Hanger Inc (HNGR) 2011 Q3 法說會逐字稿

Good morning. My name is Sheila, and I will be your conference operator today. At this time, I would like to welcome everyone to the Hanger Orthopedic Group Third Quarter 2011 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)

Mr. Tom Kirk, Chief Executive Officer of the Hanger Orthopedic Group, you may begin your conference.

Well, thank you, Sheila, and good morning to everyone, and welcome to Hanger Orthopedic Group's discussion of our third quarter results.

Before starting the discussion, let me ask Tom Hofmeister, our Chief Accounting Officer 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 during this call 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 but are not limited to the Company's ability to enter into and derive benefits from managed care contracts, the demands for the Company's products and services, and other factors identified in the Company's periodic reports on Form 10-K and 10-Q, which are filed with the Securities and Exchange Commission under the Securities 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.

Well, thank you, Tom.

So let's begin with some overall views. The quarter contained several noteworthy points.

Consolidated sales grew by 13.8% over the third quarter of last year. This sales performance, combined with cost management, yielded an adjusted EPS of $0.46, excluding the costs associated with our relocation and acquisitions. Now, this is an increase of 24.3% compared to the $0.37 per share for the third quarter of last year.

During the quarter, our patient care segment achieved a 4% increase in same center sales growth. Also during Q3, we witnessed some trends that have caused us to adjust our guidance for Q4. I'll talk more about these factors in my detailed comments, but I do want to point out that after the change, we are still predicting adjusted EPS growth of up to 13% for the quarter and 19% for the year.

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

Thank you, Tom, and thank you all for joining us today.

First of all, I'll talk about the income statement for the quarter.

Q3, as Tom pointed out, was another excellent quarter in which we -- it was also a quarter in which we saw some changes in our environment that altered our short-term view of our business in the fourth quarter.

The important takeaways for the quarter are as follows --

Adjusted EPS of $0.46 represents 24.5% growth over the prior year, and it includes a $0.01 of non-recurring tax benefits. These results are in line with Street consensus estimates.

Adjusted EBITDA leverage increased by 170 basis points in the quarter. ACP added 150 basis points to our margins, and our core business added 20 basis point, which is in the expected range of 20 to 40 in our guidance.

Overall sales increased by 13.8% for the quarter. Comp sales in our patient care segment increased by 4%, which was in the middle of our expected range. Our distribution segment reported a 3.9% increase. Therapeutic services contributed $15.7 million increase in sales. ACP accounted for most of that increase. Their sales were below the low end of our expectations due to the noise surrounding the RUGs-IV giveback. However, their earnings were on target due to excellent expense control.

Our [com] rate of 29.5% was 1.2% below last year due to the impact of ACP and slightly higher than our internal forecast.

G&A increased by $3.4 million compared to 2010, principally due to the acquisition of ACP.

The tax rate for the quarter was benefited by one penny of non-recurring tax benefits. If you remove that, it adjusts our rate to 37%, and we expect our rate going forward is going to be between 37 and 38%.

Moving on to the year, our consolidated sales increased by 13.5% for the first nine months. Comp sales in our core patient care segment increased by 2.9%.

Our distribution segment reported a 5.6% increase through September 30.

Therapeutic services, including the new ACP acquisition, contributed a $47.4 million increase in sales.

Our [com] rate of 29.2% was 1.2% below last year due to the favorable impact of ACP.

Personnel and operating expenses as a percentage of revenue improved 50 basis points from the prior year due to effective expense control, including lower incentive compensation accruals.

When you combine our 13.5% sales growth and effective expense control, we were able to leverage the sales growth into 27.1% growth in EBITDA and a 170-basis-point improvement in EBITDA margin. ACP accounted for 140 basis points of that margin improvement, and our core business added 30 basis points, right in the middle of our range.

D&A increased by $9.6 million compared to 2010, principally due to the acquisition of ACP, and that all led to adjusted EPS of $1.10, which represents 22.2% growth over the prior year.

Moving on to the balance sheet --

Our AR balance of $127.2 million. DSOs were 52 days, which is slightly higher than we expected. Collections in a couple of pilot businesses that we have started in our patient care segment are at a lower rate than we expected and account for the build in AR. We're comfortable with our reserve for doubtful accounts.

Our inventory increased by $12.3 million to $110.6 million from 98.3 at the end of calendar 2010.

Inventory turns were 3.8 times, which is slightly slower than the 4.0 times we recorded a year ago.

CapEx was $6.4 million for the quarter, which was $600,000 lower than last year. We anticipate that our capital additions for the full year will be in a range of 30 to $35 million.

Cash flow provided by operating activities for the quarter was $24.5 million, a $7.7 million decrease compared to $32.2 million in 2010. The decrease is due to normal changes in working capital.

For the year, cash flow provided by operating activity stands at $35.2 million compared to $37.4 million last year.

Talking about liquidity, the Company currently has a total liquidity of $128 million, comprised of $31.4 million in cash and $96.6 million in availability on our revolver. So that's increased nicely over the reported numbers last quarter.

Our total leverage per our bank calculation improved to 3.12 times, which is well below our covenant of five times and an improvement over Q2.

Moving on to guidance --

As Tom mentioned, we are revising our guidance for the remainder of 2011. As we enter the fourth quarter, three factors have influenced our decision to lower guidance.

First of all, the elimination of Medicaid coverage for adult orthotics in Arizona has hurt one of our most productive markets pretty dramatically. They were down 10% during Q3, and they're down 5.6% for the year, so there was a little acceleration in that during Q3. This will continue in Q4, but it's not a long-term issue as it will be absorbed in the comps after Q4.

With this change and other Medicaid rollbacks in Texas and Florida, we don't believe we have the backlog to achieve the 6 to 7% growth that was anticipated in the Q4 guidance and that we have delivered historically. We expect to grow more in the 2 to 4% range in patient care.

