Hanger Inc (HNGR) 2010 Q3 法說會逐字稿

Good morning. My name is Kyle, and I will be your conference operator today. At this time I'd like to welcome everyone to the Hanger Orthopedics Group's third quarter results conference call. (Operator Instructions) Thank you. Mr. Kirk, you may begin your conference.

Thank you, Kyle. Good morning to everyone and welcome to Hanger Orthopedics Group's discussion of our third quarter results. Before starting the discussion, let me ask Tom Hofmeister, our Chief Accounting Officer and Director of Investor Relations, to review with you our declaration on forward-looking statements. Tom?

Good morning.

During this call, management will make forward-looking statements related 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. These include the Company's ability to enter into and derive benefits from managed care contracts, the demands 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.

Thank you, Tom. In addition to Tom Hofmeister, I'm also joined this morning with George McHenry, our EVP and Chief Financial Officer.

If we step back from the quarter, on an overall basis, I think there's several noteworthy points. We grew our consolidated sales by 7.5% over the third quarter of last year. This sales performance, combined with cost management, yielded $0.37 earnings per share and excluding the costs associated with our relocation of our corporate office here to Austin and the costs associated with the diligence efforts surrounding Accelerated Care Plus.

Now, this earnings per share equates to a 23.3% growth over last year's third quarter and this makes the 19th consecutive quarter where we have met or exceeded first call estimates. In addition, I just want to note that we've completed our corporate office relocation to Austin on time and within budget and we recently announced the signing of a definitive agreement to purchase Accelerated Care Plus. It certainly has been a busy quarter.

Now let me turn this over to George, who will review our financial results and balance sheet changes in detail.

Thank you, Tom. Good morning, everyone and thank you for joining us.

Q3 was really an outstanding quarter for the Company. The important takeaways are as follows. Our adjusted EPS, as Tom mentioned, of $0.37 represented 23.3% growth over the prior year, exceeding Street estimates. Our track record of consistent performance now dates back almost five years.

We increased operating leverage, excluding relocation expense, by 60 basis points through a combination of healthy sales growth and controlled spending. We experienced accelerated growth in all lines of our business. Our sales growth accelerated overall to 7.5% from 6.4% in Q2 and 5.4 in Q1. Comp sales in the Patient Care segment accelerated to a 4.1% increase, which was an improvement over 4.0% in Q2 and 3.6% in Q1 and our Distribution segment reported a healthy 10.5% increase compared to 10.4% in Q2, so they're doing very well.

Our com rate at 30.7% is comparable to the prior year, but slightly higher than the rate we expect for the full year. We continue to do an excellent job managing expenses. Personnel costs were below budgeted amounts and generated a considerable amount of operating leverage. Operating expenses were below budget overall and also contributed to EBITDA margin improvements. As I mentioned last quarter, our employees have to be commended for their efforts in this area, because they really make this work.

We moved into our new headquarters, as Tom mentioned, on schedule on August 16th. In this quarter we recorded $8.0 million in costs. The largest single charge included in this number was a $5.0 million reserve for rent related to the abandonment of our old headquarters in Bethesda, Maryland. These expenses are nonrecurring and are shown on a separate line item in our income statement.

D&A increased by $0.5 million compared to 2009, which is commensurate with the run rate of capital expenditures over the last 12 months.

All of these factors I have just discussed led to the 23.3% increase in adjusted EPS for the quarter.

Moving on to the nine months, overall performance for the first nine months was in line with our expectations in terms of sales and exceeded our expectations from an earnings perspective. Operating leverage has improved by 50 basis points, which exceeds our goal of 20 to 40 basis points.

Revenue growth improved to 6.5%, in the middle of our expected range, with HPO same-center sales increasing by 4.0% and our distribution business increasing 8.5%. Our com rate of 30.4% was equal to last year and is in line with our internal expectations.

Excluding the relocation costs, income from operations increased to 11.9%, a 50 basis point improvement. Year-to-date we have incurred $14.2 million of relocation costs, which is in line with our internal projections and guidance to the Street.

D&A was $1.0 million higher than last year due to higher capital additions and our tax rate today is approximately 37.3%. Some of that rate decrease was due to a FIN-48 release in Q2. Our rate for the full year should approximate 38%. Adjusted diluted EPS was $0.90, or an 18.4% increase over the prior year.

Moving on to the balance sheet and the cash flow, our AR balance was $104.6 million. We continue to do a commendable job collecting our cash. DSOs were 47 days, which is in the low end of the range we expect. We are comfortable with our reserve for doubtful accounts and our bad debt expense remains low at approximately 2.0%.

Inventory increased by $7.3 million to $98.6 million from $91.3 million at the end of last year. Inventory turns were 4x. Our sales backlog remained strong at quarter-end and we believe that our inventories are at an appropriate level to serve our patients.

Capital additions for the quarter were $7.1 million and $19.7 million year-to-date, which was $7.0 million higher than last year. We anticipate that our capital additions for the full year will be in the $25 million to $30 million range.

Cash flow provided from operations for the quarter was $32.5 million. That's a 7.1% -- I'm sorry, a $7.1 million increase over the prior year. We had an excellent cash-flow-generating quarter. For the nine months, cash flow from operations now stands at $38.9 million, compared to $46.1 million last year. The decrease is due to an increase in working capital and it was expected.

Liquidity, the Company currently has total liquidity of $159.1 million, comprised of $95.6 million in cash and $63.5 million in availability on our revolver. Total leverage per our bank calculation decreased to 2.5x, which is a historic low.

As Tom mentioned, our move to Austin is now complete and was completed on schedule. As I mentioned earlier, we moved into our new space on August 16th and it's pretty rare in construction schedules of this magnitude to be completed precisely on schedule. We will incur another $1.0 million to $2.0 million in relocation costs in Q4 as our remaining employees complete their moves.

Moving on to ACP and the refinance, we expect to close on the ACP transaction approximately on December 1st. We were extremely pleased with the market's reaction to our bond offering, which is expected to close on November 2nd. We expect to launch our bank financing next week. We will provide guidance for 2011, including the expected accretion from ACP and the refinance, as we normally do when we release our Q4 results.

