HEALTHTRONICS SURGICAL SERVICES INC - 10-Q Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR

15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

for the quarterly period ended September 30, 2003

o TRANSITION REPORT PURSUANT TO SECTION 13 OR

15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 000-30406

HealthTronics Surgical Services, Inc.

(Exact name of registrant as specified in its charter)

Georgia		58-2210668
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

1841 West Oak Parkway, Suite A Marietta, Georgia		30062
(Address of principal executive offices)		(Zip Code)

(770) 419-0691
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ý

No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes ý

No o

Indicate the number of shares outstanding of each of the issuer’s classes of common stock.

11,579,000 Shares of No Par Value Common Stock as of October 31, 2003

HEALTHTRONICS SURGICAL SERVICES, INC.

INDEX TO FORM 10-Q

PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements
		Condensed Consolidated Balance Sheets as of September 30, 2003 and December 31, 2002

		Condensed Consolidated Statements of Income for the three-month and the nine-month periods ended September 30, 2003 and 2002

		Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2003 and 2002

		Notes to Condensed Consolidated Financial Statements

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 3.	Quantitative and Qualitative Disclosure of Market Risk

Item 4.	Controls and Procedures

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings

Item 2.	Changes in Securities and Use of Proceeds

Item 6.	Exhibits and Reports on Form 8-K

	Signatures

Part 1. Financial Information

Item 1. Financial Statements

HealthTronics Surgical Services, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(000’s omitted)

	September 30, 2003			December 31, 2002
	*(Unaudited)*
Assets
Current assets:
Cash and cash equivalents	$	9,313		$	16,808
Trade accounts receivable, less allowance for doubtful accounts of $1,374 and $1,264 at September 30, 2003 and December 31, 2002, respectively	14,424			13,660
Other receivables	82			757
Inventory	7,118			5,231
Prepaid expenses and other current assets	1,998			1,395
Deferred income taxes	1,221			1,103
Total current assets	34,156			38,954

Property and equipment, at cost:
Land	349			349
Building and leasehold improvements	1,181			902
Medical devices placed in service	23,340			21,692
Office equipment, furniture and fixtures	1,604			1,317
Vehicles and accessories	3,577			3,385
	30,051			27,645
Less accumulated depreciation	(11,655		)	(8,532		)
Net property and equipment	18,396			19,113

Investments in unconsolidated entities	2,378			1,866
Goodwill	45,937			42,755
Other assets	3,406			4,474
Total assets	$	104,273		$	107,162

	September 30, 2003			December 31, 2002
	*(Unaudited)*
Liabilities and shareholders’ equity
Current liabilities:
Trade accounts payable	$	3,653		$	4,073
Income taxes payable	447			3,030
Other accrued expenses	5,773			13,301
Deferred profit on service contracts and sales of partnership interests	996			517
Short-term borrowings	10,500			9,500
Current portion of capital lease obligations	171			593
Current portion of long-term debt	5,475			6,126
Total current liabilities	27,015			37,140

Deferred profit on medical device sales to related parties (subject to debt guarantees)	248			248
Noncurrent deferred income taxes	814			1,093
Capital lease obligations, less current portion	228			1,484
Long-term debt, less current portion	6,681			20,375
Minority interest in consolidated subsidiaries	27,566			12,133
Other liabilities	2,195			1,858
Total liabilities	64,747			74,331

Shareholders’ equity:
Common stock – no par value, voting:
Authorized – 30,000 shares at September 30, 2003 and December 31, 2002; Issued – 11,573 and 11,345 shares at September 30, 2003 and December 31, 2002, respectively; Outstanding – 11,573 and 11,292 at September 30, 2003 and December 31, 2002, respectively	18,923			17,028
Accumulated other comprehensive expense	(106		)	(312		)
Retained earnings	20,709			16,115
Total shareholders’ equity	39,526			32,831
Total liabilities and shareholders’ equity	$	104,273		$	107,162

See accompanying notes.

HealthTronics Surgical Services, Inc. and Subsidiaries

Condensed Consolidated Statements of Income

(Unaudited)

(000’s omitted except per share information)

	Three months ended September 30,						Nine months ended September 30,
	2003			2002			2003			2002

Net revenue	$	22,963		$	23,071		$	65,306		$	66,898

Cost of devices, service parts and consumables	5,074			5,739			13,887			12,756
Salaries, general and administrative expenses	10,847			9,633			30,219			27,919
Depreciation and amortization	1,414			1,381			4,218			4,500
	5,628			6,318			16,982			21,723
Equity in earnings of unconsolidated partnerships	351			134			831			249
Partnership distributions from cost based investments	130			253			408			535
Gain on sale of subsidiary and investment interest	2,129			3,656			4,344			4,097
Gain on sale of property and equipment	358			181			372			457
Interest expense	(521		)	(650		)	(1,564		)	(2,333		)
Interest income	57			64			132			164
Income before minority interest and income taxes	8,132			9,956			21,505			24,892
Minority interest	(5,233		)	(3,668		)	(13,962		)	(13,354		)
Income before income taxes	2,899			6,288			7,543			11,538
Provision for income taxes	(1,133		)	(2,514		)	(2,950		)	(4,613		)
Net income	$	1,766		$	3,774		$	4,593		$	6,925
Income per common share:
Basic	$	0.15		$	0.34		$	0.40		$	0.62
Diluted	$	0.15		$	0.32		$	0.39		$	0.59
Weighted average common shares outstanding:
Basic	11,567			11,171			11,479			11,107
Diluted	11,764			11,889			11,744			11,715

See accompanying notes.

HealthTronics Surgical Services, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(000’s omitted)

	Nine months ended September 30,
	2003			2002

Operating activities
Net income	$	4,593		$	6,925
Adjustments to reconcile net income to cash provided by operating activities:
Net change in fair value of interest rate swap	206			(332		)
Depreciation and amortization	4,218			4,500
Amortization of loan costs	196			211
Provision for doubtful accounts	110			(227		)
Deferred profit on medical device sales to related parties	—			(1,105		)
Deferred profit on service contracts	479			(455		)
Deferred income taxes	(398		)	—
Equity in earnings of unconsolidated partnerships, net of dividends	(51		)	(104		)
Minority interest in subsidiaries, net of distributions to minority interests	(2,055		)	1,961
Gain on sale of subsidiary and investment interest	(4,344		)	(3,654		)
Gain on sale of property and equipment	(372		)	(457		)
Changes in operating assets and liabilities, net of businesses acquired:
Trade accounts receivable	(874		)	1,584
Other receivables	675			2,300
Inventory	(1,887		)	(1,036		)
Prepaid expenses and other assets	254			(1,995		)
Trade accounts payable	(420		)	873
Income taxes payable	(706		)	3,558
Accrued expenses and other liabilities	694			736
Net cash provided by operating activities	$	318		$	13,283

	Nine months ended September 30,
	2003			2002

Investing activities
Purchases of property and equipment, net of businesses acquired	$	(4,206	)	$	(5,174	)
Proceeds from sales of investment interest	13,948			5,558
Proceeds from sale of property and equipment	1,091			1,473
Acquisition of partnership interest	(461		)	(3,726		)
Acquisition of businesses, net of cash acquired	(5,057		)	(249		)
Net cash provided by (used in) investing activities	5,315			(2,118		)

Financing activities
Proceeds from issuance of common stock	1,895			1,275
Proceeds from issuance of long-term debt	3,824			1,766
Principal payments on long-term debt and capital leases	(19,847		)	(11,953		)
Proceeds from issuance of short-term borrowings	4,300			6,000
Principal payments on short-term borrowings	(3,300		)	(7,900		)
Net cash used in financing activities	(13,128		)	(10,812		)

Net (decrease) increase in cash and cash equivalents	(7,495		)	353
Cash and cash equivalents at beginning of period	16,808			9,905
Cash and cash equivalents at end of period	$	9,313		$	10,258

See accompanying notes.

