Hanger Inc (HNGR) 2008 Q4 法說會逐字稿

Good morning. My name is Jackie, and I will be your conference operator today. At this time I would like to welcome everyone to the Hanger's year-end results conference call. (Operator Instructions). Thank you. Mr. Kirk, you may begin your conference.

Thank you, Jackie. Good morning to all and welcome to Hanger Orthopedic Group's discussion of our fourth-quarter results.

Before starting, let me take a few moments to review with you our declaration on forward-looking statements. During this call management will make 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 document reflect the 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 benefits from managed care contracts, the demands for the Company's Orthotics and Prosthetics services and products, and other factors identified in the Company's periodic reports on Form 10-K and Form 10-Q 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.

And with me this morning I have George McHenry, Executive Vice President and Chief Financial Officer, and Ken Abod, our Vice President, Treasurer and Director of Investor Relations.

So this morning I will open things up with a few general comments, and then we will ask George to review the details of our financial results, and then I will come back on and give a little color on some of the business and our operations.

From an overall perspective, the quarter contains several noteworthy points. All of our business grew their sales over the fourth quarter of last year, thereby enabling us to have a solid quarter and to grow our pro forma earnings by almost 26% compared to the comparable quarter last year. This makes the 12th quarter where we have met or exceeded First Call estimates. We continue to see the benefits of the programs we placed into operation over the last several quarters and the results of our people's efforts. Examples are the progression of the high-tech products in our patient care business. The extension of the customer and product basis in our distribution business, increases in volume and pricing within the Linkia book of business, and a reversal of a noncoverage decision for our WalkAide product. Our balance sheet and liquidity are strong, enabling us to execute our strategic plans without any constraint.

Now I will turn it over to George who will review our financial results and balance sheet changes in detail.

Good morning, everyone. Thank you, Tom. As Tom mentioned, Q4 is another solid quarter for the Company. We reported pro forma EPS of $0.26 on an 8.6% increase in sales, a 29.4% increase in pretax income and 12.2% increase in net income.

Keep in mind last year's Q4 tax rate was only 30% compared to 39% this year due to a onetime benefit. So our earnings were linear with the pretax income when you take that out. Pro forma EPS for the year was $0.86, a 34.4% increase compared to $0.64 last year. Now I will move onto my detailed comments.

First on the quarter, our sales increased by $14.7 million or 8.6%. Our patient care centers had another great quarter, reporting same center sales increase of 6.1% or $9.2 million for the quarter. SPS also had a strong quarter, reporting a $2 million or 11% increase. The balance of our sales increase came from acquired entities, which accounted for a $3.5 million increase.

Cost of goods sold as a percentage of sales increased by 2.9% to 47.7% due to the favorable impact of the inventory adjustment on the prior year's cost. Labor costs increased by $1.5 million in the quarter, principally due to the impact of merit increases and acquisitions but showed good leverage as it decreased as a percentage of sales by 7/10 of 1 point. Material costs increased by $10.5 million or 3.6% as a percentage of sales. The $14.7 million sales increase accounted for $4.4 million of the increase. The distribution sales increase accounted for $1 million of the increase, and the balance was due to the $4.2 million of favorable inventory adjustment last year compared to a pickup of $800,000 this year. Our material rate is comparable to last year when you factor in that difference in the inventory adjustment year-over-year. SG&A of $70.8 million did not change from a year ago, despite a $1.3 million increase attributable to acquisitions. As a percentage of sales, SG&A declined by 3.4% to 38.1% from 41.5% in 2007. EBITDA at $26.3 million increased by $2.8 million or 11.9% compared to the prior year due to the factors I just mentioned. Our EBITDA margins increased by 40 basis points from 13.8% to 14.2% this year despite that 2.9% impact of the inventory adjustment I just mentioned. When you exclude the material cost change, we increased our leverage by almost 400 basis points this year, so we did a commendable job of controlling expenses. Our interest was $1 million less than last year, due principally to the impact of lower variable interest rates. Our total leverages calculated under the terms of our loan agreement now stand at 3.55 times our trailing EBITDA, which has the lowest leverage we have had threatened since the NovaCare acquisition almost 10 years ago. Our income tax provision for the quarter was 39.4% of pretax, which is consistent with prior quarters, and based on that, our EPS was $0.26 compared to $0.23 last year, a 13% increase.

For the year our sales increased by $65.7 million or 10.3%. Comp sales and patient care increase 7.3% or $41.3 million for the year. SPS's outside sales increased by $11.5 million or 19.1%, and acquisitions accounted for $11.9 million, which rounds out the balance of the increase. Our cost of goods sold as a percentage of sales increased by 0.5% this year due to a 9/10 of 1% increase in material costs, which was offset by 0.5 point decrease in labor cost. Our labor cost increased in dollars by $9.8 million due to a combination of increased health care costs, merit increases and acquisitions. Material costs increased by $25.7 million or 9/10 of 1% as a percentage of sales due to a combination of the $19.1 million coming from the sales increase, and then the balance was due principally to a mix change. The sales increase at our distribution business accounted for most of the increase in material costs as a percentage of sales as those sales carry a considerably higher material rate than the consolidator rate.

SG&A increased by $19.3 million for the year but decreased by 80 basis points as a percentage of sales. The increase in dollars was principally due to $4.1 million from personnel costs, $2.9 million in merit increases, $3.7 million related to acquisitions, $3.3 million in health care and benefit costs, $3.1 million in variable compensation, and $2.1 million that was spent on our growth initiatives.

