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Hanger Orthopedic Group, Inc. (NYSE:HGR)

Q1 2009 Earnings Call

April 28, 2009 9:00 am ET

Executives

Tom Kirk - President and CEO

Ken Abod - VP, Treasurer and IR

George McHenry - EVP, CFO and Secretary

Analysts

Bryan Sekino - Barclays Capital

Larry Solow - CJS Securities

Greg Williams - Sidoti & Company

Daniel Owczarski - Avondale Partners

Michael Petusky - Noble Financial Group

Operator

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

Thank you. I will now turn the call over to Mr. Tom Kirk. Thank you.

Tom Kirk

Good morning. This is Tom Kirk, President and CEO and with me is George McHenry our Executive Vice President and CFO and Ken Abod who is our VP Treasurer and IR Director. I would like to welcome you to Hanger Orthopedic Group's discussion of our first quarter results.

Before starting the discussions let me ask Ken Abod our Treasurer and IR Director to review with you our declaration on forward-looking statements. Ken?

Ken Abod

Thanks Tom. During this call, management will make forward-looking statements relating to the company's results of operations. The United States Private Securities Litigation Reform Act of 1995 provides a Safe Harbor for certain forward-looking statements. Statements relating to future results of operations in this document reflect the views of management.

However, various risks, uncertainties and contingencies could cause actual results or performance to differ materially from those expressed in or implied by these statements, including the company's ability to enter into and derive benefits from managed care contracts, the demands for the company's orthotic and prosthetic services and products, and the other factors identified in the company's periodic reports on Form 10-K and Form 10-Q, filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934. The company disclaims any intent or obligation to update publicly these forward-looking statements whether as a result of new information, future events or otherwise.

Thanks. I will turn the call back over to Tom Kirk.

Tom Kirk

Thank you, Ken. Overall, I think you have seen in our press release where last evening we announced net sales of $169.1 million for the quarter which was an increase of $11.4 million or 7.3% increase from the $157.7 million in the prior year.

Just want to make some broad statements and some summary comments about the quarter, there are several noteworthy points that I would like to bring to your attention.

Our core businesses grew their sales over the first quarter of last year in spite of some challenging economic conditions and some more severe than normal weather conditions in selective parts of the country.

Their outstanding performance on sales enabled us to post $0.14 earnings per share which equates to slightly more than 17% growth over the EPS from last year's first quarter. This makes our 13th consecutive quarter where we have met or exceeded first call estimates.

We are continuing to see the benefits of the programs that we placed into operation over the last several quarters and certainly the results of our people's efforts.

Examples are more aggressive marketing program designed to position Hanger as the provider of choice in all of our business lines. We are continuing to educate our referral sources on the benefits of new products in the market. We are increasing the business that we have under contract by Linkia and we are extending the customer and product bases in our distribution business.

Last but not least, we have initiated the government and third party reimbursements for the WalkAide product. All of these things combine to make a very successful and solid quarter for us. And last but not least, our balance sheet and liquidity are strong which will enable us to execute our strategic plan without any constraints.

Now, I will it turn over to George who will review our financial results and then I will come back and have a few more words about our operations. George?

George McHenry

Thank you Tom, good morning everyone. For the quarter, sales increased by $11.4 million or 7.3% which was principally attributable to the comparable store sales growth in our patient care centers. $5.6 million or 4.1% of the sales, a $2 million increase or a 10.4% in outside sales of our distribution business, and $4.1 million of sales that are attributable to the acquired businesses.

Linkia sales increased by $1.5 million or 9.1% to $17.5 million for the quarter. They continue to be accretive to our overall sales growth and patient care.

System wide sales for WalkAide were $1.3 million for the quarter compared to $3.2 million in the prior year which benefited from the Good Morning America appearance. We did not expect the WalkAide sales in Q1 to exceed the prior year and we remain comfortable with our WalkAide sales expectations for the year which I will report on the overall sales guidance that I will discuss in a second.

Cost of materials as a percentage of sales was 13.2% which was six-tenth of a percent higher than the prior year due to a change in the mix of sales related to a combination of the SPS sales growth which was higher than the growth that we had in patient care. So that’s of course some increase in comp.

An increase in the sales of hi-tech items like the computer game which earned higher gross profit dollars per transaction but lower gross margin. And then we had some loss margin on the previously mentioned decrease in the WalkAide sales.

Personnel cost increased by $3.7 million compared to the same quarter last year, but decreased by 40 basis points as a percentage of sales as we levered our work force. The increase in dollars was due principally to $900,000 related to merit increases, $1.2 million related to benefit cost and $1.9 million from acquisitions offset by $200,000 and temporary labor cost.

SG&A increased by $2.2 million compared to 2008 and remained flat at 20.4% as a percentage of sales. The company was able to maintain the leverage of its fixed and variable SG&A despite the increase in cost.