HealthTronics Surgical Services, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

1. Basis of Presentation

The accompanying condensed consolidated financial statements include the accounts of HealthTronics Surgical Services, Inc. (“HealthTronics” or the “Company”) and its subsidiaries. All significant intercompany transactions have been eliminated.

In the opinion of HealthTronics management, the accompanying consolidated financial statements include all the necessary adjustments (consisting of normal recurring adjustments) for a fair presentation of its consolidated financial position and results of operations for the interim periods presented. The information presented in these financial statements was prepared in conformity with accounting principles generally accepted in the United States for interim financial information and instructions for Form 10-Q and Rule 10-01 of Regulation S-X. Although management believes that the disclosures in these financial statements are adequate to make the information presented not misleading, certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. These financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2002 filed with the Securities and Exchange Commission.

Preparation of these interim consolidated financial statements in accordance with accounting principles generally accepted in the United States requires management to make certain estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The interim results may not be indicative of the results that may be expected for the year.

Certain prior year balances have been reclassified to conform to the 2003 presentation.

2. Summary of Significant Accounting Policies

Cash Equivalents

The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.

Revenue Recognition, Gain Recognition and Allowance for Doubtful Accounts

Net revenue includes fees for medical procedures in the clinical setting and certain sales of equipment to unaffiliated entities. Procedure revenue is primarily “wholesale” or “retail”. Wholesale revenue is generated primarily from fixed fee contracts with various medical facilities and is recorded in the month the related treatments are performed. Retail revenue, generated when the Company bills third party payors for medical facility and technical fees, is recorded at the time services are

rendered. These third party billings may or may not be contractual. Adjustments which reduce revenue from established contractual or estimated non-contractual billing rates to amounts estimated to be reimbursable are recognized in the period the services are rendered. Differences in estimates recorded and final settlements are reported during the period final settlements are made.

The Company has certain negotiated agreements with third party payors that provide for payments to the Company or its subsidiaries. Revenues are reported at the estimated net realizable amounts from medical facilities, contracted and non-contracted third party payors and individual patients for services rendered.

For sales of medical devices to unaffiliated entities, revenue is recognized upon delivery at the customer’s destination; for miscellaneous sales of consumables, revenue is recognized at the time of shipment by the Company.

Revenue generated from service contracts is recognized ratably over the life of the related contract.

Accounts receivable consist primarily of amounts due from the medical facilities or partnerships, managed care health plans, commercial insurance companies and individual patients. Estimated provisions for doubtful accounts are recorded to the extent it is probable that a portion or all of a particular account will not be collected. In evaluating the collectibility of accounts receivable, the Company considers a number of factors, including the age of the accounts, changes in collection patterns, the composition of accounts by payor type, the status of ongoing disputes with third party payors and general industry conditions. Changes in these estimates are charged or credited to the results of operations in the period of the change.

Inventory

Inventory is carried at the lower of cost (first-in, first-out) or market and consists of medical devices, spare parts and consumables.

Consolidation and Partnership Investments

Historically, the Company has made a number of investments in various entities including general and limited partnerships. The majority of these investments are consolidated based upon the Company’s financial interest and its ability to exercise control. The remaining investments are recorded using the cost or equity method of

accounting, depending upon the Company’s percentage of ownership and ability to exercise significant influence over the operating and financial policies of the partnership.

For entities created after January 31, 2003, the Company has considered FASB Interpretation No. 46, Consolidation of Variable Interest Entities, (“FIN 46”) as well as the factors described above to determine whether the entity should be consolidated.

Impairment of Long-Lived Assets

In accordance with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, management reviews long-lived assets used in operations for impairment when there is an event or change in circumstances that indicates the carrying amount of the asset may not be recoverable and the future undiscounted cash flows expected to be generated by the asset are less than its carrying amount. If such assets are considered to be impaired, the Company records impairment losses and reduces the carrying amount of impaired assets to an amount that reflects the fair value of the assets at the time impairment is evident. The Company’s impairment review process relies on management’s judgment regarding the indicators of impairment, the remaining lives of assets used to generate assets’ undiscounted cash flows, and the fair value of assets at a particular point in time. Management uses historical experience, current market appraisals and various other assumptions to form the basis for making judgments about the impairment of real estate assets. Under different assumptions or conditions, the asset impairment analysis may yield a different outcome, which would alter the gain or loss on the eventual disposition of the asset.

Property and Equipment

Property and equipment is stated at cost. Depreciation (which includes amortization of assets under capital leases) is computed based on the straight-line method over three to seven years based on the estimated useful lives of the related equipment or over the term of the related lease or over 39 years for buildings.

Income Taxes

The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the

enacted tax rates and laws that are expected to be in effect when the differences are expected to be recovered or settled.

The Company recognizes deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities. The Company regularly reviews its deferred tax assets for recoverability and establishes a valuation allowance based upon projected future taxable income and the expected timing of the reversals of existing temporary differences.

Stock Based Compensation

The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations in accounting for employee stock options and adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock Based Compensation (“SFAS 123”) as amended by Statements of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation – Transitional Disclosure, an Amendment to SFAS No. 123, (“SFAS 148”) for option grants to employees. The Company generally grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant and, accordingly, recognizes no compensation expense for the employee stock option grants.

The following table illustrates the effect on net income and earnings per share as if the Company had applied the fair value recognition provisions of SFAS 123 as amended by SFAS 148.

	Three months ended September 30,						Nine months ended September 30,
	2003			2002			2003			2002
	(000’s omitted except per share information)

Net income – as reported	$	1,766		$	3,774		$	4,593		$	6,925
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects	(217		)	(62		)	(575		)	(184		)
Net income — pro forma	$	1,549		$	3,712		$	4,018		$	6,741

Earnings per share — as reported:
Basic	$	0.15		$	0.34		$	0.40		$	0.62
Diluted	$	0.15		$	0.32		$	0.39		$	0.59
Earnings per share — pro forma:
Basic	$	0.13		$	0.33		$	0.35		$	0.61
Diluted	$	0.13		$	0.31		$	0.34		$	0.58

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates and such differences may be material.

Related Party Transactions

Transactions between related parties and between different subsidiaries of the Company occur in the normal course of business. The Company eliminates transactions with its consolidated subsidiaries and appropriately discloses significant related party transactions.

Concentrations of Credit Risk

The Company sells its products primarily in the United States. Credit is extended based on an evaluation of the customer’s financial condition and collateral is generally not required. Accounts receivable are generally receivable from medical facilities, insurance companies or patients.

