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EX-10 - HEALTHTRONICS, INC.ex1032.htm
EX-10 - HEALTHTRONICS, INC.exh1029.htm
EX-10 - HEALTHTRONICS, INC.exh1030.htm
EX-10 - HEALTHTRONICS, INC.exh1031.htm
EX-32 - HEALTHTRONICS, INC.exh321.htm
EX-31 - HEALTHTRONICS, INC.ex312.htm
EX-21 - HEALTHTRONICS, INC.ex211.htm
EX-31 - HEALTHTRONICS, INC.ex311.htm
EX-23 - HEALTHTRONICS, INC.exh231.htm
EX-32 - HEALTHTRONICS, INC.exh322.htm
EX-10 - HEALTHTRONICS, INC.ex1034.htm
EX-10 - HEALTHTRONICS, INC.exh1033.htm

_______________________________________________________

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

_____________________________

FORM 10-K

[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2009
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from ________ to ________

Commission File Number: 000-30406

_____________________________

HEALTHTRONICS, 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.)


  9825 Spectrum Drive, Building 3, Austin, Texas
    (Address of principal executive office)
   78717   
 (Zip Code)
       (512) 328-2892      
(Registrant’s telephone number,
including area code)

Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock

      Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES __ NO X

      Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. YES __ NO X

      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 X NO __

     Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).YES __ NO __

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. X

      Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (check one):



Large accelerated filer __ Accelerated filer X  Non-accelerated filer __
(do not check if a smaller
   reporting company)
Smaller reporting company __

      Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES __ NO X

      State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. For purposes of this computation, all officers, directors and ten percent beneficial owners of the registrant’s common stock are deemed to be affiliates. This determination should not be deemed an admission that such persons are in fact affiliates.


Aggregate Market Value at June 30, 2009: $ 61,728,000


Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.


  Title of Each Class
     Common Stock, no par value
  Number of Shares Outstanding at February 28, 2010
45,587,235

DOCUMENTS INCORPORATED BY REFERENCE

      Selected portions of the Registrant’s definitive proxy material for the 2010 annual meeting of stockholders are incorporated by reference into Part III of the Form 10-K.


HEALTHTRONICS, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2009
PART I

ITEM 1.     BUSINESS

General

We provide healthcare services and manufacture medical devices, primarily for the urology community.

For a discussion of recent developments, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Recent Developments.”

In this document, references to “we,” “us,” “our” and “HealthTronics” shall mean HealthTronics and its consolidated subsidiaries.

Lithotripsy services. We provide lithotripsy services, which is a medical procedure where a device called a lithotripter transmits high energy shockwaves through the body to break up kidney stones. Our lithotripsy services are provided principally through limited partnerships and other entities that we manage, which use lithotripters. In 2009, physicians who are affiliated with us used our lithotripters to perform approximately 50,000 procedures in the U.S. We do not render any medical services. Rather, the physicians do.

We have two types of contracts, retail and wholesale, that we enter into in providing our lithotripsy services. Retail contracts are contracts where we contract with the hospital and private insurance payors. Wholesale contracts are contracts where we contract only with the hospital. The two approaches functionally differ in that, under a retail contract, we generally bill for the entire non-physician fee for all patients other than governmental pay patients, for which the hospital bills the non-physician fee. Under a wholesale contract, the hospital generally bills for the entire non-physician fee for all patients. In both cases, the billing party contractually bears the costs associated with the billing service, including pre-certification, as well as non-collection. The non-billing party is generally entitled to its fees regardless of whether the billing party actually collects the non-physician fee. Accordingly, under the wholesale contracts where we are the non-billing party, the hospital generally receives a greater proportion of the total non-physician fee to compensate for its billing costs and collection risk. Conversely, under the retail contracts where we generally provide the billing services and bear the collection risk, we receive a greater portion of the total non-physician fee.

Although the non-physician fee under both retail and wholesale contracts varies widely based on geographical markets and the identity of the third party payor, we estimate that nationally, on average, our share of the non-physician fee was roughly $2,100, respectively, for both 2009 and 2008. At this time, we do not anticipate a material shift between our retail and wholesale arrangements, or a material change in our share of the non-physician fee.

As the general partner of limited partnerships or the manager of other types of entities, we also provide services relating to operating our lithotripters, including scheduling, staffing, training, quality assurance, regulatory compliance, and contracting with payors, hospitals, and surgery centers.

Prostate treatment services. We provide treatments for benign and cancerous conditions of the prostate. In treating benign prostate disease, we deploy three technologies: (1) photo-selective vaporization of the prostate (“PVP”), (2) trans-urethral needle ablation (“TUNA”), and (3) trans-urethral microwave therapy (“TUMT”) in certain partnerships. All three technologies apply an energy source which reduces the size of the prostate gland. For treating prostate and other cancers, we use a procedure called cryosurgery, a process which uses lethal ice to destroy tissue such as tumors for therapeutic purposes. In April 2008, we acquired Advanced Medical Partners, Inc. (“AMPI”), which significantly expanded our cryosurgery partnership base. In July 2009, we acquired Endocare, Inc. (“Endocare”), which manufactures both the medical devices and related consumables utilized by our cryosurgery operations, and also provides cryosurgery treatments. Our prostate treatment services are provided principally by us using equipment that we lease from limited partnerships and other entities that we manage. Benign prostate disease and cryosurgery cancer treatment services are billed in the same manner as our lithotripsy services under either retail or wholesale contracts. We also provide services relating to operating the equipment, including scheduling, staffing, training, quality assurance, regulatory compliance, and contracting.


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Radiation therapy services. We provide image guided radiation therapy (“IGRT”) technical services for cancer treatment centers. Our IGRT technical services may relate to providing the technical (non-physician) personnel to operate a physician practice group’s IGRT equipment, leasing IGRT equipment to a physician practice group, providing services related to helping a physician practice group establish an IGRT treatment center, or managing an IGRT treatment center.

Anatomical pathology services. We also provide anatomical pathology services primarily to the urology community. We have one pathology lab located in Georgia, Claripath Laboratories, that provides laboratory detection and diagnosis services to urologists throughout the United States. In addition, in July 2008, we acquired Uropath LLC, which managed pathology laboratories located at Uropath sites for physician practice groups located in Texas, Florida and Pennsylvania. Through Uropath, we continue to provide administrative services to in-office pathology labs for practice groups and provide pathology services to physicians and practice groups with our lab equipment and personnel at our Uropath laboratory sites.

Medical products manufacturing, sales and maintenance. We, through our Endocare acquisition, manufacture and sell medical devices focused on minimally invasive technologies for tissue and tumor ablation through cryoablation, which is the use of lethal ice to destroy tissue, such as tumors, for therapeutic purposes. We develop and manufacture these devices for the treatment of prostate and renal cancers and we believe that our proprietary technologies have broad applications across a number of markets, including the ablation of tumors in the lung and liver and palliative intervention (treatment of pain associated with metastases). We also manufacture the related spare parts and consumables for these devices. We also sell and maintain lithotripters and related spare parts and consumables.

Revenue Recognition

We recognize revenue primarily from the following sources:


 

Fees for urology treatments. A substantial majority of our revenue is derived from fees related to lithotripsy treatments performed using our lithotripters. For lithotripsy and prostate treatment services, we, through our partnerships and other entities, facilitate the use of our equipment and provide other support services in connection with these treatments at hospitals and other health care facilities. The professional fee payable to the physician performing the procedure is generally billed and collected by the physician. We recognize revenue for these services when the services are provided. IGRT technical services are billed monthly and the related revenues are recognized as the related services are provided.

 
 

Fees for managing the operation of our lithotripters and prostate treatment devices. Through our partnerships and otherwise directly by us, we provide services related to operating our lithotripters and prostate treatment equipment and receive a management fee for performing these services. We recognize revenue for these services as the services are provided.