Moving on to guidance, we are increasing our EPS guidance and reaffirming our sales guidance for 2010. We expect net sales in the range of $815 million to $825 million. That's a growth rate of between 7.2% and 8.5%. Our goal remains to improve adjusted EBITDA leverage by 20 to 40 basis points during 2010, although at this point we will likely exceed that goal for the full year.

Full year EPS guidance, excluding costs of relocating our corporate office and the acquisition of ACP, is being increased to $1.29 to $1.31.

Now I'm going to turn the call over to our CEO, Tom Kirk, to comment on operations.

Thanks, George. I'll take a few moments to add a little bit of color on the business drivers from an operations perspective.

First, our Patient Care segment achieved a $6.9 million increase, or 4.1%, same center sales growth for the quarter compared to Q3 of 2009. We estimate that approximately 1.0% to 1.5% of this increase can be attributed to price resulting from the roll forward of the fee schedule increases that we received in 2008 and 2009. And the balance of that growth, 4.1%, can be attributable to volume and mix and we estimate that that's about a 50-50 split here.

The key programs that are impacting volume and mix are the following. First, the continued improvement in our Linkia book of business. 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 is up by about 9.0% for the quarter and almost 10.5% for the year, compared to the comparable periods in 2009.

Second are our Patient Evaluation Clinics in which we call our patients in for an education session on their fit and function. This is an example of good patient care that provides incremental revenue. Revenues from this source provided more than $5.5 million of incremental revenue for the quarter.

And third 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, such as the opening of satellite offices and the launching of market programs.

Just a few words on the general environment in which our Patient Care division resides. We're still seeing high levels of unemployment. Currently, unemployment stands at 9.6% compared to 9.8% at the end of Q3 2004.

Our practitioners and administrators are continuing to work with our patients to identify other sources of assistance for their reimbursement, co-insurance and co-pays. This is a nagging problem that is beginning to take effect and if any of you say the "60 Minutes" program this past Sunday called "The 99ers", there is a portion of the population in general that's out there now that's been out of work for 99 weeks. So this has become a fulltime task that our people are engaged in, in helping patients find ways that they can cover their financial responsibilities.

We continue to work with the lawmakers and their staffs to educate them on the impact of the recently passed healthcare legislation on overall costs in patient care. We've developed white papers, which clearly show that the cost of incomplete or no O&P care far exceeds the cost of the care itself. Our partners in this effort are the Amputee Coalition of America, the American Orthotics and Prosthetic Association, the O&P Alliance and a number of the member advocate associations that sponsor care and support for patients suffering from MS, diabetes, etc.

This is a continuing effort that we have underway of making sure that as the legislatures, both at the state and federal level, look for ways to save money that they don't cut in the wrong place. Because our white papers and some of the papers by the states themselves, such as Colorado, clearly show that the long-term cost of not providing care far exceeds the cost of the care itself.

Turning to the new legislation, there are a series of pluses and minuses associated with this new act. First, it does admit over 30 million new potential patients into the system without rejection for preexisting conditions. Now this is a huge positive. We're still trying to understand the interpretation and the implementation of some of the other provisions in the new law.

At present, we have House and Senate versions of the Custom Orthotics and Prosthetics Parity Bill and we're working hard to build broader support base in the Congress for these bills.

In addition, we have been a strong supporter and counselor to CMS in their efforts to reduce the cost of fraud and abuse in the system and we've even worked with Shelly Berkly out of Nevada to introduce a bill into the House demanding that payments for O&P services be limited to those that are licensed and/or certified practitioners. And within the last couple of weeks I'm sure you all have seen where the OIG did crack down on a group of folks that were billing Medicare. In excess of $35 million was the amount that they billed Medicare and didn't provide any services. So we have been advocating for some time that CMS and the OIG really initiate actions against these folks, because they're giving the industry a bad name and they're sapping off funds that could be used for patient care.

Now let's turn our attention to SPS. Their outside sales were up approximately $2.4 million, or 10.5%, compared to the third quarter of 2009. During Q3, SPS reached an agreement with a major manufacturer to expand the amount of their products that SPS will carry. This further reinforces SPS's concept of hassle-free, one stop shopping. In addition, they've inked a deal with an electronic supply house to supplement SPS's own electronic purchasing system.

This gives us two paths to reach the practitioners that are out there much more user-friendly ways. So we believe that this will ultimately result in SPS's ability to capture a higher percentage of the business to the independent practitioners.

Next let's turn our attention to Linkia. They continue to execute their dual mission of building volume while negotiating a fair price for the services and the value they provide to their customers. The payors tells us that they recognize the value that Linkia brings to them in helping them control costs while ensuring good clinical care and high levels of customer satisfaction. The Linkia book of business, as I mentioned before, is up by 9.0% for the quarter and 10.4% for the year, clearly a validation of their valued offering.

Linkia continues to advance the pilot offering other services that they could incorporate into their model to provide benefit to the payors. Examples of these are building a mastectomy network, doing billing review for the payors to ensure that documentation is correct and that the services that have been provided are inline with the doctor's prescription. And on the marketing side, they are continuing discussions and negotiations with a key national and large regional healthcare management company, as well as firms in the Workman's Compensation segment.

The pipeline is full. This is an ongoing -- as we've talked about in prior quarters, its an ongoing effort to encourage these folks to understand the Linkia model and to sign up for either the preferred or the exclusive types of contracts that Linkia offers.

Let's now turn our attention to Innovative Neurotronics. Their sales for Q3 were comparable to Q3 of last year, but they're up about 22% on an overall basis for the year. We're continuing to work with the clinical sites to go through the IRB and contracting processes for our InStride pivotal clinical trial. In total, we're working with about 30 institutions and the enrolled patients are increasing.