Fair Value of Financial Instruments

The Company’s financial instruments are comprised principally of cash and cash equivalents, trade accounts receivable, amounts due from affiliated partnerships, trade accounts payable, customer deposits, short-term borrowings and long-term debt. The carrying amounts of these financial instruments approximate their fair values.

Long-Lived Assets

The Company has recorded property, plant and equipment and intangible assets at cost less accumulated depreciation and amortization. The determination of useful lives and whether or not these assets are impaired involves significant judgment. The Company reviews long-lived assets, including identifiable intangible assets whenever events or changes in circumstances indicate the carrying amounts of such assets may not be recoverable. Goodwill is the excess of the purchase price over the fair value of identifiable net assets acquired in business combinations accounted for as purchases. Goodwill was previously amortized on a straight-line basis over the periods benefited. Goodwill is now no longer being amortized to earnings, but instead is subject to annual testing for impairment at the reporting unit level unless events or circumstances indicate the carrying amount is impaired.

Other Comprehensive Income or Expense

Effective February 12, 2002, the Company entered into two two-year interest rate swap agreements which qualify as cash flow hedges. These hedges are effective and, thus, the change in fair values for the three and nine months ended September 30, 2003 are reported as other comprehensive income of $85,000 and $206,000, respectively, and for the three and nine months ended September 30, 2002 are reported as other comprehensive loss of $191,000 and $332,000, respectively.

Recently Issued Accounting Standards

In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”). FIN 46 addresses the consolidation of entities whose equity holders have either (a) not provided sufficient equity at risk to allow the entity to finance its own activities or (b) do not possess certain characteristics of a controlling financial interest. FIN 46 sets forth a model to evaluate potential consolidation of these entities, known as variable interest entities (“VIE’s”), based on an assessment of which party to the VIE, if any, absorbs a majority of the exposure to its expected losses, receives a majority of its expected residual returns, or both (the “primary beneficiary”). FIN 46 is effective for all new VIE’s created or acquired after January 31, 2003. Originally for VIE’s created or acquired prior to February 1, 2003, the provisions of FIN 46 were to be applied for the first interim or annual period beginning after June 15, 2003. However, on October 8, 2003, the FASB deferred the effective date for applying the provisions of FIN 46 until the first reporting period after December 15, 2003 for interests held by public entities in VIE’s or potential VIE’s created before February 1, 2003. FIN 46 also sets forth certain disclosures regarding interests in VIE’s that are deemed significant, even if consolidation is not required. Implementation of FIN 46 for the entities created after January 31, 2003 did not have a material impact on the Company’s consolidated financial statements. The Company is currently evaluating the impact of FIN 46 for the entities created before January 31, 2003 on its consolidated financial position, results of operations and cash flows. The provisions of this statement may have a material impact on the Company’s consolidated financial position.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (“SFAS 149”). SFAS 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement amends SFAS No. 133 for decisions made as part of the Derivatives Implementation Group process and in connection with implementation issues raised in relation to the application of the definition of a derivative. SFAS 149 is effective for

contracts entered into or modified after June 30, 2003. The Company does not expect the requirements of SFAS 149 to have a material impact on its results of operations or its financial position.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This statement establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. In accordance with the standard, financial instruments that embody obligations for the issuer are required to be classified as liabilities. This statement shall be effective for financial instruments entered into or modified after May 31, 2003 and otherwise shall be effective at the beginning of the first interim period beginning after June 15, 2003. The provisions of this statement relating to certain mandatorialy redeemable noncontrolling interest has been indefinitely deferred. The Company has subsidiaries with limited lives for which this statement has been deferred. The Company is currently evaluating the potential impact of implementation of the provisions of this statement.

3. Description of Business

HealthTronics Surgical Services, Inc. was incorporated in the State of Georgia in 1995. The Company was founded for the purpose of providing state-of-the-art non-invasive treatment solutions for certain urologic and orthopaedic conditions. The Company initially sought to obtain approval (Pre-Market Approval - “PMA”) from the Food & Drug Administration (“FDA”) to market certain products manufactured by HMT High Medical Technologies, AG (“HMT”), a Swiss corporation, in particular, certain medical devices utilizing shock wave technology, known as the LithoTron^® and the OssaTron^®. Both products were being used outside the United States and Canada. During 1997, the Company received FDA approval to market the LithoTron. On October 12, 2000, the Company received FDA approval to market the OssaTron for treatment of chronic proximal plantar fasciitis commonly known as heel pain. On March 14, 2003, the Company received FDA approval to market the OssaTron for treatment of chronic lateral epicondylitis commonly known as tennis elbow.

In 1996, HMT granted to the Company the right to purchase limited manufacturing rights to the OssaTron medical device. The Company also operates under the terms of distribution agreements with HMT that grants the Company the exclusive right to use, sell and lease the LithoTron and OssaTron and related devices and parts in the United States, Canada and Mexico.

With each FDA approval, it is the Company’s intent to generate revenues from three sources: 1) fees for clinical services provided by consolidated subsidiaries; 2) recurring revenues from leasing, licensing fees, sales of consumable products and maintenance of equipment; and 3) sales of medical devices including related accessories. The Company also generates gains from sales of partnership interests.

In October 2000, with the FDA approval of the OssaTron the Company began establishing Orthotripsy^® partnerships for the purpose of purchasing, owning and operating OssaTron devices. HealthTronics contributed certain capital to partnerships and offered equity interests to third parties. As sole general partner, through its subsidiary, HT Orthotripsy Management Company, LLC, the Company maintains control and, therefore, under existing accounting principles generally accepted in the United States, consolidates the second tier Orthotripsy partnerships. The Company has equity interests in these partnerships ranging from 5% to 100%.

In December 2001, the Company purchased 100% of the outstanding stock of Litho Group, Inc. (“LGI”) for $42,500,000 in cash. Through its various 100% subsidiaries, LGI is the sole general partner of several separate second and third tier lithotripsy partnerships with equity interests ranging from approximately 15% to 100%, operating in the northern, eastern and southern United States. As sole general partner, LGI, under existing accounting principles generally accepted in the United States, consolidates the second and third tier partnerships. The Company is also general partner or managing partner in various separate lithotripsy partnerships, which it controls and, therefore, consolidates under existing accounting principles generally accepted in the United States. Since acquisition of LGI, the Company has provided urologic services with lithotripters manufactured by companies other than HMT.

The Company also offers services with other urologic devices to treat benign prostatic hyperplasia and prostate cancer.

The accompanying consolidated financial statements include the accounts of each of the Company’s subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

4. Business Acquisitions and Dispositions

During the nine months ended September 30, 2003, the Company separately and individually purchased controlling interests ranging from 25.0% to 56.4% in two lithotripsy partnerships, two prostate thermotherapy partnerships and two cryosurgery partnerships for aggregate purchase prices totaling $5,621,000 which included cash and issuance of 125,304 shares of common stock. The results of operations for these entities have been included since the dates of acquisition.

