Hanger Inc (HNGR) 2009 Q2 法說會逐字稿

Good morning, my name is Andrea and I will be your conference Operator today. At this time, I would like to welcome everyone to the Hanger Orthopedic Group Second Quarter Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.

(Operator Instructions)

Thank you. I would now like to turn the call over to Mr. Tom Kirk, President and CEO of Hanger Orthopedic Group. You may begin your conference, sir.

Thank you, Andrea. Good morning and welcome to Hanger Orthopedic Group's discussion of our second quarter results. Before starting this discussion, let me ask Ken Abod, our Treasurer and IR director, to review with you our declaration on forward-looking statements.

Thank you, Tom. 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 reflect the views of management.

However, there is 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 demand for the Company's orthotic and prosthetic 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. I will now turn the call back over to Tom Kirk.

Thank you, Ken. Overall, we had a very solid quarter. Let me just touch on a few noteworthy points. Our core business grew their sales over the second quarter of last year in spite of the changing economic climate and increasing unemployment conditions. This enabled us to generate record revenue for the quarter. This sales performance combined with effective cost management yielded $0.31 earnings per share, which equates to a 24% growth over the pro forma EPS from last year's second quarter. This makes the fourteenth consecutive quarter where we have met or exceeded first call estimates. The performance of our business is also the basis for our increasing EPS guidance for the year, which George will have more to say about in a few minutes.

We continue to emphasize our strong marketing effort for our services, continued education of our referral sources on the benefits of new products in the market, the value to our third party payors and network partners of our Linkia contract, extension of the customer and product bases in our distribution business, and of course, the pursuit of government and third party reimbursements for our WalkAide product through the reimbursement desk, which we established last quarter. Finally, our balance sheet and liquidity are strong, enabling us to execute our strategic plans without any constraints. Now let me turn it over to George, who will review our financial results and our balance sheet changes in detail.

George McHenry; Thank you, Tom. Good morning, everyone. As Tom mentioned, we really had an excellent quarter in Q2. The important takeaways, first on the income statement, are as follows. Overall, the quarter was a solid $0.03 feed to our internal budget, which called for $0.28. Sales increased by a respectable 6.8% and we controlled our expenses, delivering a 30 basis point increase in EBITDA margins and a 70 basis point improvement in our operating margins. Our COM rate decreased slightly compared to the prior year, which is a positive sign going in to the second half, and our inventory balance is reasonable given our level of sales growth.

G&A costs were under control with most expenses below our internal business. In about half the categories we track we are below last year's actual, so we are very happy with expense control. Our compensation accruals are right where they should be given our performance. If our sales performance continues at the current level in Q3 and Q4, our accrual should be pretty linear and consequently, not put any pressure on our second half earnings. D&A and interest was about $900,000 below last year due to lower interest rates and lower than anticipated capital additions. Our tax rate remained consistent with Q1 at 40%.

All the factors I've just discussed led to a $0.06 or 24% increase in EPS for the quarter and our decision to raise guidance by another $0.06 for the full year, which represents up to 21% growth in EPS year after year. We are not changing our sales guidance and I will repeat the guidance at the end of my comments. Year-to-date, the trends were very similar to the quarter. We had solid sales and earnings growth, with the latter being higher than our expectations at the beginning of the year.

Moving on to the balance sheet and the cash flow, our accounts receivable, despite the $12.3 million increase in sales, decreased by $2.2 million compared to year-end and by $100,000 compared to June 30, 2008. DSOs remained steady at 48 days since Q1, a four-day improvement over our DSOs a year ago. AR of 120 days was $13.2 million, that's a $200,000 decrease compared to a year ago and that makes us very happy with the quality of our receivables, which has improved. And we are comfortable with our reserve for doubtful accounts. Overall, our collections remain strong.

Inventory increased by $800,000 to $86.8 million from $86 million at 12/31/08. Our sales backlog was strong at quarter end. Capital additions for the quarter was 3.3 million, which was 1.4 million less than last year, as we have made a concerted effort to control capital projects. Our cash flow from operations in Q2 was $24.5 million. That is a $4.5 million improvement over last year. For the year, we now stand at $20.8 million. That is an $8.2 million improvement compared to 2008. The improved cash flow was due to a combination of our earnings growth and good control of our working capital.

Liquidity. As a company, we have total liquidity of $114.1 million, comprised of $76.4 million in cash and $37.7 million in availability on our revolver. So that liquidity, important liquidity number continues to improve quarter over quarter. As a result of our strong cash balances and operating results, we repaid the $15.3 million that we had borrowed on a revolver in early July, so that was repaid just after the end of the quarter. The company continues to have more than adequate cash and borrowing capacity to conduct operations and execute our plans.

