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HANGER, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

Edgar Online, Inc.

Overview




The following is a discussion of our results of operations and financial
condition for the periods described below. This discussion should be read in
conjunction with the Consolidated Financial Statements included in this report.
Our discussion of our results of operations and financial condition includes
various forward-looking statements about our markets, the demand for our
products and services and our future results. These statements are based on our
current expectations, which are inherently subject to risks and uncertainties.
Refer to risk factors disclosed in Part II, Item 1A of this filing as well as
the risk factors disclosed in the Company's Annual Report on Form 10-K for the
year ended December 31, 2011 for further discussion of risks and uncertainties.
Our actual results and the timing of certain events may differ materially from
those indicated in the forward looking statements.



Business Overview



General



The goal of Hanger, Inc. (the "Company") is to be the world's premier provider
of services and products that enhance human physical capabilities. Built on the
legacy of James Edward Hanger, the first amputee of the American Civil War,
Hanger is steeped in 150 years of clinical excellence and innovation.  We
provide orthotic and prosthetic patient-care services, distribute O&P devices
and components, manage O&P networks, and provide therapeutic solutions to the
broader post acute market. We are the largest owner and operator of orthotic and
prosthetic patient-care centers in the United States and, through our
distribution subsidiary, Southern Prosthetic Supply, Inc. ("SPS"), the largest
dedicated distributor of O&P products in the United States. We operate in excess
of 730 O&P patient-care centers located in 45 states and the District of
Columbia and six strategically located distribution facilities. In addition to
providing O&P services and products we, through our subsidiary, Linkia LLC
("Linkia"), manage an O&P provider network and develop programs to manage all
aspects of O&P patient care for insurance companies. We also provide therapeutic
solutions through our subsidiaries Innovative Neurotronics ("IN, Inc.") and
Accelerated Care Plus Corp ("ACP"). IN, Inc. introduces emerging neuromuscular
technologies developed through independent research in a collaborative effort
with industry suppliers worldwide. ACP is a developer of specialized
rehabilitation technologies and a leading provider of evidence-based clinical
programs for post-acute rehabilitation serving more than 4,400 long-term care
facilities and other sub-acute rehabilitation providers throughout the U.S.



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For the three and nine months ended September 30, 2012, our net sales were
$243.5 million and $713.4 million, respectively, and we recorded net income of
$17.3 million and $42.3 million, respectively. For the three and nine months
ended September 30, 2011, our net sales were $235.3 million and $670.5 million
respectively, and we recorded net income of $15.4 million and $37.1 million,
respectively.


We have three segments-Patient-Care Services, Distribution and Therapeutic Solutions. For the three months ended September 30, 2012, net sales attributable to our Patient-Care Services, Distribution and Therapeutic Solutions segments were $200.3 million, $27.4 million and $15.7 million, respectively. For the nine months ended September 30, 2012, net sales attributable to our Patient-Care Services, Distribution and Therapeutic Solutions segments were $584.5 million, $81.0 million and $47.4 million, respectively. See Note L to our consolidated financial statements contained herein for further information related to our segments.

Executive Positions Available for Seasoned Marketers



Industry Overview



We estimate that we currently account for approximately 21% of an addressable
$4.3 billion O&P market. Hanger provides a unique portfolio of orthotic,
prosthetic, post-operative and physical therapeutic solutions to patients in the
acute, post-acute, and patient care clinic settings.  We estimate that the
traditional O&P patient-care clinic market in the United States is approximately
$2.6 billion, of which we account for approximately 26%.  Acute, post-acute and
addressable adjacent O&P care opportunities we have identified comprise an
additional $1.7 billion market.



The O&P patient-care market is highly fragmented and is characterized by local,
independent O&P businesses, with the majority of these businesses generally
having a single facility with annual revenues of less than $1.0 million. We do
not believe that any single competitor accounts for more than 2% of the
country's total estimated O&P patient-care clinic revenues.



The O&P services industry is characterized by stable, recurring revenues,
primarily resulting from new patients as well as the need for periodic
replacement and modification of O&P devices. Based on our experience, the
average replacement time for orthotic devices is one to three years, while the
average replacement time for prosthetic devices is three to five years. There is
also an attendant need for continuing O&P patient-care services. In addition to
the inherent need for periodic replacement and modification of O&P devices and
continuing care, we expect the demand for O&P services to continue to grow as a
result of several key trends, including the aging of the U.S. population,
resulting in an increase in the prevalence of disease associated disability, and
the demand for new and advanced devices.



We estimate the post-acute rehabilitation market to include approximately 15,700
skilled nursing facilities (SNF) and to have a market potential of approximately
$240 million. We provide technologically advanced rehabilitation equipment and
clinical programs to approximately 28% of the SNF market. We estimate the
broader post-acute rehabilitation markets to be approximately $0.6 billion. We
currently provide goods and services to very few customers in this portion of
the market; however, we believe this market would benefit from our products and
services.