The estimated purchase price of each acquisition has been allocated on a preliminary basis to assets and liabilities based on management’s estimate of their fair values. These allocations are subject to change pending the completion of the final analysis of the total purchase price and fair values of the assets acquired and liabilities assumed. The impact of any of these changes could be material.

5. Inventory

Inventory is carried at the lower of cost (first-in, first-out) or market and consists of the following:

	September 30, 2003		December 31, 2002
	(000’s omitted)

Medical devices / other equipment	$	5,859	$	4,010
Spare parts	611		746
Consumables	648		475
	$	7,118	$	5,231

6. Gain on Sale of Subsidiary and Investment Interest

The Company sold a subsidiary and partnership interests of certain limited partnerships and recognized gains of $2,129,000 and $4,344,000 for the three and nine months ended September 30, 2003, respectively and $3,656,000 and $4,097,000 for the three and nine months ended September 30, 2002, respectively. In 2002, the gain on sale of subsidiary and investment interest for the three and nine months includes a gain of $3,654,000 on the sale of a certain lithotripsy subsidiary. The remaining 2002 gains and all of the 2003 gains relate to sales of partnership interests and represent the excess of the sales price over the Company's investment basis in the partnership interest sold.

7. Interest Rate Swaps

In order to protect the Company from interest rate volatility, effective February 12, 2002, the Company entered into two two-year interest rate swap agreements (“the swaps”), with a total notional amount of $13,750,000 and $17,500,000 at September 30, 2003 and December 31, 2002, respectively. The swaps effectively convert a portion of the Company’s floating-rate debt to a fixed-rate basis through February 12, 2004, thus reducing the impact of interest-rate changes on future interest expense. This fixed rate is 3.2525% plus the applicable percentage (currently 2.50%), based on the previous quarter leverage ratio, within the credit facility agreement. The swaps qualify as cash flow hedges under Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, and expire on February 12, 2004. The Company believes that its hedges are effective with changes in fair value to be reported in other comprehensive income. As of September 30, 2003 and December 31, 2002, the

market value of the derivatives was a liability of approximately $106,000 and $312,000, respectively, which is included on the accompanying balance sheet. The change in fair values for the three and nine months ended September 30, 2003 are reported as other comprehensive income of $85,000 and $206,000, respectively, and for the three and nine months ended September 30, 2002 are reported as other comprehensive loss of $191,000 and $332,000, respectively.

The counterparties to the interest rate swap agreements are major commercial banks. The Company is exposed to counterparty credit risk for nonperformance and, in the event of nonperformance, to market risk for changes in interest rates. The Company does not anticipate nonperformance of the counterparties.

8. Comprehensive Income

The components of comprehensive income are as follows for the three and nine months ended September 30, 2003 and 2002:

	Three months ended September 30,					Nine months ended September 30,
	2003		2002			2003		2002
	(000’s omitted)

Net income	$	1,766	$	3,774		$	4,593	$	6,925
Net change in fair value of interest rate swap	85		(191		)	206		(332		)
Comprehensive income	$	1,851	$	3,583		$	4,799	$	6,593

9. Earnings Per Share Information

The following table sets forth the computation of earnings per share:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2003		2002		2003		2002
	(000’s omitted except per share amounts)

Numerator: Net income	$	1,766	$	3,774	$	4,593	$	6,925
Weighted average shares outstanding	11,567		11,171		11,479		11,107
Effect of dilutive securities:
Stock options	197		718		265		608
Denominator for diluted earnings per share	11,764		11,889		11,744		11,715
Basic earnings per share	$	0.15	$	0.34	$	0.40	$	0.62
Diluted earnings per share	$	0.15	$	0.32	$	0.39	$	0.59

10. Segment Information

The Company applies the disclosure provisions of SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. Effective April 1, 2003, the Company internally reorganized its operating structure and as a result the Company’s business units have been aggregated into two reportable operating segments: Lithotripsy and Orthotripsy. The factors for determining the reportable segments were based on the distinct nature of their operations. They are disclosed as separate operating segments because these business units each have different marketing strategies due to differences in types of consumers, different market conditions and different capital requirements. Asset information by segment, including capital expenditures, and net income beyond operating margins are not provided to the Company’s chief operating decision maker.

The Lithotripsy segment provides lithotripsy services to doctors and medical facilities. The Orthotripsy segment provides non-invasive surgical solutions for a variety of orthopedic conditions. The “Other” category includes corporate and the Company’s non-reportable segments.

The Company primarily evaluates segment performance based on the income or loss before income taxes from its operating segments, which do not include unallocated corporate overhead and intersegment eliminations.

	Three Months Ended September 30 ,
	2003								2002
	(000’s omitted)								(000’s omitted)
	Lithotripsy		Orthotripsy			Other			Lithotripsy		Orthotripsy			Other

Revenue from external customers	$	14,329	$	4,978		$	3,656		$	14,420	$	3,121		$	5,530
Intersegment revenue	438		—			1,206			177		—			744
Segment income (loss) before income taxes	$	4,811	$	(26	)	$	(29	)	$	7,982	$	(554	)	$	948

	Nine Months Ended September 30,
	2003							2002
	(000’s omitted)							(000’s omitted)
	Lithotripsy		Orthotripsy			Other		Lithotripsy		Orthotripsy			Other

Revenue from external customers	$	41,320	$	13,577		$	10,409	$	49,307	$	6,762		$	10,829
Intersegment revenue	989		—			2,781		644		—			2,156
Segment income (loss) before income taxes	$	12,193	$	(269	)	$	206	$	16,897	$	(1,924	)	$	953

The following is a reconciliation of the measure of segment income before income taxes as shown above to consolidated income before income taxes per the consolidated statements of income:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2003			2002			2003			2002
	(000’s omitted)						(000’s omitted)

Total segment income before income taxes	$	4,756		$	8,376		$	12,130		$	15,926
Unallocated corporate expenses	(1,857		)	(2,088		)	(4,587		)	(4,388		)
Total company income before income taxes	$	2,899		$	6,288		$	7,543		$	11,538

11. Subsequent Events

In October 2003, the Company purchased the remaining 39% interest in a consolidated thermotherapy subsidiary for approximately $1,100,000.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of financial condition and results of consolidated operations should be read in conjunction with the unaudited condensed consolidated financial statements included elsewhere in this Form 10-Q.

Overview

We provide equipment as well as technical and administrative services to physicians, hospitals, and surgery centers performing lithotripsy and Orthotripsy^® extracorporeal shock wave surgery and other non-invasive urologic treatments. We were formed in December 1995 and began offering lithotripsy services in 1996. In October 2000, we received FDA approval to market an orthopaedic extracorporeal shock wave surgery device, the OssaTron^®, and since then we have invested significant resources in developing our orthopaedic services network while expanding our lithotripsy operations.

Our services are provided principally through limited partnerships or other entities that we manage which use lithotripsy devices or the OssaTron orthopaedic shock wave device. Many of these partnerships were formed by us, and we have retained an equity interest ranging from approximately 5% to 100% while selling any remaining interests to physicians. We generally retain the sole general partnership interest in the partnerships and manage their daily operations. We also provide equipment maintenance services to the partnerships and supply them with various consumables used in lithotripsy and Orthotripsy extracorporeal shock wave surgery procedures using the OssaTron device. To date we have expanded our operations by forming partnerships in new geographic markets and acquiring interests in partnerships from third parties, and we expect to continue to do so in the future.