I mentioned, during our last call, our pivotal study InStride will be a much larger, multicenter, randomized clinical trial. We continue to work closely with the FDA and CMS to make certain that the InStride trial proceeds appropriately to support the reimbursement and to provide meaningful clinical endpoints. The InStride trial is an FDA, IDE-approved trial to enroll 1,100 patients in 30 sites throughout the U.S. Currently, four sites are active and we hope to double this number by the end of the year.

In order to populate the trials, we have retained an outside firm to assist us in patient recruitment. In terms of a timeline, we anticipate complete patient enrollment in 2011. This is going to be dependent on site enrollment in a large part. We think we can get this job done. Once the study is complete, we will submit to the appropriate regulatory agencies and expect the data to be published in several peer magazines. We anticipate a 2012 submission of the data to FDA and CMS.

At the same time, we continue to work with third party payors to gain authorizations for our patients. To date, we are still seeing about a 70% success rate and we do recognize that these are an iterative process and sometimes we have to go through as many as four iterations and appeals before we actually get the authorization.

Now a few final words on our acquisition program. With the pending acquisition of ACP and its subsequent integration, we've pulled back a bit on our O&P acquisitions in Q3 and we expect this will continue into Q4.

We expect to end up slightly less than the normal $20 million to $22 million target of annualized sales. However, some of these deals in the pipeline will still close in Q1 of 2011. The pipeline remains active and we expect to come back to the $20 million to $22 million of annualized sales as a target in 2011. This will be comparable to prior years. As we've said in the past, 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.

As I mentioned in my opening comments and George reiterated the point, we've signed a definitive agreement to acquisition Accelerated Care Plus, which we refer to as "ACP". We expect this deal to close by December 1st. We view ACP as a new strategic growth platform. Historically, they've grown by 25% to 30% per year and we expect this to continue. The sources for this growth will be the 70% of the SNF market segment that they do not currently serve, new products and clinical modalities that they will bring to the market and the extension of their unique business model to other healthcare venues. We also see the opportunity to introduce Hanger's traditional business offerings to their relationships and customers.

All in all, these growth opportunities equate to more than $1.5 billion in revenue. Obviously we won't be able to capture them all, but even a small percentage of this will add significantly to Hanger shareholder value.

Finally, I'd just like to mention that we continue to operate in a changing and challenging environment. With issues like a stubbornly higher unemployment rate, states that are trying to close budget gaps, and dealing with federal regulations concerning healthcare. And throughout all of this, I'm very proud of our ability to grow the top-line despite this challenging environment. In addition, we've contained, and in some cases reduced, costs without sacrificing clinical and operational excellence. We expect these efforts to continue throughout this year and into 2011.

Thank you. Now I'll turn it over to Kyle, who'll open up our line for questions.

(Operator Instructions) David MacDonald, SunTrust Robinson Humphrey

Good morning, Dave.

Just a couple questions. Tom, I was wondering if you could provide a little bit more detail. A couple of the things you talked about was SPS - I just want to make sure I heard it right - that they had reached an agreement with a major manufacturer to sell more of their existing products? Or is this a completely new manufacturer that you'll start selling their products?

This is a well-known and existing supplier to the O&P industry, Dave. Currently, SPS sells a portion of their product line.

Okay.

And we have just reached an agreement to expand the number and types of products that SPS will handle. Historically, they have opted to sell a portion of the product line that we just picked up exclusively through their own internal sales efforts. And I think what they realized is that SPS has a far better reach into some of the smaller independents and therefore have allowed this portion of their product portfolio to come over to SPS.

And Tom, can you give us some sense of the scope of this? I mean, were you selling a quarter of their product line before, half, three-quarters, and now it's the full thing? Or just anything that can size it a little bit for us?

Sure. I think your estimates are pretty much on target. I would -- rough back-of-the-envelope estimate, we were selling probably about a quarter of their product line. There's two ways that we could look at this, Dave. We could look at it in terms of the number of products or we could look at it from a revenue perspective, in order to put those percentages on it. And if we're looking at it from the number of products, probably about 25% going to 50% would be appropriate.

If we looked at it from a revenue perspective, it would be a little bit smaller, maybe more like 15% going to 30% in terms of overall revenue. Because they will continue to market and sell their higher end, the more complicated, sophisticated, higher price point products with their own direct salesforce. But we're very pleased with this, because we think that, really, these products are always in high demand, a very high quality manufacturer and we think it will broaden our overall offering while increasing our revenues.

Okay and then just the other question on SPS about the electronic supply house. Can you just explain in a little more detail exactly what that does for you?

Certainly. Traditionally, SPS has used three mechanisms for securing sales. One is direct, face-to-face with their salesforce; two is orally over the phone with the customer service and you've heard me in the past talk about how excellent that is where the customer service folks will actually call the customer and remind then that "Perhaps you need to be checking, we believe your inventories may be down".

And the third way is SPS has an electronic purchasing system where practitioners can get on SPS's website and almost like an Amazon-style point, click, drop it in the basket and then order.

What they have just signed is there is a company that operates within the industry that is a provider of software to the industry, particularly appealing to the mom and pops. It's a modular-based practice management, inventory control, billing, accounts receivable. So they have a number of different modules and they have been very aggressive in going out and marketing this to some of the smaller manufactures who obviously can't afford to put their own custom system in.

One of the modules is a purchasing module, and in conjunction with that purchasing module, they have sort of a supermarket on the backend and that supermarket allows various manufactures to post up their products in an electronic catalog form. Which then enables those folks that have purchased this software to go in and purchase from the supermarket and SPS has just joined up with them.

And we think that that's going to be a nice help in terms of increasing the sales, because anyone that's on that system prefers to just stay right within the system, purchase materials, because it gives then an automatic link to the inventory management module. They're connected. So we think that this is going to help SPS in their ability to reach smaller folks in a very user-friendly way, consistent with their overall system that's in place.

Okay and then just on Linkia. Should we expect some additional managed care deals, clients coming on? And the other thing is maybe you have in the past, but haven't heard you speak a lot about the Worker's Comp opportunity with Linkia. Can you just spend a minute on that?