ACP is a run rate business, and they have been not growing as fast as we expected due to the impact of the SNF reimbursement rollback. They've been able to make their numbers through the third quarter by exceptional cost control, but in our judgment, the sales shortfall is just going to be too large in Q4 for them to be able to reach their earnings goal in Q4. So we do not expect them to add the $0.02 to earnings that we had originally anticipated. This is still a very good business that we expect to grow long-term.

Final point -- two pilot businesses in patient care are having some operational problems, and we've slowed their expansion, which has impacted their sales growth, while we deal with these issues. We've made some personnel changes, and we're adding more IT support, and we expect to have these pilots back on track by the end of Q2 of next year.

With those factors taken into consideration, we expect net sales in the range of 914 to $918 million for the year. That's a growth rate of between 11.9 and 12.4%. Included in the sales growth is the assumption that we'll increase comp sales and patient care by 2 to 4%.

Our goal remains to improve adjusted EBITDA leverage in our core business by 20 to 40 basis points.

Full-year adjusted EPS guidance will be in the range of $1.59 to $1.62, which is a growth of between 17 and 19%. We are also guiding to between 70 to $75 million in cash flow from operations and 30 to $35 million in CapEx.

That concludes my comments, and I'm now going to turn the call back over to Tom Kirk, our CEO.

Thanks, George.

I'll add a little color on the business conditions, drivers, and the results from an operations perspective.

Let's start with patient care.

Their sales increased by 7.2 million, or 4%, same store sales growth for the quarter, compared to Q3 of 2010. This is in spite of some states restricting segments of their population from receiving care due to their budget cuts and/or reducing reimbursement levels, as George had mentioned.

Absent these issues, our growth rate would have been over 5%. Now, our challenge is to find ways to regain those revenues by taking share and offering some new products, and we are working on those.

Also, we've been working on two pilots within our patient care to expand our offering. These have experienced some growing pains in terms of the back office processes and has a corresponding impact on AR. While the business premise absolutely remains viable, we've slowed their sales expansion to permit improvements in these processes, again, as George had mentioned, with additional resources and management changes.

Also, we have to keep in mind that it's been two years since CMS granted O&P a fee schedule increase. We've benefited from the roll-through of the 2009 price increase as it rolled through our third-party payer contracts.

While we have not yet been notified of a fee schedule increase for 2012, one positive is that social security, which was also frozen for two years, received a 3.6% cost of living increase, which will be effective January 1st of 2012.

Throughout the quarter, we did stress the programs that positively impact the volume and mix sides of our revenue equation. These are --

First is the continued improvement in our Linkia book of business. Let me remind you that HPO is the primary vehicle for the delivery of most of the services under the Linkia contracts.

On an overall basis, the revenue from the Linkia-designated contracts was up 9.5% compared to Q3 of 2010 and 5.6% year over year.

Second, educating our referral sources on the enhanced lifelike features of our high-performing products, such as advanced suction suspension systems, microprocessor prosthetic arms, hands, knees, and feet components. And for Q3, the revenues from these product lines were up about 9% compared with Q3 of 2010.

The third area we've been active in is sponsoring our patient evaluation clinics in which we call our patients in for an education session on their fit and function. Revenues from this source provided about $5.5 million of incremental revenue for the quarter and about $15.5 million for the year over year.

Our practitioners continue to offer assistance as needed to our patients. Some patients have difficulty in identifying other sources of assistance on their reimbursement, coinsurance, and copays. This is due to the unemployment situation.

At the end of Q3 2011, the unemployment rate was 9.1%, down slightly from the 9.2% at the end of Q2 of this year and 9.6% at the end of Q3 of last year. This high level of sustained unemployment imposes a hardship on some of our patients, but rest assured that we continue to do everything in our power to help these patients get through this sluggish economy.

And we continue to advocate for our patients and for fairer regulations. The bills that we're working on in the federal Congress are the Insurance Fairness for Amputees Act, the Veterans Bill of Rights, and the Medicare Improvement Act.

We're pushing to have this last bill included in the super committee negotiations, and that committee has been charged with figuring out how to reduce spending by $1.5 trillion. Their deliberations are scheduled to end around Thanksgiving, and we believe by inclusion of this bill can save $250 million over 10 years by eliminating fraud and abuse, and so this would be a direct savings to Medicare.

At the state Medicaid level, healthcare providers are facing challenges as the states struggle to balance their budgets. At present, we're working each state on an individual basis in terms of education, communications, and public relations that support our patients. We've had success in California, Nevada, Minnesota, but as George had mentioned, Arizona, Texas, and Florida have implemented fee schedule reductions or excluded portions of their population from coverage.

We've launched a national PR effort which stresses the cost effectiveness of the services we provide, and we are working to restore orthotic coverage for patients over 21 years of age in Arizona, and that's by making a direct appeal to the legislature down there.

Well, let's discuss SPS. Their outsides sales were up approximately $1 million, or 3.9%, compared to the third quarter of 2010. SPS went live with a new purchasing software system that is utilized by almost 200 of the independent O&P facilities.

Shipments were initiated during the quarter from the new Midwest distribution center, and it is experiencing substantial sales growth. There's no question that these economic conditions are also influencing the patient flow in the independent O&P provider centers.

The SureFit business continues to gain traction with the Hanger practitioners, the independent practitioners, and the podiatrists. SureFit has introduced the scanning solution to obtain a scan for custom foot orthotics, as well as ulcer measurement capability. This will improve our competitive condition, with customers looking to move from impression blocks or casting to newer technologies. And they are continuing to have discussions with retail companies regarding them handling portions of the product line. For the year, the SureFit revenues are up about 5% over 2010.

Now, let's turn to Linkia. Linkia continues to execute its dual mission of building volume while negotiating a fair price for the services and the value they provide to their customers. Their book of business, as I mentioned before, is up about 9.5% for the quarter.