EBITDA of $94.9 million increased by $11.1 million or 13.2% compared to the prior year. Our EBITDA margins increased by 30 basis points in 2008, which met our expectations. Again, if you exclude the material cost increase that was attributable mostly to the healthy increase at our distribution business, then we increased the leverage on our SG&A and our labor by 130 basis points, which is again showing I think very good cost control.

Interest expense was $4.4 million less than last year, due principally to lower variable interest rates.

Our income tax rate for the year ended up at 39.8% compared to 37.8% last year ago. The prior year was impacted by a onetime benefit, and that benefit was all realized in the fourth quarter.

Moving onto the balance sheet, our A/R increased by only $700,000 since 2007 despite a $65.7 million increase in sales, and our DSOs remain low at 51 days compared to 56 days a year ago. Bad debt expense was 2.3% compared to 2.5% last year, and our A/R over 120 days, a measure of the quality of our receivables, was 11.8% of total A/R compared to 14.4% last year, which is the lowest that has ever been. So our A/R is healthier than ever.

Inventory increased by $3.7 million to $86 million compared to the year-end balance last year of $82.2 million. Inventory balance makes sense given our business needs, and it is adequate to support our business growth.

CapEx for the fourth quarter was $7.3 million compared to $6.7 million in the prior year. For the year we spent $19.3 million compared to $20.1 million last year. Cash flow from operations was $18.4 million in Q4 '08 compared to $21.4 million last year, a decrease of $3 million. For the year cash flow from operations was $53.2 million compared to $51.7 million last year, an increase of $1.5 million. So we had another good year from a cash flow standpoint.

The Company's liquidity remains strong. The Company had total liquidity of approximately $96.6 million at year-end comprised of $58.4 million in cash and $38.2 million in remaining availability on the revolver after factoring out the Lehman commitments, borrowings and outstanding letters of credit. Hanger also generated over. Hanger also generated over $30 million in free cash flow from operations in 2008. Based on these facts, we believe Hanger has adequate cash and borrowing capability to conduct operations and execute our growth plans.

Moving onto guidance, the Company is establishing guidance for 2009. We expect revenues in the range of $750 million to $760 million, which would be a growth rate of between 6.7% and 8.1%, and based on the sales guidance, we expect to report EPS of between $0.96 and $0.98, which translates into EPS growth rates of up to 14% if we hit the high-end of the range.

That is the end of my comments. I am going to give the call back to Tom Kirk now, our President and Chief Executive Officer.

Thanks, George. Let's take a few minutes and delve into our business operations and see what the key drivers were. Obviously this will have a profound impact on our ability to to meet the guidance that George just discussed.

HPO, our patient care division, achieved a $9.2 million increase in sales or 6.1% same center sales growth for the quarter. The performance for this quarter is partially attributable to the rollout of the CMS fee schedule increase that we received on January 1, 2008. I will remind you that that was 2.7%. That increase in the first-year impacts about 35% of our book of business, and this combined with the rollout of the increase of other prior fee schedule increases to our total commercial book of business translates to about a 2% of the 6.1% in terms of our overall growth. The balance of the growth, or 4.1%, is attributable to volume and mix, and we look at that as about a 75% coming from volume, 25% coming from mix. On January 1 of this year, 2009, we received a 5% increase, which will translate to about a 2.5% price increase in '09 as that increase marries up with the prior ones to impact our book of business.

The other programs impacting volume and mix are the following. First is the continued improvement in our Linkia book of business, and let me remind you again that HPO is the primary vehicle for the delivery of most of the services under the Linkia contracts. On an overall basis, the revenue from the Linkia-designated contracts was up 16.5% for the quarter and 13.8% for the year.

The second area that has impacted volume and mix is the emphasis that we placed on our high performing products such as microprocessor, prosthetic hands, knees and feet components. For the quarter the revenue from the delivery of these product lines was up 32% compared to the comparable quarter last year, and for the year the revenue increase is about 31%. This is continuing to be an important part of our business and strategy.

The third area that is impacting volume and mix in patient care is our use of our patient evaluation clinics. And I think I have mentioned these in the past to you, and that is where we actually contact our patients and bring them back in on a prearranged schedule so that we can check their fit and functionality of their devices. These are effective mechanisms of staying in touch with the patients, and they produced approximately $4.7 million in revenue for the quarter and over $19 million for the year.

In the last area impacting volume and mix are our sales, marketing and public relations efforts by our practitioners and all those that support them in identifying opportunities specific to their local businesses, and then, of course, they go out and implement the activities to translate those action plans into results.

Now a few words on the state of the economy because I think we certainly receive a lot of interest in this area specifically how that will affect our business. Thus far, we have not seen any evidence that the challenging financial environment is translating into Patient Care delays. However, we do recognize that if workers lose their jobs and do not find other benefits for COBRA, we may see some stretching out of the time between their visits. Normally we would also expect to see some increase in the maintenance procedures when this occurs, but to date this has not happened. We have not seen that particular phenomenon.

Further, it is our understanding that the proposed stimulus plan that is being discussed in Congress will contain a provision to help those who have lost their jobs with supplemental payments to offset the cost of COBRA or other insurances that they may have to procure. So we are waiting to see the outcome of this. Obviously any kind of a stimulus package of this type would mitigate to a certain extent some of the historical trends that we see when people lose insurance.