And moving on to guidance, we are reiterating our sales guidance that was established during our February 11, 2009 Q4 conference call, with calls for sales in a range of $750 million to $760 million. That is a growth rate of up to 8.1%. We are increasing our full year EPS guidance by $0.06, that's the $0.03 from this quarter and an additional $0.03 for the second half. That makes our new guidance 1.02 to 1.04, which is a growth rate of up to 21%. We also are keeping our guidance that we want to improve our EBITDA margins by 20 to 40 basis points and that we will deliver 40 to $50 million in cash flow from operations. We will probably be at the high end of that range. That concludes my remarks and I am going to turn the call back over to Tom Kirk.

Thanks, George. Let me take a few moments and provide a little bit of color on some of the business drivers from an operations perspective. First, HPO, our patient care division, achieved a $6.9 million increase in sales, which equates to 4.4% same center sales growth for the quarter. Now the performance for this quarter is partially based on the rollout of the January 1, 2009 5% CPIU increase, which impacts about 30% of our book of business this year. This combined with the rollout of the last two years' increases to our commercial book of business translates to about 2 to 2.5% of the 4.4%, with the balance of the growth attributable to volume and to mix and we break those down about 75% volume and 25% mix.

The other programs impacting the volume and mix areas are first, the continued improvement in our Linkia book of business. Let me again remind you as I have in prior quarters that HPO is the primary vehicle for the delivery of most of the services under the Linkia contract. On an overall basis, the revenue from the Linkia designated contracts is up over 9.5% compared to the comparable first half of last year. The second point that is driving our business is the continuing education of our referral sources on the enhanced lifelike features of our high-performing products, such as our microprocessor prosthetic arms, hands, knees, feet and other kinds of components.

For the first half of this year, the revenues from these product lines were up almost 20% compared to the comparable first half last year. The third area are our patient evaluation clinics, which have produced approximately 14% in terms of incremental revenues as compared to the first half of last year, and I think you will remember that these patient evaluation clinics are an opportunity to bring our patients back and provide education for them in terms of fit and functionality of their device and then they are turned over to the local prosthesis for execution of whatever their needs may be.

And fourth are our continuing 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 implement the activities to translate those plans into results, namely as our business development managers that are out in the field.

One of the things I wanted to note is that the percentage of unemployment currently stands at 9.5% for the US average. Now that is up from 8.5% during the first quarter of '09 and is considerably up from the 5.6% at the end of Q2 last year. We know in our business that as the unemployment rate rises, it creates additional challenges in terms of securing reimbursement for our patients so that they can afford the treatment they need.

We have been working with some of our patients to help them identify other sources of assistance for their co pays. We are managing through these on a case-by-case business. Now the government subsidy ahs certainly helped us in this regard and as you will recall, part of the stimulus act was to make monies available so that people could continue in their COBRA and have some ability to have insurance coverage when they are unemployed. But to date, our patients are receiving the care they need and we are getting the appropriate reimbursement.

I also want to point out that we are in the middle of a high period of legislative activity on healthcare reform, and as a result of this, we have intensified our efforts in working with our allied patient advocates and trade associations to ensure that our message is heard. We continue to support the Amputee Coalition of America on educating state legislatures on the issues involved with reimbursement caps and how these deprive patients of quality care and doom them to lower levels of mobility. Currently there are 17 states that have passed parity, nine this year, and we have almost 30 others that are working on parity legislation as we speak.

On the Federal level, the Medicare Orthotics and Prosthetics Improvement Bill and the Prosthetics and Custom Orthotics Parity Act have been introduced into the House and we have been trying to gather support in the Senate for these bills. These are very important bills in terms of assuring our patients quality care, and I might add that the Medicare Orthotics and Prosthetics Improvement Bill acts to save over $200 million a year, so when this is scored out over ten years, which we are hearing a lot about, it certainly adds benefit in terms of reducing costs and ensuring quality delivery of services.

In addition to these acts, we are also watching closely the two healthcare reform bills that are moving in the Senate and the Tricom bill that is in the House to make certain the provisions contain an understanding of the services we offer and their value to our patients, and this certainly is a very, very conscious effort that we are mounting with our trade associations and carefully monitoring the language to ensure that these things contain the right provision.

So let's move over to SPS. Their outside sales were up approximately $900,000 or 4.2% compared to the second quarter of '08. This growth rate is a bit lower than we've seen over the past several quarters, but let's remember that these are trying times and they are comping against a very tough quarter where they grew in excess of 20% last year in their second quarter. SPS is continuing to utilize all of its tools, such as superior customer service, education and training courses and their electronic catalog and ordering.