As a result of the control we exert over the partnerships by virtue of our sole general partnership interest, level of financial interest, management contract and otherwise, for financial reporting purposes we consolidate the results of operations of the partnerships with our own even though we own less than all (and in many cases less than 50%) of their outstanding equity interests. We reflect the equity of third party partners in the partnerships’ results of operations in our consolidated statements of income and on our consolidated balance sheets as minority interest. We are currently evaluating the impact that implementation of FASB Interpretation No. 46, Consolidation of Variable Interest Entities, (“FIN 46”) will have on consolidation of these entities.

In certain instances, we do not control partnerships or other entities in which we have ownership interests. We account for our interests in these entities either on the equity or cost basis, depending on our percentage of ownership and the degree of influence we exert over the entity. We are currently evaluating the impact that implementation of FIN 46 will have on consolidation of these entities.

We recognize revenue in our consolidated statements of income from the following three principal sources:

• Fees for clinical services provided by the partnerships. A substantial majority of our consolidated revenues are derived from technical fees relating to treatments performed using our equipment and related services. We bill for these fees under two different models. Under the “wholesale” billing model, we charge a fee to the hospital or surgery center at which the treatment is performed. Our fee might be a set fee per procedure or a set fee per month based on a specified number of days of service at the facility per month. Under the “retail” billing model, we charge the patient’s insurer, HMO or other responsible party, and we pay a fee to the health care facility for access to its premises or for services. Under either model, the professional fee payable to the physician performing the procedure is generally billed and collected by the physician. The billing and collection cycle for wholesale fees is typically significantly shorter than for retail fees, although the gross margin for retail billing is moderately higher than for wholesale billing.

• Technical services, equipment maintenance and sale of consumables to unaffiliated third parties. We charge fees to unaffiliated third parties who own or operate lithotripsy devices for equipment maintenance, technical support and related services. We also sell a variety of consumables used in lithotripsy and orthopaedic extracorporeal shock wave surgery procedures to unaffiliated third parties.

• Equipment sales to third parties. To a limited extent, we generate revenue from the sale of shock wave devices to third parties.

Historically, our revenue was derived primarily from service fees and the sale of lithotripsy devices and related consumables. We have implemented a strategy of structuring our operations to focus on revenues from procedure fees, which generate significantly greater operating margins.

As the percentage of our revenue attributable to procedure fees has increased, we have become more dependent, both directly in the case of “retail” billing and indirectly in the case of “wholesale” billing, on the reimbursement policies of governmental and private third party payors. While the reimbursement status of lithotripsy is well established, orthopaedic extracorporeal shock wave surgery is a relatively new procedure in the U.S., and the reimbursement policies of third party payors for this procedure are still developing. The reimbursement policies of payors for OssaTron procedures vary from those that still deem our treatment experimental to those that have entered into contractual arrangements for reimbursement. Our results of operations could be significantly affected by changes in reimbursement policies regarding lithotripsy or by decisions made regarding the reimbursement status of Orthotripsy extracorporeal shock wave surgery.

In October 2000, we received FDA approval to market our Orthotripsy extracorporeal shock wave device for the treatment of chronic plantar fasciitis. Since then we have been engaged in an active program of training physicians, forming orthopaedic services partnerships, selling interests in these partnerships to physicians and other activities designed to promote this new orthopaedic treatment modality. On March 14, 2003, we received FDA approval to market

our orthopaedic shock wave device for the treatment of chronic lateral epicondylitis commonly known as tennis elbow. The acquisition of Litho Group, Inc. in December 2001 also increased our patient treatment revenue substantially. While Litho Group partnerships use some LithoTrons, they also use numerous other types of lithotripters.

Results of Consolidated Operations

General

HealthTronics Surgical Services continues to shift its focus from being a seller of equipment, equipment maintenance and consumables to being a provider of clinical services. During the third quarter of 2003, approximately 87.9% of the Company’s revenues were generated by clinical services, particularly lithotripsy and Orthotripsy^® extracorporeal shock wave surgery with the OssaTron^® device. During this quarter, HealthTronics performed 12,471 procedures, a 17% increase over the 10,629 procedures performed during the same period last year.

The Company provides through its subsidiaries clinical services such as patient scheduling, staffing, training, quality assurance, maintenance and contracting with hospitals, surgery centers and third party payors. The Company has continued to grow its lithotripsy business through increased utilization of existing machines and through the acquisition of new lithotripsy partnerships. In December 2001, the Company completed an acquisition of Litho Group, Inc. During 2003, the Company sold certain equity interests in four consolidated subsidiaries originally purchased as part of the Litho Group, Inc. acquisition. Proceeds of approximately $11,546,000 were used to pay down long-term debt.

HealthTronics has focused on increasing utilization of the OssaTron devices currently in the U.S. market. On March 14, 2003, the Company received pre-market approval from the Food and Drug Administration to market the OssaTron for the treatment of chronic lateral epicondylitis, commonly known as tennis elbow.

Three Months Ended September 30, 2003 Compared to Three Months Ended September 30, 2002

Net Revenue: Net revenue decreased from $23,071,000 for the three months ended September 30, 2002 to $22,963,000 for the three months ended September 30, 2003, a decrease of less than 1%. This decrease is attributable to lower device sales, offset in part by an increase in clinical treatment revenues and revenues related to certain acquisitions.

Cost of Devices, Service Parts and Consumables: Cost of devices, service parts and consumables decreased from $5,739,000 for the three months ended September 30, 2002 to $5,074,000 for the three months ended September 30, 2003, a decrease of 12%. This decrease is attributable to a decrease in device sales over the comparable three months in 2002, offset in part by higher direct costs from increased Orthotripsy treatment revenues.

Salaries, General and Administrative Expenses: Salaries, general and administrative expenses increased from $9,633,000 for the three months ended September 30, 2002 to $10,847,000 for the three months ended September 30, 2003, an increase of 13%. This increase is attributable to increased costs related to growing the Orthotripsy business and increased expenses related to acquisitions.

Depreciation and Amortization: Depreciation and amortization expenses increased from $1,381,000 for the three months ended September 30, 2002 to $1,414,000 for the three months ended September 30, 2003, an increase of 2%. This increase is primarily attributable to depreciation of additional capital assets related to certain acquisitions

Equity in Earnings of Unconsolidated Partnerships: Equity in earnings of unconsolidated partnerships increased from $134,000 for the three months ended September 30, 2002 to $351,000 for the three months ended September 30, 2003, an increase of 162%. This increase is primarily attributable to income related to the addition of certain equity investments.

Partnership Distributions from Cost Based Investments: Partnership distributions from cost based investments decreased from $253,000 for the three months ended September 30, 2002 to $130,000 for the three months ended September 30, 2003, a decrease of 49%. This decrease is attributable to the timing of the payment of the related distributions.

Gain on Sale of Subsidiary and Investment Interest: Gain on sale of subsidiary and investment interest decreased from $3,656,000 for the three months ended September 30, 2002 to $2,129,000 for the three months ended September 30, 2003, a decrease of 42%. Included in the third quarter gain on sale of partnership interest is a $425,000 additional gain related to the sales of partnership interest in the first quarter. The remaining decrease is attributable to fewer sales of investment interests compared to the third quarter of 2002.