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Fees for maintenance services. We provide equipment maintenance services to our partnerships as well as outside parties. These services are billed either on a time and material basis or at a fixed contractual rate, payable monthly, quarterly, or annually. Revenues from these services are recorded when the related maintenance services are performed.

 
 

Fees for equipment sales, consumable sales and licensing applications. We manufacture and sell medical devices focused on minimally invasive technologies for tissue and tumor ablation through cryosurgery, and their related consumables. We also sell and maintain lithotripters and manufacture and sell consumables related to the lithotripters. We distribute the Revolix laser and consumables related to the laser. With respect to some lithotripter sales, in addition to the original sales price, we receive a licensing fee from the buyer of the lithotripter for each patient treated with such lithotripter. In exchange for this licensing fee, we provide the buyer of the lithotripter with certain consumables. All the sales for equipment and consumables are recognized when the related items are delivered. Revenues from licensing fees are recorded when the patient is treated. In some cases, we lease certain equipment to our partnerships as well as third parties. Revenues from these leases are recognized on a monthly basis or as procedures are performed.

 
 

Fees for anatomical pathology services. We provide anatomical pathology services primarily to the urology community. Revenues from these services are recorded when the related laboratory procedures are performed.


Revenues and Industry Segments

In the fourth quarter of 2008, our Medical Products division relocated from Kennesaw, Georgia to our corporate headquarters in Austin, Texas. Concurrent with this relocation, we made certain changes within our Medical Products management team so that these operations now report to the President of our Urology Services operations. After making these changes, we redesigned our internal financial reporting materials provided to our chief operating decision maker, as well as our executive management team. As of the first quarter of 2009, we do not have any operating segments, except our Urology Services operations, that meet the quantitative requirements of ASC 280, Segment Reporting (“ASC 280”), (formerly Statement of Financial Accounting Standards (“SFAS”) 131, Disclosures about Segments of an Enterprise and Related Information).

Raw Materials

We rely on third party suppliers to provide certain critical components and consumables for the medical devices we manufacture and certain services we provide. In certain cases, the suppliers are our sole source of supply for these components and consumables. Our policy is to enter into long-term supply agreements that require suppliers to maintain adequate inventory levels and which contain other terms and conditions designed to protect us against unforeseen interruptions in their production. We endeavor to maintain adequate stock levels at our own locations to ensure an uninterrupted source of supply. We typically seek to establish secondary sources of supply or other manufacturing alternatives. Nevertheless, despite these efforts, it is possible that we may experience an interruption in supply of one or more of our critical components resulting in backorders to our customers. However, we believe that we could locate alternative sources of supply upon such terms and within such a timeframe as would not result in a material adverse effect on our business.

Patents and Intellectual Property

We have rights to United States patents relating to cryoablation and lithotripsy technology. Our policy is to secure and protect intellectual property rights relating to our technology through patenting inventions and licensing others when necessary. While we believe that the protection of patents and licenses is important to our business, we also rely on trade secrets, know-how and continuing technological innovation to maintain our competitive position. Given our technology and patent portfolio, we do not consider the operation of our business to be materially dependent upon any one patent, group of patents or single technological innovation.


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Our policy is to sell our products and services under trademarks and to secure trademark protection in the United States and elsewhere where we deem such protection important.

No assurance can be given that our processes or products will not infringe patents or other intellectual property rights of others or, if they are held to infringe, that any license required would be made available under any such patents or intellectual property rights, on terms acceptable to us or at all. In the past, we have received correspondence alleging infringement of intellectual property rights of third parties. No assurance can be given that any relevant claims of third parties would not be upheld as valid and enforceable, and therefore we could be prevented from practicing the subject matter claimed or could be required to obtain licenses from the owners of any such intellectual property rights to avoid infringement.

We seek to preserve the confidentiality of our technology by entering into confidentiality agreements with our employees, consultants, customers and key vendors and by other means. No assurance can be given, however, that these measures will prevent the unauthorized disclosure or use of such technology.

Competition

The lithotripsy services market is highly fragmented and competitive. We compete with other companies, private facilities and medical centers that offer lithotripsy machines and services, including smaller regional and local lithotripsy service providers. Certain of our current and potential competitors have substantial financial resources and may compete with us on services for acquisitions and development of operations in markets targeted by us. Additionally, while we believe that lithotripsy has emerged as the superior treatment for kidney stone disease, we also compete with hospitals, clinics and individual medical practitioners that offer alternative treatments for kidney stones.

The prostate treatment services market is also highly fragmented and competitive. We compete with other companies, private facilities and medical centers that offer prostate treatment equipment and services, including smaller regional and local service providers. Certain of our current and potential competitors have substantial financial resources and may compete with us on services, for acquisitions and development of operations in markets targeted by us.

In our manufacturing operations, we also compete with other manufacturers of minimally invasive medical devices in our markets. The primary competitors include Dornier MedTech GmbH, Siemens AG, Storz Medical, Richard Wolf GmbH, Direx and Galil Medical, Ltd.

Competition in our lab business is also intense. We compete with national, regional and local anatomical pathology labs. Certain of our lab competitors have significantly greater resources than us and some have nationally-recognized reputations. In addition, regional and local labs may have regionally-recognized reputations. In addition, these regional and local labs may have pre-established long-term relationships with physicians and practice groups whereby the physicians and practice groups are comfortable with the level of expertise of the labs and therefore place a high value on the relationships.

Potential Liabilities-Insurance

All medical procedures performed in connection with our business activities are conducted directly by, or under the supervision of, physicians who are not our employees. We do not provide medical services to any patients. However, patients being treated at health care facilities at which we provide our non-medical services could suffer a medical emergency resulting in serious injury or death, which subjects us to the risk of lawsuits seeking substantial damages.


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We may also face product liability claims as a result of our medical device manufacturing.

We currently maintain general and professional liability insurance with a total limit of $1,000,000 per loss event and $3,000,000 policy aggregate and an umbrella excess limit of $10,000,000, with a deductible of $25,000 per occurrence. In addition, we require medical professionals who utilize our services to maintain professional liability insurance. All of these insurance policies are subject to annual renewal by the insurer. If these policies were to be canceled or not renewed, or failed to provide sufficient coverage for our liabilities, we might be forced to self-insure against the potential liabilities referred to above. In that event, a single incident might result in an award of damages that might have a material adverse effect on our results of operations or financial condition. We sponsor a partially self-insured group medical insurance plan for our employees. The plan is designed to provide a specified level of coverage, with stop-loss coverage provided by a commercial insurer. Our maximum claim exposure is limited to $110,000 per person per policy year.

Government Regulation and Supervision

We are directly, or indirectly through physicians and hospitals and other health care facilities, which we will refer to as Customers, subject to extensive regulation by both the federal government and the governments of states in which we conduct business, including:


 

the federal Medicare and Medicaid anti-kickback law, and state anti-kickback prohibitions;

 
 

the federal physician self-referral prohibition commonly known as the Stark Law and the state law equivalents of the Stark Law;

 
 

the federal False Claims Act;

 
 

federal and state billing and claims submission laws and regulations;

 
 

the federal Health Insurance Portability and Accountability Act of 1996 and state laws relating to patient privacy;

 
 

state laws that prohibit the practice of medicine by non-physicians, and prohibit fee-splitting arrangements involving physicians;

 
 

state and federal laws affecting the ownership and operation of the equipment we use and the manner in which we provide services; and

 
 

federal and state laws governing the equipment we use in our business concerning patient safety and equipment operating specifications.