We believe these benefits are attractive to the practitioners and they have told us so and it ultimately will result in incremental business as we go into the future. SureFit, which was an acquisition that we made approximately two years ago, has now improved its infrastructure and its processes so that they have all been reengineered and now it is really appropriate to augment the in-house sales team with an external sales force. So we are adding resources to that area. We are bringing in new field sales and marketing personnel to increase the penetration into the podiatry market and to introduce a new line of shoe designs. These steps, along with introducing a new 3D scanner, will be the focus of the second half of the year for this business.

Let's turn back over to Linkia for a second. Linkia continues to execute its dual mission of building volume while negotiating a fair price for the services provided by the providers within its network. Payors tell us that they recognize the value that Linkia brings to them in helping them control cost while ensuring good clinical care and high levels of customer satisfaction. Their sales, as I mentioned before, are up over 9% for the year and the quarter, clearly a validation of their offering. The network consists of the Hanger patient care centers and independent providers and it has held steady at about the same number, that is 310 since the last quarter. We do expect this number to fluctuate a bit from time to time, depending on our book of business and the success of our acquisition programs.

In addition, Linkia is advancing the piloting of other services that they could incorporate into their model to provide benefit to the payors. And on the marketing side, they have ongoing discussions and negotiations with key national and large regional healthcare management companies, as well as the firms in the workman's compensation segment.

Now let's turn our attention to innovative Neurotronics. Their sales were below those of Q2 and H1 of 2008. This is because last year's sales were positively impacted by a large international order and the coverage that we received on Good Morning America in Q1, which continued to be a source of leads for several months following the airing of that show. Sales for the quarter are off about 40% compared to the comparable quarter of last year. We are making some changes in our marketing and reimbursement programs and believe that we will achieve enterprise revenues comparable to those that we achieved in 2008.

As an example of these changes, we have been adding resources to our reimbursement desk, which you will recall, we initiated last quarter once the standing non-coverage decision was overturned by CMS. This desk works as an advocate for our patients in trying to secure reimbursement for our patients from the third party payors. To date, over 500 claims have been processed and we have secured approval on about 20% of these, with the remainder still in the process. Now I can't require several iterations of appeal until final resolution, but we are getting approval on the authorizations and this is working and as time moves on, we will establish a legacy in these insurance companies at providing coverage for those that need the care.

Medicare continues to cover and reimburse us for patients with incomplete spinal conditions that can benefit from the WalkAide. On that topic, a patient with an incomplete spinal condition a as a result of a snowboarding accident was just featured last week on the CBS Early Show, that without WalkAide and the with WalkAide tapes of her walking were absolutely dramatic. As to be expected, we received several thousand inquiries as a result of this piece, which we are now currently qualifying those leads and following up on them and we expect them to be similar sources of revenue as we saw from the Good Morning America show last year. So it really takes several months to work through all those leads and convert them into revenue.

We are continuing with the analysis of the data from the clinical trials for stroke patients while working with the appropriate agencies and associations to look at the best measurements for all indications. Recent consultations with CMS indicate that additional studies to validate different endpoints are going to be required in order to fully address the recently adopted criteria by which they judge stroke rehabilitation progress.

We are currently compiling the necessary protocols and the research design packages as well as contacting the outside agencies where these studies will be performed. It is our intent to move forward expeditiously in launching these supplemental studies once all the necessary clearances are secured, so that these studies will be in total compliance with the new CMS study procedures. We are also continuing to work with certain patient advocate groups and research hospitals such as NIH, who have expressed interest in launching new studies on indications that are germane to their membership, such as MS and CP.

Again, I want to remind you that this dual track of public and private is the same progression that we went through to gain reimbursement on the MPKs and other ONP devices. We are confident that this is the best route and we have stated publicly that 2009 will be a transition year for WalkAide. With the requirement for additional studies, we do not expect to submit an application for Medicare coverage on the stroke indication earlier than the second half of 2010.

And finally, a few words on acquisitions and other developmental projects. We continue to pursue strategic acquisitions. In 2009, we are targeting to complete acquisitions which would have about 18 to 20 million in annualized sales. The strategy is to look for tuck-in candidates that have strategic value to us in the form of location, quality practitioners and/or favorable product service mix. On the development front, we have made some progress and we have initiated pilots on those that were launched in Q4 of last year and the first half of this year and we will be speaking publicly about those later this year.

In closing, I am proud of what we have been able to accomplish this year despite the negative environment. We have been able to hold the line or in some cases, cut costs comparable to the prior year, and at the same time, continue to provide unsurpassed service to our patients and our customers. We fully intend to continue to embrace the revenue generation and cost containment initiatives that made us successful in the first half of this year. Thank you very much for your attention and I will now turn it over to Andrea to open up the line for questions.