Sure. Linkia, as I mentioned, continues to negotiate with some of the large regionals and the nationals to try and move them. We're servicing them today, Dave, but not to the extent that we would like and we would like to get them up onto a preferred or an exclusive basis. So they're continuing to negotiate with those folks in trying to bring that value proposition to them so that they can see how this could save them some, quite a bit, of administrative money while improving their quality of care.

So that remains the goal, and when we talk about Linkia's growth rate of 9.0% to 11%, which they've been running for the last several years, that's attributable to two factors. One is, for those companies that we preferred contracts with, they continue to give us more and more share of their overall book of business. For example, one of them recently said, "We're not too pleased with what's going on in a certain portion of the country. Will you take that over?" Linkia obviously would agree to do so and we'll put the network in place to service those patients.

So that's one area of growth, is growing with our existing preferred. The second is by picking up new accounts, new folks where we can come in and provide the preferred or the exclusive relationship.

We know that our overall market is probably growing in the neighborhood of 1.0% to 1.5% on an overall basis. So, when Linkia is growing at 11%, I mean just the math alone is a key indicator of the kind of value they bring. It far exceeds the average growth rate, so that's why they're growing so much, is that they're continuing to bring new folks onboard and expand the existing ones and we expect that to continue.

Okay, thanks guys.

Larry Solow, CJS Securities

Good morning, Larry.

Tom, wonder if you could just spend a few minutes with the persistent high unemployment and sort of the lag or potential lagging impact of COBRA? Have you guys seen any significant or material change at all in your business trends or how that's impacting you?

I wouldn't go so far as to say "significant", but we certainly see some impact in our business, because the discussions go on, on a daily basis, about handling financial responsibility.

The impact to us is that, as I mentioned, we're spending more and more time, Larry, just trying to figure out ways that we can get people into their device. And so we have, for example, a patient right now that we're working with this fellow, who is looking for a leg, and we've provided documentation and information. He's working with a state vocational rehab and his local church who are trying to do some fundraisers for him.

So we are seeing one of the impacts of people that have either lost their insurance or secondarily, of people that maybe don't have the same level of coverage that they did in the past.

We're seeing some of our 99 codes, utilization of those codes, which are primarily dedicated to maintenance, going up a bit. And there's no question that if people can elect to delay by using more socks or other mechanisms, there is some of that going on and they're trying to maintain the devices. At the end of the day, obviously if an individual has to have an amputation, that's not elective surgery. They have to have it or there are going to be a lot more serious consequence.

So, in those cases, we're proceeding to work with them to figure out how we can get them covered. But we're seeing some people trying to stretch this out a bit. There's no question about it. We're at the cusp of the Baby Boomers beginning to hit and we don't know yet if some of these folks are trying to stretch this out so that they can get to be 65 and get on Medicare and get coverage that way.

But I think these tough economic times are taking their toll on people and I mean, we're not seeing a collapse in the business. But I will tell you that our administrators and practitioners out there are working harder for every sale, particularly with some of the troubled population that just don't have the coverage that they did three or four years ago.

Got you. So it sounds like you've had this pressure or a little bit of resistance for quite some time and maybe its not getting it worse, but not necessarily getting any better.

That's right. I think we're all very anxious to try and see the hiring start picking up and economic activity, but that's a broader discussion. But it is impacting those who have been out of work for some time and as I mentioned, the "60 Minutes" special was focused on San Jose, California where we all expect Silicon Valley to be a drop in the ocean. And I was aghast to see the number of folks out there with degrees - Bachelors, Masters, Doctors degrees - all looking for work. Anything that can be delayed is going to be delayed in these environments, because these folks are facing loss of home, etc, etc.

So our folks are doing the best they can and the manifestation of that is a lot more work on behalf of practitioners and administrators trying to help people find alternative sources so they can get this done or cover their financial responsibility.

Got you and then in terms of a -- maybe you can give us a little more color just on the sense of the scope of the OIG and the CMS investigations, which clearly you guys welcome. I mean, I think there was some, a little bit, of controversy in the market in the last few months. But has their investigations -- are they broadening? Are they expanding this investigation? Or is it just sort of pilot individual studies with potential expansion as we look out into '11?

I think the pilot phase is pretty much complete, as we understand it. They did some pilots in Miami-Dade down in Florida and in Los Angeles and they came away not at all upset with what I'll call "the traditional O&P industry". But it was a number of folks that had secured Medicare supplier numbers and they put investigators out in the field.

They went to the actual sites that were reported on the application and they didn't find anything. They found empty storefronts, etc, etc. And then, as they started digging deeper, they found out that these people were sometimes organized into almost like crime rings where they were stealing the identification numbers of doctors, social security numbers of patients and billing Medicare.

"60 Minutes" had a special on that. One guy that they had tracked down was a former drug dealer. He hustled Medicare out of $20 million and openly admitted that he never provided one device. There's a guy that Medicare's going after and that's why, of course, we believe the best way to lock that down is to link it all back to the certifee's number or the licensee's number on the bill. Because in order to get those, you have to be a reliable person.

But there's no question and certainly in our discussions. I mean, Medicare rang us up and asked us if we'd spend some time talking about the industry so that they could just understand how it works and we marched them through what certification is about, the educational qualifications, what licensure is about, residency and introduced them to how it all works. Obviously trying to push them in the direction of supporting this legislation, saying the only true barrier here would be to link this back to certification and licensed numbers.

I think they get it now and they're starting to examine things on a more careful basis and that, I think, was part of what led them to this Armenian-American roundup that they had a couple weeks ago where they found that these guys billed $35 million and provided nothing. So I think we're going to see the Medicare investigations increase. They're going to be targeted as these fraudulent folks. Because not only is it a source of embarrassment to Medicare when they don't have money to provide what they need to provide, it is actually siphoning off dollars that should be going to patient care.