 

The federal anti-kickback law prohibits the knowing and willful offer, payment, solicitation or receipt of any form of remuneration in return for, or in order to induce, (i) the referral of a person for services, (ii) the furnishing or arranging for the furnishing of items or services, or (iii) the purchase, lease or order or arranging or recommending purchasing, leasing or ordering any item or service, in each case, reimbursable under any federal health care program. The Stark Law prohibits a physician from referring a Medicare patient for “designated health services,” or DHS, to an entity with which the physician has a direct or indirect financial relationship, whether in the nature of an ownership interest or a compensation arrangement, subject only to limited exceptions. The Stark Law also prohibits the recipient of a prohibited referral from billing for the DHS provided pursuant thereto. We contract with physicians under a variety of financial arrangements, and physicians have ownership interests in some entities in which we also have an interest. If our operations are found to be in violation of any of the laws and regulations to which we or our Customers are subject, we may be subject to the applicable penalty associated with the violation, including civil and criminal penalties, damages, fines, exclusion from the Medicare, Medicaid, and other governmental healthcare programs, loss of licenses, and the curtailment of our operations. While we believe that we are in compliance with all applicable laws, we cannot assure that our activities will be found to be in compliance with these laws if scrutinized by regulatory authorities. Any penalties, damages, fines or curtailment of our operations, individually or in the aggregate, could adversely affect our ability to operate our business and our financial results. The risks of us being found in violation of these laws and regulations is increased by the fact that many of the laws and regulations have not been fully interpreted by the regulatory authorities or in the courts, and their provisions are open to a variety of interpretations. Any action brought against us for violation of these laws or regulations, even if we were to successfully defend against it, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business.


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The Centers for Medicare & Medicaid Services (“CMS”) recently issued a rule that amended regulations that implement the Stark Law. Under the rule, which went into effect October 1, 2009, certain physician-owned ventures (e.g., laser, cryotherapy, and TUMT partnerships) are not able to contract with hospitals for the lease of space or equipment under a per-procedure or per-click payment arrangement. Also under the rule, CMS acknowledged that lithotripsy services performed under arrangements at hospitals is not a DHS under the Stark Law. However, to the extent a physician with an ownership or compensation interest in one of our lithotripsy partnerships otherwise refers patients to the hospital for DHS services, the Stark Law still applies and an exception must be met. CMS has also issued an answer in the form of a “Frequently Asked Question” on its website, where it indicates that the provision of lithotripsy services may be considered a service contract and not a lease of space or equipment. Thus, according to the FAQ advice from CMS, our lithotripsy partnerships may continue to contract with hospitals on a per-procedure payment basis so long as the contract is a service arrangement rather than a leasing arrangement and the physician partners in the partnership do not otherwise refer “designated health services” to the contracting hospitals (unless under an applicable exception). If the partnership provides a technician and related support when providing lithotripsy services, we believe such arrangement is a service arrangement. If a lithotripsy arrangement is considered a leasing arrangement or if any of the physician partners in the lithotripsy arrangement refer “designated health services” to a contracting hospital, then the fee arrangements between the partnership and the hospitals are required to be in compliance with the new rule effective as of October 1, 2009. In addition, our prostate treatment partnerships were required to be in compliance with the new rule effective as of October 1, 2009. We restructured our prostate partnerships and/or their hospital contracts to comply with the amended regulations as of October 1, 2009. Although we believe the prostate partnerships as restructured are in compliance with the amended regulations, no assurance can be made that the prostate partnerships as restructured will be found to be in compliance with the amended Stark law regulations if reviewed by regulatory authorities. If regulatory authorities were to conclude that our prostate partnerships were not in compliance, any resulting penalties, damages, fines or curtailment of our operations, individually or in the aggregate, could adversely effect our ability to operate our business and affect our financial results.

In light of these amended regulations and the resulting effects on our operations as described above, physician investment in our partnerships may become less attractive. As a result, it may be more difficult to retain physician partners in our partnerships and attract new physician partners to our partnerships. At this time we are unable to assess the extent to which the amended regulation will affect relationships with our existing physician partners and our ability to attract new physician partners. However, if the amended regulations have a negative effect on our physician partner relationships, then our operations and results of operations could be materially adversely affected.


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Generally, physician ownership and contracts with entities that provide ancillary medical services are a subject of intensive legislative and regulatory attention. It is likely that additional legislation may be passed and additional regulations will be promulgated that will further affect our business and our relationships with physicians. The recently-passed American Recovery and Reinvestment Act of 2009 (commonly known as the Stimulus Bill) contains a number of provisions affecting healthcare entities like us, including new requirements relating to information technology, privacy, and data security. The U.S. President has stated that his administration will make health care reform a major initiative, which may impact our provision of services and our reimbursement. Potential changes that have been considered include controls on health care spending and price controls. Any health care reform could have a material adverse effect on reimbursement for our services and products and could negatively affect the commercial acceptance of our services and products, which could have a material adverse effect on our operations financial position and results of operations. We are unable to state with certainty the effect of any such pending legislation or regulation on our business.

Governmental regulation in the United States and other countries is a significant factor affecting the research and development, manufacture and marketing of medical devices, including our products. In the United States, the U.S. Food and Drug Administration (“FDA”) has broad authority under the Federal Food, Drug and Cosmetic Act (“FD&C Act”) to regulate the development, distribution, manufacture, marketing and sale of medical devices. Foreign sales of medical devices are subject to foreign governmental regulation and restrictions that vary from country to country. We can provide no assurance that we will be able to obtain or maintain clearances or approvals for clinical testing or for manufacturing and sales of our existing products for all applications in all targeted markets, or that we will be able to obtain or maintain clearances or approvals needed to introduce new products and technologies. After a device is placed on the market, numerous regulatory requirements apply. These include, but are not limited to:


 

quality system regulation, which requires manufacturers to follow design, testing, control, documentation and other quality assurance procedures during the manufacturing process;

 
 

labeling regulations, which require specific information on product labels and in labeling, prohibit certain information, prohibit the promotion of products for unapproved or “off-label” uses and impose other restrictions on labeling; and

 
 

medical device reporting regulations, which require that manufacturers report to the FDA if their device may have caused or contributed to a death or serious injury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if it were to recur.

 

Failure to comply with applicable regulatory requirements can result in enforcement action by the FDA, which may include, but is not limited to, any of the following sanctions:


 

fines, injunctions, and civil penalties;

 
 

recall or seizure of our products;

 
 

operating restrictions, partial suspension or total shutdown of production;

 
 

refusing our request for 510(k) clearance or premarket approval of new products;

 
 

withdrawing 510(k) clearance or premarket approvals that are already granted; and

 
 

criminal prosecution.

 
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Equipment

We either manufacture or purchase our urology equipment and maintain that equipment with either internal personnel or pursuant to service contracts with the manufacturers or other service companies. For mobile lithotripsy, we either purchase or lease the truck, usually for a term up to five years, and purchase the trailer or a self contained coach. We are not dependent on any one manufacturer of medical equipment.

Employees

As of February 28, 2010, we employed approximately 619 full-time employees and approximately 39 part-time employees.

Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed below, which could materially affect our business, financial condition or future results.

If we are not able to establish or maintain relationships with physicians and hospitals, our ability to successfully commercialize our current or future service offerings will be materially harmed.