Business Description



Patient-Care Services



As of September 30, 2012, we provided O&P patient-care services through over 730
patient-care centers and over 1,200 clinicians in 45 states and the District of
Columbia. Substantially all of our clinicians are certified, or are candidates
for formal certification, by the O&P industry certifying boards. A clinician
manages each of our patient-care centers. Our patient-care centers also employ
highly trained technical personnel who assist in the provision of services to
patients and who fabricate various O&P devices, as well as office administrators
who schedule patient visits, obtain approvals from payors and bill and collect
for services rendered.



In our orthotics business, we design, fabricate, fit and maintain a wide range
of custom-made braces and other devices (such as spinal, knee and
sports-medicine braces) that provide external support to patients suffering from
musculoskeletal disorders, such as ailments of the back, extremities or joints
and injuries from sports or other activities. In our prosthetics business, we
design, fabricate, fit and maintain custom-made artificial limbs for patients
who are without limbs as a result of traumatic injuries, vascular diseases,
diabetes, cancer or congenital disorders. O&P devices are increasingly
technologically advanced and are custom-designed to add functionality and
comfort to patients' lives, shorten the rehabilitation process and lower the
cost of rehabilitation.



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Executive Positions Available for Seasoned Marketers




Patients are referred to Hanger by an attending physician who determines a
patient's treatment and writes a prescription. Our clinicians then consult with
both the referring physician and the patient with a view toward assisting in the
design of an orthotic or prosthetic device to meet the patient's needs.  The
fitting process often involves several stages in order to successfully achieve
desired functional and cosmetic results.  Custom devices are fabricated by our
skilled technicians using plaster castings, measurements and designs made by our
clinicians.  Frequently our proprietary Insignia system is used to measure and
design devices.  The Insignia system scans the patient and produces a very
accurate computer generated image of the patient which results in a faster
turnaround for the patient's device and a more professional overall experience.



To provide timely service to our patients, we employ technical personnel and
maintain laboratories at many of our patient-care centers. We have earned a
strong reputation within the O&P industry for the development and use of
innovative technology in our products, which has increased patient comfort and
capability, and can significantly enhance the rehabilitation process. The
quality of our services and the success of our technological advances have
generated broad media coverage, building our brand equity among payors, patients
and referring physicians.


The principal reimbursement sources for our services are:

† Commercial and other, which consist of individuals, rehabilitation providers, private insurance companies, HMOs, PPOs, hospitals, vocational rehabilitation, workers' compensation programs and similar sources;

Medicare, a federally funded health insurance program providing
health insurance coverage for persons aged 65 or older and certain disabled
persons, which provides reimbursement for O&P products and services based on
prices set forth in fee schedules for 10 regional service areas;



†          Medicaid, a health insurance program jointly funded by federal and
state governments providing health insurance coverage for certain persons in
financial need, regardless of age, which may supplement Medicare benefits for
financially needy persons aged 65 or older; and



†          U.S. Department of Veterans Affairs.



Government reimbursement, comprised of Medicare, Medicaid and the U.S.
Department of Veterans Affairs, in the aggregate, accounted for approximately
40.8% and 40.4% of our net sales for the nine months ended September 30, 2012
and 2011, respectively. These payors have set maximum reimbursement levels for
O&P services and products. Medicare prices are adjusted each year based on the
Consumer Price Index-Urban ("CPIU") unless Congress acts to change or eliminate
the adjustment. The Medicare price (decreases)/ increases for 2012, 2011, 2010,
2009, and 2008 were 2.4%, (0.1%), 0.0%, 5.0%, and 2.7%, respectively. There can
be no assurance that future changes will not reduce reimbursements for O&P
services and products from these sources.



We enter into contracts with third-party payors that allow us to perform O&P
services for a referred patient and be paid under the contract with the third-
party payor. These contracts typically have a stated term of one to three years.
These contracts generally may be terminated without cause by either party on 60
to 90 days' notice or on 30 days' notice if we have not complied with certain
licensing, certification, program standards, Medicare or Medicaid requirements
or other regulatory requirements. Reimbursement for services is typically based
on a fee schedule negotiated with the third-party payor that reflects various
factors, including geographic area and number of persons covered.



Through the normal course of business, we receive patient deposits on devices not yet delivered. At September 30, 2012 and December 31 2011, we held $1.1 million and $0.5 million of deposits, respectively, from our patients.

Executive Positions Available for Seasoned Marketers

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Provider Network Management



Linkia is the only provider network management company dedicated solely to
serving the O&P market. Linkia is dedicated to managing the O&P services of
national and regional insurance companies. Linkia partners with healthcare
insurance companies by securing a national or regional contract either as a
preferred provider or to manage their O&P network of providers. Linkia's network
now includes approximately 1,070 O&P provider locations, including approximately
389 independent providers. As of September 30, 2012, Linkia had 53 contracts
with national and regional providers.