So, I think you're going to see it intensify and frankly, we welcome that because it will put some sanity into and industry and the reason why prosthetics and orthotics are part of what this investigation is all about. These are high-ticket numbers and so why bill for an ordinary walker or a piece of DME equipment for $800,000-$900,000 if you can bill a $15,000 to $35,000 prosthetic leg. It's where the dollar are.

So I think you're going to see more and more action around this. But I don't think you're going to see it focusing on the actual traditional providers in the industry, because the system provides for quality care. It's the guys that aren't providing any care and they're illegitimate that they're going after.

Okay and then, if I just look at your guidance, you didn't change your revenue guidance. So it's $815 million to $825 million. That sort of implies a pretty nice acceleration. I mean, so the low end would only be about 9.0% revenue growth, but in order to hit that low end -- I mean, excuse me, the high end, it would imply like almost 15% year-over-year revenue growth. Does that seemed a little bit aggressive or?

Yes. We're likely to be closer to the low end of our range.

Okay. Right, okay, which is fine and I think most of the analysts out there are sort of estimating towards the lower end. Okay, so that's fair enough. Just a couple housekeeping questions, George. On your tax rate, 38% now for the full year as for your guidance and its been closer to 40% in 2008 and 2009. I mean, do you think its closer to this 38% or is it sort of too early to tell as you look out to '11 and beyond?

Well, in Q4, by signaling that we're going to be closer to 38%, we're expecting a return closer to 40% in Q4 and we haven't seen anything yet that says our rate's going to change dramatically. The acquisition could have some impact, but it'll take time to evaluate that.

Okay, so its sort of keep it sort of closer to the 40% historical rates and maybe this year is a bit of an aberration.

Yes. I think 40% is safe for right now, yes.

Got you and then are you still comfortable with your cash flow from operations guidance for the full year?

We are. Our cash flow accelerated in Q3. We were pretty pleased with that and exceeding the prior year. We think we've incurred most of the working capital costs that we need to incur to run our business. You know we got a big benefit out of AR in the past and that has stabilized. So we are building some working capital, but we don't expect a lot in the fourth quarter and we think we should be able to get to the guidance that we have out there.

Got you, great. Okay, thanks a lot, guys. I appreciate it.

You're welcome.

Bryan Sekino, Barclays Capital

Good morning, Bryan.

Hi guys. A quick question on the guidance. You mentioned ACP closes on December 1st. Is there anything in the guidance from having a month of ACP?

No there is not. We're not going to change our guidance for ACP until we close the deal, because obviously there are a lot of variables in closing a transaction like this and we're not absolutely certain what day its going to close. So, if it does have impact, it could have some impact on our sales, but in one month we don't expect it to have a material impact on our EPS guidance.

Got it and a follow-up on Tom, your comments earlier regarding the pressure, I guess, as you see patients extending the use of a device and as I look at your same-store growth rate of 4.0%, you talk about a 3.0% to 5.0% range. Do you see -- coming in at 4.0% versus the high end of the range, really that's the impact that the economy is having and maybe your real same-store growth rate is 5.0% to 6.0%?

I think its two things, Bryan. One is certainly -- what we're seeing is that this sort of tendency to use the maintenance codes or the tendency to delay, that's built into that 4.0%. That's already in there. And the other factor is you recall that we did not receive a price increase from Medicare this year, so we're really living off of the 1.0% to 1.5% that's reporting into that growth rate. That is the roll forward of the increases from prior years.

So, if it were not for the economic conditions and if we had even a modest increase of 1.0% to 2.0% in the past couple of years, we've been as high as 5.0%, even if we were able to secure that, that certainly would put us at the high end and maybe even take us over. So right now this is a battle for market share and product mix that's going on and its all about how you can build stronger relationships and get patients referred to you by going out and providing higher levels of service. And that's the only way you win the business.

Got it and in terms of the -- you mentioned the nagging impact of the economy on co-pays and co-insurance. Is that going to put bad debt expense under some pressure going forward a bit?

No. We don't think so. Tom's talking about things that we've been dealing with for some time and I think the comment we've made in the past is, unless unemployment gets worse, we don't expect it to effect our run rates for things like bad debts or our AR. But I think what he's describing is a battle that we fight every day to help our patients get their devices. Then we've been effectively doing it to date and our backlog still looks consistent with what it has been in the recent past. So we don't see a -- we don't have a view, at this point, that it's going to negatively affect our business.

And the success in collecting those amounts is largely determined by how much work you put up-front in working with the patient just to handle that financial responsibility. Clearly, if you let it go to the end and then try to come back, you're not successful and what you see even in doctor offices now, they have really put this up forward such that you've got to make your co-pay before you can even see the doctor. It used to be on your way out of the office you would take care of the co-pay.

So it's the realization that you've got to take care of that discussion and secure those funds or find the method of securing those funds up-front and that's exactly what our process that we put in several years ago does. It's a little more work for our people, but it certainly pay dividends in terms of reducing bad debt.

Okay, great and just one more for me, just a bit of housekeeping on the operating costs coming up a bit year-over-year. I know last quarter you had some variable comps shifting around between this line and personnel costs. Is there something else going on this quarter with that kind of reversing?

I'm not sure I totally understand your question. Okay, you're looking at operating?

Yes, other operating costs were 20 basis points up year-over-year and --.

Well --.

Last quarter they were, I guess, down about 40 basis points year-over-year.

We -- the acquisition costs, I believe, were in there. That's part of it, that $600,000, that we adjusted out of the number. That's part of it, but I don't think there's anything material going on there.

Okay. Okay, thanks a lot.

You're welcome.

Mike Petusky, Noble Research Financial Group

Good morning, Mike.

Good morning, a couple of question, Tom. I just think on the last call you had said that your expectation from the CMS pricing was up about 1.0%. Is that still the guess there or do you have any better clarity on that?

We don't have any validation of that number, Mike, and we obtained that number just by going to the Bureau of Labor Statistics and looking up the growth in CPIU year-over-year, because that is the mechanism that drives our fee schedule increase.

Normally about September or October at the latest we get official confirmation. This year we've not received that. What we believe is that they are holding off until after the election and we're not certain what the logic is behind this.