(Operator Instructions)

Your first question comes from the line of Larry Solow from CJS Securities. Your line is open.

Good morning, Larry.

Good morning. Could you just clarify, there has been some controversy in the market over the CPIU, which was obviously down for June. We know that is kind of what the government looks at in terms of decreasing, and historically, I don't believe that is only used as an inflationary measure. But can you just clarify that? Because I know there was some talk since it was down 1.5%, you could actually have a price decrease?

Sure, Larry. The CPIU year-over-year has decreased by about 1.4%. Under the legislation as it is currently written, the MedPAC group looks at the CPIU along with any other indicators that they may have to determine what is the magnitude of the increase and I want to emphasize that word because when you read the statutes, what you see is that word, increase. There is no mention of decrease. So I believe that it has been contemplated in the legislature that we should receive an increase.

However, we know that historically there have been periods, most recently 2004, '05, and '06 where we were absolutely frozen and there was positive movement on the CPIU. So the government does have the right and the power to come back in and by legislative approval, to either endorse whatever MedPAC may recommend for an increase or they may choose to overrule that. But as we read the statute, there is nothing in there that by law authorizes them to decrease. But as we are dealing with Congress, this could change.

So we of course are trying to get clarity on that by trying to understand where CMS is on this. But it is our interpretation and we have gone out for some outside legal opinions on this that in fact what we may see is a zero amount, but we don't believe at the current time and we'll certainly inform you once the decision is finally made by CMS, that they under the existing statutes could actually decrease our fee schedule.

All right. So it seems like it would take an act of Congress in some shape or form?

That's our belief and as we try to understand where is the mind of Congress and the current administration, we've recently seen where the administration came out and in terms of cost of living for Social Security recipients, they have frozen that at zero and just said it is going to be flat for 2010 and possibly 2011. There is no question that the cost of living for Social Security recipients follows the CPI, perhaps not the CPIU. So if we were to take in an indication from that on where their minds are, I would come down with more of, it may be zero but I don't see it being negative, with that hopefully being a precedent-setting event on the Social Security.

Got you. And remind us, if it is a zero increase, you would still get, just based on lagging and private contracts, approximately 2% price in your favor? Is that correct in 2010?

Yes. The existing contracts would roll through and we would go through and look at the mix of those. But it would probably be somewhere between 1.5% and 2%, the tail that would report into our business.

Okay. Then in terms of WalkAide, just to clarify, so you now don't expect to file with the CMS until at least middle part of calendar 2010?

That is correct. We are going to have to go back and do some supplementary tests on different measures that they believe are more effective in terms of indicating improvement over existing technology for stroke recovery. So we are working with them to design the protocols and establish the research design and we have contacted about 15 research institutions around the country to ensure that once that is locked down, that we can move quickly with them on securing IRBs and getting these things up and going.

But it is our expectation based on what we know today that probably we would not be filing a submission for coverage until the second half. So by that, I am really looking at Q3 or early Q4 of 2010. Now there is a possibility it could go faster, but just trying to set expectations where we think they are going to come down.

Now would you still expect reimbursement approval, especially on the private side, to obviously it is a dual track and you have a lot of other efforts going besides CMS. So would you still expect, it is reasonable to expect WalkAide to grow in 2010 without CMS approval?

We believe so, because the reimbursement desk that we have put in is seeing increased volumes. Our practitioners and the practitioners that are in the independent side that are also featuring WalkAide are making their submissions to the desk and that flow is growing. We are adding additional resources and as I mentioned, we have been getting authorizations in 20% of the cases. Now that is not to say that the other 80% are not going to get authorized. We recognize it is a new product and we handle each one individually and sometimes, it takes up to three iterations of appeals before we get it finalized, hence the consumption of resources.

But we are seeing what happens over time as the medical directors and the insurance companies become more knowledgeable about the advantages of the device, which happens through these iterations, that they are now understanding how it works and which people, which patient populations are best suited to have a WalkAide. Now that is a long way around saying, we think it is going to get easier over time. But we know that it is going to be a process and it is going to take some effort. So I don't want to go there. We are certainly seeing that familiarity does help us in this respect. So yes, the answer is we'd get reimbursement.

Okay. And it does sound like, just to clarify, you were expecting $15 million in 2009 and now it seems more like $10 million or so, kind of similar to last year's levels?

That is correct, Larry.

Okay.

And as I have said, we want to certainly impact it in every positive way. So we have made and are making a number of marketing changes in addition to that reimbursement desk to try to counter this sort of sluggish behavior. But it is all part of the launch and we think that what we are seeing is once patients recognize that they can achieve reimbursement, this will pick up a little bit. But there is no question that the more we discuss this, the more that people get into their head that reimbursement is right around the corner, that they have been delaying or dragging their feet when it comes to Medicare reimbursement, waiting to get that approval so they don't have to pay for it, so.