On the regulatory front, we continue to support the Amputee Coalition of America, or ACA, on educating state legislatures on the issues involved with reimbursement caps and limits, how these caps and limits deprive patients of quality care and doom them to lower levels of mobility. There are 11 states that have passed parity, and almost 30 are working on parity legislation today. Seven states have bills on the floor, and as I mentioned, we're actively supporting the AC in trying to get these bills passed.

On the federal level, a bill was introduced into the Senate last year for national prosthetic parity, and that complements the House version, and we hope to see action on these during the first quarter of 2009.

Let's turn our attention to SPS, our distribution company. Their outside sales were up approximately $2 million or 11% compared to the fourth quarter of '08. Excuse me, fourth quarter of '07. Success in continuing to build sales in SPS's core business is attributable to three major areas. First is the continued leveraging of the location of our new warehouse that we opened in July of '07. This warehouse is in Pennsylvania, and it really provides outstanding access into the Northeast market so that SPS can deliver into that geographic area the same kinds of service that it provides in other parts of the country.

The second area that we look at as being a major driver on their sales is their superior customer service and training, which has been the impetus for their gaining some new large customers. And third is the addition of some new standard and high-tech products into their portfolio, which is evidenced by a new line of modular componentry and microprocessor products that were assumed earlier last year in '08.

And regarding SureFit, the acquisition in custom foot orthotics that we made in July of '07, we are nearly complete with the integration into the Hanger family. We have installed the SPS financial software applications, reengineered the manufacturing processes, and also fixed and straightened out order entry to fulfillment processes. Fourth-quarter sales were up modestly by 2% compared to Q4 of last year. However, December was more than 15% over the comparable month from last year. So we think that SureFit is really coming into form.

In addition, SureFit is preparing to launch a new scanning system to capture image in order to better service its practitioner and patient customers. We think that that is going to be a major development and a much better way, much more efficient way of getting the shape and size that are necessary to make these custom inserts in shoes.

Now let me provide an update on Linkia. Linkia continues in its dual mission of a) building its share among the key health care companies books of business, and b) negotiating a fair price for the services provided by the providers within its network. On this point they are expecting to reach favorable outcome with two large health care payers this year on price increases. These demonstrate that payers continue to recognize the value that Linkia brings to them in helping them control their administrative costs while ensuring good clinical care and high levels of customer satisfaction to their membership. The Linkia network consists of the Hanger patient care centers and independent providers, and the number of independent providers has grown to 316. Linkia's book of business revenues for the quarter was up by over 16% and for the year by almost 14%.

In addition, Linkia is piloting other services that they could incorporate into their model to provide benefit to the payers. And on the marketing side, they are continuing discussions and negotiations with key national and large regional health care management companies, as well as the firms in the workman's compensation segment.

Let's direct our attention now to Innovative Neurotronics. They also had a good quarter by increasing enterprise revenues by almost 24% as compared to Q4 of '07, and an overall basis for the year, they were up 98% compared to 2007. While their absolute sales were weaker in the quarters in the end of the year, the reason for that was that we had an outstanding public relations event that occurred last January, which really acted as a great stimulus to the first-quarter and second-quarter sales. And obviously recognizing the benefit that the PR has in just the marketing, we also recognize the benefit that the PR has in trying to influence the outcome for many of our patients such as stroke and MS. We're actively working with a number of networks to see if we can get our patients the kind of recognition that they need when they are wearing these devices so we can advertise the benefits, and we have redoubled our efforts in this area.

Several significant events have occurred during the quarter on the reimbursement front. First, Medicare issued a specific code for WalkAide, attesting to the unique value WalkAide can deliver to the patients.

In November CMS overturned a standing noncoverage decision for WalkAide, and they approved the WalkAide for coverage of patients with incomplete spinal types of upper motor neuron lesions. This was a major achievement and came earlier that we anticipated. And when CMS reversed the noncoverage decision and gave us limited coverage for incomplete spinal in November, it changed our timetable as well. This November decision and the specific code that we received in January allowed us to initiate a proactive reimbursement program. We are engaged with CMS and private insurers in discussing coverage for the other kinds of patient groups. This is a process of working with them to understand their needs, and it is proceeding quite well, and we cannot put a definitive timetable on it. One of the reasons is that right now CMS is actually reviewing the standards by which they judge stroke rehabilitation progress. Obviously we are following this very closely and will comply with their decisions on the appropriate parameters that they want to see.

On the third-party payer front, the removal of the noncoverage decision opened the door to have discussions with third-party payers on the benefits of fitting their members with the WalkAide. We have expanded our reimbursement department within Innovative Neurotronics, and we're actively working with our patients to support them in their efforts to secure authorization and reimbursement.

Now this dual track of public and private is the exact same progression that we went through to gain reimbursement on microprocessor needs and other O&P devices. It works, we will get there, and it has been effective in the past, and frankly, that removal of that noncoverage decision was a huge advantage as I mentioned in opening the door to getting reimbursement from the third-party payers.

And with respect to our clinical trials on the stroke patients, we closed down new enrollment as of November 15, and the final patients are wrapping up their trials. We're still working on the clinicals, and once all the participants are through the study, we will work on getting the results published. I cannot talk about the specific results at this time because this would really taint the results and could end up invalidating our studies. But as soon as we get them complete, as I mentioned, it is our intent to get them out for peer review and get them published, and we are continuing to work with Medicare through this process to make certain that our ultimate submission meets their needs. And we're confident that this is the best route in trying to get coverage both publicly and privately.