But we know that there is a number of issues that are facing CMS, not the least of which is this doctor fix, the doc-fix as they call it, that was pushed forward and will expire November 30these. And you'll recall that this was a 5.0% annual decrease in the doctors' fee schedule. It began roughly about three, almost four-and-a-half years ago. Its never been implemented and if you tally it up to where we are today, it accumulates up to something like a 23.5% rate reductions for the doctors.

No one knows how this is going to get fixed. At one point, when Baucus was doing a lot of the markup on the Patient Protection bill, the Obama Care bill, they tried to put the fix in for the docs' fee schedule reduction and it added billions of dollars. And they recognized that it was going to take it over the mark of around $1.0 trillion that had been set by the administration, so they abandoned it.

So they are facing some real problems out there in terms of how to handle these fee schedule increases and/or decreases. And I don't think they wanted to come out with any proclamations before the election, simply because it would be very controversial and would raise the hair on the back of AMA and a number of other healthcare providers.

So we haven't seen any validation of that. In the absence of having validation, I'm still running with the assumption that we're scheduled to get a 1.0% to 1.5% increase for next year, with the caveat that we also recognize - and remember my comments about this new legislation - that there are some things in there that have not been totally defined. One of which is empowering the secretary. I think the exact words are, "The secretary of HHS shall study productivity trends in the United States and take that into account in setting fee schedules".

We don't know what that means. There's no formula. There's no logic. It's very subjective. So how all this is going to play out, we're as anxious as other providers in the healthcare space to figure out what this is going to mean. But, certainly, not having a fee schedule increase in '10, we feel that we deserve one in '11. We're a small industry as I mentioned before, the work that we do really saves government and payors money in the long-term, but the cost of not providing that care is a lot more expensive.

So we have been lobbying that we've already given over the years since the Medicare fee schedule has started. Overall inflation has gone up about 108% or 109% and we've received fee schedule increases in the 37% to 38% range. So the mechanism is already built in for us. If we just look at a long-term history, we've had to find other ways to improve productivity and take costs out of the system.

So a much longer answer than I know you expected, but it's a complicated issue and we're active on it and trying to appeal to the legislators so they know and understand the issues.

No, I appreciate the detail. I'm sure everybody else does as well. Do you guys have -- I have a note from, I guess, last year's Q3 that WalkAide revenue was about $1.9 million and I think you said something comparable. Is $1.9 million a good number or was there some other more exact number we should use as far as WalkAide?

No, its right in that ballpark, like $1.7 million, $1.8 million, similar right in the there.

Okay and do you guys -- I've a little bit lost track. Do you guys have an absolute revenue number for Linkia for the quarter by any chance?

Linkia is running about $100 million a year.

Okay.

So their number for the quarter in their book of business -- remember, they don't deliver anything themselves. Its probably in the neighborhood, if we factor the growth into it, of around $24 million maybe for the quarter.

Okay and then just a couple of questions, I guess, back to WalkAide. Tom, I have a note from last quarter where you guys had said that there were three sites operational in the InStride and that there were four in the final stages. And I guess, given that comment, I'm probably slightly disappointed that there were only four sites now operational. Can you just comment on what's going on there? I know this is not the easiest process in the world, but could you just elaborate, I guess, on that?

Sure. Sure. Well, those other three sites are still in the pipeline and as you know, the process to try and get the IRB approval is the one that we're working on. As I mentioned, we're hoping to have eight or nine sites go live by the end of the year, which is an indicator that the other sites that are in the pipeline are very close to completion.

And so, as we try to slug through this, that's our expectation that we're going to wrap up this year with hopefully eight. We've got four live now. A couple are just right on the cusp, but actually I'd hoped that we would be able to report those today, but they didn't come in as we had planned. But we think we're going to be at eight or nine and then there's a number of the right behind that we expect that are going to flip in Q1.

This patient enrollment is the nagging issue in terms of trying to get this clinical launched on an official way and the key to making that happen is to get these sites up and ready.

Tom, let me ask you, in terms of your ultimate submission of the data to CMS. I mean, do you need to have all 1,100 patients run through or would CMS be willing to kind of take an early look if you had, say half of those, or a quarter of those, or two-thirds of those through? I mean, is there any out for you in terms of that or do you have to have all 1,000 run through the trial?

We have strong indications, Mike, that when we get to the halfway point that we can tally up the data and obviously, if the results are overwhelming in favor of the WalkAide, I think we've proven our point. We don't have that in writing. I wish we did, but you know the government doesn't give us anything in writing.

So there is the possibly that, if the results justify the end, that we may be able to submit earlier and that we certainly have fond hopes that we can make that happen. Which would allow us to move on and secure coverage and then ultimately reimbursement at an earlier stage than waiting until sometime out in 2012. So that possibility exists and we are focusing on trying to make that happen.

Alright and then just a last question on the -- I just want to make sure I understand the way you, I guess, define these terms. When you say 70% success rate on WalkAide on the commercial side, does that mean essentially, roughly -- of the claims that you put in, roughly a third of those ultimately are rejected and the other 70% you get approval. Is that -- maybe that's obvious, but I just want to make sure I'm understanding what you're saying there.

I think you have the correct interpretation and our reimbursement, as we receive a number of claims, we screen through them for completeness, documentation, etc, etc, and does the WalkAide really fit the patient's needs.

Some are excluded at that point, but the vast majority make it through the process and just as you have suggested, the ones that enter into the process, about 30% of those through that iterative appeals process fall out for one reason or another. And it might just the bias of the insurance company. It might be patient-specific information, but make no mistake, we'll go the full route in being advocates for our patients; 70% do result in getting authorization and moving forward.

Okay and shouldn't that number go up over time, since you probably will get a sense of which insurance companies will make which decision is based on a particular patient's condition, etc. I mean, that number probably should actually go up over time, right?

We would expect that. I think that's reasonable to assume that that's going to be going up over time. And the other thing that we're learning is that, as the insurance companies become more familiar with the device and the benefits that it offers -- and I think I mentioned this on a prior call.