Distribution Services



We distribute O&P components to independent customers and to our own
patient-care centers through our wholly-owned subsidiary, SPS, which is the
nation's largest dedicated O&P distributor. We are also a leading manufacturer
and distributor of therapeutic footwear for diabetic patients in the podiatric
market. SPS maintains in inventory approximately 30,000 individual SKUs
manufactured by more than 340 different companies. SPS operates distribution
facilities in California, Florida, Georgia, Illinois, Pennsylvania, and Texas,
which allows us to deliver products via ground shipment anywhere in the
contiguous United States typically within two business days.



Our Distribution business enables us to:

† centralize our purchasing and thus lower our material costs by negotiating purchasing discounts from manufacturers;



†          reduce our patient-care center inventory levels and improve inventory
turns;



†          perform inventory quality control;


† encourage our patient-care centers to use clinically appropriate products that enhance our profit margins; and

† coordinate new product development efforts with key vendor "partners".




Marketing of our Distribution services is conducted on a national basis through
a dedicated sales force, print and e-commerce catalogues, and exhibits at
industry and medical meetings and conventions. We direct specialized catalogues
to segments of the healthcare industry, such as orthopedic surgeons, physical
and occupational therapists, and podiatrists.



Therapeutic Solutions



We provide therapeutic solutions to the O&P market and post-acute rehabilitation
market through our subsidiaries IN, Inc. and ACP. ACP is the nation's leading
provider of rehabilitation technologies and integrated clinical programs to
rehabilitation providers. ACP's unique value proposition is to provide its
customers with a full-service "total solutions" approach encompassing proven
medical technology, evidence based clinical programs, and continuous onsite
therapist education and training. ACP's services support increasingly advanced
treatment options for a broader patient population and more medically complex
conditions. ACP has contracts to serve more than 4,400 skilled nursing
facilities nationwide, including 21 of the 25 largest national providers. ACP's
contracts contain negotiated pricing and service levels with terms ranging from
one to five years. ACP generally bills its customers monthly and revenue is
recognized based upon the contractual terms of the agreements.



IN, Inc. specializes in the product development and commercialization of
emerging products in the O&P and Rehabilitation markets. Working with inventors
under licensing and consulting agreements, IN, Inc. commercializes the design,
obtains regulatory approvals, develops clinical protocols for the technology,
and then introduces the devices to the marketplace through a variety of
distribution channels. IN, Inc. currently has two commercial products: the
WalkAide System which benefits patients with a condition referred to as drop
foot, and the V-Hold which is active vacuum technology used in lower extremity
prosthetic devices.



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Critical Accounting Policies and Estimates




Our analysis and discussion of our financial condition and results of operations
is based upon our Consolidated Financial Statements that have been prepared in
accordance with accounting principles generally accepted in the United States of
America ("GAAP"). The preparation of financial statements in conformity with
GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period.  GAAP provides the
framework from which to make these estimates, assumptions and disclosures. We
have chosen accounting policies within GAAP that management believes are
appropriate to accurately and fairly report our operating results and financial
position in a consistent manner. Management regularly assesses these policies in
light of current and forecasted economic conditions. Our accounting policies are
stated in Note B to the Consolidated Financial Statements included elsewhere in
this report.  We believe the following accounting policies are critical to
understanding our results of operations and the more significant judgments and
estimates used in the preparation of our Consolidated Financial Statements.



†          Revenue Recognition:  Revenues in our Patient-Care Services segment
are derived from the sale of O&P devices and the maintenance and repair of
existing devices and are recorded net of all contractual adjustments and
discounts. The sale of O&P devices includes the design, fabrication, assembly,
fitting and delivery of a wide range of braces, limbs and other devices.
Revenues from the sale of these devices are recorded when (i) acceptance by and
delivery to the patient has occurred; (ii) persuasive evidence of an arrangement
exists and there are no further obligations to the patient; (iii) the sales
price is fixed or determinable; and (iv) collectability is reasonably assured.
Revenues from maintenance and repairs are recognized when the service is
provided. Revenues on the sale of O&P devices to customers by the Distribution
segment are recorded upon the shipment of products, in accordance with the terms
of the invoice, net of merchandise returns received and the amount established
for anticipated returns. Discounted sales are recorded at net realizable value.
Revenues in our Therapeutic Solutions segment are primarily derived from leasing
rehabilitation technology combined with clinical therapy programs and education
and training. The revenue is recorded on a monthly basis according to terms of
the contracts with our customers.



Certain accounts receivable may be uncollectible, even if properly
pre-authorized and billed. Regardless of the balance, accounts receivable
amounts are periodically evaluated to assess collectability. In addition to the
actual bad debt expense recognized during collection activities, we estimate the
amount of potential bad debt expense that may occur in the future. This estimate
is based upon our historical experience as well as a review of our receivable
balances.



On a quarterly basis, we evaluate cash collections, accounts receivable balances
and write-off activity to assess the adequacy of our allowance for doubtful
accounts. Additionally, a company-wide evaluation of collectability of
receivable balances older than 180 days is performed at least semi-annually, the
results of which are used in the next allowance analysis. In these detailed
reviews, the account's net realizable value is estimated after considering the
customer's payment history, past efforts to collect on the balance and the
outstanding balance, and a specific reserve is recorded if needed. From time to
time, we may outsource the collection of such accounts to collection agencies
after internal collection efforts are exhausted. In cases where valid accounts
receivable cannot be collected, the uncollectible account is written off to bad
debt expense.