The increase was due principally to a $1.9 million increase in the variable compensation accrual. Since the company reached its profitability goal for a few booked of approval for discretionary plans which will take some pressure off future quarters.

Other changes included $700,000 increase related to acquisitions and a $800,000 increase in occupancy cost which was offset by a $700,000 decrease in advertising cost and a $500,000 decrease in other costs.

EBITDA increased by $1.2 million or 6.6% to $19.6 million from $18.4 million in the prior quarter due to the factors I just discussed. EBITDA margins stayed the same compared to the prior year due to the increase of material costs, when you exclude that increase and we do expect our comp rate to be lower for the balance of the year. The company improved leverage of personnel and other cost by 50 basis points which exceeds the range that we expected for the year.

Interest in depreciation, interest decreased by $700,000 due principally to decreased variable interest rates which favorably impacted borrowings under the Term B and the revolver. Depreciation expense increased by $300,000 compared to last year principally due to higher level of additions in 2008 compared to prior years.

Our income tax provision remained at 40% for the quarter and EPS as a result of the factors I just discussed for the first quarter increased by 16.7% to $0.14 per diluted share compared to $0.12 last year.

Moving onto the balanced sheet and cash flow, our AR decreased by $3.8 million compared to year-end and $300,000 compared to the prior year.

DSOs improved to 48 days which is the lowest count ever. Our AR over 120 days was $13.9 million or $600,000 increase compared to year-end. The quality of our receivables is still very good.

We have not seen a slack in write-offs but we have been increasing our reserves to be conservative in this tough economic environment. Our inventory increased by $1.3 million to $87.3 million from $86 million at 12/31 which makes sense compared to our relative comp and recorded sales backlog at the end of the quarter.

CapEx for the quarter was $2.8 million which is inline with our expectations. Cash flow from operations in Q1 was a use of $3.7 million compared to $7.5 million in the prior year. The primary cause of the increase in cash flow compared to the prior year was improved earnings and continued excellent AR collections.

So, keep in mind Q1 every year is a use for us on the liability side, we are paying out our variable compensation plans.

Liquidity for the company was at $89.8 million comprised of $51.9 million in cash and $37.9 million in availability on the revolver. So we continue to have more than adequate cash and borrowing capability to conduct operations and execute our growth plans.

As mentioned in the press release, we are reiterating guidance that was established during our February 11, 2009 Q4 conference call, was called for sales in a range of $750 million to $760 million at the growth rate of 6.7% to 8.1%. EPS of $0.96 to $0.98 which is a growth rate of up to 14% and $14 million to $15 million in cash flow from operations.

That concludes my comments I am going to turn the call back over to Tom, now.

Tom Kirk

Thanks, George. I will add a little bit of color on each of our businesses and an overall perspective on our operating environment. Let's start with our patient care division HPO, as George mentioned, they achieved $5.6 million increase in sales, or 4.1% same center sales growth rate for the quarter. This performance for the quarter is partially based upon the rollout of the January 1, 2009, 5% CPIU increase in our fee schedule. This impacts about 35% of our book of business immediately.

This increase combined with the rollout of the last two year's increases to our commercial book of business translates to about 2.5% which we attribute to price of the 4.1% in overall growth.

Now the balance of the growth is attributable to volume and mix, we estimate the breakdown between those two of about 75% volume and 25% mix. So, let's now turn our attention to what are the programs that drive the volume and mix growth. First is the continued improvement in our Linkia book of business.

I want to remind you again that HPO is the primary vehicle for delivery of most of the services under the Linkia contract. Linkia does not provide patient care. On an overall basis. the revenue from the Linkia designated contract is up over 9% compared to the comparable quarter last year.

The second factor impacting volume and mix, is our continuing education that we give to our referral sources on the enhanced life like features of our high performing products such as our microprocessor prosthetic arms, hands, knees and feet components.

Now we stress these because the improved functionality that they offer to our patient is really better patient care and for the quarter, the revenue from the delivery of these product lines combined was up 34% compared to the comparable quarter last year.

The third area that impacts our volume and mix, our patient evaluation clinics. For this quarter, these clinics have produced approximately 20% more incremental revenue as compared to this activity in the first quarter of last year.

And fourth, the fourth area that's impacting our volume and mix are our sales, marketing and public relations efforts by our practitioners and those that support them in identifying specific opportunities in the local business areas to increase market share and then going out and actually implementing the plans to translate those opportunities into results.

So those four areas are primary drivers of our volume and mix. I want to make a few comments on the overall business climate because frequently we received some questions about this that our patient care business faces. Right now we know that the percentage of unemployment stands at 8.5%. Now, if we compare that to the 5.1% which is where we were last year at this time, it's a increase of about 3.4 percentage points.

Some studies suggest that for every 1% increase in unemployment, roughly 2.5 million people lose their insurance coverage. This includes of course, both the worker and their dependents.