Linkia has advanced their pilot projects to commercialization, and these involve post-mastectomy services and prosthetic and orthotic claim review services.

Payers tell 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 in the base business, as well as in the new services.

And on the marketing side, they are continuing discussions and negotiations with key national and large regional healthcare management companies for their commercial, as well as their state Medicaid book of business, and obviously, we're continuing to have discussions with firms in the workmen's compensation segment.

Now, let's discuss the therapeutic solutions segment, which consists of Accelerated Care Plus and Innovative Neurotronics. Sales for this segment were up by $15.7 million compared to Q3 in 2010, principally due to the acquisition of ACP.

ACP continues to market their unique value proposition and to emphasize the clinical and technological sides of their offering. As we discussed on the last call, portions of ACP's customer base have been affected by CMS's announcement in early Q2 that they are reducing the reimbursement rates for certain physical therapy services.

The SNFs are all trying to determine where this could end up and how to best manage their business. ACP has been working with the SNFs in order to customize their product and service offerings to accommodate the SNFs' needs.

In spite of these changes, ACP grew revenues in excess of 10% and signed some long-term contracts with several of the SNFs.

The two pilots to determine the best method to capture the synergy between our patient care division and ACP have been successful, and we are beginning a national rollout.

And, finally, ACP is moving into alternative venues to offer their services.

Turning now to Innovative Neurotronics, they launched the new pediatric Functional Electrical Stimulation system with the new WalkAide pediatric system and a revised version of the original WalkAide with higher reliability and greater simplicity in Q2. Both of these developments have been favorably received in the field, and over 200 pediatric cuffs were sold during the third quarter.

We're continuing to work with the clinical sites to go through the IRB and the contracting process for our INSTRIDE pivotal clinical trial. In total, we're working with 30 institutions. We still anticipate sufficient patient enrollment by the end of 2011 or early 2012 to analyze the data to pursue submission of coverage for a decision in 2012. And by the way, a third party clinical trial has been initiated for MS, and IN, Inc. is supporting that effort, as well.

At the same time, we continue to work with the third payers to gain authorizations for our patients. To date, we have been seeing about a 70% success ratio on those authorizations.

Finally, a few words on our acquisition program. We still expect to exceed our normal range of 20 to $22 million of annualized sales for the year. As we have 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.

So, in closing, let me again say that we operate in a changing and a challenging environment with issues like unemployment that retreats very slowly, energy and food inflation, states trying to close budget gaps, and federal regulations concerning healthcare reimbursement.

These factors are affecting our patient flow, and for those reasons, we've revised our guidance to 914 to $918 million for the full year, and we expect full-year adjusted diluted EPS of $1.59 to $1.62. We will continue to seek ways to capture additional revenues, and we hold the line on expenses.

Thank you. We'll now open up the line for any questions. Sheila?

(Operator Instructions)

Brian Tanquilut, Jefferies and Company.

Tom, just a first question for you, I guess Tom and George. Your same store guidance for Q4 is still positive at 2 to 4%, so that's good. I guess a question that I have is do you think that it was just -- you know, Xing out the impact of Arizona, is it an issue of having too high of an assumption in Q4, and, obviously, you've got all these factors in the background just not letting you see the acceleration? Or is there a new headwind that came out basically during the end of Q3 or early Q4?

I think it was the -- it is the first thing. Typically, we've seen Q4 really rally and bring in a lot of sales, as we certainly did last year. And so we set that bar up there. We're still expecting positive growth, but in view of these factors that have just come into view, the feeling is that we may not be able to log that same kind of explosive growth in Q4 as we did last year, but we still expect to see positive growth. And we are about the business of trying to find ways to either, as I mentioned, take market share or bring some new products in here to try to make up for that revenue, but that's going to take a little bit of time, so we just don't think we're going to be able to get to that level that was in our original guidance.

Hey, Tom, (inaudible - multiple speakers). Go ahead.

The one thing that did change is we did see an acceleration in the decline in Arizona, and we thought that was going to make it tougher. Since that historically has been one of our most profitable markets and fastest growing markets, we just thought that was going to be too much to overcome to get that extra boost in sales that Tom was talking about. So that was the one kind of new thing.

I'd like to point out that 13 out of our 16 markets during the quarter grew by 5%, so our core business is -- it's strong, but we have some specific events going on in three markets that caused them not to grow.

Okay. And then as I think of this, Tom and George, I mean is this -- is it safe to think that your typical 3 to 5% average same store number is still intact, I guess?

And I know you've talked about initiatives to drive same store and also mentioned that you slowed down two pilots. If you don't mind just giving more detail around what you're doing there?

Going back to your first question, the 3 to 5 longer term is still intact. There's not been any kind of a what I could call as a fundamental change in the business. These are a couple of issues and just specifically within a couple of states that we're just going to work through. But the business is sound. We still see the need for our products and services, and certainly, all the drivers are intact in terms of old age and disease state. If anything, those things seem to be increasing.

This is sort of a nagging problem that has resulted from, as I mentioned, either reductions in the reimbursement rate within the state or, in the case of Arizona, a portion of the population not being allowed to participate and get care, and we're trying to work through those.

In terms of the two pilots, we had started up a business. One provides a service to the emergency room and trauma centers in hospitals, and the other one is a post-surgical business in which depending on how the doctor writes the script, after a patient would receive surgery, say, for a total knee or hip implant, frequently, they'll request a brace. They may request a continuous passive motion machine, polar packs, which are temperature units to control pain and swelling.

And so we kit all of that up and deliver it to the patient or the caregiver, along with instructions on how to use those, and then after the patient is finished with those, we'll go back and pick them up.

So those businesses are unique niches and really filling a very valuable and worthwhile need. And so they -- when we've launched them, they've proved their worth very quickly in terms of our ability to grow the sales.