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The following represents the composition of our accounts receivable balance by
type of payor:



September 30, 2012
(In thousands)                  0-60 days       61-120 days      Over 120 days        Total
Patient Care Services
Commercial insurance           $     43,779    $      10,432    $        14,254    $    68,465
Private pay                           5,529            4,002              7,934         17,465
Medicaid                             11,213            2,904              3,821         17,938
Medicare                             26,564            5,481              7,155         39,200
VA                                    2,626              463                342          3,431
Distribution & Therapeutic
Solutions
Trade accounts receivable            11,988            3,953              4,227         20,168
                               $    101,699    $      27,235    $        37,733    $   166,667




December 31, 2011
(In thousands)                  0-60 days       61-120 days      Over 120 days        Total
Patient Care Services
Commercial insurance           $     50,136    $       9,594    $        11,759    $    71,489
Private pay                           3,936            3,791              9,219         16,946
Medicaid                             12,018            3,678              4,173         19,869
Medicare                             25,438            3,489              4,433         33,360
VA                                    1,428              373                159          1,960
Distribution & Therapeutic
Solutions
Trade accounts receivable            11,367            2,663              3,200         17,230
                               $    104,323    $      23,588    $        32,943    $   160,854




†          Inventories:  Inventories, which consist principally of raw
materials, work in process and finished goods, are stated at the lower of cost
or market using the first-in, first-out method. At our Patient-Care Services
segment, we calculate cost of goods sold-materials in accordance with the gross
profit method for all reporting periods. We base the estimates used in applying
the gross profit method on the actual results of the most recently completed
physical inventory and other factors, such as sales mix and purchasing trends
among other factors. Cost of goods sold-materials is adjusted once the annual
physical inventory is taken and the valuation is completed in the fourth
quarter. We treat these inventory adjustments as changes in accounting
estimates.



†          Goodwill and Other Intangible Assets:  Goodwill represents the excess
of purchase price over the fair value of net identifiable assets of purchased
businesses. We assess goodwill for impairment annually during the fourth
quarter, or when events or circumstances indicate that the carrying value of the
reporting units may not be recoverable.  The Company will first assess
qualitative factors to determine whether it is more likely than not that the
fair value of a reporting unit is less than its carrying amount as a basis for
determining whether it is necessary to perform the two-step goodwill impairment
test.  If the Company determines that a two-step goodwill impairment test is
necessary or more efficient than a qualitative approach, it will measure the
fair value of the Company's reporting units using a combination of income,
market and cost approaches.  Any impairment would be recognized by a charge to
operating results and a reduction in the carrying value of the intangible
asset.  As of October 1, 2011, there were no indicators of impairment as the
fair values of the reporting units were substantially in excess of their
carrying values.



Non-compete agreements are recorded based on agreements entered into by us and
are amortized, using the straight-line method, over their terms ranging from
five to seven years. Other definite-lived intangible assets are recorded at cost
and are amortized, using the straight-line method, over their estimated useful
lives of up to 17 years. Whenever the facts and circumstances indicate that the
carrying amounts of these intangibles may not be recoverable, we review and
assess the future cash flows expected to be generated from the related
intangible for possible impairment.  Any impairment would be recognized as a
charge to operating results and a reduction in the carrying value of the
intangible asset.



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†           Income taxes:  We are required to estimate income taxes in each of
the jurisdictions in which we operate. This process involves estimating the
actual current tax liability together with assessing temporary differences in
recognition of income (loss) for tax and accounting purposes. These differences
result in deferred tax assets and liabilities, which are included in the
Consolidated Balance Sheet. We then assess the likelihood that the deferred tax
assets will be recovered from future taxable income and, to the extent that we
believe that recovery is not likely, we establish a valuation allowance against
the deferred tax asset.



We recognize liabilities for uncertain tax positions based on a two-step
process. The first step requires us to determine if the weight of available
evidence indicates that the tax position has met the threshold for recognition;
therefore, we must evaluate whether it is more likely than not that the position
will be sustained on audit, including resolution of any related appeals or
litigation processes. The second step requires us to measure the tax benefit of
the tax position taken, or expected to be taken, in an income tax return as the
largest amount that is more than 50% likely of being realized upon ultimate
settlement. This measurement step is inherently complex and requires subjective
estimations of such amounts to determine the probability of various possible
outcomes. We re-evaluate the uncertain tax positions each quarter based on
factors including, but not limited to, changes in facts or circumstances,
changes in tax law, expirations of statutes of limitation, effectively settled
issues under audit, and new audit activity. Such a change in recognition or
measurement would result in the recognition of a tax benefit or an additional
charge to the tax provision in the period.