We are dependent on health care providers in two respects. First, if physicians and hospitals and other health care facilities, which we will refer to as Customers, determine that our services are not of sufficiently high quality or reliability, or if our Customers determine that our services are not cost effective, they will not utilize our services. In addition, any change in the rates of or conditions for reimbursement could substantially reduce (1) the number of procedures for which we or our Customers can obtain reimbursement or (2) the amounts reimbursed to us or our Customers for services provided by us. If third-party payors reduce the amount of their payments to Customers, our Customers may seek to reduce their payments to us or seek an alternate supplier of services. Because unfavorable reimbursement policies have constricted and may continue to constrict the profit margins of the hospitals and other healthcare facilities we bill directly, we may need to lower our fees to retain existing customers and attract new ones. These reductions could have a significant adverse effect on our revenues and financial results by decreasing demand for services or creating downward pricing pressure. Second, physicians generally own equity interests in our partnerships. We provide a variety of services to the partnerships and in general manage their day-to-day affairs. Our operations could become disrupted, and financial results adversely affected, if these physician partners became dissatisfied with our services, if these physician partners believe that our competitors or other persons provide higher quality services or a more cost-beneficial model or service, or if we became involved in disputes with our partners.

We are subject to extensive federal and state health care regulation.

We are subject to extensive regulation by both the federal government and the governments of states in which we conduct business. See “Government Regulation and Supervision” under this Part I for further discussion on these regulations.

Third party payors could refuse to reimburse health care providers for use of our current or future service offerings and products, which could make our revenues decline.

Third party payors are increasingly attempting to contain health care costs by limiting both coverage and the level of reimbursement of medical procedures and treatments. In addition, significant uncertainty exists as to the reimbursement status of newly approved health care products. Lithotripsy treatments are reimbursed under various federal and state programs, including Medicare and Medicaid, as well as under private health care programs, primarily at fixed rates. Governmental programs are subject to statutory and regulatory changes, administrative rulings, interpretations of policy and governmental funding restrictions, and private programs are subject to policy changes and commercial considerations, all of which may have the effect of decreasing program payments, increasing costs or requiring us to modify the way in which we operate our business. These changes could have a material adverse effect on us.


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New and proposed federal and state laws and regulatory initiatives relating to various initiatives in health care reform (such as improving privacy and the security of patient information and combating health care fraud) could require us to expend substantial sums to appropriately respond to and comply with this broad variety of legislation (such as acquiring and implementing new information systems for privacy and security protection), which could negatively impact our financial results.

Recent legislation and several regulatory initiatives at the state and federal levels address patient privacy concerns. New federal legislation extensively regulates the use and disclosure of individually identifiable health-related information and the security and standardization of electronically maintained or transmitted health-related information. We do not yet know the total financial or other impact of these regulations on our business. Continuing compliance with these regulations will likely require us to spend substantial sums, including, but not limited to, purchasing new computer systems, which could negatively impact our financial results. Additionally, if we fail to comply with the privacy regulations, we could suffer civil penalties of up to $25,000 per calendar year per standard (with well over fifty standards with which to comply) and criminal penalties with fines of up to $250,000 for willful and knowing violations. In addition, health care providers will continue to remain subject to any state laws that are more restrictive than the federal privacy regulations. These privacy laws vary by state and could impose additional penalties.

The provisions of HIPAA criminalize situations that previously were handled exclusively civilly through repayments of overpayments, offsets and fines by creating new federal health care fraud crimes. Further, as with the federal laws, general state criminal laws may be used to prosecute health care fraud and abuse. We believe that our business arrangements and practices comply with existing health care fraud law. However, a violation could subject us to penalties, fines and/or possible exclusion from Medicare or Medicaid. Such sanctions could significantly reduce our revenue or profits.

A number of proposals for health care reform have been made in recent years, some of which have included radical changes in the health care system. We anticipate that federal legislation will be enacted in the next few years that will significantly reform health care. Health care reform could result in material changes in the financing and regulation of the health care business, and we are unable to predict the effect of such changes on our future operations. It is uncertain what legislation on health care reform, if any, will ultimately be implemented or whether other changes in the administration of or interpretation of existing laws involving governmental health care programs will occur. Future health care legislation or other changes in the administration of or interpretation of existing legislation regarding governmental health care programs could have an adverse effect on our business and the results of our operations.

If we fail to obtain or maintain necessary regulatory clearances or approvals for the medical products we manufacture, or if approvals are delayed or withdrawn, we will be unable to commercially distribute and market our products or any product modifications.

Government regulation has a significant impact on our business. Government regulation in the United States and other countries is a significant factor affecting the research and development, manufacture and marketing of the products we manufacture. In the United States, the Food and Drug Administration (the “FDA”) has broad authority under the Federal Food, Drug and Cosmetic Act (the “FD&C Act”) to regulate the development, distribution, manufacture and sale of medical devices. Foreign sales of drugs and medical devices are subject to foreign governmental regulation and restrictions, which vary from country to country. The process of obtaining FDA and other required regulatory clearances and approvals (collectively, “regulatory approvals”) is lengthy and expensive. We may not be able to obtain or maintain necessary regulatory approvals for clinical testing or for the manufacturing or marketing of the medical products we manufacture. Failure to comply with applicable regulatory approvals can, among other things, result in fines, suspension or withdrawal of regulatory approvals, product recalls, operating restrictions and criminal prosecution. In addition, new or additional governmental regulations may be established that could prevent, delay, modify or rescind regulatory approval of our medical products. Any of these actions by the FDA or foreign regulatory authority, or change in FDA regulations or those of a foreign regulatory authority, could have a material adverse effect on our business, financial condition, results of operations and cash flows.


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Regulatory approvals of medical products, if granted, may include significant limitations on the indicated uses for which the medical products we manufacture may be marketed. In addition, to obtain such regulatory approvals, the FDA and foreign regulatory authorities may impose numerous other requirements on us. FDA enforcement policy prohibits the marketing of approved medical devices for unapproved uses. In addition, regulatory approvals can be withdrawn for failure to comply with regulatory standards or as a result of unforeseen problems following initial marketing. We may not be able to obtain or maintain regulatory approvals for our products on a timely basis, or at all, and delays in receipt of or failure to receive such regulatory approvals, the loss of previously obtained regulatory approvals or failure to comply with existing or future regulatory requirements could have a material adverse effect on our business, financial condition, results of operations and cash flows.

Our manufactured medical products may be subject to product recalls even after receiving FDA clearance or approval, which would harm our reputation and our business.

The FDA and similar governmental authorities in other countries have the authority to request and, in some cases, require the recall or similar actions for the medical products we manufacture in the event of material deficiencies or defects in design, manufacture or labeling or in the event of patient injury. A governmental mandated or voluntary recall by us could occur as a result of component failures, manufacturing errors or design defects. Any recall of product would divert managerial and financial resources and harm our reputation with customers and our business, impact our ability to distribute the recalled product in the future, require costly redesign or manufacturing changes and leave us vulnerable to additional regulatory sanctions and product liability litigation.

We face intense competition and rapid technological change that could result in products that are superior to the products we manufacture or superior to the products on which our current or proposed services are based.

Competition in our business operations is intense. We compete with national, regional and local providers of urology services. This competition could lead to a decrease in our profitability. Moreover, if our customers determine that our competitors offer better quality products or services or are more cost effective, we could lose business to these competitors. The medical device industry is subject to rapid and significant technological change. Others may develop technologies or products that are more effective or less costly than our products or the products on which our services are based, which could render our products or services obsolete or noncompetitive. These developments could have a material adverse effect on our business, financial condition and result of operation. Our business is also impacted by competition between lithotripsy and prostate treatment services, on the one hand, and surgical and other established methods for treating urological conditions, on the other hand.

Competition in our lab business is also intense. We compete with national, regional and local anatomical pathology labs. Certain of our lab competitors have significantly greater resources than us and some have nationally-recognized reputations. In addition, regional and local labs may have regionally-recognized reputations. In addition, these regional and local labs may have pre-established long-term relationships with physicians and practice groups whereby the physicians and practice groups are comfortable with the level of expertise of the labs and therefore place a high value on the relationships.


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We may be subject to costly and time-consuming product liability actions that would materially harm our business.