As we have stated before, we believe that 2009 is really going to be a transition year for WalkAide. As we look at the guidance that George spoke about, our guidance for '09 contains a pretty healthy increase in sales of about 50% over 2008, but we would certainly expect that once we secure the reimbursement, that those sales levels on a year-over-year basis would go much higher. So we think we have gone down the middle of the fairway on this one, recognizing that third-party payers will obviously be generating more business. Our public relations efforts will help us, but we have not gone crazy in terms of anticipating huge benefit from WalkAide in '09, and that is pretty consistent with what we have said in other public forums.

And finally, a few words on our acquisitions and other developmental projects. We're continuing to pursue strategic acquisitions. In 2008 we executed 12 acquisitions, and they are already integrated into the Hanger family. We're going to continue to look for tuck-in candidates that add strategic value to us in the form of location, the quality of the practitioners and/or favorable product service mixes.

On the development front, we have made some progress, and we have initiated some pilots on our developmental projects in Q4, and we will be starting another one in Q1 of this year. We anticipate a public launch a little later this year on a couple of these projects, and we will be talking to you about those as the year moves on.

So in closing, we believe the results of the fourth quarter demonstrate that our programs continue to yield positive results. However, we recognize that this environment of volatile economic and financial conditions really requires us to be extra vigilant with respect to revenues and, of course, cost management, and we have put several programs in on that front, and they have been working, and we will monitor their performance and ensure that they continue to work in '09.

So thank you very much, and I will now open up the line for questions. Jackie, can you help us with that?

(Operator Instructions). Adam Feinstein.

A very strong quarter here. Just a few questions, maybe just a couple of housekeeping questions. I just wanted to make sure, and I apologize, I missed the first couple of minutes. But did you break out the pricing relative to the volume in the same store growth number?

Same-store sales was 6.1. We attribute the pricing to 2% of that, and then the balance we split 75% to volume and 25% to mix.

Okay. Great. And then just on the bad debt side, just did you have -- do you have a bad debt number for the quarter first?

Sure. Bad debt for the quarter was 2.2%.

2.2%? And how did that compare to last year, George?

Last year was 2.3%, and for the year we were at 2.3% compared to 2.5%. So our collections were strong. We have got -- actually our reserve went up a bit even with that lower expense, so we had a very strong year from a collections standpoint and feel good about that result.

Okay. You made reference to the economy and just clearly a big unknown there. But, as you are thinking about bad debt for the coming year, maybe just walk us through a little bit in terms of the process.

Then I am just curious in terms of your thoughts -- well, I guess in terms of the past, what is the highest that number has been?

Well, let me first address your question on looking forward into 2009. We in our -- inherent in our projections that led to the guidance we just gave is about 2.5% bad debt expense. So we were a little conservative in our internal projections, assuming that there could be some pressure on copays going forward.

Now we think our process helps us in terms of collecting copays, and that is where the real exposure is as opposed to the 80% that is being paid by the insurance companies or Medicare and because we collect that before the device is delivered, which is a process that is pretty similar to what you see when you are in any doctor's office. That is really ingrained into our process right now, and it is really part and parcel to the reason we have been able to over the years reduce our DSOs and our bad debt expense at the same time.

Now looking back into the past, it is not really -- it is kind of apples and oranges to go back and talk about our bad debt expense in the past because we have significantly improved our systems and our process over the years. If you go back to 2001, our bad debt expense was up in the 4% range, 4% plus range, but in 2001 we had 15 different billing platforms and did not have the kind of process we have today. So we don't think it is possible that that is a place we could even go, and we think we are pretty conservative at the 2.5%.

Okay. Great. One more question and I will get back in the queue. Just in terms of margins, you guys did a good job this year in terms of driving the margins higher. Just last year in the fourth quarter, you had the issue with the comp accrual, but it looks like you managed through it better this year. So maybe just talk about that as well. I was glad to see the margin leverage, and I just wanted to make sure that we will see a similar thing in 2009.

Well, we were happy as well with the leverage as I mentioned during the call, you know for the year when you pull out the cost of materials, which is obviously tied into our mix. Directly we improved our margins really by 130 basis points in our labor and our SG&A. The accruals for our incentive compensation we think makes sense. They are lined up with our earnings, and we got over that issue that we had in the fourth quarter that it was partially based on the fact that we had that big inventory adjustment, favorable inventory adjustment last year. This year our inventory adjustment is only $800,000, and we did a very good job estimating our costs throughout the year. So we expect to see continued improvement. In our leverage we are expecting I think when we talked about '08 guidance, we talked about 20 to 40 basis points, and we think we're going to be in that same kind of range this year.

Brendan Strong.

Just maybe a couple of other questions here. On the cost of goods sold line, I mean what percentage of that ends up being just pure material costs? I'm just wondering if there is some upside there in 2009 versus 2008?

In our cost of goods, our material costs for the year was just below 30% of our sales. So the rest of that cost is labor, which runs at right around 19%. So there is some opportunity for leverage in the labor as we increase our sales and our existing base of practices.

And just lower material costs, you don't think that is necessarily a possibility in 2009?

It depends on mix. It depends on a lot of things. Like a lot of other companies, we do have a fair amount of imported goods. We do depend to some degree on oil prices staying in a reasonable range as we use a lot of plastic and titanium in our product, and the current government policies relative to the economic situation that we found ourselves in could have an impact on the strength of the dollar depending on how much borrowing the government does. So those factors could have a negative impact on our cost of materials.