What we did was we slowed down the solicitation for new business because, as George mentioned, the back office processes on these things are a bit different than the back office processes on the way we do our patient care business. And so we had to recognize that. We had to recognize that the billing and the collection are a bit different. These are much smaller ticket items, and in some cases, there's actually a leasing or a rental situation that occurs on some of that equipment.

And so we've found ourselves in a little bit different kind of territory. We saw the problem. We have changed out some of the people. We've assigned more IT resources to it so that we can better automate because this is a business that has a high number of low dollar value invoices, and so just the sheer volume really presented a challenge. And so we're taking all the right steps, and as George mentioned, we expect that by Q2 or the end of Q2 of next year, that these issues are all going to be behind us, but we just didn't want to put those receivables in jeopardy by not being able to process them, so that's why we slowed the sales down.

But our customers tell us, and certainly the reception in the marketplace, that these are high quality service product offerings, and they're really helping our customers in terms of either saving money or taking care of managing that nasty inventory problem.

And then, Tom, turning to ACP, by my computation, it seems like it grew 10% during the quarter. I know when you acquired the business, you were talking about sort of a 15 to 20% growth rate. Do you think that after all the noise around the SNFs dissipate, do you think that we are going to go back to 15% growth rate? Or have we reset the expectations for ACP long term?

Our hope is that we can go back to that 15%, but right now, there's a lot of sorting out that the SNFs are going through. As I mentioned in my comments, they're trying to figure out how they can run their business profitably.

And so we have worked with them. We've customized some product service offerings to assist them, in some cases giving them a little better deal and a little better value. We've been able to swap out some of our costs because we can reassign some of these folks to other challenges that we have and other opportunities.

So we haven't jeopardized our profitability by these custom offerings, but we are working with SNFs to make sure that it suits their needs.

So longer term, we think we'll get back up to that growth rate, but right now, we're going through that sorting-out process. And another thing we have to keep in mind is even after the reduction that CMS put out there of around 11% and a few rule changes, the SNFs' reimbursement level is still 3% above what it was in 2010. So we think this is a situation where they're adjusting to their new world and then ultimately it will get back to some degree of normalcy.

Hey, Tom, just a follow-up on that. If you break down attrition versus a slowdown in new signups for ACP, which one do you think is the bigger contributor of the slowdown to overall growth? Are you losing clients? Or is it just that you're not getting new signups?

It's a slower expansion.

Okay, got it.

It's new signups. And, Brian, I think we have -- there's other guys waiting in the queue. If you want to come back --

No, that's all. You got all my questions. Thank you.

Okay.

Thanks, Brian.

Brian Sekino, Barclays Capital.

Just wanted to get a sense of the timing on the Medicaid cuts and the coverage decision in Arizona. Was that during the quarter that you saw that?

That's when we experienced the --

Acceleration.

-- the acceleration. The rule was promulgated and went into effect October 1st of last year. We managed through that because we still had to take care of some customers that were out there. So we were really treading on thin ice as we got into the third quarter, and that's where it really impacted us.

Okay, okay. So I guess we'll be hear -- I mean this is something that won't be anniversaried till maybe Q3 of next year, as well?

No, actually, it will be anniversaried starting after Q4.

After Q4. But the accel -- so you, I guess, assume there's some improvement in Arizona where the coverage decision was taken away for orthotics?

Yes, and certainly in Q1 of next year, we expect that market to improve because that will all be in their comp at that point.

Okay. And then, Tom, question on the Medicare pricing for next year. I know you mentioned you've got -- this year you get the pull-through from the 2009 increase, but I mean I guess as I think about the chance of there being a flat pricing in 2012, does that mean, I guess, there's going to be essentially flat pricing for both your Medicare and commercial books since we've had no Medicare increase for the past two years?

Certainly correct for the past two years. In '10 and '11, there was no increase.

And, actually, the technical thing that happened here in '11 is that when we calculate out the CPIU, we actually were deserving about a 1.1% increase. But as part of the new ObamaCare, there is this thing in there called a productivity adjustment, and so that calculated out to roughly about 1.1%. So one nullified the other, and that's how we ended up with zero.

As we're looking at '12, the calculation for CPIU yields 3.6%, just as the social security increase was 3.6%. We don't know what the productivity adjustment will be, but assuming it might be around that 1% level, we would expect to see somewhere in the, say, 2.5% increase. That's according to law, and that's what we should get.

But we do know right now there's a lot of deliberations going on and there's a lot of issues around healthcare. And so it remains to be seen if the Congress is going to award us what the calculation yields, or would this be given up as part of some cost reduction measure to reduce spending? So we don't know. We received no word. We're still expecting to see about a 2.5% increase, but certainly, this is going to be all determined in the deliberations of the Congress.

Got it. And just one more for me. On ACP, just wondering if you could provide some color on -- I know the nursing homes are figuring out their own business right now in light of the new reimbursement system, but in the conversations that you're having with the nursing homes, is it something like they're saying they're very interested in the product; they just want to wait right now until they can sort things out and they recognize the value? Or is it just they're not willing to talk because they're just not focused on that, on growing revenue through use of the device?

Probably a combination of all of the above, but specifically, I just don't want to leave you with the wrong impression. We are still, net-net, adding new sites. We're still adding new installations even through 2011, even during the period when people were trying to sort this out. So the business is still growing.

However, as each SNF figures out what the impact of this is going to be and how to manage their business, in some cases, they are slowing down. They're hesitant to jump right in. In other cases, they're just looking for different product service offerings.

So the reason that we're seeing the slowdown in growth is that they're just taking their time and deliberating a bit more around what's best for their business and to jump in. But we are still signing up new customers, and we are still working on a one-on-one basis to design whatever they need to help them be successful in their business.

ACP truly is a partner to the SNFs. They bill themselves in that regard. That is one of their, what I would call, customer service features is one of being a partner, so they try to be flexible and they try to work with the SNF based upon its patient population and the specific needs of each facility.

Okay. Thanks a lot.

Thank you.

David McDonald, SunTrust.