Since some families have two working members, perhaps the other partners' insurance may mitigate this impact slightly. But I think this is a pretty good statistic for us to work with. Thus far, we have not seen any evidence that the challenging financial environment is translating into patient-care delays. We watch this very closely.

However, we have been working with some our patients to help them identify other sources of assistance on their co-pays. In addition, many workers who have lost their jobs have secured coverage via COBRA. And certainly, the government subsidy in this area has helped in making this insurance affordable and making sure that our patients are coming in for proper care.

While we've seen an increase in the number of folks that we help on their co-pays and those that have lost their job, but have picked up on the COBRA, we haven't seen this translate into a material negative impact on our sales.

We also must remember that different sections of the company are more profoundly impacted by this recession. And certainly states such as Michigan, where we have low market share is really suffering in this environment. But rest assured that we continue to monitor all of our maintenance codes, and stay very close to this. And we are very closely with our patients to make sure that they have the financial wherewithal and get good patient care.

Also impacting our environment is the regulatory and legislative front, we have been continuing to support the entity Coalition of America on educating state legislatures on the issues involved with reimbursement caps and limits and how these deprived patients of quality care and doing them to actually lowering levels in mobility.

Happy to say that there are now 15 states that have passed parity, if you remember when we last spoke with you there were 11, so we picked up four more, and almost 30 more are working on parity legislation at the state level.

On the federal level the Medicare orthotics and prosthetics improvement bill will be introduced into the house very shortly, which is going to tie reimbursement to the qualifications of the provider. This is going to improve patient-care, while at the same time reduce fraud and abuse by excluding non-qualified providers from payments.

Also support is building for the national orthotics and prosthetic parity bill which will remove caps to limits from existing medical plan operating under [RSTA]. This bill we have to remember is not a mandate for coverage, rather it simply states that O&P benefits must be fairly pursued with other kinds of medical treatments.

Several of the states that have passed parity have estimated that the incremental costs is less than three-one hundreds of a percent of the total insurance reimbursement on a per member per month basis. Very compelling argument in terms of taking care of patient and making the investment today and avoiding more substantial investment in the future in the way of cost. We expect this bill to be introduced into the senate in the coming weeks.

Okay, now let's turn our attention to SPS, our distribution business. Their outside sales were up approximately $2 million, or 10.4% compared to the first quarter of '08. Their success is in continuing to build sales through their core distribution business is really attributable to three major areas.29

First, is their superior customers service. Second, is an intensified sales and marketing effort, which includes additional education and training courses for their independent O&P practitioners. And third is the addition of some new standard and high-tech products into their product portfolio, which enables the purchasing practitioners to handle all of their needs with one visit to the SPS electronic website or in the case of some, just one phone call.

All three of these combined to help gain some new large contracts and increase their market share. And if you remember back in 2007, we made an acquisition in our distribution business of a company called Surefit, and Surefit sales are running ahead of the sales we had in the first quarter of last year.

We are seeing some of the anticipated benefit of linking the relationship with the podiatrist which Surefit has with our patient-care business by expanding the relationship, because many of the podiatrists actually have the license to do surgery and when they do partial feet or total feet there is a natural need for a prosthetic and prosthesis in which case prosthetists come calling and serve that need.

At the same time, SPS has been working with the podiatrists to expand the line of products that is available to the podiatrists going beyond the basic product line that we picked up in the acquisition. Surefit is upgrading its shoe designs and styles and is preparing to launch a scanning system to better service its practitioner and physician customers.

Now, let's turn our attention to Linkia, and I’ll provide an update of their activities. Linkia continues its dual mission of, A, building it’s share of the key healthcare company’s book of business. And B, negotiating a fair price for the services provided by the practitioners within its network.

On this point, they are expecting to reach favorable outcomes with two large healthcare payers this year on price increases. These demonstrate that payers recognize the value that Linkia brings to them and helping them control their administrative costs by ensuring good clinical care and high levels of customer satisfaction.

The network consists of the Hanger patient-care centers and independent providers. The number of independents has held pretty steady and it's currently at about 310, and we expect this number to fluctuate from time-to-time depending on our book of business and of the success of our acquisition program.

Linkia's book of business revenues for the quarter was up over 9% compared to last year’s comparable quarter. In addition, Linkia is continuing with the piloting of other services that they could incorporate into their model to provide benefit to these payers. And on the marketing side, they are continuing discussions and negotiations with the key national and large regional healthcare management companies as well as some of the firms in the Workmen's Compensation segment.

Now let's talk a little bit about Innovative Neurotronics. Innovative Neurotronics sales were below those of Q1 of 2008 as George had mentioned. This is because last year's sales were very positively impacted by a large international order in the first quarter and coverage by Good Morning America.

However, as George did say, we are on target with our sales level. It is in accordance with our guidance for 2009. And we are seeing the benefits of the events that occurred during the fourth quarter of last year. For example, the approval of coverage by CMS for incomplete spinal disorders has permitted Medicare to reimburse effective January 1, 2009 for this indication.