Our urology services and manufacturing business exposes us to potential product liability risks that are inherent in these industries. All medical procedures performed in connection with our business activities are performed by or under the supervision of physicians who are not our employees. We do not perform medical procedures. However, we may be held liable if patients undergoing urology treatments using our devices are injured. We may also face product liability claims as a result of our medical device manufacturing. We cannot ensure that we will be able to avoid product liability exposure. Product liability insurance is generally expensive, if available at all. We cannot ensure that our present insurance coverage is adequate or that we can obtain adequate insurance coverage at a reasonable cost in the future.

Our success will depend partly on our ability to operate without infringing on or utilizing the proprietary rights of others.

The medical device industry is characterized by a substantial amount of litigation over patent and other intellectual property rights. No one claims that any of our medical devices infringe on their intellectual property rights; however, it is possible that we may have unintentionally infringed on others’ patents or other intellectual property rights. Intellectual property litigation is costly. If we do not prevail in any litigation, in addition to any damages we might have to pay, we could be required to stop the infringing activity or obtain a license. Any required license may not be available to us on acceptable terms. If we fail to obtain a required license or are unable to design around a patent, we may be unable to sell some of our products, which would reduce our revenues and net income.

If we fail to protect our intellectual property rights, our competitors may take advantage of our ideas and compete directly against us.

Our success will depend to a degree on our ability to secure and protect intellectual property rights and to enforce patent and trademark protections relating to our technology. From time to time, litigation may be advisable to protect our intellectual property position. However, these legal means afford only limited protection and may not adequately protect our rights or permit us to gain or keep any competitive advantage. Any litigation in this regard could be costly, and it is possible that we will not have sufficient resources to fully pursue litigation or to protect our other intellectual property rights. Litigation could result in the rejection or invalidation of our existing and future patents. Any adverse outcome in litigation relating to the validity of our patents, or any failure to pursue litigation or otherwise to protect our patent positions, could have a material adverse effect on our business, financial condition, and results of operations. Also, even if we prevail in litigation, the litigation would be costly in terms of management distraction as well as in terms of cash resources. In addition, confidentiality agreements with our employees, consultants, customers, and key vendors may not prevent the unauthorized disclosure or use of our technology. It is possible that these agreements could be breached or that they might not be enforceable in every instance, and that we might not have adequate remedies for any such breach. Enforcement of these agreements may be costly and time consuming. Furthermore, the laws of foreign countries may not protect our intellectual property rights to the same extent as the laws of the United States.


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We may be required to modify our agreements, operations, marketing and expansion strategies in response to changes in the statutory and regulatory environment.

We regularly monitor developments in statutes and regulations relating to our business. However, we may be required to modify our agreements, operations, marketing and expansion strategies from time to time in response to changes in the statutory and regulatory environment. We plan to structure all of our agreements, operations, marketing and strategies in accordance with applicable law, although we can provide no assurance that our arrangements will not be challenged successfully or that required changes may not have a material adverse effect on our business, financial condition, and results of operations.

If we fail to attract and retain key personnel and principal members of our management staff, our business, financial condition and operating results could be materially harmed.

Our success depends greatly on our ability to attract and retain qualified management and technical personnel, as well as to retain the principal members of our existing management staff. The loss of services of any key personnel could adversely affect our current operations and our ability to implement our growth strategy. There is intense competition within our industry for qualified staff, and we cannot assure you that we will be able to attract and retain the necessary qualified staff to develop our business. If we fail to attract and retain key management staff, or if we lose any of our current management team, our business, financial condition and operating results could be materially harmed.

The market price of our common stock may experience substantial fluctuation for reasons over which we have little control.

Our stock price has a history of volatility. Fluctuations have occurred even in the absence of significant developments pertaining to our business. Stock prices and trading volume of companies in the health care and health services industry have fallen and risen dramatically in recent years. Both company-specific and industry-wide developments may cause this volatility. Factors that could impact the market price of our common stock include the following:


 

future announcements concerning us, our competition or the health care services market generally;

 
 

developments relating to our relationships with hospitals, other health care facilities, or physicians;

 
 

developments relating to our sources of supply;

 
 

claims made or litigation filed against us;

 
 

changes in, or new interpretations of, government regulations;

 
 

changes in operating results from quarter to quarter;

 
 

sales of stock by insiders;

 
 

news reports relating to trends in our markets;

 
 

general economic conditions;

 
 

economic conditions within our industry;


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acquisitions and financings in our industry; and

 
 

overall volatility of the stock market.


Furthermore, stock prices for many companies fluctuate widely for reasons that may be unrelated to their operating results. These fluctuations, coupled with changes in our results of operations and general economic, political and market conditions, may adversely affect the market price of our common stock.

Our acquisition strategy could fail or present unanticipated problems for our business in the future, which could adversely affect our ability to make acquisitions or realize anticipated benefits from those acquisitions.

We have followed an acquisition strategy that has resulted in rapid growth in our business. This acquisition strategy includes acquiring healthcare services businesses and is dependent on the continued availability of suitable acquisition candidates and our ability to finance and complete any particular acquisition successfully. Moreover, the U.S. Federal Trade Commission, or FTC, initiated an investigation in 1991 to determine whether the limited partnerships in which Lithotripters, Inc., now one of our wholly-owned subsidiaries, was the general partner posed an unreasonable threat to competition in the healthcare field. While the FTC closed its investigation and took no action, the FTC or another governmental authority charged with the enforcement of federal or state antitrust laws or a private litigant might, due to our size and market share, seek to (1) restrict our future growth by prohibiting or restricting the acquisition of additional lithotripsy operations or (2) require that we divest certain of our lithotripsy operations. Furthermore, acquisitions such as our acquisition of Endocare in July 2009, involve a number of risks and challenges, including:


 

diversion of management’s attention;

 
 

the need to integrate acquired operations;

 
 

the risk that the expected cost savings and other synergies from the acquisition may not be fully realized, realized at all or take longer to realize than anticipated;

 
 

potential loss of key employees of the acquired companies; and

 
 

an increase in our expenses and working capital requirements.


Any of these factors could adversely affect our ability to achieve anticipated levels of cash flows from our acquired businesses or realize other anticipated benefits from those acquisitions.

Our results of operations could be adversely affected as a result of goodwill impairments.

Goodwill represents the excess of the purchase price paid for a company over the fair value of that company’s tangible and intangible net assets acquired. As of December 31, 2009, we had goodwill of $103 million. If we determine in the future that the fair value of any of our reporting units does not exceed the carrying value of the related reporting unit, goodwill in that reporting unit will be deemed impaired. If impaired, the amount of goodwill will be reduced to the value determined by us to be the fair value of the reporting unit. The amount of the reduction will be deducted from earnings during the period in which the impairment occurs. An impairment will also reduce stockholders’ equity in the period incurred by the amount of the impairment. In the fourth quarter of 2008, in connection with our annual goodwill impairment test, we recorded an impairment to our urology services reporting unit goodwill totaling $144 million. Although our core operations remain stable and reflect growth over the prior year, we adjusted certain assumptions in our discounted cash flow model to address the declines in our market capitalization, which had fallen significantly below our consolidated net assets. In addition, the market comparables component of our impairment test was negatively impacted by the current global economic crisis and global decline in the stock markets. In the fourth quarter of 2007, in connection with our annual goodwill impairment test, we recorded an impairment to our urology services reporting unit goodwill totaling $20.8 million. This impairment was due to a decrease in our estimated future discounted cash flows from this reporting unit. This decrease was primarily caused by lower projected growth rates for our laser operations as well as the timing of certain future growth for our IGRT operations. For further discussion of our 2008 and 2007 goodwill impairments, see footnote C to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.


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Our operations are partially dependent upon third-party suppliers, making us vulnerable to a supply shortage.