Although we believe the measurement of our liabilities for uncertain tax
positions is reasonable, no assurance can be given that the final outcome of
these matters will not be different than what is reflected in the historical
income tax provisions and accruals. If additional taxes are assessed as a result
of an audit or litigation, it could have a material effect on the income tax
provision and net income in the period or periods for which that determination
is made. We operate within multiple taxing jurisdictions and are subject to
audit in these jurisdictions. These audits can involve complex issues which may
require an extended period of time to resolve and could result in additional
assessments of income tax. We believe adequate provisions for income taxes have
been made for all periods.



Guidance and Outlook



The Company expects full year 2012 revenues between $970 million and $990
million resulting from a comparable store sales growth in our patient-care
services segment of 3% to 5% and growth in our distribution segment of 3% to
7%.  We expect flat to slightly higher revenues in our Therapeutic Solution
Services segment for the year, with sales in the first half of the year down
then trending up the second half as the rate of new contract sales accelerates.
The Company anticipates diluted earnings per share between $1.75 and $1.79. 

As

in past years, the Company's goal is to increase operating margins by twenty to
forty basis points. The Company anticipates generating cash flow from operations
between $70 million and $80 million in 2012 and investing a total of $35 million
to $45 million in capital additions.  The Company will continue its acquisition
program with a goal of closing acquisitions that total approximately $20 million
in annualized revenues. We have already exceeded that goal in 2012 by closing
$35.6 million in patient care acquisitions through October 2, 2012.



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Results of Operations


The following table sets forth for the periods indicated certain items from our Consolidated Statements of Operations as a percentage of our net sales:



                                    Three Months Ended           Nine Months Ended
                                       September 30,               September 30,
                                    2012          2011          2012          2011
                                 (Unaudited)   (Unaudited)   (Unaudited)   (Unaudited)

Net sales                              100.0 %       100.0 %       100.0 %       100.0 %
Cost of goods sold - materials          30.0          29.5          29.5          29.2
Personnel costs                         34.6          34.9          35.2          36.1
Other operating expenses                17.3          18.9          19.0          18.9
Relocation expenses                        -           0.1             -           0.1
Depreciation and amortization            3.6           3.3           3.6           3.4
Income from operations                  14.5          13.3          12.7          12.3
Interest expense                         3.2           3.3           3.2           3.6
Income before taxes                     11.3          10.0           9.5           8.7
Provision for income taxes               4.2           3.4           3.6           3.2
Net income                               7.1 %         6.6 %         5.9 %         5.5 %



Three Months Ended September 30, 2012 Compared to the Three Months Ended September 30, 2011




Net Sales.  Net sales for the three months ended September 30, 2012 increased
$8.2 million, or 3.5%, to $243.5 million for the third quarter of 2012 compared
to $235.3 million for the same period of 2011.  This increase was due to a $1.9
million, or 1.0%, increase in same-center sales in the Patient-Care Services
segment; a $5.8 million increase from acquired entities; a $0.9 million, or
3.5%, increase in sales in the Distribution segment; and a $0.4 million decrease
from the Therapeutic Solutions segment.



Cost of Goods Sold - Materials.  Cost of goods sold - materials for the three
months ended September 30, 2012 was $73.1 million, an increase of $3.7 million
over $69.4 million for the three months ended September 30, 2011due to sales
growth. Cost of goods sold - materials as a percentage of net sales increased 50
basis points due to revenue mix.



Personnel Costs.  Personnel costs for the three months ended September 30, 2012
increased by $2.0 million to $84.1 million from $82.1 million for the three
months ended September 30, 2011 due to approximately $1.7 million from acquired
entities and the remainder from merit and staffing increases.   As a percentage
of net sales, personnel costs decreased 30 basis points to 34.6% in 2012 from
34.9% in 2011 due to leveraging existing headcount over increased sales volume.



Other Operating Expenses.  Other operating expenses, which are comprised
primarily of professional, office, bad debt, incentive compensation, and
reimbursable employee expenses, decreased $2.2 million to $42.2 million, or
17.3% of net revenues, in the third quarter of 2012 compared to $44.4 million,
or 18.9% of net revenues, in the third quarter of 2011.  The decrease is
primarily attributable to a $1.6 million decrease in variable operating expenses
and a $1.2 million decrease in bad debt expense.  These decreases were partially
offset by a $0.6 million increase from acquired entities.



Relocation Expenses.  As of January 1, 2012, we had completed the relocation of
our corporate office from Bethesda, Maryland to Austin, Texas.  During the three
months ended September 30, 2011, we incurred nominal costs related to the
relocation of employees.



Depreciation and Amortization. Depreciation and amortization for the three months ended September 30, 2012 increased $0.8 million, to $8.7 million, compared to $7.9 million in the third quarter of 2011. The increase was primarily due to software, leasehold improvements, and machinery and equipment purchased over the last 12 months.




Income from Operations.  Income from operations increased $4.2 million, to $35.4
million, for the three months ended September 30, 2012 compared to $31.2 million
for the three months ended September 30, 2011 due to increased sales volume and
improved leverage of operating expenses.