And the overturning of the standing non-coverage decision in Q4 of last year along with a specific code that the WalkAide was granted, has permitted Innovative Neurotronics the opportunity to present the WalkAide to commercial third-party payers.

Each of these claims are being handled on a patient by patient basis and we are receiving reimbursement across all of the indications from our third-party payers. IN Inc. has put in place a proactive team to advocate for payment on behalf of the patients. And currently, there are more than 200 applications in the system.

We will be expanding the team dedicated to this service and it is available to all practitioners, both inside our patient-care divisions as we well as outside in the form of independents that are also showing the WalkAide.

We are analyzing the data from the clinical trials for our stroke patients, which we have talked to you about historically, while continuing to work with the appropriate agencies and associations to look for the best measurements for all of the indications.

For example, CMS is reviewing the standards by which they judge the stroke rehabilitation progress. Obviously, we are following this very closely and we will comply with their decisions on the parameters they want to see.

In addition, certain patient advocate groups that research hospitals have expressed interest in launching their own studies on indications that are germane to their specific membership. This dual track of public and private is the same progression that we went through to gain reimbursement on our microprocessor needs and other O&P products.

So, this is the way it is done, which is to complete your clinical trials, gather the statistics, present those for evidence and all the while working with the groups that are advocating for their patient populations. And we are confident that this year is the best throughout. And as we have stated publicly, 2009 is really the transition year for WalkAide.

We really expect to see the benefits of full reimbursement in 2010. But I don't want to discount that our guidance for 2009 does contain a pretty healthy increase in sales of roughly 50%.

Finally, a few words on acquisitions and other developmental projects. We are continuing to pursue our strategic acquisition program. In 2009, we are targeting to complete acquisitions, which would have about $20 million in annualized sales benefit for us. Our strategy is to work for tuck-in candidates that add strategic value to us in the form of locations, quality practitioners and/or favorable product service mix.

On the development front, we have made some progress with the pilots that we initiated in Q4 and the early part of Q1 and we anticipate a public launch of these piloted projects little later this year. In closing, I think the results of this quarter demonstrate that our programs continue to generate positive results.

However, we do recognize that in this environment of volatile unemployment and financial conditions that we must be extra vigilant with respect to revenues and of course managing our cost.

So, that's pretty much it for the quarter. Let me turn it back over to Niva, our operator for questions. Thank you very much.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Bryan Sekino. Please go ahead.

Bryan Sekino - Barclays Capital

Good morning. This is actually Brian Sekino on behalf of Adam Feinstein.

Tom Kirk

Good morning.

Bryan Sekino - Barclays Capital

Good morning. Just I want to see if you guys could give us a couple of housekeeping details here. As far as the impact from leap year and I guess the poor weather, do you guys have an indication in terms of what that did for your same-store number?

George McHenry

Well, the extra day from leap year last year would have given us about 1.2% in additional sales. That will be roughly what the impact should be for leap year. So a little more nebulous to try to find a value to the weather, clearly were some sever weather in Midwest in particular. And we did some studies and determined that roughly half of practices were impacted at one point or other by weather, but whether that was more sever than the prior year is really hard to tell. So we are not assigning any value to that in numbers.

Bryan Sekino - Barclays Capital

Okay. And then did you give a bad debt number for the quarter?

George McHenry

Bad debt expense was at 2.2%.

Bryan Sekino - Barclays Capital

Okay.

George McHenry

So, it’s tracking to historic norms.

Bryan Sekino - Barclays Capital

Right. And then George, I think, you said that your SG&A, did you say that was up about 1.2% year-over-year?

George McHenry

No, it was up in dollar, but not as a percent.

Bryan Sekino - Barclays Capital

Okay.

George McHenry

Our SG&A other than labor was from margin standpoint at the same level as the prior year and that's with a higher comparable competition accrual.

Bryan Sekino - Barclays Capital

I got you, but that's not something that we are going to see going forward with your new presentation in terms of just breaking out SG&A on its own.

George McHenry

It's correct.

Bryan Sekino - Barclays Capital

Okay.

George McHenry

New presentation is going to concentrate on our personnel cost and then all other SG&A will be in one category.

Bryan Sekino - Barclays Capital

Okay. Great, and then with your guidance for revenue, the 6.7% to 8.1% growth, can you kind of breakout what portion of that relates to kind of same-store, and what relates to kind of acquisitions that you made in 2008 that are not included in the year-over-year same store number.

George McHenry

The comp assumptions in our sales growth assumption is 4% to 6%. The benefit we should get from acquisitions that were made in 2008 and 2009 are in the range of about $8 million. That's included in the total 750 to 760. Then of course we had some assumptions in there for SPS growth as well.

Bryan Sekino - Barclays Capital

Okay. And then just one more question here before I jump back in, I noticed that there was a slight decline in commercial business and other as a percentage of total sales. In terms of just how we should think about that trend, is there something that you are seeing with an impact from the economy or is there something else going on there?