A couple questions, one just on Arizona. Could you do us a favor and size that market in terms of either percentage of the Company's revenues or percentage of profits, whatever you're willing to give?

That market -- give me a second there -- that's a market for us that's about -- it's over 10% of patient care in terms of size. It's between 10 and 12% in terms of sales, so it's (inaudible) important market for us.

Okay. And then obviously with Medicaid, that's changed, but historically, had it been a higher (inaudible - technical difficulty)...

Dave?

Yes?

I want to make sure I'm clear. That's the entire market, which includes more than Arizona. I can't break down just the one state.

Sure, sure. And, obviously, the dynamics have changed there a bit, but historically, has that been a margin -- a market where your margins have run kind of ahead of the company average?

The margins have been good there. They've been -- the margins have been probably right around the average for us for the entire patient care segment, but what's been -- what their specialty has been is growth. And the reason we're kind of taking it on the chin with this change is because -- and this is an anomaly for us -- in this particular market, we have 70, 80% of the market, so we're taking most of the pain.

And then, guys, just on ACP, you mentioned that you signed long-term contracts with several clients. By long term, I would assume you're talking roughly three-year deals, and can you give us a sense of, say, your top 10 or 15 clients at ACP, how many of them are locked up in a long-term contract at this point?

Those contracts are typically three to five years, Dave, depending on the specifics of the customer and of the major clients that are out there. I don't have the percentage, and we can certainly get that, but the majority of them, let's put it this way, are under long-term contracts.

Okay. And then just could you guys give me the Linkia numbers one more time? I didn't catch the growth rates. And any sense where we are in terms of potentially incremental contract wins there?

For the quarter, their book of business was up 9.5%, and for the year, it was up about 5.3% for the total year.

And Linkia continues to do two things. One, they're adding to the book of business on existing customers where we're not exclusive, we're just preferred, but they continue to pick up more and more geography, so they add to that.

And at the same time, they are out promoting their ability to build a network to help other companies. And certainly right now what we're seeing is that with this Medicaid thing going on where states are trying to find ways to manage it, in some cases, they're actually turning that over to third-party insurance companies, and we're working with them to say that we can assist them by coming to their aid, if you will, with a network of high-quality providers. So we want to move in that direction, as well.

And, of course, then the other thing that I've mentioned is they have two pilots that have been successful, and they're out now selling contracts on those services, one in mastectomy and the other is on invoice review, and that seems to be taking very well.

Okay. Thanks, guys.

You're welcome.

Larry Solow, CJS Securities.

Could you guys maybe -- you mentioned that the 13 of 16 regions are upgrading 5% on same store basis in the quarter, and I imagine those are probably the same regions you expect to sort of carry the brunt of the growth in Q4. The three regions that are underperforming, is the commonality among them, is it Medicaid? Or is there other things, as well, that are driving these three other regions down?

Well, the --

On a common basis, I mean. Go ahead, sorry.

Yes. The big one is Medicaid. In the case of one of the other markets, we purposely pulled back on some contracts simply because the offering price was not such that we felt it was attractive for us. So we've pulled back. They were mainly some low-end orthotics and some off-the-shelf kinds of products, but it hit us on the sales line. But it helped our overall profitability, so we pulled back on that one.

And the third one that's out there, that was a contract issue where someone else came in and acquired a couple of contracts and took them over, and we're in the process right now of winning back some of that business through some advanced negotiations.

So if we look at it, one is what I'd call product portfolio trimming for enhanced profitability. The second thing would be some of these state characteristics that we've talked about on the Medicaid. And, last but not least, there were some contract issues that we're trying to go back and work our way through. So a little assortment across all three things.

Okay. And, obviously, Medicaid by itself is only 6% of revenues or a little over that, and I fully appreciate that perhaps it's a little more skewed in this case because clearly Arizona is one of the states being impacted and it's 80% -- it's where you have a big market share.

But any way just to sort of quantify what the impact directly is from these Medicaid rollbacks and cut versus more of just general malaise and utilization and whatnot that seems to finally be hurting you guys more than it had been through the last couple of years?

You mean in dollars, Larry --

Yeah.

-- the Medicaid is the biggest effect on our overall business. The two rollbacks and the elimination of coverage for adult orthotics compared to the other issues, I can't give you a precise number because you're talking about thousands of claims they have to track.

Right. The only thing I'm just struggling with is clearly your miss, just to use round numbers, is like 15 million in Q4 versus what your guidance was prior, and Medicaid quarterly is probably only 15 million. So, obviously, and you're talking about a few states, so I mean are you telling me that Medicaid is half of that 7 million cut? I mean are you losing 7 million in Medicaid revenue from three states? That's sort of where I'm struggling.

Oh, okay. Well, I mean if you look at that overall change in guidance, there's a few things. We were just concentrating on answering your question, which was specifically directed at HPO.

Right.

As we mentioned before, we also had slower growth at ACP --

Right.

-- and we have had slower growth at these pilots that Tom talked about.

Got it.

And we had slower growth at SPS, as well.

Right.

I mean SPS doesn't add a lot of margin to our business, but they've been a grower and they were down in Q3 versus their recent history, and they tend to sometimes be a leading indicator of where the next quarter's going to be. With them only growing in 3 to 4% range, that was another reason that we thought we're not going to be able to get that extra bump up to the 6 or 7% range that we expected.

Got it.

So it's all those factors together.

Right. So it sounds like 1 or 2 million or whatever from each bucket plus the Medicaid plus just an overall slowness, you're not getting the more (inaudible).

Yes.

Okay, that's fair enough. And just on the -- anything anecdotally or anything you could sort of surmise from your experience? And it may not be that easy of a question to answer. You guys have sort of been able to have pretty good growth over the last few years, and I realize healthcare overall utilization is still not rebounding even though the economy has rebounded somewhat. Why you think now? You're seeing more impact or maybe it's you're just not getting the growth, the seasonal pickup you thought in Q4? Is it anything that...?