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Interest Expense.  Interest expense remained consistent at $7.8 million for the
three months ended September 30, 2012, compared to $7.8 million, for the three
months ended September 30, 2011.  Variable interest rates were comparable in the
two periods and the Company made required repayments of debt.



Provision for Income Taxes.  The provision for income taxes for the three months
ended September 30, 2012 was $10.3 million, or 37.2% of pre-tax income, compared
to $8.0 million, or 34.3% of pre-tax income, for the three months ended
September 30, 2011. The effective tax rate consists principally of the 35%
federal statutory tax rate and state income taxes, less permanent tax
differences.  The 2011 period has a lower effective tax rate primarily due to
the recognition of discrete tax benefits.



Net Income. Net income increased $1.9 million, to $17.3 million, for three months ended September 30, 2012, from $15.4 million for the three months ended September 30, 2011, due to the reasons noted above.

Nine Months Ended September 30, 2012 Compared to the Nine Months Ended September 30, 2011




Net Sales.  Net sales for the nine months ended September 30, 2012 increased
$42.9 million, or 6.4%, to $713.4 million from $670.5 million for the same
period in 2011.  The sales increase was driven by a $21.2 million, or 3.9%,
increase in same-center sales in the Patient- Care Services segment; a $17.3
million increase from acquired entities; a $5.5 million or 7.3% increase in
sales in the Distribution segment; and a $1.1 million decrease from the
Therapeutic Solutions segment.



Cost of Goods Sold - Materials.  Cost of goods sold - materials for the nine
months ended September 30, 2012 was $210.1 million, an increase of $14.1 million
over $196.0 million for the nine months ended September 30, 2011. The increase
was the result of growth in sales. Cost of goods sold - materials as a
percentage of net sales increased 30 basis points due to mix of revenue.



Personnel Costs.  Personnel costs for the nine months ended September 30, 2012
increased by $9.2 million to $251.2 million from $242.0 million for the nine
months ended September 30, 2011. The increase was due to approximately $6.7
million from acquired entities and the remainder from merit increases and
increased employee benefit costs. As a percentage of net sales, personnel costs
decreased 90 basis points to 35.2% in 2012 from 36.1% in 2011 due to leveraging
headcount over increased sales volume.



Other Operating Expenses.  Other operating expenses, which are comprised
primarily of professional, office, bad debt, incentive compensation, and
reimbursable employee expenses, increased $9.2 million to $135.6 million, or
19.0% of net revenues, for the nine months ended September 30, 2012, compared to
$126.4 million, or 18.9% of net revenues, for the nine months ended September
30, 2011.  The increase is attributable to $2.7 million from acquisitions, a
$4.1 million increase in incentive compensation, with the remainder attributable
to increased operating and bad debt expense.



Relocation Expenses.  As of January 1, 2012, we had completed the relocation of
our corporate office from Bethesda, Maryland to Austin, Texas.  During the nine
months ended September 30, 2011, we incurred $0.7 million of employee relocation
costs.



Depreciation and Amortization. Depreciation and amortization for the nine months
ended September 30, 2012 increased $2.5 million, to $25.4 million, compared to
$22.9 million for the nine months ended September 30, 2011.  The increase was
primarily due to software, leasehold improvements, and machinery and equipment
purchased over the last 12 months.



Income from Operations.  Income from operations increased $8.5 million, to $91.1
million, for the nine months ended September 30, 2012 compared to $82.5 million
for the nine months ended September 30, 2011 due to increased sales volume and
improved leverage of operating expenses.



Interest Expense.  Interest expense decreased $0.8 million for the nine months
ended September 30, 2012, to $23.2 million, compared to $24.0 million for the
nine months ended September 30, 2011, primarily due to lower interest rates
resulting from the amendment to our credit facilities in March 2011.



Provision for Income Taxes.  The provision for income taxes for the nine months
ended September 30, 2012 was $25.6 million, or 37.7% of pre-tax income, compared
to $21.5 million, or 36.7% of pre-tax income, for the nine months ended
September 30, 2011. The effective tax rate consists principally of the 35%
federal statutory tax rate and state income taxes, less permanent tax
differences.  The 2011 period has a lower effective tax rate primarily due to
the recognition of discrete tax benefits.



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Net Income. Net income increased $5.2 million, to $42.3 million, for nine months ended September 30, 2012, from $37.1 million for the nine months ended September 30, 2011, due primarily to increased sales volume and improved leverage of operating expenses.

Financial Condition, Liquidity and Capital Resources



Cash Flows



Our working capital at September 30, 2012 was $276.8 million, compared to $216.9
million at September 30, 2011. The increase in working capital is primarily due
to increases in cash, inventory, and accounts receivable. Days sales outstanding
("DSO"), which is the number of days between the billing date of O&P services
and the date of receipt of payment thereof, for the nine months ended September
30, 2012 increased to 54 days from 51 days for the same period last year. Net
cash provided by operating activities was $59.0 million for the nine months
ended September 30, 2012 compared to $35.2 million for the same period in the
prior year. The increase in cash provided by operating activities in the current
year resulted primarily from increased net income, and a decrease in incentive
compensation payments in 2012.