Tom Kirk

Well, with the baby boomers aging, there should be a natural progression where Medicare will be a higher percentage. Now with overtime, now with that said, Q1 since it's our lowest seasonal sales quarter can give you some numbers that are a little unusual.

So, we don't expect there to be a 2% shift from commercial to Medicare for the whole year. But we think that’s something peculiar to Q1. We do expect there to be a shift overtime, but not that dramatic in one year.

Bryan Sekino - Barclays Capital

Okay.

George McHenry

And two, it's normally the commercial book of business where people have to contend with the out-of-pocket. They have to get through, so perhaps when we have looked at that, our feeling was they are being just a little more cautious in trying to eat into their deductible and out-of-pocket simply because of disposable income concern. So they are probably trading a little lighter on the commercial side than the Medicare side.

Bryan Sekino - Barclays Capital

Okay. Okay, and I apologize, one more question here. Will you be making available the historical data for your new presentation of your income statement?

George McHenry

Yes, we will. And when we will file the 10-Q everything will be reformatted for prior years.

Bryan Sekino - Barclays Capital

Great.

George McHenry

And we can supply any comparable information that you need.

Bryan Sekino - Barclays Capital

Great, great. Thanks for taking my questions.

George McHenry

Thank you, Bryan.

Operator

The next question comes from Larry Solow's line. Please go ahead.

Larry Solow - CJS Securities

Good morning, guys. Just a quick follow-up, do you think you’ll have your Q out in the next couple of days, when can we get that reclassification for then, or?

George McHenry

The 10-Q normally trails our earnings call by about a week.

Larry Solow - CJS Securities

Okay, got you. Okay, just looking at Linkia, which actually the growth of the quarter was 9%, which is nice. Is that kind of inline with what your outlook is for the year, and then I know on the Q4 call you had mentioned, you were in multiple talks with maybe some new national contracts or a partial new contract with Blue Cross, any update on that?

George McHenry

Well, let's take them one at a time. The 9% is in the range of where we would see Linkia for the year. Remember last year. it was up almost 14%, I think it was around 13.8 for the year, so we would like to see the 9% come up a bit more, but it certainly is in the satisfactory range for the first quarter.

Regarding the second question, Linkia continues to have discussions with all the large regional and the nationals about bringing them into either Linkia preferred, or Linkia exclusive contracts as well as having discussions with our current customers, current payors about price increases, so those are ongoing. We remain optimistic.

We think that the validation of the Linkia model is apparent in two ways. One, is that we continue to increase that book of business. So, we know that we wouldn't be doing that if we weren't bringing administrative simplicity and quality care to the payors. And some of the payors have actually reached out to Linkia asking them on a pilot basis to try and develop some other products and services for them that are based upon the Linkia model.

So, we look at that as a potential for expansion of the Linkia business, but it’s expanding beyond our normal book of O&P services. So we remain optimistic that we are going to be able to entice these people in with some solid numbers and good performance. So, they are ongoing and as we have said over the past few years, early in the Linkia days, we were probably a little more irrationally exuberant about how the Linkia model was going to take-off, and we have since learned that it is not one that is going to go and capture all of the business instantaneously, but it is one that your perseverance will continue to build a near double-digit increases.

So, would we see Linkia doing the job and we believe that we have got a pretty happy and satisfied customer base out there and we are very proud of the independent network that we have put together and our ability to work with those independents and providing value for them in rounding all our networks. So we think that we got a very good value proposition with Linkia.

Larry Solow - CJS Securities

Okay good and then I think George you mentioned, you expect compensation as a percentage of sales to trend down during the year, is that what you stated?

George McHenry

Compared to Q1 yes, we do not, first SPS will not be as bigger component of sales in Q3 and Q4 as it was in Q1 simply because of the seasonality issue and we also won’t have to see the impact from the differential in the WalkAide sales.

Larry Solow - CJS Securities

Got you and then in terms of WalkAide I guess reimbursement now is just on a case-by-case basis. Is there any time line or kind of milestone, we should look for when national coverage may come, able to get some, you have to file these clinical trial results and, how should we view that?

George McHenry

Well right now for the incomplete spinal, Medicare is paying us for those average reimbursements at $5200 and we are filing those and we are being reimbursed with those. In terms of our stroke clinical trials, we are analyzing that data and then the process once the analysis is complete, we think that could be like a 60 day time frame. Take a look at the results, we are working with some of the principle investigators, they are anxious to get those results to put some papers together and send those out to peer review journals, we could expect that, that process could be in 60 to 90 days and upon acceptance by some satisfactory journals out there, we can then can take that information back to Medicare, submit it for coverage along with health economics study and talk about reimbursement.