Now the flip side of the coin, we are continually working on utilizing SPS, our distribution company, to buy as much product as we can in order to control prices. We had some new products coming out, the WalkAide. You know things like the WalkAide sales help us since we have manufacturers margins on that, and we have some other new products that we're working on this year that could help us on the margin side.

So I think it is fairly balanced, and we could potentially keep our com right about where it is. I don't think there's a lot of opportunity to bring it lower this year with all the variables that I just talked about. Tom, do you have any other --?

The only other area is the utilization factor, and we are constantly educating our folks on how best to fabricate devices so that we can reduce the consumption as much as possible. Rework is obviously a major enemy here. We have just finished with our education fair last week, and we had many sessions on this. So I think we might be able to squeeze a little bit more out from a he utilization perspective. Hopefully we will not have some of the wild swings that we experienced in 2008, and the leverage that SPS can bring bear, we started a whole new program called Premium Choice Products, and that's nothing more than determining the best product clinically and economically for any situation in SPS is proceeding to work with their vendors to put more people into this. And this is a volume play where we shift our buy onto a smaller number of suppliers in exchange for getting some better pricing. So we believe we might be able to get a little bit more out of this, but I don't think you're going to see anything of a substantial nature here.

Thank you. Then maybe just one more if I may. Just your outlook for CapEx and free cash flow in 2009 and a related point, I'm just curious with the cash on the balance sheet, do you continue to run high levels there because you don't want to pay down the revolver? How do you see that playing out?

Well, first of all, free cash flow and CapEx we expect to spend about $22 million on CapEx in 2009. So we are continuing to invest in the Company. We're not pulling back on that. And, of course, we expect to be able to fund that out of cash flow from operations. We expect our cash flow from operations to be about $5 million less than we reported this year in that range. So it will be in a range of $40 million to $50 million. And relative to our cash position and our borrowings, we're not comfortable enough yet with our view of what is going on in the financial ranks to pay down the $15 million that we borrowed on the revolver. But that is something we will consider as 2009 progresses.

We will, however, keep the remaining cash we have. We think it is important to maintain our liquidity so that we are certain that we can execute on our growth plans. Because when you come right down to it, if you are not able to do that, you are kind of sacrificing the future, so we think that is very important.

Larry Solow.

Just a quick follow-up. Is there any particular reason why you expect that free cash flow to fall $5 million? Is there one -- can you cite one particular, or is there a couple of factors?

No, it is really just one thing. After two years in a row of reducing our DSOs down, frankly, we have below 55 days. That was better than I thought we could do with our present technology and process, and I don't think we will get that same benefit next year. So that is going to cause us to create a little bit more working capital as we grow our sales in 2009.

So maybe the DSOs got -- not that they will still be contained, but maybe got a little ahead of themselves it looks like in '08?

Yes, I think they will stay level at 50, 51 days, but (multiple speakers) versus a five-day improvement obviously has an impact on your working capital.

Got you.

If you factor that against the increase in sales that we gave in guidance, obviously even if you stay flat, the number gets a little bigger.

Got you. And you guys you discussed this, you expect about a 2.5% benefit to price for the full-year '09, and I think you said it was a 2% increase for a benefit in Q4. Do you happen to have a full-year '08 what that benefit was?

It is about 2%. As we go all across the board, we look at the -- it is better to look at the annual averages because these things come through different contracts at different times. So we say 2% in '08, 2.5% in '09.

So essentially the 5% increase, you're going to get maybe a third of that, and then obviously some of the initial increases that you got in 2007 will start to wean off I guess or have already been implemented?

Yes, we had 4.3% in '07 and a 2.7 in '08 and now the 5% beginning in '09 so. So things are starting to flow through.

And then as we look out to WalkAide, do you expect maybe towards the tail and of 2009, if you see a more broader reimbursement approval, that you have to maybe spend a little more investment spending on selling expense and marketing of the product, or how does that come into play?

Two areas that we believe can help us quite a bit. One, and we have made investment, and this is really an investment in people. We have hired a new director of reimbursement back midyear '08, and she has just recently added an additional resource, and that is because with the changing of this noncoverage decision as I mentioned, it really opens the door for us to work with third-party payers and become their advocates to explain the device. So through our department of reimbursement, as well as to our Chief Medical Officer, we're going out and having discussions with third-party insurance companies so that they can understand what this is all about and the appropriateness of using the device on various indications. By the way, we have tremendous support from the MS society because they see the benefit, and they are working with us to provide some of that education of the insurance company. So that is one area.

The other area that we are looking at I would call PR/marketing. We certainly notice the impact that the Good Morning America feature had on our sales, and we are trying to duplicate that by finding appropriate patients that could showcase the device. But more importantly could at least alert a number of the patients that are out there suffering with this indication that there is hope on the way, and there is the device that will start building. So we want to put some more resources into that area to try and get the word out as well. So you're right, through the year, we will be monitoring this action very closely in determining just what is the proper level of resources. That is already built into overbudget. This is not something that we will have to come in and add. We have just anticipated doing this as part of what we thought would be necessary to get the approximately 50% sales increase for '09 and really setting us up for '02 when you would expect to see this thing start to take off even in a more profound way.

And would you kind of accelerate your marketing effort and discussions with these third-party payers once you have I guess -- would it make sense to wait until you have your full clinical trial results assuming they are positive?

