HANGER, INC. – 10-Q – Management’s Discussion and Analysis of Financial Condition and Results of Operations
|Edgar Online, Inc.|
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, 2011for 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 Statesand, 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 Columbiaand 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. 15 --------------------------------------------------------------------------------
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For the three and nine months ended
September 30, 2012, our net sales were $243.5 millionand $713.4 million, respectively, and we recorded net income of $17.3 millionand $42.3 million, respectively. For the three and nine months ended September 30, 2011, our net sales were $235.3 millionand $670.5 millionrespectively, and we recorded net income of $15.4 millionand $37.1 million, respectively.
We have three segments-Patient-Care Services, Distribution and Therapeutic Solutions. For the three months ended
Industry Overview We estimate that we currently account for approximately 21% of an addressable
$4.3 billionO&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 Statesis 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 billionmarket. 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. 16
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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 Medicarebenefits for financially needy persons aged 65 or older; and † U.S. Department of Veterans Affairs. Government reimbursement, comprised of Medicare, Medicaidand 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, 2012and 2011, respectively. These payors have set maximum reimbursement levels for O&P services and products. Medicareprices are adjusted each year based on the Consumer Price Index-Urban ("CPIU") unless Congressacts to change or eliminate the adjustment. The Medicareprice (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, Medicareor Medicaidrequirements 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
Table of Contents 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 Statestypically 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. 18
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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. 19
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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. 20
Table of Contents † 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 millionresulting 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.
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 millionin 2012 and investing a total of $35 million to $45 millionin capital additions. The Company will continue its acquisition program with a goal of closing acquisitions that total approximately $20 millionin annualized revenues. We have already exceeded that goal in 2012 by closing $35.6 millionin patient care acquisitions through October 2, 2012. 21 --------------------------------------------------------------------------------
Table of Contents 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
Net Sales. Net sales for the three months ended
September 30, 2012increased $8.2 million, or 3.5%, to $243.5 millionfor the third quarter of 2012 compared to $235.3 millionfor 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 millionincrease from acquired entities; a $0.9 million, or 3.5%, increase in sales in the Distribution segment; and a $0.4 milliondecrease from the Therapeutic Solutions segment. Cost of Goods Sold - Materials. Cost of goods sold - materials for the three months ended September 30, 2012was $73.1 million, an increase of $3.7 millionover $69.4 millionfor 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, 2012increased by $2.0 millionto $84.1 millionfrom $82.1 millionfor the three months ended September 30, 2011due to approximately $1.7 millionfrom 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 millionto $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 milliondecrease in variable operating expenses and a $1.2 milliondecrease in bad debt expense. These decreases were partially offset by a $0.6 millionincrease from acquired entities. Relocation Expenses. As of January 1, 2012, we had completed the relocation of our corporate office from Bethesda, Marylandto 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
Income from Operations. Income from operations increased
$4.2 million, to $35.4 million, for the three months ended September 30, 2012compared to $31.2 millionfor the three months ended September 30, 2011due to increased sales volume and improved leverage of operating expenses. 22 --------------------------------------------------------------------------------
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Interest Expense. Interest expense remained consistent at
$7.8 millionfor 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, 2012was $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
Nine Months Ended
Net Sales. Net sales for the nine months ended
September 30, 2012increased $42.9 million, or 6.4%, to $713.4 millionfrom $670.5 millionfor 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 millionincrease from acquired entities; a $5.5 millionor 7.3% increase in sales in the Distribution segment; and a $1.1 milliondecrease from the Therapeutic Solutions segment. Cost of Goods Sold - Materials. Cost of goods sold - materials for the nine months ended September 30, 2012was $210.1 million, an increase of $14.1 millionover $196.0 millionfor 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, 2012increased by $9.2 millionto $251.2 millionfrom $242.0 millionfor the nine months ended September 30, 2011. The increase was due to approximately $6.7 millionfrom 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 millionto $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 millionfrom acquisitions, a $4.1 millionincrease 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, Marylandto Austin, Texas. During the nine months ended September 30, 2011, we incurred $0.7 millionof employee relocation costs. Depreciation and Amortization. Depreciation and amortization for the nine months ended September 30, 2012increased $2.5 million, to $25.4 million, compared to $22.9 millionfor 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, 2012compared to $82.5 millionfor the nine months ended September 30, 2011due to increased sales volume and improved leverage of operating expenses. Interest Expense. Interest expense decreased $0.8 millionfor the nine months ended September 30, 2012, to $23.2 million, compared to $24.0 millionfor 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, 2012was $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. 23 --------------------------------------------------------------------------------
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Net Income. Net income increased
Financial Condition, Liquidity and Capital Resources
Cash Flows Our working capital at
September 30, 2012was $276.8 million, compared to $216.9 millionat 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, 2012increased to 54 days from 51 days for the same period last year. Net cash provided by operating activities was $59.0 millionfor the nine months ended September 30, 2012compared to $35.2 millionfor 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 millionfor the nine months ended September 30, 2012, compared to $32.5 millionin 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 millionin capital assets, compared to $21.8 millionfor 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 millionof cash in order to eliminate letters of credit obligations under our revolving credit agreement. Net cash used by financing activities was $4.0 millionand $7.5 millionfor the nine months ended September 30, 2012and 2011, respectively. During the first nine months of 2012 we: (i) repaid $2.9 millionrelated to term loan borrowings under our credit facilities ("Term Loans"); (ii) made $3.4 millionof required repayments of promissory notes issued in connection with acquisitions ("Seller Notes"); and (iii) received $2.2 millionof proceeds from issuance of stock under employee stock compensation plans. During the first nine months of 2011 we: (i) borrowed and repaid $10.0 millionunder our revolving credit facility; (ii) repaid $2.2 millionrelated to Term Loans; (iii) made $2.6 millionof required repayments of Seller Notes; (iv) incurred $4.2 millionof financing costs related to the amendment to our credit agreement in the first quarter of 2011; and (v) received $0.6 millionof 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 24
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Amendment to Credit Agreement
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 millionof fees related to this amendment, which will be amortized into interest expense over the remaining term of the debt.
Revolving Credit Facility
$100.0 millionRevolving Credit Facility matures on December 1, 2015and 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, 2011to 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, 2012to September 30, 2012, and 4.00:1.00 from October 1, 2012thereafter 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 millionfrom 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 millionavailable under the Revolving Credit Facility. Availability under the Revolving Credit Facility as of September 30, 2012was 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 millionTerm Loan Facility matures on December 1, 2016and requires quarterly principal payments of $750,000that 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
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. 25 --------------------------------------------------------------------------------
Table of Contents 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 millionwas 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
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
(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, 2011for 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.