We obtain materials and manufactured components from third-party suppliers. In addition, we obtain consumables for use in performing lithotripsy and prostate treatment services with our partnerships’ equipment. Some of our suppliers are the sole source for a particular supply item. Any delay in our suppliers’ abilities to provide us with necessary material and components or consumables may affect our manufacturing capabilities and urology services or may require us to seek alternative supply sources. Delays in obtaining supplies may result from a number of factors affecting our suppliers, such as capacity constraints, labor disputes, the impaired financial condition of a particular supplier, suppliers’ allocations to other purchasers, weather emergencies or acts of war or terrorism. Any delay in receiving supplies could impair our ability to deliver products or services to our customers and, accordingly, could have a material adverse effect on our business, results of operations and financial condition.

We could be adversely affected by special risks and requirements related to our medical products manufacturing business.

We are subject to various special risks and requirements associated with being a medical equipment manufacturer, which could have adverse effects. These include the following:


 

the need to comply with applicable federal Food and Drug Administration and foreign regulations relating to good manufacturing practices and medical device approval requirements, and with state licensing requirements;

 
 

the need for special non-governmental certifications and registrations regarding product safety, product quality and manufacturing procedures in order to market products in the European Union;

 
 

potential product liability claims for any defective goods that are distributed; and

 
 

the need for research and development expenditures to develop or enhance products and compete in the equipment markets.

 

Our indebtedness may limit our financial and operating flexibility.

As of December 31, 2009, we had indebtedness of approximately $4.5 million related to equipment purchased by our limited partnerships, which indebtedness we believe will be repaid from the cash flows of the partnerships. We also have a revolving line of credit with a borrowing limit of $60.0 million pursuant to our senior credit facility. As of December 31, 2009, we have drawn $44 million on the revolver.

We must comply with various covenants contained in our revolving credit facility and any other future debt arrangements that, among other things, limit our ability to:


15


 

incur additional debt or liens;

 
 

make payments in respect of or redeem or acquire any debt or equity issued by us;

 
 

sell assets;

 
 

make loans or investments;

 
 

acquire or be acquired by other companies; and

 
 

amend some of our contracts.

 

We currently have $44 million drawn on our $60 million revolving line of credit, which could have important consequences to you. For example, it could:


 

increase our vulnerability to general adverse economic and industry conditions;

 
 

limit our ability to fund future working capital and capital expenditures, to engage in future acquisitions, or to otherwise realize the value of our assets and opportunities fully because of the need to dedicate a portion of our cash flow from operations to payments on our debt or to comply with any restrictive terms of our debt;

 
 

limit our flexibility in planning for, or reacting to, changes in the industry in which we operate; and

 
 

place us at a competitive disadvantage as compared to our competitors that have less debt.

 

In addition, if we fail to comply with the terms of any of our debt, our lenders will have the right to accelerate the maturity of that debt and foreclose upon the collateral, if any, securing that debt. Realization of any of these factors could adversely affect our business, financial condition and results of operations.

Our lenders may be unable or unwilling to fund their commitments under our senior credit facility.

Our senior credit facility includes a revolving line of credit under which we may regularly draw funds. Many U.S. financial institutions are having difficulty maintaining regulatory capital at levels required for additional lending, and some institutions are experiencing liquidity shortfalls. If some of the lenders participating in our senior credit facility fail to meet their funding commitments, we could be required to borrow from other sources at a higher cost or we may be required to monetize some of our assets to meet our liquidity requirements, which could have an adverse effect on our financial position and results of operations.

The current turmoil in the equity and credit markets could limit demand for our services and products and affect the overall availability and cost of capital.

The current turmoil in the equity and credit markets could limit demand for our services and products, and affect the overall availability and cost of capital. At this time, it is unclear whether and to what extent the actions taken by the U.S. government, including, without limitation, the passage of the Emergency Economic Stabilization Act of 2008 and the American Recovery and Reinvestment Act of 2009 and other measures currently being implemented or contemplated, will mitigate the effects of the crisis. While we have no immediate need to access the equity or credit markets at this time, the impact of the current crisis on our ability to obtain financing in the future, and the cost and terms of the financing, is unclear. No assurances can be given that the effects of the current crisis will not have a material adverse effect on our business, financial condition and results of operations.


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We have in the past identified material weaknesses in our internal control over financial reporting, and the identification of any significant deficiencies or material weaknesses in the future could affect our ability to ensure timely and reliable financial reports.

Although our management will continue to periodically review and evaluate the effectiveness of our internal controls, we can give you no assurance that there will be no material weaknesses in our internal control over financial reporting. We may in the future have material weaknesses in our internal control over financial reporting as a result of our controls becoming inadequate due to changes in conditions, the degree of compliance with our internal control policies and procedures deteriorating, or for other reasons. If we have significant deficiencies or material weaknesses in our internal control over financial reporting, our ability to record, process, summarize and report financial information within the time periods specified in the rules and forms of the SEC will be adversely affected. This failure could materially and adversely impact our business, our financial condition and the market value of our securities.

The risks described in our Annual Report on Form 10-K and above are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.


Executive Officers

As of March 6, 2010, our executive officers were as follows:


Name Age   Position
 
James S.B. Whittenburg 38    Chief Executive Officer and President
 
Richard A. Rusk 48    Chief Financial Officer and Treasurer
 
Clint B. Davis 37    Senior Vice President, General Counsel and Secretary
 
Clayton H. Duncan 37    Vice President-Radiation Therapy
 
Scott A. Herz 33    Vice President-Corporate Development
 
Laura A. Miller 40    President of Pathology Services
 

The foregoing does not include positions held in our subsidiaries. Our officers are elected for annual periods. There are no family relationships between any of our executive officers and/or directors.

Mr. Whittenburg was appointed as our President and Chief Executive Officer on August 13, 2007. From June 2006 until August 13, 2007, Mr. Whittenburg served as President of our Urology Division, and he was our acting President and Chief Executive Officer from May 2007 until August 2007. He served as President of our Specialty Vehicle Manufacturing Division from December 2005 until its sale in July 2006 and was our General Counsel and Senior Vice President—Development from March 2004 until June 2006. Previously Mr. Whittenburg practiced law at Akin Gump Strauss Hauer & Feld LLP, where he specialized in corporate and securities law. Mr. Whittenburg, a CPA, is licensed to practice law in Texas.


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Mr. Rusk was appointed Chief Financial Officer in November 2009. Mr. Rusk joined us in August 2000 as our Corporate Controller and was named Vice President in June 2002. In June 2006, Mr. Rusk was named our Treasurer and in September 2006, Mr. Rusk was named our Secretary. In September of 2008, Mr. Rusk was named Interim Chief Financial Officer. Before joining us, Mr. Rusk, a CPA, was with KPMG LLP for approximately seventeen years, the last ten years as a senior audit manager.

Mr. Davis joined us in July 2009 as Senior Vice President and General Counsel. From January 2006 to July 2009, Mr. Davis was employed by Endocare where he served as Senior Vice President, Legal Affairs, General Counsel and Secretary. From August 2000 to January 2006, Mr. Davis was a corporate attorney with the San Diego office of Morrison & Foerster LLP. While at Morrison & Foerster, Mr. Davis represented a number of life sciences and technology companies in a wide variety of business transactions, contractual arrangements and corporate governance matters. Prior to his employment with Morrison & Foerster, Mr. Davis was a corporate attorney with law firms in Boston and Los Angeles. Mr. Davis holds a B.A. from Rice University and a J.D. from Harvard Law School.