There's a willingness to open the process up where one insurance company actually came and said, "This is a little absurd. You're wasting a lot of time. We're wasting a lot of time. We're spending a lot of money. Why don't we just sit down and negotiate a deal, a contract price for this device, sort of off the schedule and let's just make it official. And if the patient has these qualifications, then we will supply the device." And so we're trying to get other insurance companies in that same frame of mind.

Very good. Thank you, guys.

Thank you, Mike.

Dawn Brock, Kaufman Brothers

Good morning, Dawn.

Good morning. Good morning. You have given great color. I'm going to ask for just a little bit more on the mix of sales between orthotics and prosthetics.

Overall and a good rule of thumb for us, Dawn, is that it's about 50-50. That our revenues derived from the orthotics business are about equal to that coming from the prosthetic business. There's a little ebb and flow. The prosthetic seem to go through a bit of a cycle every once in a while where folks that have -- we've taken care of a big population with microprocessors and remember, too, that about 50% of our business is recurring. And so we'll see a little and flow on that side, but not enough to try and get more sophisticated around the number, but it's about a 50-50 split.

Okay, that's great and I think the reason that I was really asking specifically this quarter is it looked like the com rate was a little bit weaker and I just wanted to get a little bit of your take on that. Was it on the material side because there were stronger higher-end prosthetic sales in the quarter?

No. It was principally because of the strong results by our distribution business. They have a higher com rate, beside the (inaudible - multiple speakers).

Okay. Okay, perfect and then second, on ACP. Would you be willing to provide some additional color on the current penetration and by that I mean in the 22 of the 25 largest SNFs where they already are, can you give us an idea of whether there is additional organic growth there? And then, of the 11,000 SNFs that are not "touched by the company today", what is the average number of facility additions that the Company has seen in the last 12 months, just ballpark?

Sure. For the large providers, those that have the vast number of sites in their network, they are roughly about 37% penetration into those sites. It means if someone has 100 sites, they've got 37 of them, meaning that there's about 63 yet as targets, so a lot of room to grow with the big ones. And the big ones account for roughly about 50% of SPOs -- excuse me, ACPs overall customer mix. So that makes sense if you think about the method of selling, which is to go into the ones that have large operations. Sell at the C-suite level, get people convinced of the value proposition.

Once you do that, that gives you a license to hunt and then you can go out and systematically start selling into those individual SNF locations by building on the credibility that you've established in other parts of the organization and so its an effective way of selling. And once they receive that sort of corporate mandate, or the corporate blessing, it makes a lot of sense to just continue through the entire organization. And that's why that's been the target and that's where they're -- as I mentioned, about 50% of their overall revenues are coming from the large ones and the other 50% are coming from smaller ones.

Of the 4,000 sites that they have, as I said, about 50% are in the large side and the other 50% are going to be in the smaller side. But I think the good news is that there's a lot of room to grow.

Yes, clearly. Tom, could you actually go one layer deeper? And I know that on the original call last week we talked about the fact that an average site has about four-to-five machines. Is four-to-five machines for an average side SNF kind of the right number? Or is that an introductory package or program? How does that sit in Q2 where the penetration is, from a program perspective?

What we've seen and I think I like the terminology you had, the "introductory package". As ACP goes into a facility, that's what they bring in introductory package and that provides, then, the base lease rate for that package.

Once the operation -- if you remember the multitude of services that they bring, part of it is optimization of the resources and building what we call a "rehabilitation plan". Once that plan is put in place, what we find is that facilities generate a need for additional pieces of equipment, depending on their patient population and at that time, they will come back and add to that initial introductory package. And as they add in additional pieces of equipment, that provides incremental revenue.

So a great deal of this is predicated on the size of the SNF, how many patients they have, how many beds they have, as well as what does the patient mix look like. And what we're seeing is that a number of these SNFs are really changing in their patient mix to accommodate the fact that the Patient Protection and Affordable Care Act is trying to push people out of hospitals sooner.

So they're dedicating some of their capacity to people that are in the 30-to-90-day stay who are being rehabbed from, say, total knees or other kinds of issue directly out of a hospital. That's a different patient mix. You need different modalities to treat them as compared to the senior living or the geriatric population. So I guess the short answer is the introductory package is the starter.

And then, based upon patient population and the optimization of the resources in the SNF, we anticipate bringing in additional pieces of current equipment as well as the Company is very active in developing new pieces of equipment.

I think I mentioned on the call that we have a device out that's a flat screen virtual reality and it actually captures the image of the patient, presents them as an avatar on the screen and then they go through a series of exercises where its actually fun. Catch this ball and the patient has to reach over to the left, right, up or down in order to capture the ball that's falling on the screen, that's just one example.

That piece of equipment is not in the introductory package. It is just being introduced right now. Its out on pilot. We're expecting the formal launch after the first of the year. But that would be another incremental source of revenue and another piece of equipment. So, introductory package supplemented by more of the same devices that are in the introductory package and then further supplemented by new products that the Company is developing and bringing to the market.

Okay. That's perfect. My other question - and this is kind of based on what you just said about other, kind of post acute care settings - is of that $1.5 billion market that you kind of outlined as the pie, where are they right now, i.e., ACP? And penetrating the inpatient rehab facilities or the long-term acute care hospitals or any of the alternative care sites that kind of fall into that post acute care family?

They are currently developing their marketing plans to go after those facilities, but to date they're exclusively focused on the skilled nursing facilities, the SNFs.

Okay, excellent. My only other question was around your battle for share and product mix and I found that to be a pretty interesting quote and George, you said that there's a solid backlog in line with historical levels. Again, are you guys seeing any sensitivity around the higher end prosthetics in that backlog? As we move into the fourth quarter, that's typically a pretty strong quarter for device placement and device demand simply because the people who do have insurance are trying to satisfy those co-pays and deductibles. So could you just give us an idea of the trend right now as you move into fourth quarter associated with that backlog?