Well, I mean if you look at the IMS reports, for some time, there's been fewer doctor visits, there's been fewer people being checked into hospitals. And to some degree, you're dealing with a cumulative effect.

And we, I think, did a pretty good job -- we have patients that if they have an amputation, they need a device, so that helped our business through the initial phase, but we are dealing, to some degree, with people that are putting off new devices as long as they can. They can't put it off forever, but they can put it off for a month, a quarter, a period like that.

And it's just -- our business is still growing. As we pointed out before, we're going to grow in Q4 to a high of 12 or 13%. If you look at our guidance range, we're just not going to get that extra bump that we had normally gotten in fourth quarter.

Right, right. And then, obviously, you're not giving '12 guidance, but where you stand today, doesn't sound like you think that there's any reason to not believe you'll get some same store sales growth, at least on a volume basis, for getting [more price starts] because you can't obviously forecast that.

Oh, yes. We clearly expect to grow in 2012. I mean we're not prepared to talk about guidance now because, frankly, we just started our budget process and we're going to -- we intend to release guidance for 2012, as we normally do, when we announce the Q4 results. But we clearly expect to grow in 2012.

Right. Okay. And then if I could make two more quick clarifying questions.

So the ACP, you said $0.02 sort of taken out from your guidance. Was that $0.02 that you expected in growth year over year? In other words, is ACP -- I imagine it's contributing to the -- it's an earnings contributor, correct?

Yes. I think when we announced the acquisition, we reported that we expected $0.07 to $0.08 of accretion from that transaction.

Right.

And because it's a run rate business, it's kind of a pyramid effect, and because we haven't expanded as quickly as we can, as we get to the top of the pyramid, it's not as tall as we expected. So we're -- sense of earnings we expected in Q4, incremental earnings, we're not going to get.

Right, right. And do you expect that business to actually [knock down] revenues to be -- so it grew 10% this quarter. You're going to obviously expect it to be not quite as good next quarter. Is that -- do you still see it growing year over year on the revenue basis in Q4 as part of your guidance?

It'll grow, but it'll be a little less than Q3.

Okay, okay. Sounds good. That's fair enough.

Last question on CapEx. I think you had expectations of up to 45 million for the year. Now it's down to 30 or 35. Can you talk about what you're cutting out and implications? Is that with the new electronic bill management system, or where is that coming from?

A couple of things. First of all, since ACP is a leasing model, the equipment they buy for new transactions is CapEx, and since they're not growing as fast as we expected, they're not going to incur the full 10 to $14 million in CapEx that we expected and was part of our guidance.

Secondly, on the new billing system, we expected to have fairly heavy payments in Q3 and Q4 related to the licenses on the -- for the vendor that's supplying the software, and it just looks to us now the way that that project is moving along that that's going to be a partial payment in Q4 and the rest will leak into 2012.

Okay. But that's more a payment schedule type thing? Your overall implementation and installation, whatever you want to call it, that's still sort of relatively on target?

Relatively on target. Their payments are based on performance from a standpoint of delivering software changes to us, and they're just a little bit behind on that, but it's not material.

Okay. All right. Thanks a lot.

Thank you, Larry.

Mike Petusky, Noble Financial.

I didn't catch it if you mentioned it. How much of the 4% same store comp was kind of volumes mix as opposed to pricing?

Very little is based on price, Mike, simply because, as you know, we didn't get any fee schedule increase for the last two years, and so any price increase as a result of increases that we've had in '09 have just rolled through, and to a certain extent, Linkia's success in getting some price increases on some existing third-party contracts.

So if we put it all together, we're probably in the neighborhood of maybe a half to three-quarters of a percent on price. Then the balance is coming from volume and mix.

All right. So based on conversation I've had with investors and based on how the stock is trading this morning, getting annihilated, I've heard people essentially kind of do the math and essentially annualize the guide-down in Q4 throughout 2012 and basically do math that essentially says, well, Hanger will do around $1.60 in EPS in 2011 and that will go to $1.60 or $1.62 or $1.65 in 2012.

And I understand that you're not giving guidance today. However, what I'm hearing you say is that you expect growth in ACP, growth in HPO same store, I assume growth in SPS, although walk me back if that's not the assumption, and that the M&A that you guys routinely do, you'll continue to routinely do. So I guess -- and you expect Arizona to bounce back in the first half of 2012.

Am I missing something here? Or am I getting something wrong? Or to me it doesn't feel like there's a sea change, although the market seems to be treating it that way.

Well, the Company -- I think -- we just finished saying we expect to grow in 2012. That's as much guidance as we can give right now. The math that you mentioned doesn't make any sense to me. We reduced our guidance relative to how much we will grow in Q4. We didn't say we're not going to grow. And taking that $0.06 change and applying it to every quarter next year doesn't make any sense to me at all. Just the business will grow, and then when we announce Q4, we'll be able to give you specifics on how much.

Okay. But in terms of essentially the assumptions that I put out there, I mean do you expect to continue to grow across the different pieces of business that I mentioned -- the SBS, the ACP, the same store comp? I mean is that a fair way to think about this, or is part of this--?

The overall business will grow. We're not in a position yet to talk about segments. I mean that's getting ahead (inaudible - technical difficulty) where we're at. Like I said, we just started our budget process. We are just pulling numbers together, and it's way premature for us to be able to talk about segments. The overall business will grow. That's the message.

All right. Okay. And, Tom, I guess in terms of the walk -- the INSTRIDE trial, the WalkAide trial, I think last quarter you had said that you hoped to have two-thirds of the sites activated by the next time you reported. I think that's right. I think that's what you said. I mean are you roughly on target there? Can you speak to that at all?

We are there. As I mentioned in my comments, we're working with about 30 locations.

Oh, there are actually 30 that are activated at this point?