So we really see it as a, when we tried to put this on a time frame extending out over the next couple of quarters. On the private pay side, what we are seeing is that we have taken the change in the national non-coverage decision and gone out, initiated discussions with all the major carriers in terms of the benefit that the WalkAide can provide.

Empirically when you see a patient on it versus their AFO, there is no question in your mind about the efficacy of the device. So much so that some of the patient-advocate associations have become very passionate about this and want to actually find ways to support studies at various independent hospitals and rehabilitation centers so that they can get this underway and use that to appeal to Medicare as well. And those things, there is about five or six of those and those things we have seen some of the plans that have been put forward.

We think that they may all come together within the next 60 days and those kinds of studies will start on the outside. And each of these private payers, when we talked about our reimbursement debt, we are working on a patient-by-patient basis. As I mentioned, there is over 200 claims in the system already and as higher practitioners and the independent practitioners who better understand this process, we expect that to increase significantly and as people on the payer side become more conversant with the scoring methodologies that we use which is similar to the way we have done the microprocessors. Where we do put a comprehensive evaluation together and use that as a screening tool.

We just do not want to put anybody in a WalkAide, we want to put people into WalkAide who deserve it and can benefit from it. So, if they become more conversant with the evaluation scoring tools, we expect that volume to increase significantly and that’s why we are putting additional resources into this.

And we expect that probably over the next two or three quarters to continue working with these outside payers until it becomes common place. So, as I mentioned, it's probably going to be fighting on a number of fronts and is probably going to be a total effort throughout '09 and our hope is that by the end of '09 we could wrap up on the federal side with Medicare. We could certainly have some tests underway with some of these other patient advocate groups and we could convince some of the third party insurance companies to extend coverage on a more routine basis.

So it's probably going to be an overall '09 event in terms of schedule.

Larry Solow - CJS Securities

Got you, expect the nice ramp up through the year and would your -- I guess -- I think your full year estimate or guidance is around $15 million in sales, is that correct?

George McHenry

That is correct, yes. 50% increase over last year on an enterprise basis.

Larry Solow - CJS Securities

Got you. And last question and just this may be a difficult one to answer but just kind of speculation, any early view of what you think there will be if any impact on reimbursement and just as a company as a whole from the new Obama administration?

Tom Kirk

Having spent couple of days down in Washington last week there are as many views on this as there are people down there. It is too soon to tell, I mean we even spent some time with one of Senator Kennedy's staffers on healthcare and they are still in the very formative stages.

The timetable as we talked to some folks which say that they want to try and get some bills into the house and the senate before the summer resets. And then come back after the summer resets and that would be when the real fun will start as they try to reconcile all this and figure out how we get paid for.

So we do know that there is a strong push underway to include $47 million uninsured into this program which should be a very positive thing for us, we do know that they are trying to make more money available to the states in the form of subsidies to Medicaid, that’s also a very positive thing for us.

The thing that we are watching very closely is with this additional coverage, hw is it all going to be paid for because the math simply does not work to higher taxes and changes in the Medicare Advantage program. And we still see this competition between sort of using the private payers versus the Medicare and Medicare offering competition if you will to the private payers and how all that’s going to sort out.

So lot of different views, some very strong positives in it, but we certainly are sensitive to how it all gets paid and what might be the reimbursement rate. So it's really too soon to tell just yet.

Larry Solow - CJS Securities

Okay, great, thank you very much.

Tom Kirk

You're welcome.

George McHenry

Thank you.

Operator

The next question comes from Greg Williams's line, please go ahead.

Greg Williams - Sidoti & Company

Good morning and thanks for taking my call.

Tom Kirk

Good morning, Greg. How are you?

Greg Williams - Sidoti & Company

Good, thanks. Just going back to the material cost and comp costs coming down, how does that translate, how do you operationalize that? Are you talking to suppliers on a contract-by-contract basis as they come in or are you actually confronting the suppliers now and just telling them to lower the prices in light of the lower commodity costs?

George McHenry

Greg, the issue I have been talking about is simply a mixed issue. SPS is distributor, they have an 80% com rate. HPO on the other hand runs about 26% to 27% and the WalkAide sales has even better lower comp rate than HPO's comp rate. So when you take that blended issue in Q1 into consideration. In Q2, we expect to have higher sales of HPO. They have a better comp rate that will grow the mix. We also expect not to have that big comparison that we had in Q1 by virtue of the fact that we have lower WalkAide sales. We expect the WalkAide sales in turn ramping up. So we expect the mix alone to change the comp rate on a consolidated basis.

Greg Williams - Sidoti & Company

Okay thanks for explaining that. Also looking at your guidance, does that assume, it looks like LIBOR is down and helped you guys this quarter, does that assume the current levels of LIBOR and the favorable interest rates here?

George McHenry

The EPS guidance that we gave assume that LIBOR is going to stay close to where it is today, there is a little bit of room in that assumption from a different standpoint.