Net cash used in investing activities was $42.3 million for the nine months
ended September 30, 2012, compared to $32.5 million in the prior year. In the
first nine months of 2012, we acquired 14 O&P companies operating 21
patient-care centers at an aggregate purchase price of $21.8 million.  During
the same period in 2011, we acquired 5 O&P companies operating 10 patient-care
centers for an aggregate purchase price of $16.2 million. Additionally, in the
first nine months of 2012, we invested $23.4 million in capital assets, compared
to $21.8 million for the same period in 2011. Capital assets acquired in the
first nine months of 2012 related to the development of the Company's new
practice management system, leasehold improvements in our patient care practices
and computer equipment purchases. Additionally, during the first nine months of
2012 we restricted $3.1 million of cash in order to eliminate letters of credit
obligations under our revolving credit agreement.



Net cash used by financing activities was $4.0 million and $7.5 million for the
nine months ended September 30, 2012 and 2011, respectively. During the first
nine months of 2012 we: (i) repaid $2.9 million related to term loan borrowings
under our credit facilities ("Term Loans"); (ii) made $3.4 million of required
repayments of promissory notes issued in connection with acquisitions ("Seller
Notes"); and (iii) received $2.2 million of proceeds from issuance of stock
under employee stock compensation plans. During the first nine months of 2011
we: (i) borrowed and repaid $10.0 million under our revolving credit facility;
(ii) repaid $2.2 million related to Term Loans; (iii) made $2.6 million of
required repayments of Seller Notes; (iv) incurred $4.2 million of financing
costs related to the amendment to our credit agreement in the first quarter of
2011; and (v) received $0.6 million of proceeds from issuance of stock under
employee stock compensation plans.



Debt


Long-term debt consisted of the following:



                                                          September 30,      December 31,
(In thousands)                                                2012               2011
                                                           (Unaudited)       (Unaudited)
Revolving Credit Facility                                $             -    $            -
Term Loan                                                        294,050           297,000
7 1/8% Senior Notes due 2018                                     200,000           200,000
Subordinated seller notes, non-collateralized, net of
unamortized discount with principal and interest
payable in either monthly, quarterly or annual
installments at effective interest rates ranging from
2.00% to 6.50%, maturing through September 2017                   14,935            11,033
                                                                 508,985           508,033
Less current portion                                              (7,775 )          (8,065 )
                                                         $       501,210    $      499,968




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Amendment to Credit Agreement




On March 11, 2011, the Company entered into an amendment to its Credit Agreement
dated as of December 1, 2010 (as amended, the "Credit Agreement"). The amendment
(i) reduced the interest rate margin applicable to the Term Loans under the
Credit Agreement by 0.75% to 3.0% and (ii) reduced the LIBOR floor applicable to
the Term Loans under the Credit Agreement from 1.5% to 1.0%. The Company
incurred $4.1 million of fees related to this amendment, which will be amortized
into interest expense over the remaining term of the debt.



Revolving Credit Facility




The $100.0 million Revolving Credit Facility matures on December 1, 2015 and
bears interest at LIBOR plus 3.75%, or the applicable rate (as defined in the
Credit Agreement). The Revolving Credit Facility requires compliance with
various covenants including but not limited to (i) minimum consolidated interest
coverage ratio of 3.25:1.00 from October 1, 2011 to September 30, 2012, and
3.50:1.00 thereafter until maturity; (ii) maximum total leverage ratio of
5.00:1.00 until December 31, 2011, 4.50:1.00 from January 1, 2012 to
September 30, 2012, and 4.00:1.00 from October 1, 2012 thereafter until
maturity; and (iii) maximum annual capital expenditures of 7.5% of consolidated
net revenues of the preceding fiscal year with an additional maximum rollover of
$15.0 million from the prior year's allowance if not expended in the fiscal year
for which it is permitted. As of September 30, 2012, the Company had $99.5
million available under the Revolving Credit Facility. Availability under the
Revolving Credit Facility as of September 30, 2012 was net of standby letters of
credit of approximately $0.5 million. As of September 30, 2012, the Company had
no funds drawn on the Revolving Credit Facility. The obligations under the
Revolving Credit Facility are senior obligations, are guaranteed by the
Company's subsidiaries, and are secured by a first priority perfected interest
in the equity interests of the Company's subsidiaries, all of the Company's
assets, and all the assets of the Company's subsidiaries.