Right. And your $10 million number I guess would still assume you would have to get pretty decent growth in the second half of the year, because clearly you are not, right? Because I imagine it's -- you didn't give the number, but it is 40% below last year, so it is running in the 3, 4 million for the first half of the year, is that about right?

That is right, Larry. You are good with that math. Yes, but we do expect to pick up certainly the Early Show and our PR department has been working feverishly to establish ourselves on some other networks and well-known entities to showcase the device.

Okay, great. Thank you very much.

Thank you, Larry.

Your next question comes from the line of [Brian Takino] from Barclays Capital. Your line is open.

Good morning, Brian.

Good morning, guys. Just wanted to ask a couple questions here on the 4.4 same store sales growth, can you break out the components of volume and pricing there?

Sure. Sort of the macro numbers are that we attribute 2% to 2.5% to price, so if we go back and look at how much was the overall increase, there was about almost $7 million. So what we are really saying here is that a little more than half of that is coming from price, and the other half is coming from volume and mix. So let's just say that we have got about $3 million to $3.5 million coming from volume and mix and three-quarters of that comes from the volume side and one-quarter of that comes from the mix side.

I mean, certainly on that mix, that is why we try to highlight the impact of the high-tech products, where functionality levels are higher, so instead of receiving a device where they would be less functional, we test them out, they go through an elaborate, we call it a protocol testing and it is actually called the [PAVIT] in the case of the microprocessor lower extremity, and we rate them to see if they would be a candidate for a higher-performing knee, and if they are, in fact, then we work with their doctors and their insurance companies to get them into that knee and that is the portion of the business that we mentioned the first half of this year has grown about 20%.

Great. And on that note, I know you guys gave us 34% in Q1 for the high-end devices, so implying that there was a decline in the growth. Is that expected to be kind of declining throughout the year, or I just want to know what your expectations were there?

We did see a slowdown from Q1 in this area. We are, I guess pleasantly surprised that it is holding up this strong. Our lower extremity is very strong. Our upper extremity benefited from an extraordinary device last year called the iLimb, which is the fully articulating hand, that hit the market by storm and of course, we are, I guess, short story is we are comping against a pretty tough quarter last year when we sold a lot of iLimbs and everybody that had the right kind of upper extremity suddenly wanted to move up from the classic to the fully articulating hand.

So we are comping against a tough quarter. In terms of looking to Q3 and Q4, it is our expectation that the lower extremity will hold up, I think the upper extremity will perform much as Q2. I think we will be perhaps around Q2 or a little bit stronger for Q3 and Q4. So we are expecting to see some turn up of that, but probably not to the levels that we experienced last year, simply because of this condition in the upper extremity side.

And we also have to remember that some of these things are sort of cyclical. While it is a recurring business, what we have been able to note historically is that we will have a big year, and then the next two years are not quite as dramatic. But it almost runs in a three-year cycle here.

Okay, thanks. And then on the CapEx, I know, George, you had mentioned it is coming down a little bit. Can you just kind of flush out where the reduction in CapEx is coming from, maybe places where you are holding back on the spending?

Well, it is mostly in the maintenance CapEx. We are just trying to keep our projects at a point where they make sense from a return standpoint. So we are holding off on projects that don't have good ROI or have a -- maybe they were acceptable levels in prior years, but we are putting a little tougher standard on it this year. And we are also looking at new projects just a second time around and either trying to push them into the latter half of the year or into next year.

Okay, and then, I guess you mentioned that is the reason for D&A being a little bit lower in the quarter. Is that expected throughout the year?

Yes, we had two things happen in D&A. We had lower CapEx. We also had the original OPS system, which is being depreciated over five years and that depreciation ended last quarter, so we should get some benefit from that in Q3 and Q4 until the next going system is put into service. But we do expect slightly higher CapEx in the second half, which will -- so the savings won't be comparable to what they were this quarter. We should see a little higher depreciation, but not as high as what we originally expected.

Got it. And then just one last one here on the cost savings going forward. I know you had highlighted the cost of materials as your patient business ran throughout the year, the potential for cost of materials to come down a bit. Is that still your expectation?

Yes, it is. We do, Tom mentioned we expect the WalkAide sales to ramp back up in the second half from their current levels. We obviously have a better comp rate on those sales. And with the high-end upper extremities and lower extremity prosthetic devices being a little lower than prior years, they have more dollars of profit per transaction, but they have higher cost of materials. So that will also benefit our materials and we do expect to see our ROE to be somewhat lower in the second half.