Gain on Sale of Property and Equipment: Gain on sale of property and equipment increased from $181,000 for the three months ended September 30, 2002 to $358,000 for the three months ended September 30, 2003, an increase of 98%. This increase is attributable to an increase in sales of capital equipment in the third quarter of 2003 compared to the third quarter of 2002.

Interest Expense: Interest expense decreased from $650,000 for the three months ended September 30, 2002 to $521,000 for the three months ended September 30, 2003, a decrease of 20%. This decrease is attributable to a reduction of total debt.

Minority Interest: Minority interest increased from $3,668,000 for the three months ended September 30, 2002 to $5,233,000 for the three months ended September 30, 2003, an increase of 43%. This increase is attributable to increased minority participation in the Company’s lithotripsy and Orthotripsy partnerships offset in part by lower net income before minority interest.

Provision for Income Taxes: Provision for income taxes decreased from $2,514,000 for the three months ended September 30, 2002 to $1,133,000 for the three months ended September 30, 2003, a decrease of 55%. The decrease is attributable to the decrease in taxable income compared to the third quarter of 2002.

Nine months Ended September 30, 2003 Compared to Nine months Ended September 30, 2002

Net revenue decreased from $66,898,000 for the nine months ended September 30, 2002 to $65,306,000 for the nine months ended September 30, 2003, a decrease of 2%. This decrease is attributable to lower lithotripsy revenue due to the July 2002 disposition of U.S. Lithotripsy, L.P. and lower device sales. This reduction was offset in part by an increase in Orthotripsy treatment revenues and revenues related to certain acquisitions.

Cost of Devices, Service Parts and Consumables: Cost of devices, service parts and consumables increased from $12,756,000 for the nine months ended September 30, 2002 to $13,887,000 for the nine months ended September 30, 2003, an increase of 9%. This increase is attributable to an increase in the cost of equipment and related consumables from our suppliers and higher direct costs from increased Orthotripsy treatment revenues.

Salaries, General and Administrative Expenses: Salaries, general and administrative expenses increased from $27,919,000 for the nine months ended September 30, 2002 to $30,219,000 for the nine months ended September 30, 2003, an increase of 8%. This increase is attributable to increased costs related to growing the Orthotripsy business and increased expenses related to acquisitions. This impact is offset in part by a reduction of cost as a result of the July 2002 disposition of U.S. Lithotripsy, L.P.

Depreciation and Amortization: Depreciation and amortization expenses decreased from $4,500,000 for the nine months ended September 30, 2002 to $4,218,000 for the nine months ended September 30, 2003, a decrease of 6%. This decrease is primarily attributable to the July, 2002 disposition of U.S. Lithotripsy, L.P., offset in part by the increase in equipment due to the acquisitions of businesses.

Equity in Earnings of Unconsolidated Partnerships: Equity in earnings of unconsolidated partnerships increased from $249,000 for the nine months ended September 30, 2002 to $831,000 for the nine months ended September 30, 2003, an increase of 234%. This increase is attributable to the addition of certain equity investments.

Partnership Distributions from Cost Based Investments: Partnership distributions from cost based investments decreased from $535,000 for the nine months ended September 30, 2002, to $408,000 for the nine months ended September 30, 2003, a decrease of 24%. This decrease is primarily due to the timing of the related distributions.

Gain on Sale of Subsidiary and Investment Interest: Gain on sale of subsidiary and investment interest increased from $4,097,000 for the nine months ended September 30, 2002 to $4,344,000 for the nine months ended September 30, 2003, an increase of 6%. This increase is primarily attributable to the sale of a portion of our interests in several partnerships during the first nine months of 2003.

Gain on Sale of Property and Equipment: Gain on sale of property and equipment decreased from $457,000 for the nine months ended September 30, 2002 to $372,000 for the nine months ended September 30, 2003, a decrease of 19%. This decrease is attributable to fewer

sales of capital equipment in the first nine months of 2003 compared to the first nine months of 2002.

Interest Expense: Interest expense decreased from $2,333,000 for the nine months ended September 30, 2002 to $1,564,000 for the nine months ended September 30, 2003, a decrease of 33%. This decrease is attributable to reduction in total debt.

Minority Interest: Minority interest increased from $13,354,000 for the nine months ended September 30, 2002 to $13,962,000 for the nine months ended September 30, 2003, an increase of 5%. This increase is attributable to increased minority participation in the Company’s lithotripsy and Orthotripsy partnerships, offset in part by lower net income before minority interest and the July 2002 disposition of U.S. Lithotripsy, L.P.

Provision for Income Taxes: Provision for income taxes decreased from $4,613,000 for the nine months ended September 30, 2002 to $2,950,000 for the nine months ended September 30, 2003, a decrease of 36%. This decrease is attributable to the decrease in taxable income over the first nine months of 2002.

Critical Accounting Policies

Our consolidated financial statements are based on the application of accounting principles generally accepted in the United States of America, which require us to make estimates and assumptions about future events that affect the amounts reported in our financial statements and the accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Estimates and assumptions are reviewed periodically and the effects of the revisions are reflected in the consolidated financial statements in the period they are determined to be necessary. Actual results could differ from those estimates, and any such differences may be material to the financial statements. If different assumptions or conditions were to prevail, the results could be materially different from our reported results.

Consolidation

Our consolidated financial statements include the accounts of those significant subsidiaries that we control. They also include our undivided interests in these subsidiaries’ assets and liabilities. Amounts representing our percentage interest in the underlying net assets of other significant affiliates that we do not control, but over which we exercise significant influence, are included in “Investments in unconsolidated entities”; our share of the net income of these companies is included in the consolidated statement of income caption “Equity in earnings of unconsolidated partnerships”. The accounting for these non-consolidated companies is based upon the equity method of accounting. Our investments in other companies that we do not control and for which we do not have the ability to exercise significant influence as discussed above are carried at the lower of cost or fair value, as appropriate.

Revenue Recognition, Gain Recognition and Allowance for Doubtful Accounts

Net revenue includes treatment fees for medical devices in the clinical setting. Treatment revenue is primarily “wholesale” or “retail”. Wholesale revenue is generated primarily from fixed fee contracts with various medical facilities and is recorded in the month the related treatments are performed. Retail revenue, generated when we bill third party payors for medical facility and technical fees, is recorded at the time services are rendered. These third party billings may or may not be contractual. Adjustments which reduce revenue from established contractual or estimated non-contractual billing rates to amounts estimated to be reimbursable are recognized in the period the services are rendered. Differences in estimates recorded and final settlements are reported during the period final settlements are made.

We may sell medical devices to certain entities in which we have an interest and may have guaranteed a portion of the long-term obligations related to such purchases. We eliminate profits on such transactions where the purchaser is a consolidated subsidiary of ours. A pro rata portion of the profit representing our percentage of ownership will be deferred on sales to unconsolidated subsidiaries where we have accounted for our investment interest using the equity or cost basis methods of accounting (depending on our ability to exercise significant influence over the operating and financial policies of the joint venture).