Mr. Duncan joined us in August 2007 as Vice President – Radiation Therapy. From August 2002 to August 2007, Mr. Duncan was employed by McKesson Provider Technologies, where he most recently held the position of Vice President of Corporate Accounts for the Automation Solutions division. Prior to that time, Mr. Duncan served in numerous development and sales leadership positions in the healthcare and technology industries. Mr. Duncan began his professional career by practicing law at Strasburger & Price LLP in the International Franchise and Distribution section. Mr. Duncan obtained his J.D. from Southern Methodist University, holds a Master of International Management from Thunderbird, The American Graduate School of International Management, and also holds a B.B.A. in Finance from Texas Tech University. Mr. Duncan is licensed to practice law in Texas.

Mr. Herz joined us in February 2005 in our Specialty Vehicles division as Associate Vice President-Finance. In June 2006, Mr. Herz was appointed Associate Vice President – Corporate Development and in December 2007 he was appointed Vice President – Corporate Development. Prior to joining us, Mr. Herz served as an associate investment banker at RSM Equico from 2004 to 2005. Prior to that time, Mr. Herz worked as a mechanical engineer at Colorado MEDtech, Inc. from 1999 to 2002. From 2002 to 2004, Mr. Herz obtained his MBA from Pepperdine University and also holds a BS in Mechanical Engineering from Michigan State University.

Ms. Miller joined us in December 2009 as President of Pathology Services. From November 2008 to December 2009, Ms. Miller served as an independent consultant to HealthTronics. From May 2007 to November 2008, Ms. Miller was employed by Lakewood Pathology Associates where she most recently held the position of Senior Vice President of Pathology Solutions. From January 2006 to May 2007, Ms. Miller served as General Manager for Strategic Development for Dianon Systems, Inc. From July 2003 to December 2005, Ms. Miller was employed by LabCorp as National Sales Manager. Ms. Miller has spent twelve years in the anatomical pathology and diagnostics industries, serving in numerous development and sales leadership positions. Prior to entering the business world, Ms. Miller served in the U.S. Army, where she achieved the rank of Captain – Military Intelligence.

Available Information

We file annual, quarterly, and current reports, proxy statements, and other documents with the Securities and Exchange Commission (“SEC”) under the Securities Exchange Act of 1934 (the “Exchange Act”). You may read and copy any materials that we file with the SEC at the SEC’s public reference room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the public reference room by calling the SEC at 1-800-SEC-0330. Also, the SEC maintains a website that contains these SEC filings. You can obtain these filings at the SEC’s website at http://www.sec.gov.


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We also make available free of charge on or through our website (http://www.healthtronics.com) our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and, if applicable, amendments to those reports filed or furnished pursuant to Section 13(a) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

ITEM 1A.     RISK FACTORS

The information required by this item is set forth under “Risk Factors” in Part I, Item 1.

ITEM 1B.     UNRESOLVED STAFF COMMENTS

None.

ITEM 2.     PROPERTIES

Our principal executive office is located in Austin, Texas. On June 16, 2008, we sold the office building in which our principal executive offices were located for approximately $6,750,000. We subsequently relocated our principal executive offices in late September 2008. In December 2008, we also relocated our Medical Products operations from leased facilities in Kennesaw, Georgia to warehouse space that occupies the same leased building as our principal executive offices in Austin, Texas. By March 2010, we intend to relocate our Endocare manufacturing operations from Irvine, California to warehouse space adjoining our executive space in Austin, Texas.

ITEM 3.     LEGAL PROCEEDINGS

We are involved in various claims and legal actions that have arisen in the ordinary course of business. We believe that any liabilities arising from these actions will not have a material adverse effect on our financial condition, results of operations or cash flows.

ITEM 4.     RESERVED


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PART II

ITEM 5.     MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER
                    MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The following table sets forth the high and low closing prices per share for our common stock on the Nasdaq Global Select Market for the years ended December 31, 2009 and 2008 (NASDAQ Symbol “HTRN”).


2009
2008
High
Low
High
Low
First Quarter     $ 2 .75 $1 .28 $4 .47 $3 .12
  Second Quarter   $ 2 .01 $1 .29 $4 .30 $2 .68
  Third Quarter   $ 2 .76 $1 .77 $4 .50 $2 .83
  Fourth Quarter   $ 2 .64 $2 .16 $3 .04 $1 .03

On February 20, 2010, we had 669 holders of record of our common stock.

We are not currently paying dividends on our common stock. We have the authority to declare and pay dividends on our common stock at our discretion, as long as we have funds legally available to do so and our senior credit facility permits the declaration and payment. Our senior credit facility restricts our ability to pay cash dividends. In addition, we intend to retain our earnings to finance the expansion of our business and for general corporate purposes. Therefore, we do not anticipate paying cash dividends on our common stock in the foreseeable future.

Issuer Purchases of Equity Securities(a)


Period
Total Number of Shares
Purchased

Average Price Paid
Per Share

Total Number of Shares
Purchased as Part of
Publicly Announced Plans
or Programs

Maximum Number (or
Approximate Dollar
Value) of Shares That
May Yet to be Purchased
Under the Plans or
Programs

Month 1 (10/1/2009 – 10/31/2009)      11,292 (b) $ 2 .23  --    
Month 2 (11/1/2009 – 11/30/2009)    31,581 (b) $ 2 .44  --      
Month 3 (12/1/2009 – 12/31/2009)     --       --  --      
    Total    42,873   $ 2 .38  --    $ 6,260,000  

_____________________


  (a)

On October 6, 2008, our Board of Directors authorized the repurchase of up to $10 million of our common stock. We anticipate that the stock will be repurchased through privately-negotiated transactions or on the open market. We intend to comply with the SEC’s Rule 10b-18, and the repurchases will be subject to market conditions, applicable legal requirements, and other factors. We are not obligated to repurchase shares under the program, and our Board of Directors may suspend or terminate the program at any time. The repurchase program has no expiration date. We have no repurchase plans or programs that expired during the period covered by the above table, and we have no repurchase plans or programs that we intend to terminate prior to expiration or under which we no longer intend to make further purchases.

 
  (b)

Represents shares used by 5 employees to pay their federal tax withholding obligation related to the vesting of certain restricted stock awards in October and November 2009.

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Equity Compensation Plan Information

At December 31, 2009, we had seven separate equity compensation plans: the Prime Medical Services, Inc. (“Prime”) 1993 and 2003 stock option plans, the HealthTronics Surgical Services, Inc. (“HSS”) general, 2000, 2001 and 2002 stock option plans, and the HSS 2004 equity incentive plan. The plans, and all amendments thereto, had been approved by Prime’s and HSS’ shareholders, as the case may be. On November 10, 2004, Prime completed a merger with HSS pursuant to which Prime merged with and into HSS with HealthTronics, Inc. as the surviving corporation. The following table sets forth certain information as of December 31, 2009 about our equity compensation plans:


(a)
(b)
(c)
 





Plan Category




Number of shares of our
common stock to be issued
upon exercise of
outstanding options






Weighted-average exercise
price of outstanding options

Number of shares of our
common stock remaining
available for future
issuance under equity
compensation plans
(exceeding securities
reflected in column (a))

Prime 1993 stock option plan      65,666   $ 7 .79  --  
 
  Prime 2003 stock option plan    69,000   $ 5 .61  --  
 
  HSS equity incentive plan and stock  
       option plans    2,653,283   $ 5 .93  1,776,237  
 
  Other equity compensation plans  
      approved by our security holders    N/A    N/A    N/A  

In 2004, in connection with the merger of HSS and Prime, we assumed in the merger stock options to acquire approximately 2,154,000 shares of common stock.


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Performance Graph

The following graph compares our cumulative total shareholder return with the cumulative total shareholder returns of the Nasdaq Market Index and the Nasdaq Health Services Index, for the period from December 31, 2005 through December 31, 2009.