Great, thanks a lot, guys.

Thank you.

Your next question comes from the line of Greg Williams from Sidoti and Company. Your line is open.

Good morning, guys. Thanks for taking my call. Just wanted to ask you again, with the application being delayed to the second half in time for WalkAide stroke victims, does that mean your -- are you ramping up at all the MS and CP reimbursement process at all?

Certainly they are part of our reimbursement desk. And we are pursuing those as they come in the reimbursement desk operates across all the patient indications. So that is certainly in place. We have, as I mentioned, some ongoing discussions. They are actually beyond the discussion stage. We are into research and design with other institutions, one of which is NIH. We have several others and they are primarily interested in conducting studies in these other indications and the MS Association itself is very impressed with the WalkAide and has been discussing with us how we could partner together with some of their backing and their medical directors to design a study specific to their patient population.

So the answer is yes, those too will have to move forward through the combination of working with the private payors through the reimbursement desk and working with these outside associations and institutions to get some studies moving on those specific populations. And of course as you now, the incomplete spinal has been approved by Medicare and we are getting reimbursed on those.

Okay, so for MS and CP, you are tracking probably towards early 2011 timeframe then?

I think it is safe to say that that is going to fall in line with the stroke, which would be submission for approvals in probably the second half of 2010 and then actually being operating or operating on that reimbursable fee schedule in '11, yes.

Okay. And just trying to get my arms around the cost controls, you guys did a great job there. I mean, you talked a little about cost of materials just before. How much of it is really permanent cost controls, like headcount reductions, versus what we are going to see with costs coming back as revenue picks up?

Well, I would say, first of all on headcount, we have not done reductions but we are being very judicious in terms of adding heads and that has helped us improve our efficiency as an organization, because we are not adding a lot of cost there. In the other areas, we across the board as an organization have been just prudent with regard to travel, with regard to professional fees, marketing expenses and while we may spend more in the marketing side in the second half, we don't intend to take the lid off the jar on any other expenses. We just intend to keep on being prudent in the second half.

Okay. And Tom, last quarter you mentioned just business opportunities sort of outside the scope of your own services as additional opportunities. Is there any more news on that front?

As I mentioned toward the end of my comments, we are pursuing those opportunities. We have pilots that are up and running and I will tell you that one of the pilots has increased its volume about 50% over last year, still getting traction in the marketplace. We believe that it is prudent to hold off until the second half to come forward with those for two reasons. One, we want to make sure that we've got a perfectly scalable model in place with all the systems and the people that are required.

And secondly is that it is probably a little bit more on the selfish side. We just really don't want to go out and telegraph our strategy to any would-be competitors. But that is sort of the long answer. The short answer is absolutely. These things are alive and well and are growing and we are looking at those to add to our future portfolio mix as we are putting together our five-year, which we do every couple of years, our five-year strategic plan for the Company. So we will be talking about those a little later this year and not only what they are, but what they could mean to the Company.

Okay, thanks, guys.

Thank you.

Your next question comes from the line of Mike Petusky from Noble Research. Your line is open.

Good morning.

Good morning, Mike. How are you?

Hi, Mike.

We are doing great. Hope you guys are. A couple questions. In terms of acquisition opportunities, intuitively I guess I would think that with a weakening economy, rising unemployment, or weak economy, rising unemployment and this potential, at least freeze or possibly small cut in pricing, I mean, I would think that maybe some of these small mom-and-pops that don't have your scale might be, I guess, more interested in looking at selling their businesses. Are you guys seeing anything either in terms of multiples coming down or more opportunities or can you just talk about that?

Sure. Currently we have a very full pipeline of opportunities, perhaps the fullest it has ever been in terms of just candidates that are approaching us to see if there is some sort of an exit strategy that we can execute together. That has not resulted in any reduction in the multiples. We are still looking at about 4.5 to 5.5 times the as found EBITDA as pretty much the norm for what these businesses are going for. In the case where there are special opportunities because of location, practitioners, that may rise up a little bit or the quality of the business.

So we are seeing higher flow, but as these are exit strategies for some of the folks and these are their children, if you will, they have built these things, we are not seeing them go to fire sale measures at all. Now I think this could change a bit. Certainly if CMS makes up its mind that they are going to provide zero increase or some of the other healthcare reform acts in such a way where people are seeing more patient flow, i.e. 47 million more people coming into the system at reduced rates, people are going to have to find some alternative way of improving their productivity, which is very difficult for a mom-and-pop.

That usually ends up meaning more hours in the lab on Friday night and Saturday. So that may start to impact the mentality of some of the folks out there that perhaps are looking to get out and just don't want to dedicate themselves to that kind of patient flow. We will see what happens over the next six months, but suffice it to say we are in active discussions with a full pipeline of folks out there.