No, that's the total -- that's the total realm that we were going after. And where we sit today, we're about two-thirds activated. You mentioned keeping with what we had forecast, and as you can imagine, the more we can get active, the quicker we can populate these trials, but it's still our intent to have sufficient numbers in by either the close of '11 or early '12 so that we can analyze this data and prepare a submission for CMS.

All right. I think that's all I've got. Thanks.

Okay. Thank you.

[Stan Mann], Mann Family Investors.

Gentlemen, a lot of them are answered, but I have a basic question on use of cash that is significant. I noticed your debt has stayed constant, so coming into 2012, what are your expectations and targets? You said you're going to do some M&A, but what about the outstanding debt? Will you be paying it down? Is that in your plan? Thank you.

Stan, we have a test flow sweep as part of our term B agreement that requires us to pay down 50% of our -- use 50% of our free cash flow to pay down debt. That calculation gets done annually.

In the meantime, we haven't taken our cash on an interim basis to pay down debt because it's much more accretive to earnings and helpful to the shareholders overall for us to use that money to do more O&P acquisitions.

The interest rate on our debt is so low that going to get a penny out of earnings for paying down debt by 20 (inaudible - multiple speakers).

How low is it, by the way?

Sorry?

How low is the debt interest rate?

It's in the 3 to 3.5% range.

Oh, okay. So what you just said, meaning in pay down a debt 2012. Can you interpret that for us, expectation?

Well, what-- we just guided to cash flow from operations of 70 to 75 million in CapEx of about 30 to 35, so that's a range of free cash from 35 to 45 million.

There's a calculation in the term B agreement that specifies how much of that gets used to pay down debt, and I can't anticipate what that's going to be at this time, and we have to go through the calculation when we get to year-end. So we'll pay down debt by whatever amount that requires us to do, but we're also going to leave some cash on the balance sheet in order to fund our operations and to do O&P acquisitions.

Okay. So potential is 18 to 23, half of the 35 to 45 anticipation?

I don't -- potentially, it will be whatever the -- the calculation has a number of factors in it. I can't predict what that will be at this point, but it'll be half of whatever that calculation comes to.

Okay, and it's tied down [defined], and that's what the plan will be every year, so if cash flow goes up -- free cash flow goes up to 50 million, there's a formula to utilize it for debt pay down but...

That's correct.

And we can expect that. Okay, thank you very much.

You're welcome.

(Operator Instructions)

Chris Sassouni, Eagle Asset Management.

Yes, I just wanted to ask you a couple questions. What was the timing of the Medicaid rollbacks? When did those actually get put in place? Was that at the beginning of the calendar year, or was it last October, or when exactly was it?

The legislation in the state of Arizona was effective October 1st of last year, and as I mentioned in response to an earlier question, we continued to see our patients. We just didn't cut them off right away, and the reason is that's just good patient care. And we worked with them to find alternative ways to pay for their treatment.

And so what we're seeing now is that after it's been out there for about nine months, it's clearly impacting the flow of new patients, and that's why we got hit so hard this time around.

Okay. And just -- I'm curious. At the time that you had provided guidance and you -- at that point, you would've known that those Medicaid cuts were in place, what was it about the ruling about these Medicaid cuts that would have led you to a conclusion that there would be growth in that market or more growth than you are currently seeing?

Well, two things. This was a ruling that said that anyone over 21 years old would no longer be eligible for a Medicaid -- state Medicaid payment in the state of Arizona.

So a couple of things. One is that we just didn't anticipate what that impact was going to be on patient flow when we were working up those guidance numbers.

Two, in working with our regional vice president in that area, he had put some programs into place where he was going to go out and try to get some market share in other parts of the O&P world.

And then number three is that he had gotten on to some new technology and thought that we could bring some new products into the space that would not be orthotic products but they would be things that would still be useful and we would be able to bill for those.

And what had happened is the patient flow was more severe than we thought. We haven't been as successful as we thought we would be in taking some share in other parts of O&P, and we're still ramping up on some of those new products. But we -- as I mentioned, we're dedicated to finding ways to recapture those revenues through those three mechanisms.

Okay. Second -- the last two questions are related to your M&A pipeline.

The first is giving us an idea of the size of the pipeline and the valuations being asked for companies that you may be considering acquiring.

And then the second thing is for companies that you have acquired within the last six to 12 months, how is the integration and patient volume growth going for those acquired entities?

Okay, take those in order. The overall size of the pipeline -- and this is companies based on their annualized sales that we're in discussions with -- hit 35 to 45 million at any given time. Companies come into that pipeline and sometimes companies go out of that pipeline because we can't reach agreement on valuation or there's something wrong with the business and we opt not to pursue it.

In terms of the valuation, we look at the as-found -- we'll take out the obvious things, but we look at the as-found EBITDA, and typically we'll pay between 4.5 to 5.5 times that EBITDA and reach agreement around that.

When we bring them in and integrate them into our processes, which is something we've been doing through tens and tens of acquisitions, so we know that game very well, when we bring them in, typically what we see is through better materials purchasing, improving some of the processes, leveraging the talent that's out there so that they can get more business, we can add about 5 percentage points on their EBITDA-to-sales ratio.

So that has been proven in and out. We go back and do postmortems annually on the businesses to determine if we're still doing that, and we are. The ones that we've made this year, we are -- there's no issues in the integration, and we're bringing them in, and it takes -- typically until we get to steady state, it can take anywhere from nine to 15, 18 months before they're totally integrated into the company because there's system changes, process changes, etcetera, etcetera, and we have to get them up to speed on our compliance programs. So it is a -- it's an effort, but it's one that we've documented and know very well.

Okay. But would you say that either the quality, volume, or the asking price of potential acquisitions has changed at all over the last quarter or so?

Not really. Question that is asked all the time, with all of these issues that are swirling around regarding fee schedule increases, decreases in Medicaid, etcetera, have the sellers been willing to reduce their asking price or accept less?

Yes?