Absolutely, Larry. That is right. You have to go out with something in your hand. We can do demos, and people can see it empirically. It is a night and a day difference, but obviously they need to be sure that these are not quirks and that statistically over a broad range of those patient indications that we're really getting that result.

And based on current thinking, not asking when we have these results published, but do you have an idea of when you will be able to show these results to your some of these potential third-party payers?

We think that it is going to be end of first quarter, beginning of second quarter, we're going to have something we can go to. The big hangup on this is that if we go with some of the results and they have not gone through the trials of fire here by having peer review, which is where you really have the experts in the field, this is the cardiopulmonary field, take a look at these things and bless them, they don't have the -- it does not have the same clout. So we can control what we can control, which is getting the results analyzed and then working with people to bring them to the attention of the peer reviewers. But we have alluded to, for example, the inventor of this product, [Dr. Dick Stein], has been running some trials in Canada for a number of years, and he, too, has been trying to get those showcased. And I think he is on his third revision with some of the sources that he has gone to.

So that is sort of the linchpin here, how quickly you can get outsiders attention and how quickly they are going to give you their blessing. So we are looking at -- we want to get in front of these people hopefully in the first half of this year.

Got you. But it sounds like you may not get even the full (inaudible) until you actually get those results peer reviewed and published?

That is, that is --

Makes sense?

Yes, but in the meantime we're continuing to work with CMS to understand exactly where they are and what they want to see. It is really -- it is a crazy process, but we know that it works because we have done this on so many other devices that you just keep chipping away at this, and we will get there. It is just a matter of trying to get it done the right way and show people the data in the form that they want to see it.

Absolutely. Okay. Just two more housekeeping questions. Sorry to ask so many questions. Do you happen to have an absolute WalkAide number for sales? I mean I guess it was in the ballpark of $10 million for the year?

It was just under $10 million. You're right. I don't have that precise -- (multiple speakers)

That is fine. And then depreciation for the quarter? I guess you gave that number. Do you have a depreciation number for outlook for '09 I should say?

Depreciation -- (multiple speakers)

That is going to pick up a bit in '09 because of the higher level of CapEx. This year we are right around 17.2, and we are going to be in the $19 million range.

Got you. And I guess some of the acquisitions I guess there is a little goodwill on those, too, so I guess that is also helping to tick it up?

You do not amortize most of that. It is principally coming from the higher level of CapEx that we have had to support our growth in projects like the paperless office that we're working on.

Greg Williams.

I just had a question on -- Tom, you mentioned Linkia. You're piloting other services. Maybe you can shed some light on what services those may be?

I am going to be a little vague on this simply because they are in the piloting stage, and we're working specifically with specific carriers. What has happened here is the carriers have come in being pleased with the way our network is providing O&P services. They have asked us, can we pilot some things with you?

So the projects are different by different third-party health care payers. So I do not want to let Peter know what Paul is doing because we have signed some agreements in this respect. Obviously we have given ourselves the flexibility that once we get it up and going for one of them, we can migrate it to the other. But suffice it to say, they are in the broader area of rehabilitative services both from the clinical, as well as from the administrative side. And I probably cannot go beyond that, but these are things where folks have come to us and asked us, can you include this kind of a service that we're reaching out to make sure that the appropriate provider network is in place and that we're providing the right kind of human and electronic services to back this up. But thus far, they are going pretty well. And I believe that over time, what you're going to see is Linkia is going to be picking up bigger pieces of the overall rehabilitative area in service to these people along what I would call a continuum of care and administrative services.

Okay. And it is still in the scope of O&P services?

Yes.

And I just had one housekeeping question. I assume in the '09 guidance, you are using the 40% tax rate, and maybe you can help us with the share count as well?

Sure. We're using the 40% tax rate, and let me see if I have the share count. Again, we are about 32.2 on share count for the year.

Daniel Owczarski.

I am not sure if you mentioned, George, but just a couple of quick questions going forward. Does your revenue guidance include impact of acquisitions? And I guess if it does not or even if it does, what is your target, your typical target there?

It does not. It only takes into consideration the partial year impact of any acquisitions that we made in 2008. We do not typically put any -- after 2009 new acquisitions into the guidance because we cannot control when those deals close, and that makes it very difficult to project for the street. So that has been our practice in the past.

Have you stated in your mind what a typical target would be?

Sure. Our target remains consistent with 2008. We want to acquire O&P or related businesses that have annual sales in the $20 million range throughout the year. So that is our goal for next year, which is similar to this year's, and I think we ended up bringing in acquisitions with total projected sales of about $22 million.

Okay. And then just for the first quarter, can you remind us do you see seasonality there? Is that -- typically should we be thinking that this is going to be sequentially a decline in the first quarter?

Yes, the first quarter will be very similar to what our first quarters have been in the past. There will be -- we will be reporting less EPS than we did in the second and third and fourth quarter this year in 2008 as I have always talked in the past.

If I remember correctly, we reported about $0.06 in '07, $0.12 last year, and we're probably going to be in the $0.14, $0.15 range for 2009. So it is definitely a lower profitability quarter for us.

Okay.

The weather is the major factor in what goes on in the wintertime, and certainly these recent ice storms that we have had through the middle part of the country are pretty good evidence of how that impacts the ability of our patients to get to the patient care centers.

Right. And when you have that kind of weather, Dan, amputees just do not schedule travel. They just stay home, number one.

And then secondly, because a lot of our patients have second indications, health indications -- a lot of them are diabetics -- they tend to want to chip away at their total year copay before they make a big expenditure on a prosthetic device. This affects our return patients. They are more likely to come in in the second, third or fourth quarter when they have covered a good portion of their annual copaid maximum.