Greg Williams - Sidoti & Company

Okay and Tom I think you said that Medicare is currently paying for WalkAide spinal around $5200, maybe I am getting ahead of myself, try to look at 2010 sales, can we assume $5200 would be universal price for Medicare if you get coverage with some of the other [locals] processing and other elements.

Tom Kirk

Right now they've not set an exact price. They are examining the merits of this each patient, because the incomplete spinals are a rather small population. So I would say they are in the data gathering stage. I would expect just based upon how we have seen other things price out through the years that when the volume tips out and we have to remember that stroke is a very large population that when they review the data and they look at the health economics data that they would come back and try to extract a bigger discount in exchange for the larger volume.

We have seen that kind of behavior before so I will be very pleased if they would accept $5200 and continue to pay at that level. But we do not see that in the cards, they do not know to what level they may go in terms of where they would price it out, but I fully expect to see a much larger discount to our usual and customary when those volumes ramp up.

Greg Williams - Sidoti & Company

Okay, it make sense. Thanks again guys.

Tom Kirk

You are welcome.

Operator

Our next question comes from Daniel Owczarski's line. Please go ahead.

Daniel Owczarski - Avondale Partners

Yes, thanks, good morning.

Tom Kirk

Good morning, Dan, how are you?

Daniel Owczarski - Avondale Partners

Good. Tom, you touched on the upcoming regulations with impacting non-qualified providers. I think it was in October it starts. Do you have an estimate of how much business right now is being performed by non-qualified providers and how that could impact you once these guidelines go into effect?

Tom Kirk

It's very hard to get that information because it's tapped up state-by-state. We have taken a look for example, there are three provisions in that Bill, one is that by October 1st everyone would have to be accredited. Second provision is in states that have licensure that federal government Medicare could only pay to licensed providers. And the third is an attempt to correlate the difficulty or the complexity of the service with the certificate of the provider, so that even gets to be little more granular.

But we do know in looking at the states that have license, and we took a look at three states, Florida, Illinois, and Texas. When we have gone into the payments and cross walked those that have the license of those states. We found that roughly 70% of the payments in those states was in non-licensed practitioners.

So, there could be a rather significant ramp up both coming from the accreditation, provision as well as the licensing provision and where this is ultimately going to go will be to those folks that do not have the proper education perhaps they are out as sales people and they are fitting devices.

So there could be a pretty comprehensive increase and let me qualify that then by saying that we are likely to see that increase on the low end of orthotics because I think it’s pretty safe to say that you are not going to have the manufacturers wrap out designing and fitting either a custom brace or certainly a prosthesis and all the prosthesis are custom.

So, this is going to go at the lower end of orthotics so while the number of billable events could go upthey are not going to be the real high dollar ones, but it certainly would help to clean up the industry and frankly right now we see some of those patients, because they are fit, they are fit in an unsatisfactory fashion.

The device does not work and then they end up coming back into our patient-care center and we then fight to get them a second device because their payers already paid once.

So, we do not have an exact quantification in terms of what we mean but hopefully have been able to put a little color on where we think it’s going to impact and in which segments of our product mix it will impact.

Daniel Owczarski - Avondale Partners

No that’s definitely helpful thank you. The other question I had was the private payers outside of Medicare, anything since the beginning of the year or the last six months? Do you see more aggressive discounting out there maybe with the mom & pops or anything different in this environment from historical?

Tom Kirk

Great question certainly there if we look at some of their financial results, they are down a bit compared to their historical levels. We have not seen any more aggression on that front and we have over the last couple of years as the matter of fact. We have just gotten at the beginning of the year price increase from one of them, and I think I don’t want to be too confident here but I think the value that Linkia really brings in saving them money is helping us in the negotiation that is certainly evidenced from the fact that we have been able to pick up 9% more revenue flow into Linkia is something we are watching because as their results fall they have to turn somewhere to try and help improve their financials and that’s probably to the healthcare providers. So I have not seen it yet.

Daniel Owczarski - Avondale Partners

Good, thank you.

Tom Kirk

You are welcome, thank you.

Operator

Out next question comes from Mike Petusky’s line, please go ahead.

Michael Petusky - Noble Financial Group

Good morning fellows.

Tom Kirk

Good morning, Mike.

Michael Petusky - Noble Financial Group

I had a, got off for a couple of minutes and I may have missed this, but George did you give on the same store, did you give the pricing volume mix breakout?

George McHenry

Price was where we expected it was in the 2% range.

Tom Kirk

2.5.

George McHenry

2.5.

Michael Petusky - Noble Financial Group

Okay and I want to go back to WalkAide real quickly relative to your expectations for 2009 and the first quarter. Tom, is it safe to assume that the incomplete spinal is a fairly immaterial amount of what you are assuming in this total say 13, 14, $15 million of revenue and in 2009?

Tom Kirk

I won’t call it as an insignificant amount but it certainly is on the low end of the spectrum, we are not looking at that to drive say the 50% increase in overall revenue.