Term Loan



The $300.0 million Term Loan Facility matures on December 1, 2016 and requires
quarterly principal payments of $750,000 that commenced on March 31, 2011. From
time to time, mandatory prepayments may be required as a result of excess free
cash flow as defined in the Credit Agreement, certain additional debt
incurrences, certain asset sales, or other events as defined in the Credit
Agreement. The Term Loan Facility bears interest at LIBOR plus 3.0%, or
applicable rate (as defined in the Credit Agreement), and includes a 1.0% LIBOR
floor. During the first nine months of 2012 the Company made a mandatory
prepayment on its Term Loan Facility of $700,000.  There were no mandatory
prepayments made during the first nine months of 2011. As of September 30, 2012,
the interest rate on the Term Loan Facility was 4.0%. The obligations under the
Term Loan Facility are senior obligations, are guaranteed by the Company's
subsidiaries, and are secured by a first priority perfected interest in the
equity interests of Company's subsidiaries, all of the Company's assets, and all
the assets of the Company's subsidiaries.



71/8% Senior Notes


The 71/8% Senior Notes mature November 15, 2018 and are senior indebtedness which is guaranteed on a senior unsecured basis by all of the Company's current and future subsidiaries. Interest is payable semi-annually on May 15 and November 15 of each year, commencing May 15, 2011.




On or prior to November 15, 2013, the Company may redeem up to 35% of the
aggregate principal amount of the notes at a redemption price of 107.125% of the
principal amount thereof, plus accrued and unpaid interest and additional
interest to the redemption date with the proceeds of a public offering of its
equity securities. On or after November 15, 2014, the Company may redeem all or
from time to time a part of the notes, upon not less than 30 days and not more
than 60 days' notice, for the twelve month period beginning on November 15, of
the indicated years at (i) 103.563% during 2014; (ii) 101.781% during 2015; and
(iii) 100.00% during 2016 and thereafter through November 15, 2018.



Subsidiary Guarantees



The Revolving and Term Loan Facilities and the 71/8% Senior Notes are guaranteed
by all of the Company's subsidiaries. Separate condensed consolidating
information is not included as the Company does not have independent assets or
operations. The Guarantees are full and unconditional and joint and several, and
any subsidiaries of the Company other than the Guarantor Subsidiaries are minor.
There are no restrictions on the ability of our subsidiaries to transfer cash to
the Company or to co-guarantors. All consolidated amounts in the Company's
financial statements are representative of the combined guarantors.



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Debt Covenants



The terms of the Senior Notes, the Revolving Credit Facility, and the Term Loan
Facility limit the Company's ability to, among other things, incur additional
indebtedness, create liens, pay dividends on or redeem capital stock, make
certain investments, make restricted payments, make certain dispositions of
assets, engage in transactions with affiliates, engage in certain business
activities and engage in mergers, consolidations and certain sales of assets. At
September 30, 2012, the Company was in compliance with all covenants under these
debt agreements.



General



As of September 30, 2012, $294.1 million, or 57.8%, of our total debt of $509.0
million was subject to variable interest rates. We believe that, based on
current levels of operations and anticipated growth, cash generated from
operations, together with other available sources of liquidity, including
borrowings available under the Revolving Credit Facility, will be sufficient for
at least the next twelve months to fund anticipated capital expenditures, to
fund our acquisition plans and make required payments of principal and interest
on our debt, including payments due on our outstanding debt.



Obligations and Commercial Commitments

The following table sets forth our contractual obligations and commercial commitments as of September 30, 2012 (unaudited):




                             Payments Due by Period



(In thousands)            Remainder of 2012      2013       2014       2015       2016       Thereafter      Total
Long-term debt           $             2,234   $  7,540   $  6,680   $  6,071   $ 285,895   $    200,565   $ 508,985
Interest payments on
long-term debt                        17,298     26,374     26,081     25,831      24,208         26,735   $ 146,527
Operating leases                       5,600     40,245     32,535     22,729      16,524         36,676   $ 154,309
Capital leases and
other long-term
obligations (1)                        7,570     15,589     12,764     11,457       5,094         13,055   $  65,529
Total contractual cash
obligations              $            32,702   $ 89,748   $ 78,060   $ 66,088   $ 331,721   $    277,031   $ 875,350



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(1) Other long-term obligations include commitments under our SERP plan. Refer to Note K of the Company's Annual Report on Form 10-K for additional disclosure.






Forward Looking Statements



This report contains forward-looking statements setting forth our beliefs or
expectations relating to future revenues, contracts and operations, as well as
the results of an internal investigation and certain legal proceedings. Actual
results may differ materially from projected or expected results due to changes
in the demand for our O&P products and services, uncertainties relating to the
results of operations or recently acquired O&P patient-care centers, our ability
to enter into and derive benefits from managed-care contracts, our ability to
successfully attract and retain qualified O&P clinicians, federal laws governing
the health-care industry, uncertainties inherent in incomplete investigations
and legal proceedings, governmental policies affecting O&P operations and other
risks and uncertainties generally affecting the health-care industry. Readers
are cautioned not to put undue reliance on forward-looking statements.  Refer to
risk factors disclosed in Part II, Item 1A of this filing as well as the risk
factors disclosed in our Annual Report on Form 10-K for the year ended
December 31, 2011 for discussion of risks and uncertainties. We disclaim any
intent or obligation to publicly update these forward-looking statements,
whether as a result of new information, future events or otherwise.
Wordcount: 7213



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