urban areas, but they're from middle-sized to large-sized metropolitan areas. The play that they run is to go out, introduce technology. We're changing it a little bit in that we're taking time to educate the BDM's. We did this over the last year. On some of the technology itself. So we're showing them, and teaching them how to use Insignia, not that we expect them to go make a leg, but when we're out there, we want them to be knowledgeable enough that they can demo this stuff. It seems to be working. It seems to be creating some interest.

Having said all of that and why I said we are still evaluating with the state of our new IT Systems, we can get good visibility into these things but we need to be able to get down to the sort of the root cause of what's the performance. Is the guy walking in the door a result of the BDM, or would we have had him anyway? Is he the -- is sales growth the result of a new practitioner that we hired? Or is it a result of the BDM effort?

So we're looking at the gross [emotto] numbers but we're quite pleased when we go across 23 different areas we think it's a lot more than coincidence, but we want to refine down the statistical side of this. But in general, 3.7% increase, new way of using these folks of making sure that they're conversant with the technology and products. And it seems to be working and they're getting out in front of key referral sources, particularly the ones where we're in the getting a lot of business today.

Have you put any of these guys in some of the tougher areas for you, kind of the Ohio, Illinois, that -- Michigan, those places, where you were really struggling as far as same-store growth?

We have one in Ohio and I'm happy to report that we've reversed the situation in Ohio that was a bit troublesome to us in the Columbus area. And he's one--he has been performing very well, and he certainly is in the top quartile, So it's--we think that that's another good sign where we have some tough areas we've been able to convert some of it over. Yes, the answer is yes.

Okay, great. And just one other thing. Earlier, and I actually took down exactly what you said, you referred to WalkAide and you said unlike anything that's on the market and I have been reading things that it--admittedly I've been reading a lot of this on the chat boards and from folks that at least represent themselves as practitioners, and they say that functional electrical stimulation has been out there. And could you just comment on how WalkAide is different and it advanced over what's out there already?

Yes. It's in the technology of the device. Certain -- the concept of functional electrical stimulations been around for a long while, with ear implants, if we look at pacemakers, that is a functional electrical stimulator. The one that we have mounts on the calf and as you walk it automatically knows where you are in the swing phase of your leg, so the timing is precisely set to the patient's gait. Now traditionally, one of the ways that this was always accomplished, was to put a device down in your shoe and run a wire up to the box so that every time your foot struck the ground it'd compress in a mechanical fashion a device that was in your shoe, send a signal up the wire and then the device would fire. Ours doesn't--you don't need any of that.

Ours has an accelerometer built right in so it has advanced technology. The other interesting thing about ours is, it is blue toothed back to a computer. We have a microprocessor in the device so it's recording all the steps that you're making. When you go back to see your practitioner, he gets a complete profile of what you've been doing since the last time you were there. He then adjusts the device in terms of the power, of the stem, where it fires, where it doesn't, because over time, and depending on the patient, if he's a new stroke patient or a stroke patient over six, or a year, all these elements are different, that's part of the unique service that we give. So that device is fine tuned over time to the progress that the patients making.

In addition, our device has a switch on it so you can flip it into an exercise mode. So the patient can be watching football on a Sunday afternoon, and this thing can fire, so it is constantly exercising the muscle. And what we've seen is not only does it keep the muscle from atrophying on you, where suddenly now you've got a whole other situation of pain pills and a bunch of other conditions, we prevent all that. We've also noted that in doing brain scans, that part of an element which is called neuroplasticity, that the brain begins to relearn some of the functionality that was lost by the frequency of use. So part of what the exercise mode, as well as using it in your daily life does is, it begins to try to restore. Now, obviously, we're going to have to chart that over a much longer term. But we think the uniqueness of the device, the way that it fires and works on the patient, the exercise mode, the link back by blue tooth into a computer, all differentiate the product.

And Tom, I would just follow up by saying that since this product is not technically going to be in the market, until the end of March, any speculation about that this is not new technology, is pure speculation on the part of anyone. Because no one's seen the product. It hasn't even hit the market yet. And I would also further note that if you look back a couple of weeks ago, at the press release that we put out about the team, that has been put together to introduce the WalkAide, their resumes I think speak for themselves. And certainly no one of the caliber of those gentlemen that have joined this effort, if they didn't believe that this was in fact a unique product.

Okay. Terrific. One last thing. On the branded shoes that you guys are doing. I just thought maybe a year or two ago that you guys had expressed maybe a lack of enthusiasm for the potential in shoes and now it sounds like you guys are putting that more front and center. Can you just talk about that? Is there anything that's changed there either on reimbursement or just the opportunity you see there?

Tom?

From two perspectives primarily. One is it just makes good business sense that we're doing 120,000 AFO's a year, why should that patient have to go down to the local retail store to buy a shoe that won't fit, that the AFO really won't fit in. The shoe won't accommodate the AFO. So why the enthusiasm is a couple of our fellas, and in particular, one of our key regional VP's spent a lot of type and effort custom designing this shoe. Not only from its ability to stabilize, but sort of the physical features of the shoe. It's got a deep inlay, so you can put in the AFO. You can put in certain kinds of inserts. It's got a wide toe box so that patients with other kinds of conditions can wear this shoe. This is part of what we called our pathways project. At the same time, the shoe, the construction of the shoe is all leather. It doesn't look like it is a medical shoe. It looks like a real shoe. So it is a bit different than some of the other things that are out there.

And so I think two things have happened. One is that the design, the look, and the construction, the engineering, if you will of the shoe, really is quite different from anything that was out there. And in the past, we always had this legacy of, I don't want to be a shoe salesman, I don't want to carry a big inventory of shoes in my place. You got all those SKU's and so there was always sort of some bad vibe around it. What we've done is a new improved shoe. Distribution system has been dramatically improved so that within each of our Patient Care Centers that are going to be featuring this, they have samples in there. They can take the shoe size, and within 24 hours your pair of shoes is in there. So we're not tying up a lot of physical space. We're not tying up a lot of working capital.

It is all handled efficiently through our SPS Distribution Company. So it really helps fit the patient's needs. It's a one-stop shopping. Reimbursements. And we're buying them in volume and sourcing them from outside the country so we've been working with some people that really know what they're doing in this area, so that the economics of the situation seem improved. So if I were to say why is it different, better economics, better design, better distribution, better patient care.

Great. Good progress this year, fellas. Thanks.

You're welcome, Mike.

[OPERATOR INSTRUCTIONS] At this time, this are no further questions. Mr. Sabel, are there any closing remarks?

Yes, thank you, Melanie. And I'd like to thank everyone for joining us this morning and we look forward to talking to you again at the end of the first quarter. Have a good day, guys.

This concludes today's Hanger Orthopedic Group fourth quarter year-end results conference call. [OPERATOR INSTRUCTIONS]