All right, great. And in terms of the positive coverage decisions that you guys have gotten for WalkAide from commercial insurance, are there certain characteristics either in terms of disease state, is it mostly stroke, is it mostly MS, are these younger folks, middle-aged, older? I mean, can you characterize where you are getting the positive coverage decisions and I guess, why you are getting the positive coverage decisions when you are?

Sure. Just by looking at our database, it sort of parallels the percentage of the disease indication in the population. We are seeing more stroke patients than anyone else. But I don't want to discount the MS patient, because typically the MS patient is younger and is a lot more aggressive in trying to find a solution to their problem, their disease is long term. The stroke patient is a bit older and not as aggressive in pursuing treatment. I think the one commonality on all of these patients and as I mentioned, we have to go through each of these individually, is what will the WalkAide bring to them compared to the known and accepted alternative technology, which is an AFO?

If this is a case where a patient is not desirous of being mobile or incapable of being movie, then the WalkAide is really not going to help them that much. If they have got other significant problems and for the most part, they are bound to a wheelchair because of the rehabilitation factors of their disease or condition, then the WalkAide is really not going to help them.

So we have to go through each one of these, and I would say the key indicator of whether or not the insurance company deems them worthy of coverage is their ability to fully utilize what a WalkAide could bring, which is in terms of enhanced mobility, their ability to walk, what is their age, what is their [lytocell], et cetera, et cetera. So we build a complete dossier on each one.

They end up being multiple pages long with doctors getting involved to certify on the benefits. So it is very difficult to say that this is the key condition. Conditions are spread across all indications and it really comes down to their ability to utilize that device and how seriously affected they are from their specific disease. And by building up that case of improved mobility and how that helps through all the other co-morbidities they may have, that is the way we are getting the reimbursement.

And then just one, I guess, additional question on WalkAide. In terms of what CMS needs from you guys, I mean, do you have any sense of how many patients you are going to need to run through this, what additional types of information do they need? I mean, what supplemental, I guess, protocols, do you -- I mean, essentially what didn't you have with the first group that you need to get with the second group?

Sure, sure. Well, CMS has not published anything per se to date that says these are the things that we must have. These have come out through various discussion and of course, we know that they held a symposium, and in that symposium, they brought doctors in from NIH and Cleveland Clinic and out of that, I don't think the results have been published in final form yet, that is where these new criteria have really come from.

And the consultations we have had with some of those doctors and with CMS, they have indicated that they are looking for some supplemental endpoints. We do have that information. What we have done with that in terms of what are those measurements they want that we didn't have before, we are also working with them to say what is an effective way of gathering that information and measuring improvement on that endpoint? That is where all of our discussions are at the current time, Mike.

So while we have got our arms around that, that is part of what the research protocols, the end points and what the trials all look like. So I think it would be unfair of me to characterize those things at the present time until they are really finalized for two reasons. One is that I am not totally knowledgeable about all of those, but our folks are and secondly, I don't want to, in this call, bias the formation of the effective research protocols.

This really needs to be tailor-made to what CMS and those doctors think are the good indications and as soon as we lock that down, as soon as we've nailed down these 15-plus institutions that are out there and working with their IRBs, we will be in a better position to comment exactly on what they are, what the significant population size would be and from that significant population size, would expect the kind of performance in terms of alpha and beta, then we could take a look at how fast we could get that population in. That would give us some clue as to size and duration of the test. So that is exactly what we have been doing over the past 30 days.

Okay. And Tom, I guess Part B to that question, I guess since you have given just a general timeframe and I know you haven't exactly put this in stone, but you have an expectation that you will be able to file somewhere, I guess, 12 to -- let's just call it 12 to 18 months from now. To me, it would seem to indicate that at least your initial take on this is that the supplemental work really won't be not quite, at least not quite as involved as the initial studies. Is that a fair assumption?

That is correct, very good assumption, Mike. We want to build on what we have, get these new endpoints and move forward. And I guess just one thing that gives me some comfort around all this, the inventor of the device has conducted and I think we have mentioned this to you in the past, has conducted some trials around certain measures that were those that were in favor, when he conducted his trial.

And he has informed us that his trial has been accepted to the peer review process and is going to be published, to prematurely talk about what the Journal will be or when it will be published. But it certainly, I think, speaks volumes to what you have just said, in that the base work is out there. Some of those measures have historically been accepted and will give us the ability to build on those and add on these other measurements so that we can have a complete dossier.

Okay, all right, great. Thank you.

Thank you, Mike.