Michael Petusky - Noble Financial Group

Okay, so --

Tom Kirk

It’s going to be one of the contributors.

Michael Petusky - Noble Financial Group

Okay. So I want to understand that. Clearly, you must be anticipating some kind of significant kind of institutional coverage decision from private insurers? I assume that must be part of your assumptions. Is that right?

Tom Kirk

Well, as we have looked last year, the results that we turned in last year were just all based on private individual pay. We did not have any of these reimbursed last year. We want to match that level of performance and then on top of it, what we are saying is that we have the coverage coming from Medicare on incomplete spinal and then we have started up this reimbursement effort if you will. And since launching that, as I mentioned, there is almost 250 claims in the process. And we expect that to go up significantly in each one of those, we try to go out and get authorized.

And they can go through as many as three appeals. It is an arduous process, but that is bringing in third-party payers, and our hope is that by making them more familiar with the device that they will extend coverage to this. So, we are looking three actually, let me say four basic ways that this could grow. We are certainly continuing to offer the devices cash pay, working with Medicare on incomplete, going after the third-party payers to have them recognize the value. And last but not least would be our international distributors. We have added a couple more of those. So, we fully expect those to start taking room and they are operating in some countries where they are going to get reimbursement this year. So, it is really the combination of all of those that we see driving this 50% increase.

Michael Petusky - Noble Financial Group

And I do not want to get argumentative, really kind of go of on a tangent here, but really I do not think you should be comparing the $9 million and then at the growth on, you just did a $1.3 million a quarter and I think some of the $9 million obviously was driven by the Good Morning America and all the rest of it, I mean do you see something comparable in terms of kind of free publicity in 2009 that could essentially bring you up more to a true $9 million run rate going forward?

Tom Kirk

It is. It's a great question. Our PR efforts are always ongoing. One of the major networks did a TRP that they seem to like very much and the producer liked just a couple of weeks ago. We do not have a definitive date, how these things go, they usually end up putting it up almost at the last minute notice. But as the device gains in popularity and we see it on more broader basis of population, we do expect to see it become a little more promoted and we’ve got several b-roll shops, but in this case they actually came to our patients' locations and filmed the patient. They are quite excited about it and we are looking at how we can enhance our PR coverage because it truly is the device. That as I said empirically you just shocked when you see with and without, so that is part of our overall game plan for this year.

Michael Petusky - Noble Financial Group

Okay. That's great. And last one and I will get off. I heard you earlier say that you are analyzing the data from the clinical, but I may or missed it earlier, does that mean the clinicals are now completed?

Tom Kirk

Yes, we got some wrapped up, there is I think one little last segment on one of the arms that will be wrapped up, but we have begun to start analyzing the data and that will be completed I think in the next two, two and half weeks.

Michael Petusky - Noble Financial Group

Okay. Alright wonderful, thank you.

Tom Kirk

Thank you, Mike.

Operator

We have one remaining question and that’s from Larry Solow's line. Please go ahead.

Larry Solow - CJS Securities

Quick follow-up, did you guys complete any acquisitions during the quarter, I know you announced some in early January for Q4, were there any announced or anything during Q1?

Tom Kirk

We did get one done towards the end of this quarter, that was not terribly material. So there was no announcement.

Larry Solow - CJS Securities

Got you, and then one more question, on Innovative Neurotronics, I would see nothing you probably can specifically announce, but any other, exciting products in the work, that are, we may hear something about in the next 6 to 12 months?

Tom Kirk

We continue to look at other products in the area of functional electrical stimulation, got a couple of very interesting prospects, that we are evaluating. We have not signed any deal to bring them into Innovative at present. So, I would at this point say that we would not have anything definitive or material within the 6 to 12 months. But one of the things we have to remember is that Innovative has brought additional capability to the company in terms of better understanding of design and manufacturing. And so we are also looking at innovative to really become the incubation chamber for perhaps helping us with some of our orthotics and prosthetics, in terms of some new componentry that we may want to produce in house to put on those.

And we are looking at one such device that one of our fellows came up with as an idea and we look at Innovative Neurotronics as being one of the two sources that we can look to. One is working with our supplier base, where they know the design and manufacturing process very well. And we can partner with them to bring new products to market or alternatively if it’s within the skill sets we could use Innovative and as I mentioned we've got one of those that we are currently looking at right now. And they actually have it on tests and depending on how those tests go, we would be talking about it more probably around Q3.

Larry Solow - CJS Securities

Okay great thank you.

Tom Kirk

You are welcome.

Operator

There are no further questions at this time.

Tom Kirk

Well thank you very much Niva. And thank all of you for joining us this morning. I hope you have a good day and a very pleasant summer. And we look forward to talking to you about the end of July. Thank you very much.

Operator

This concludes your conference call. You may now disconnect.

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Source: Hanger Orthopedic Group, Inc., Q1 2009 Earnings Call Transcript
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