We're still seeing -- I mean, if we compare where we are this year to where were are last year, we're still seeing that insurance companies recognize the value of the higher end of ISIS. Keep in mind that each one of those devices brings higher levels of functionality and that may just be the ability to ambulate.

But in addition to that, part of that functioning is to do it in a more stable fashion, a safer fashion and so I think the groundwork and certainly our practitioners would attest to this, the groundwork has been laid with Medicare. I mean, they've provided thousands of these things with the insurance companies, that these are not luxury kinds of items.

As a matter of fact, we put together a scoring document, which we call the PAVET, p-a-v-e-t, its an acronym, but it really talks about a patient evaluation and we score the patient on that PAVET. Depending on that score, that equates to whether they get a higher end device at all and then which one in the family. There's a hierarchy of these things. So there's just not one of them. It's all based upon justification and adding value to the patient and saving the insurance company money in the longer-term.

So I think -- and most of the insurance companies have now adopted the PAVET and whether its coming -- whether the patient's a Hanger patient or coming from someone else, they're not even going to look at the file, unless there's a PAVET in it. And we have licensed it to insurance companies on a no-charge basis, because we think its good patient care.

So, with that as a background, I think the insurance companies recognize when a patient presents for one of these devices, it's well documented. They can see the results of -- we're not seeing pushback, saying "they don't get a microprocessor, put them in a standard safety knee". Every once in a while we certainly have to go to appeal, but that's all part of the process. We've been doing that for years.

So, I would say characterizing this year's demand versus last year's demand, its continuing to increase. We're not seeing any pushback and what we've -- I would actually say and I was just having a discussion on this last night, that our penetration into this market in terms of patients that we put on the higher performing products. As a percent of our overall patient population, its higher this year than last year in terms of our utilization of these devices. So I think the acceptance is there.

The key to all of this is to get more patients in and then apply that percentage conversion and that's going to yield more revenue.

Tom, this PAVET structure or scoring system, is that something that CMS has looked at or is open to looking at it as far as best practices in their evaluation?

Absolutely. Its on every file that we submit. They recognize the value and it's a definitive device -- I mean, definitive document that clearly you can draw the line from the document, how they score, to the type of device they should be in, based on good (inaudible - multiple speakers)--.

And that's -- I'm sorry.

I was going to say it's all based on clinical principles and aptitude of the patients.

That's excellent. I mean, is that something that they could, at some point, actually roll out as a requirement for the industry?

Sure. The insurance companies have. Third party insurance have done that.

Excellent. Thank you so much.

You're welcome, Dawn.

Todd Morgan, Oppenheimer & Co.

Good morning, Todd.

Hey, good morning. You talked about same-store sales or same-center growth rates and obviously continuing pretty strong. How hard is it going to be for you to continue at or above this kind of level? I mean, for example, you talked a little bit about the price increasing trends, but if you don't get a 1.0% or so price increase how much early opportunity exists with the Linkia blending in of those revenues? And how much share really is out there for you guys to reach for easily? Thanks.

Well, we estimate our market share to be around 25%, which I think the half-full glass translation of that is there's 75% out there that we currently do not receive. The way you receive that is, at the very local level, while healthcare is perceived to be national, the battles are really fought at the local level. And its to get out and work with referral sources to convince them that you can be responsive to the patients' needs. You can communicate with the doctor.

Another key factor is that you can provide those patients with superior care in terms of latest technology product. I think this is an area where Hanger really excels. Because of our scale and size, we're the natural outlet for manufactures that develop products, come to Hanger and say, "Let's work together to commercialize this product. We understand the design and manufacturing, but you guys are the clinical experts, so let's work together".

That gives us a leg up, so to speak - sorry about the pun - to get into the marketplace sooner and do it either at a best pricing basis or on an exclusive basis. And so convincing the docs is what it's all about and that we've done surveys on this to understand what is it that they are looking for. I think we understand it.

So, when we come back to our overall growth rate, I think in the absence of any fee schedule increases, we're going to have to continue to slug it out and we'll be around that 4.0% level. Naturally it'll go up and back down a little bit, but that's -- we believe at that level with an overall industry growth of 1.0% to 1.5%, we think we're taking some share away from folks.

We also recognize that this is the way they put bread on the table. We have seen, through our acquisition studies, that some of these folks have gotten to the point where they don't have the competitive strength or the operational economics, so they're laying people off, technicians, etc. And the owner/practice manager is dedicating more time to the practice, coming in, in the evenings, at night, trying to make this thing still work.

So, at the end of the day, we think we're in a good position. I don't want to discount the tenacity of these folks at all, but we think that we can survive and continue to automate, improve productivity. So just around that 4.0% same-store sales level is certainly achievable on a go forward basis.

Great. Thanks. That's helpful.

I guess that must be all that we have, Kyle?

There are no further questions at this time.

Okay. In closing, just want to mention that we are hosting Hanger Orthopedic Group's first Analyst Day, first time we've done this, in New York, on Thursday, December 2nd. And on this day what we intend to have is a full day -- or excuse me, probably about a half a day dedicated to review of each one of our operational divisions.

We will have some of our corporate staff there along with the division presidents from SPS, HPO, Linkia, etc, to talk about their business. The opportunities, the issues they see. So that we can help you better understand what Hanger is all about and project that into your spreadsheets and also, hopefully, give us some sense of what our overall strategic plan is on a go forward basis.

So, if you have any interest in attending, please give Tom Hofmeister a call or his assistant, Angie Houtz. Both of them can be reached here in our corporate offices or drop them an email and in Tom's case it's thofmeister@hangar.com, H-o-f-m-e-i-s-t-e-r, and Angie is the same way, H-o-u-t-z at Hanger.com. They'll be happy to answer any inquiries and get you set up with all the information you need.

And so, with that, let me close and wish you a very good holiday season and we'll be back talking to you in February when we have our year-end wrap-up and results and hopefully we'll see a number of you at our analyst day on December 2nd in New York. Thank you.

This concludes today's conference call. You may now disconnect. Thank you. 19