Okay. Just moving maybe to a bigger picture competitive question, you have talked maybe in the past about the independent practitioners being squeezed in this type of environment. Can you give us any data points or color or specific issues they are facing now more than ever? Anything more concrete than just kind of general commentary? Because I know that you have talked about that you might be seeing -- you might be in a better position from an acquisition standpoint.

I think the squeeze occurs from a couple of perspectives. First is on the materials front. They just don't have the volume to try and negotiate the prices, and as I mentioned earlier, that is one of the key tenants of SPS's strategy, which is to work with the vendors in a very fair way to use that -- our volume and our purchasing volume in an effective way to reduce prices. So they do have that advantage, and that is not to say that they are seeing double our costs. They are just not getting the same kind of benefit. And then in an industry where 5% can really impact the outcome in terms of percentage of sales, we know because of the way we do the acquisitions that we can have great visibility into their cost structure. So that is one area.

The second area is what I would refer to as the ability to sustain the ebb and flow on the cash flow side. And what you see is that in some cases, folks don't pay as promptly, and they just don't have the ability when they are faced with meeting payroll and paying their rent check, they do not have the ability to sustain that kind of ebb and flow, and we know that because a number of people have come to us and said, I got into this to do clinical work and to help my fellow men. And what I'm finding out is I am taking home equity loans on my property, etc. to try and meet payroll to carry me through.

What ends up happening typically is they finance that on the back of their vendors. That only works for so long, and then they go COD, and then things start to get a little ugly.

So it is the ebb and flow on the cash flow. It is the higher cost of materials. One of the ways that people try to alleviate this is through reduction in their labor force, and we have seen some of them actually reduce their technical and their support staff, which now means that the owner of the facility has to go in on Saturdays and on the evenings to make the devices.

And finally, his balance and quality of life starts to come unwound, and then two, that forces them to not go out and do the kind of marketing that they would like to do because they have got to be hands on in the shop.

So from all three of those areas, that is what impacts them, and in some cases it is not that they are facing bankruptcy, it is just they get tired. And the folks have said, I don't want to do this anymore. I want to really get out of this thing. So that is the manifestation of what we see that is out there.

Very helpful. Thank you.

Mike Petusky.

A couple of quick questions. In terms of -- I did not catch it, if you gave the WalkAide revenue for the fourth quarter. Did you actually give a number?

No, we did not.

No, we just talked about the annual year, and the first half of the year, the revenues were stronger. So we don't break it out from a segment accounting perspective, but we were front-end loaded because of the Good Morning America piece.

Right. We had $1.3 million in the fourth quarter, and we are about $9.1 million for the year. Somebody had asked for the year earlier, and I did not have it right in front of me, but I have it now.

Okay. I'm a little surprised, I guess pleasantly so, that your guidance for '09 does not include any acquisition revenue. Can you talk about what you're assuming in terms of same-store growth and SPS?

Sure. We're expecting same-store growth in the 3% to 5% range, and we're expecting low teens for SPS.

Okay. In terms of what you are assuming in the Linkia relationships, are you guys assuming that you guys get some better pricing from two of the sizable payers, or what is the assumption in Linkia? Are you making any assumptions in terms of unemployment? I mean how deep have you guys gone in terms of that piece of your business?

I guess let's talk volume and then price. First off, Linkia continues to talk to some other carriers. We have got contracts with all the carriers, but what we really like is to either get the preferred contract, which is what Linkia does or the exclusive contract, which is the second basis.

And so we have discussions going with the Blues. I mean that is going to be the toughest one because even though they are the largest, they operate in a very, very decentralized fashion, and we also have discussions going with the other carriers. We hope that by year-end, those things will come to fruition. We're trying to evaluate the impact of the financial results that some of these folks are seeing. I mean the Blues announced they were down 61% in the fourth quarter. I think it was Humana announced they were down 28%. We offer an alternative in terms of helping them manage their costs. So we're trying to look at where we can be part of their success, and we think that maybe this is a good time for us to intensify our marketing efforts. But we have learned over the years they do move on their on pace, and we are not going to influence that much, except that we want to update all of our numbers so that they can see the value.

In terms of the price negotiations, some of these happen by contract where we have multiple year contracts with these carriers. And other ones are discrete events when a contract expires of going back in and trying to open up the negotiation on the price front. And, as I alluded to in my remarks, we have a couple of these that are ongoing now, and we expect that at least one of them is going to bear fruition before the end of the year. And so we have tried to be a bit conservative in our guidance and assumed that we will get one of the two that we're talking to, and we will pick up some additional volume. And so in building our estimate for Linkia's book of business, we do go to the level of understanding the customer and where they are in the numbers of customers. We have not gone to factoring in the level of unemployment to say what is going to happen to their membership because I guess the real key to this is whether or not these folks are going to get impacted by the stimulus bill and have alternatives. We also know that Congress, if there is a broader healthcare reform, is looking at doing some restructuring on Medicare Advantage, and that could enter into this.

So from that overall perspective of the unemployment and how it balances with different government programs, we have assumed that they are just going to be pretty much a wash and that we are not going to see a gain and we are not going to see any deterioration. So on an overall basis, we still expect Linkia to grow consistent with its past performance, but we are not going to slash it in half nor are we going to double it. So it is pretty much staying on the same slope as before.

