Reiterating Hanger at Neutral

We reaffirm our Neutral rating on orthotic and prosthetic (O&P) company Hanger Orthopedic (HGR - Analyst Report) following its mixed third quarter results. Adjusted earnings of 46 cents per share for the quarter beat the Zacks Consensus Estimate by a penny. Profit more than doubled year over year on the back of higher sales and lower relocation charges.

Revenues climbed roughly 14% year over year to $235.3 million, yet missed the Zacks Consensus Estimate. Revenues were boosted by higher sales from Hanger’s therapeutic solutions division, aided by the Accelerated Care Plus (“ACP”) acquisition. Higher same center sales in the Patient Care Services division also contributed to the growth.

Hanger witnessed greater pressure on sales volumes and operating margin in the quarter. The company chopped its revenues and earnings forecasts for fiscal 2011 given the prevailing difficult operating backdrop.

Hanger leads in the O&P patient care services market, operating across more than 680 patient care centers in the U.S. The company’s economies of scale are unmatched by competition, which include notable players in the O&P space such as Orthofix International (OFIX - Snapshot Report), Conmed Corp. (CNMD - Analyst Report), Exactech Inc. (EXAC - Snapshot Report) and Owens & Minor Inc. (OMI - Snapshot Report).

Hanger is enjoying healthy demand for its services. Linkia, the company’s network management wing, continues to expand its relationship with national and regional insurance companies.

Hanger continues to explore acquisitions to boost its geographic presence. Moreover, the company is poised to achieve meaningful cost synergies from its corporate relocation.

Another significant growth catalyst represents broader reimbursement coverage for its electrical stimulation device WalkAide. Hanger is currently conducting a clinical study to secure this benefit (expected in 2012).

We remain impressed by Hanger’s ability to post top line improvement at a healthy quarterly run rate. However, we are cautious about the company’s exposure to reimbursement uncertainties and its aggressive acquisition strategy which has inherent risks.

Moreover, Hanger has lowered its guidance for fiscal 2011 and provided a tepid outlook for the fourth quarter citing a host of macro issues which impacted its volume and margins in the most recent quarter. These factors, among others, are a soft U.S. economy, high unemployment, uncertainties surrounding the health care reform and measures (including reimbursement cuts) adopted by the state governments to cover budget deficits.

Hanger currently retains a Zacks #4 Rank, which translates into a short-term “Sell” recommendation.

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