Revenue is recognized upon delivery at the customer’s destination for sales of medical devices to unaffiliated entities. For miscellaneous sales of consumables, revenue is recognized at the time of shipment by the Company.

Revenue generated from service contracts is recognized ratably over the life of the related contract.

We form wholly owned limited partnerships in which we are the general partner and then contribute a medical device to the partnership. We may sell interests in these partnerships to other investors. We generally recognize a gain on the interest sold as non-operating income at the time the subscription agreement is signed. Certain gains on the sale of partnership interests are deferred when payment terms exceed one year.

In order to record our accounts receivable at their net realizable value, we must assess their collectibility. A considerable amount of judgment is required in order to make this assessment including the analysis of historical bad debts and other adjustments, a review of the aging of our receivables and the current creditworthiness of our customers. We have recorded allowances for receivables which we believe are uncollectible. However, depending upon how such potential issues are resolved, or if the financial condition of any of our customers was to deteriorate and their ability to make required payments became impaired, increases in these allowances may be required.

Inventory

We are required to state our inventories at the lower of cost or market. Our inventories include medical devices, parts for servicing the medical equipment we sell and consumables for

the medical equipment we use. We continually evaluate the inventory for excess and obsolescence. At this time we believe that no inventory reserve is required to reduce the carrying value of our inventory to its net realizable value. However, if the demand for our product were to decline we might be required to establish such reserves.

Long-Lived Assets

We have recorded property, plant and equipment and intangible assets at cost less accumulated depreciation and amortization. The determination of useful lives and whether or not these assets are impaired involves significant judgment. We review long-lived assets, including identifiable intangible assets whenever events or changes in circumstances indicate the carrying amounts of such assets may not be recoverable. Goodwill is the excess of the purchase price over the fair value of identifiable net assets acquired in business combinations accounted for as purchases. Goodwill was previously amortized on a straight-line basis over the periods benefited. Goodwill is now no longer being amortized to earnings, but instead is subject to annual testing for impairment at the reporting unit level unless events or circumstances indicate the carrying amount is impaired. Intangible assets determined to have definite lives are amortized over their remaining useful lives. Goodwill of a reporting unit is tested for impairment on an annual basis or between annual tests if an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying amount.

Income Taxes

We account for income taxes in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities. They are measured using the enacted tax rates and laws that are expected to be in effect when the differences are expected to be recovered or settled.

We regularly review our deferred tax assets for recoverability and establish a valuation allowance based upon projected future taxable income and the expected timing of the reversals of existing temporary differences. A valuation allowance is required when it is more likely than not that all or a portion of a deferred tax asset will not be realized. We have established a valuation allowance for that portion of the deferred tax asset for which it is more likely than not that it will not be realized.

Derivative Instruments and Hedging

We manage risks associated with interest rates and we may use derivative instruments to hedge these risks. As a matter of policy, we do not use derivative instruments unless there is an underlying exposure and, therefore, we do not use derivative instruments for trading or speculative purposes. The evaluation of hedge effectiveness is subject to assumptions based on the terms and timing of the underlying exposures. All derivative instruments are recognized in our consolidated balance sheet at fair value. The fair value of our derivative instruments is generally based on quoted market prices.

Related Party Transactions

Transactions between related parties occur in the normal course of business. We provide services and products to our subsidiaries; our subsidiaries provide services and products to other subsidiaries. We eliminate transactions with our consolidated subsidiaries and appropriately disclose other significant related party transactions.

Recently Issued Accounting Standards

In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”). FIN 46 addresses the consolidation of entities whose equity holders have either (a) not provided sufficient equity at risk to allow the entity to finance its own activities or (b) do not possess certain characteristics of a controlling financial interest. FIN 46 sets forth a model to evaluate potential consolidation of these entities, known as variable interest entities (“VIE’s”), based on an assessment of which party to the VIE, if any, absorbs a majority of the exposure to its expected losses, receives a majority of its expected residual returns, or both (the “primary beneficiary”). FIN 46 is effective for all new VIE’s created or acquired after January 31, 2003. Originally for VIE’s created or acquired prior to February 1, 2003, the provisions of FIN 46 were to be applied for the first interim or annual period beginning after June 15, 2003. However, on October 8, 2003, the FASB deferred the effective date for applying the provisions of FIN 46 until the first reporting period after December 15, 2003 for interests held by public entities in VIE’s or potential VIE’s created before February 1, 2003. FIN 46 also sets forth certain disclosures regarding interests in VIE’s that are deemed significant, even if consolidation is not required. Implementation of FIN 46 for the entities created after January 31, 2003 did not have a material impact on our consolidated financial statements. We are currently evaluating the impact of FIN 46 for the entities created before January 31, 2003 on our consolidated financial position, results of operations and cash flows. The provisions of this statement may have a material impact on our consolidated financial position.

as liabilities. This statement shall be effective for financial instruments entered into or modified after May 31, 2003 and otherwise shall be effective at the beginning of the first interim period beginning after June 15, 2003. The provisions of this statement relating to certain mandatorialy redeemable noncontrolling interest has been indefinitely deferred. We have subsidiaries with limited lives for which this statement has been deferred. We are currently evaluating the potential impact of implementation of the provisions of this statement.

Liquidity and Capital Resources

We have funded our working capital requirements and capital expenditures from net cash provided by operating activities and borrowings under bank credit facilities. In conjunction with the purchase of Litho Group, we obtained a $50,000,000 credit facility. At September 30, 2003 and December 31, 2002, we had approximately $18,514,000 and $33,495,000, respectively, outstanding under the credit facility plus additional debt of approximately $4,541,000 and $4,583,000, respectively, primarily at the subsidiary level. Included in the credit facility is a $15,000,000 line of credit under which $4,500,000 was available at September 30, 2003. Debt at the subsidiary level is typically related to equipment purchased and operated by that subsidiary and is secured by that equipment. Cash and cash equivalents decreased from $16,808,000 at December 31, 2002 to $9,313,000 at September 30, 2003.

We use the after tax cash proceeds received from the sales of lithotripsy partnership interests to reduce our existing debt.

Net cash provided by operating activities for the nine months ended September 30, 2003 was $318,000 compared to $13,283,000 for the nine months ended September 30, 2002. This decrease was primarily the result of decreased operating earnings before depreciation and amortization and minority interest and the timing of income tax payments. Net cash provided by investing activities was $5,315,000 for the nine months ended September 30, 2003 compared to net cash used in investing activities of $2,118,000 for the nine months ended September 30, 2002. The increase in 2003 was due primarily to increased acquisition costs of consolidated entities. Net cash used in financing activities aggregated $13,128,000 in the nine months ended September 30, 2003 and $10,812,000 in the nine months ended September 30, 2002 and consisted primarily of principal payments on short-term borrowings and long-term debt offset by proceeds from the issuance of stock related to stock option exercises.

Our capital expenditures, primarily for the purchase of medical devices, aggregated $4,206,000 in the nine months ended September 30, 2003. We currently estimate that our capital expenditures will aggregate approximately $5,000,000 to $7,000,000 for the year ended December 31, 2003 and will be used to purchase additional medical devices for partnerships. We continuously review new investment opportunities and believe that our financial position can support higher levels of capital expenditures, if justified by opportunities to increase revenue or decrease recurring costs. Accordingly, it is possible that our capital expenditures in 2003 could be higher than anticipated. We plan to use our cash generated from operations and borrowings under our revolving credit facility to fund these expenditures.