Your next question comes from the line of Daniel Owczarski from Avondale Partners. Your line is open.

Yes, thanks. Good morning.

Good morning, Dan. How are you?

Good. Tom, can you talk a little bit more about the unemployment rate as in how it impacts your business? From what I understand, that patients are still receiving care even though you have these dramatic increases, so it doesn't seem like you guys are impacted yet, I guess. Is that fair? And then two, when you have seen other economic downturns and maybe some spikes in unemployment, is there a certain lag time before you see it impacting your business?

Good question. What we have seen and we know that there is a rough measure for every 1% increase in unemployment, about 2.5 million people fall off of the insured ranks. Now that is certainly the primary wage earner as well as the dependents that he or she may have. If we take that as a percentage of the population, when we have seen an increase of four to five points that we are currently seeing, depending on the region of the country, that becomes rather significant.

Two things have acted to mitigate that. One is the government through the stimulus act has put out supplemental payments to keep people into COBRA and to help them afford COBRA, whereas historically when they lost their job, they really had to pay for COBRA out of their severance or whatever savings they had. So this has been a tremendous assistance and the COBRA is running out there an extra 12 or 18 months. So that is number one, that we haven't seen that drop in insurance coverage to the same extent as before.

Number two, it still brings up the issue of the co pay, because even though you have insurance, you have co pay and that is where I made the comment that we have been working a lot harder on trying to find ways to help people get their co pay taken care of. As one of our regional vice presidents has talked about, he said, I never knew that I was going to be so involved with so many community and church bake sales, because a good deal of this happens at the local level.

The other thing that we have found out is that a number of the states and large cities also have supplemental programs to assist people, either through vocational rehab or some other programs they have, on meeting their co pay. So what this has really done is placed a burden back on our people and the primary burden is through documentation and trying to assist them in explaining their case and why it is necessary to these other charitable groups.

Thus far, knock on wood, we have not seen any big, significant tail off. Now certainly there are some pockets that this occurs in more than others. We have been working with these people as a last desperation effort to design some programs where they can take care of their co pay over time. We also have set up some deals on the outside that if they are credit-worthy, they can go to the outside and through CareCredit, for example, they can finance this over time if they are good, credit-worthy people.

So there are measures that are in place today that certainly make this deterioration of the employment stat not as impactful as it has been historically. I think the big question that we are all asking is when is the turnaround going to occur, because what we have been able to do is insulate ourselves a little bit from the hard shock. But over time, if this continues to languish, it will be more trying.

Typically, what we have seen in other areas when there has been some sort of deterioration in employment, but again, not under the same conditions and certainly not as dramatic as today, is that our lag is about six to nine months, which should say that we should be seeing this kind of performance right now. We haven't seen that. We even monitor our maintenance codes to see if those are changing, and there has not been a significant run-up in those.

So what we are really trying to balance is, how quickly is this economy going to come back up and some people are going to get restoration of their income-producing capability, versus this sort of tail and lag that you've talked about. And no one really knows the answer. Will the stimulus programs kick in and unemployment will start to go down? I think the forecast is that we are going to hang around the nine to ten for the next quarter or two and then it will start to go down.

So we are just managing our way through it and unfortunately, because of the pluses and minuses, past precedent doesn't really help us too much in trying to understand what we are doing. But we have told all of our folks at the local levels that this is the time that they really have to get involved with the community. This is the time that they need to get out in front of this and have these alternative sources in their back pockets, so when our patients come in, we are prepared to help them. So I wish I had a more definitive answer on what this tail is going to look like, but presently don't really have any view on that.

No, that is very helpful. And then just one quickie on the distribution business. It was up, what, 10% in the first quarter, 4% in the second. Do you have expectations or can you share expectations for the rest of the year growth, what we should look for with SPS?

Sure. Remember, they were comping against a pretty tough quarter out there. For the rest of the year, we think this is going to come back up a little bit. We believe that the floor was a bit low. I think we are looking at SPS in the high single digits for this year, maybe close to pushing the 10%. They have some new marketing programs and they are also talking about some of the realignment in terms of their services.

If you remember a couple of years ago, we put a warehouse in the Pennsylvania area enabling us to better service the Northeast, and that has paid dividends. And so we are looking at other areas where perhaps a similar kind of move could help us out a little bit. But high single digits for the year would probably be pretty respectful in this economy.

Okay, thank you.

Thank you, Dan.

This concludes our allotted time for questions. I will turn the call back over to yourself, Mr. Kirk.

Well, thank you very much for being with us. We certainly know what our work has to be for Q3 and we will look forward to talking to you at the end of Q3, which will be at about the end of October when we have our next call. Thank you again and good day.

This concludes today's conference call and you may now disconnect.