All right. One last one, just going back to WalkAide. Maybe I'm fixated on this and I should not be, but I had thought that I understood that you guys were roughly around 75 patients. How many of those are still kind of in the process of completing clinicals, and how many of them are actually finished or completed at this point?

We are over 75. We kept, as we announced at Q3, we kept the door open through November 15. So now we're up to almost 100. We believe that the larger sample size will really work in our favor. 75, we always viewed as sort of the minimum, and we thought as long as we could get people into the trials, let's get them in and increase the number. And if you remember when we first started this, we had some difficulty trying to get them into the trials and keep them in the trials. The real issue was after they went out and paid for their WalkAide, they did not necessarily want to be in the trial because that forced them to go back on an AFO for part of the regime.

So we had some issues in the very beginning of getting the trials populated. We think we solved that towards the latter end with some things that we did internally without destroying the validity of the test. And as we could get more people, we said let's just keep them all coming, and let's try to go for 100. So we're up in that range now, which we think is going to really benefit us with the larger sample size. Those folks are in the final stages.

You know, it is a three-way arm where you are on one device and then you are on the other one, and then you go back on the third one. So we're expecting that as they went in in November 15, that we will probably -- it takes about three months to get through that. We will get that wrapped up, and then we will do our analysis. Our Chief Medical Officer will be working with the principal investigators. A number of them have expressed some interest in trying to co-author some papers and get those out for peer review. So we think that process is the right one, get the number up, get all the data in, and then go out and get some peer review data here.

So essentially though, you are saying, Tom, I just want to make sure, you're saying that you have got at least 75 patients completely through the trials? They have gone through the six weeks on, six weeks off, they have done the 18 weeks?

Yes.

Okay. And essentially now you have got a minimum of 75, and obviously then you work on a peer review, and CMS is reviewing their standards for stroke rehabilitation. But essentially on your end, you have at least got a minimum of the work that is needed to be done, done?

That is correct. That is correct. We're in this constant dialogue with CMS to really understand, and actually just this week there was a major meeting of a number of cardiologists, pulmonologists, vascular doctors, radiologists, all discussing these latest view of CMSs and whether they were appropriate and whether you had to have subpopulations of stroke patients in terms of acute and subacute and chronic. So it is a process, and it is a moving target, and we're very, very close to it. We actually had a representative at that meeting to know and understand where that was all coming down.

Terrific, and Tom, congratulations on finishing up your first year.

Thank you very much.

Larry Solow.

Just a quick follow-up. In previous quarters, Tom or George, you guys have talked about some new beta programs you're working on. Anything you care to share?

Probably a little premature. Those beta programs are in three major areas. One is in Linkia with some of the work that we mentioned before that we're trying to do for third parties. Another one is in the, what I will call the device area for use in our patient care business. And another one is in our distribution area, distribution business, in terms of a new way to get product.

But we want to really get the beta test wrapped up to understand those a little better. As I have mentioned on the Linkia example, since we're working with specific carriers on that, some of the agreements that we have in place don't permit us to go out. They really want to be the owner of that for a period of time, and then we can roll it. So it is across all the areas of our business.

As we step back and look at our business, while our driver and our routes are in patient care and we're going to continue to grow that business and feed it with new product services in new locations, we really see the company as having four major footprints all dedicated to this rehabilitative area within the O&P space. And we want to leverage the physician to patient care in our distribution business because we think that there are some opportunities in the adjacencies area. And frankly, it is a move that is designed to give us a little bit of diversification in terms of where we source our revenues. And we see opportunities out there where we can come in just as we did with Linkia by bringing in a combination of clinical and admin and systems, we can help people save money and be a part of their solution. And that is why we want to go at these things so that we can broaden the Company's footprint and move it from a patient care dependency on the fee schedule to one that can provide more consistent growth across all economic environments.

Okay, great. Just one other question. Clearly WalkAide is obviously Innovative Neurotronics main focus, but I know you guys are working on other products. Is there anything new and exciting? Obviously you probably cannot share too much, but anything in the pipeline we may be hearing about?

Yes, but probably not going to be a first-quarter event. Routinely when we created Innovative Neurotronics, it was with the understanding that we were going to have a family of products in this area, and they have since their inception really, they have had a number of folks that come to them with their business plans. They are really entrepreneurs. They also maintain a lot of contact with universities that develop product and are anxious to roll that out, and we work with an outside firm as well that on a worldwide basis is acting pretty much as an antenna for what is going on worldwide. And they bring us ideas, and we certainly follow-up with them. We probably have looked at in 2008 at least a dozen different opportunities where we were beyond a cursory look, but we actually got down inside and looked. And some of those, there's three that have sort of emerged as been quite interesting. We want four things in place before we move on that, and one is a demonstration of efficacy. Two is a prototype device. Three is some position around the intellectual property, so that we're not dealing with a commodity. And four is a sustainable business model. If we can get people to bring those four things because we don't fancy ourselves as a research house, we think we have got the makings for a discussion. And so we have found a couple of three of those things, and we're engaged in those discussions as we speak.

There are no more questions in queue.

Thank you then, Jackie, very much. So I would like to thank you all for spending this hour and 15 minutes with us. We're proud of the results that our people have achieved in the fourth quarter. George has shared with you our guidance, and we're going to go make that happen and be mindful of this economic situation we are in. So we will look forward to talking to you after our first quarter, probably about the end of April.

Have a good 2009. Thank you.

This concludes today's conference call. You may now disconnect.