We believe that our cash generated from operations and borrowings under our revolving credit facility will be sufficient to meet our liquidity and capital spending needs at least through the end of 2003.

Significant contractual obligations are as follows:

Contractual Obligations	Payments Due by Period
	(000’s omitted)
	Total		Less than 1 year		1-3 years		4-5 years		After 5 years
Short-Term Borrowings	$	10,500	$	10,500	$	—	$	—	$	—
Long-Term Debt	12,156		5,475		5,462		1,219		—
Capital Lease Obligations	399		171		218		10		—
Operating Leases	6,615		1,331		2,191		1,549		1,544
Purchase Obligations (1)	26,400		6,400		12,000		8,000		—
Total Contractual Cash Obligations	$	56,070	$	23,877	$	19,871	$	10,778	$	1,544

(1) Pursuant to our distribution agreement with HMT we have an ongoing commitment to purchase certain medical devices. Based upon current market prices, this commitment is approximately $6.4 million in 2003.

Quantitative and Qualitative Disclosure of Market Risk

We are subject to market risk from exposure to changes in interest rates on our variable rate debt. Although there can be no assurances that interest rates will not change significantly, we do not expect changes in interest rates to have a material effect on income or cash flows in 2003. As of September 30, 2003 and December 31, 2002, our corporate-level fixed-rate debt was approximately $13,750,000 and $17,500,000, respectively, and our corresponding corporate-level variable-rate debt was approximately $4,765,000 and $15,995,000, respectively. Based on our variable-rate debt at September 30, 2003 and December 31, 2002, in the absence of the swaps discussed below, a one-percent change in interest rates would result in an annual change in interest rate expense calculated on a simple interest basis of approximately $48,000 and $160,000, respectively.

In order to protect us from interest rate volatility, effective February 12, 2002, we entered into two two-year interest rate swap agreements (“the swaps”), with a total notional amount of $13,750,000 and $17,500,000 at September 30, 2003 and December 31, 2002, respectively. The swaps effectively convert a portion of our floating-rate debt to a fixed-rate basis for the next two years, thus reducing the impact of interest-rate changes on future interest expense. This fixed-rate is 3.2525% plus the applicable percentage (currently 2.50%), based on the previous quarter leverage ratio, within the credit facility agreement. The swaps qualify as cash flow hedges under Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, and expire on February 12, 2004. We believe that our hedge is effective with changes in fair value to be reported in other comprehensive income. As of September 30, 2003 and December 31, 2002, the market value of the derivatives was a liability of approximately $106,000 and $312,000, respectively, which is included on the accompanying balance sheet. Comprehensive income of approximately $206,000 has been recorded for the

nine months ended September 30, 2003 and comprehensive expense of approximately $332,000 was recorded for the nine months ended September 30, 2002.

The counterparties to the interest rate swap agreements are major commercial banks. We are exposed to counterparty credit risk for nonperformance and, in the event of nonperformance, to market risk for changes in interest rates. We do not anticipate nonperformance of the counterparties.

Cautionary Statements

Included in this report are forward-looking statements that reflect management’s current outlook for future periods. As always, these expectations and projections are based on currently available competitive, financial, and economic data, along with operating plans, and are subject to future events and uncertainties. Among the events and uncertainties which could adversely affect future periods are: inability to establish or maintain relationships with physicians and hospitals; health care regulatory developments that prevent certain transactions with healthcare professionals or facilities; inability of the Company or healthcare providers to obtain reimbursement for use of the Company’s current or future products; competition or technological change that impacts the market for the Company’s products; and difficulty in managing the Company’s growth. Readers are cautioned that, in addition to the above cautionary statements, all forward-looking statements contained herein should be read in conjunction with the detailed risk factors found in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002.

Item 3. Quantitative and Qualitative Disclosure of Market Risk

The information called for by this item is provided under the caption “Quantitative and Qualitative Disclosure of Market Risk” under Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Item 4. Controls and Procedures

(a) Evaluation of disclosure controls and procedures

Under the supervision and with the participation of our management, including our Chairman of the Board and Chief Executive Officer (“CEO”) and our Chief Financial Officer (“CFO”), we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures and, based on their evaluation, our CEO and CFO have concluded that, as of September 30, 2003, these controls and procedures were adequate and effective to ensure that material information relating to our company and our consolidated subsidiaries would be made known to them by others within those entities.

(b) Changes in internal controls

There were no significant changes in our internal controls or in other factors that could significantly affect our disclosure controls and procedures subsequent to the date of their evaluation, nor were there any significant deficiencies or material weaknesses in our internal controls. As a result, no corrective actions with regard to significant deficiencies and material weaknesses were required or undertaken.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Beginning in September 2003, purported class action complaints were filed in the United States District Court for the Northern District of Georgia by four HealthTronics shareholders against the Company and certain of its current directors and officers. Plaintiffs seek unspecified damages for alleged violations of the Securities Exchange Act of 1934, and generally allege that the Company, through some of its current directors and officers, made false or misleading statements during periods beginning January 4, 2000 and continuing until July 25, 2003 concerning the efficacy, testing, and market acceptance for the Company's OssaTron product, and the impact thereof on the Company's business and financial condition. The Company believes these suits to be without merit and intends to defend vigorously against them.

Item 2. Changes in Securities and Use of Proceeds

The Company issued 122,059 shares of its common stock on April 9, 2003 and 3,245 shares of common stock on April 30, 2003 in exchange for interests in two prostate therapy partnerships. These transactions were exempt from registration pursuant to Regulation D under the Securities Act of 1933.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

	In accordance with SEC Release No. 33-8212, Exhibits 32.1 and 32.2 are to be treated as “accompanying” this report rather than “filed” as part of this report.

	31.1	Principal Executive Officer Certification of Argil J. Wheelock Pursuant To Section 302 of the Sarbanes-Oxley Act of 2002

	31.2	Principal Executive Officer Certification of Martin J. McGahan Pursuant To Section 302 of the Sarbanes-Oxley Act of 2002

	32.1	Certification of Chief Executive Officer Pursuant To Section 906 of the Sarbanes-Oxley Act of 2002

	32.2	Certification of Chief Financial Officer Pursuant To Section 906 of the Sarbanes-Oxley Act of 2002

(b) Reports on Form 8-K

	During the third quarter of 2003, the Company filed the following current reports on Form 8-K:

Date of Report		Description
August 7, 2003		Furnished text of press release reporting the Company’s financial results for the second quarter of 2003.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	HEALTHTRONICS SURGICAL SERVICES, INC.

	By:	/s/ Victoria W. Beck

		Victoria W. Beck
		Chief Accounting Officer

	Date: November 13, 2003

Exhibit Index

Exhibit No.		Description

31.1		Principal Executive Officer Certification of Argil J. Wheelock, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Principal Executive Officer Certification of Martin J. McGahan, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1		Certification of Chief Executive Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2		Certification of Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002