And the answer to that is no. I mean when we build out the valuations, we'll project out the P&L, and we'll certainly take a good strong look at the cash flow. But we've not seen any deterioration in terms of asking price, and the reason for that is pretty simple. These fellows, while there may be headwinds, they've built this business. They know exactly what they need to do to be profitable, and in some cases, they'll take their personnel down, they'll take labor costs down, and they'll just work harder and longer themselves. And so they'll do everything they can to hold the value at that point.

Looking into the future, we expect that -- and that's a fair price. I mean in our mind, 4.5 to 5.5 is fair in the as-found condition. As long as we can continue to bring them in and improve them, it's good for our shareholders because we can get the synergy and pick up on the accretion. But we've not seen any deterioration in the last quarter in terms of volume, quality, or price.

So your total number of acquisitions year to date is how much again?

Right now, we're a little north of 20 --

Okay.

-- in terms of the annualized sales.

And you would anticipate that that would grow in Q4?

Yes, simply by looking at the pipeline. That's why I made that comment that we will be above the 20 to 22 million, which is our target each year.

Okay. Thank you.

You're welcome.

David McDonald, SunTrust.

Actually, guys, it's been asked. Thank you.

Thank you, David.

Brian Sekino, Barclays Capital.

Thanks for squeezing me back in here. Just a follow-up on a comment on the legislation that you're pushing into the super committee. You mentioned the savings from the reduction in fraud and abuse, but as part of that, are you trying to attach anything in terms of gaining clarity on 2013 reimbursement or coverage?

No. We know that they are going to be looking for ways to save money. And so what we have suggested is that when we score this out, it looks like there's about $250 million of savings here over 10 years, and we think that's conservative. And as I mentioned, that's just by eliminating some of these characters that are out there that are fraudulently billing the government because this act, this Medicare -- we call it the Orthotics and Prosthetics Medicare Improvement Act, what it's designed to do is to restrict payment to only certified and/or licensed practitioners, and 13 states have licensure.

So with that thought in mind, it says that the government can't pay folks if they aren't certified or licensed. Then if we look at where the fraud occurs, it's people that don't have a license, aren't certified, and they're still getting paid.

There was a special that was on 60 Minutes probably about six months ago where a fellow down in Miami had given up on the drug business and he just started billing Medicare. Got a Medicare provider number, and he admitted on TV, and he was going to jail for it, that he billed Medicare for $20 million and never put a device on anyone. He had a storefront and that was it.

So what happens is these are all fraudulent bills, and he doesn't -- he has no certification number, he's no provider, so it restricts that payment and says you can't pay unless when that bill comes in there is a [Certifee] number on it that can be backtracked to who it is. So that's where the savings would come from.

Thanks a lot.

But we haven't attempted to link it to anything in the 2013 other than saying here is something. Here is some savings.

Great. Thank you.

Larry Solow, CJS Securities.

Great. Thanks for taking a follow-up. Just on the coverage of the orthotics that Medicaid's no longer covering in Arizona, is -- looking out across the country, is this something that could happen in other states? Or has this coverage already not -- is there already not coverage in many of these states? Or is there a potential for additional cuts like this [in other states]?

Larry, a number of the states have trimmed back their Medicaid programs, and we've seen that over the years. Arizona is particularly troublesome to us because of our high market share.

Right.

And the other thing is just the demographic that's down there. As the population gets older, what we typically see is more orthotic work because now you're dealing with falls, you're dealing with implants, and then subsequent bracing, etcetera.

So as I've said, a number of the states have already gone through and trimmed out portions of their population. I remember South Carolina did it a few years ago. So we watch it very closely and try to go lobby. We've been successful in some of the states to prevent budget cutbacks or elimination in the population.

We've just put a movie together where a patient comes in and is forced to give up his prosthesis in exchange for a crutch to try and drive the point home, that this isn't good patient care and it removes an individual from the workforce and quality of life.

So we just -- we've watched them very, very closely just to stay in touch with what's going on, but this has been going on for some time, but as I say, the magnitude of the Arizona change is the thing that really got us here.

And are you seeing more increased pressure just from other states, as well, just on price rollbacks? I mean I imagine with budgets, a lot of budgets under water, is there a potential for more price cuts on Medicaid, just in general?

Well, if the states can't raise the revenue, and maybe some of the good news is early receipts seem to going up instead of going down, but there is -- there's profit in businesses more so than before, and individuals maybe are a little better off. But it's a balloon, and if you press it in in one place, then you're going to have to see it pop out somewhere else.

So as states either come up with shortfalls, they have to figure out ways to cut. We've seen some aggressive action that's been taken in states like New Jersey, but they're not going after the healthcare benefits; they're going after other costs that are in the system.

So we're not the only target. We believe that ours is really an investment and it really helps the community and helps the patient, and it avoids costs that can exceed the investment that they would make in the orthotic or prosthetic device. But who knows where all this is going to go with the states and how it's going to end up? So we just have to be ready.

Plus, as we all know, this is only 6% of our business. It's not a huge piece of (inaudible - multiple speakers).

Right. That's why -- that's what kind of surprised me as to the -- sort of my earlier question. If it's only 6%, what's -- why is it such a big impact this quarter? But I think (inaudible - multiple speakers).

It's an unusual situation --

Right, right.

-- in Arizona --

Right.

-- where we have a very large market share that we don't have anywhere else in the country.

No, fair enough.

So it's a one-off.

Right, no, understood. Okay, thanks. I appreciate it.

You're welcome.

There are no further questions at this time. I turn the call back over to the presenters.

Thank you, Sheila, and I want to thank everybody out there for the time that you spent listening to us and the time and the diligence you put into the questions, all very good questions.

We will be working on this fourth quarter, and we'll be announcing that in February, so as we're not going to have any more communications with you, I wish you all a very happy holiday season and a safe holiday season and look forward to talking to you when we report the results of our fourth quarter. Thank you all very much.

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