 

ITEM 6.      SELECTED FINANCIAL DATA

The following tables set forth our summary consolidated historical financial information that has been derived from (a) our audited consolidated statements of income and cash flows for each of the years ended December 31, 2009, 2008, 2007, 2006 and 2005, (b) our audited consolidated balance sheets as of December 31, 2009, 2008, 2007, 2006, and 2005, and (c) our unaudited consolidated statements of income and cash flows for each of the three months ended December 31, September 30, June 30, and March 31, for 2009 and 2008. You should read this financial information in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our historical financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K. The historical results are not necessarily indicative of results to be expected in any future period.


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(In thousands, except per share data) Years Ended December 31,
2009
2008
2007
2006
2005
Revenues from continuing operations     $ 185,330   $ 165,942   $ 140,418   $ 142,891   $ 152,267  
Income (loss) attributable to HealthTronics, Inc. from:  
    Continuing Operations   $ (3,916 ) $ (128,693 ) $ (14,485 ) $ (16,446 ) $ 10,933  
    Discontinued Operations     --     --    (147 )  25,129    (1,745 )
    Net income (loss)   $ (3,916) (1) $(128,693)(2) $ (14,632 )(3) $ 8,683 (4) $ 9,188  
 
Diluted earnings (loss) per share  
attributable to HealthTronics, Inc.:  
    Continuing Operations   $ (0.10) $ (3.53) $ (0.41 ) $ (0.47 ) $ 0.31  
    Discontinued Operations       --     --    --    0.72    (0.05 )
    Total   $ (0.10) $ (3.53) $ (0.41 ) $ 0.25   $ 0.26  
 
Dividends per share   None  None   None    None    None  
Total assets   $ 249,119   $ 234,386  $ 336,056   $ 346,733   $ 483,037  
Long-term obligations (a)   $ 49,336   $ 45,662   $ 4,269   $ 6,063   $ 129,980  

_____________________


  (a)

Includes long term debt, other long term obligations and deferred compensation liability.


Quarterly Data
Quarter Ended
(in thousands, except per share data)

March 31
June 30
Sept. 30
Dec. 31
2009

(unaudited)

Revenues     $ 43,612   $ 44,156   $ 47,283   $ 50,279  
Net income (loss) attibutable to HealthTronics, Inc.   $ 390   $ 329   $ (2,302 )(1) $ (2,333 )(1)
 
Per share amounts (basic):  
     Net income (loss)   $ 0.01   $ 0.01   $ (0.06 ) $ (0.05 )
     Weighted average shares outstanding    35,892    36,006    41,043    43,491  
 
Per share amounts (diluted):  
     Net income (loss)   $ 0.01   $ 0.01   $ (0.06 ) $ (0.05 )
     Weighted average shares outstanding    35,966    36,161    41,043    43,491  



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Quarterly Data
Quarter Ended
(in thousands, except per share data)

March 31
June 30
Sept. 30
Dec. 31
2008

(unaudited)

Revenues     $ 33,954   $ 42,580   $ 44,771   $ 44,637  
Net income (loss) attributable to HealthTronics, Inc.   $ 452   $ 710   $ 1,327   $ (131,182 )(2)
 
Per share amounts (basic):  
     Net income (loss)   $ 0.01   $ 0.02   $ 0.04    ($ 3.64 )
     Weighted average shares outstanding    35,425    37,059    37,503    36,004  
 
Per share amounts (diluted):  
     Net income (loss)   $ 0.01   $ 0.02   $ 0.04    ($ 3.64 )
     Weighted average shares outstanding    35,425    37,165    37,604    36,004  

_____________________


(1)   In the third quarter of 2009, in connection with our acquisition of Endocare, we booked approximately $3.9 million in acquisition related costs which are required to be expensed when incurred beginning in 2009. In the fourth quarter of 2009, we booked an additional $4.8 million in costs related to the Endocare acquisition and the restructuring of our partnerships as noted in the discussion of government regulation and supervision in Item 1.

(2)   In the fourth quarter of 2008, in connection with our annual goodwill impairment test, we recorded a goodwill impairment to our urology services reporting unit totaling $144 million. Although our core operations remain stable and reflect growth over the prior year, we adjusted certain assumptions in our discounted cash flow model to address the recent declines in our market capitalization, which had fallen significantly below our consolidated net assets. In addition, the market comparables component of our impairment test was negatively impacted by the current global economic crisis and global decline in the stock markets.

(3)   In the fourth quarter of 2007, in connection with our annual goodwill impairment test, we recorded an impairment to our urology services unit goodwill totaling $20.8 million. This impairment was due to a decrease in our estimated future discounted cash flows for this unit. This decrease was primarily caused by lower projected growth rates for our laser operations as well as the timing of certain future growth for our IGRT operations.

(4)   In the fourth quarter of 2006, we recorded an impairment to our goodwill totaling $12.2 million related to our urology services unit and $8.4 million related to our medical products unit. The impairment to our urology services unit was due primarily to a decrease in the number of overall procedures during 2006, primarily across our western region partnerships, combined with the loss of certain partnerships and contracts late in 2006 to competitors. The impairment in our medical products unit relates primarily to our decision to reduce or exit certain product lines, specifically patient management tables and orthopedic consumables during the fourth quarter of 2006 along with the closing of our European operations. In the third quarter of 2006, we completed the sale of our Specialty Vehicle Manufacturing segment and recognized a gain of $53.6 million. This gain utilized approximately $20.4 million of our deferred tax asset.


ITEM 7.      MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                    AND RESULTS OF OPERATIONS

Forward-Looking Statements

This Annual Report on Form 10-K includes “forward-looking statements” within the meaning of Section 21E of the Exchange Act and the Private Securities Litigation Reform Act of 1995 about us that are subject to risks and uncertainties. All statements other than statements of historical fact included in this document are forward-looking statements. Although we believe that in making such statements our expectations are based on reasonable assumptions, such statements may be influenced by factors that could cause actual outcomes and results to be materially different from those projected.


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Statements that are predictive in nature, that depend upon or refer to future events or conditions, or that include words such as “will”, “would”, “should”, “plans”, “likely”, “expects”, “anticipates”, “intends”, “believes”, “estimates”, “thinks”, “may”, and similar expressions, are forward-looking statements. The following important factors, in addition to those discussed under “Risk Factors” under Part I, Item 1, could affect the future results of the health care industry in general, and us in particular, and could cause those results to differ materially from those expressed in such forward-looking statements.


 

uncertainties in our establishing or maintaining relationships with physicians and hospitals;

 
 

the impact of current and future laws and governmental regulations;

 
 

uncertainties inherent in third party payors’ attempts to limit health care coverages and levels of reimbursement;

 
 

the effects of competition and technological changes;

 
 

the availability (or lack thereof) of acquisition or combination opportunities;

 
 

the integration of acquired business; and

 
 

general economic, market or business conditions.


General

We provide healthcare services and medical devices, primarily to the urology marketplace.

Lithotripsy services. We provide lithotripsy services, which is a medical procedure where a device called a lithotripter transmits high energy shockwaves through the body to break up kidney stones. Our lithotripsy services are provided principally through limited partnerships and other entities that we manage, which use lithotripters. In 2009, physicians who are affiliated with us used our lithotripters to perform approximately 50,000 procedures in the U.S. We do not render any medical services. Rather, the physicians do.

We have two types of contracts, retail and wholesale, that we enter into in providing our lithotripsy services. Retail contracts are contracts where we contract with the hospital and private insurance payors. Wholesale contracts are contracts where we contract only with the hospital. The two approaches functionally differ in that, under a retail contract, we generally bill for the entire non-physician fee for all patients other than governmental pay patients, for which the hospital bills the non-physician fee. Under a wholesale contract, the hospital generally bills for the entire non-physician fee for all patients. In both cases, the billing party contractually bears the costs associated with the billing service, including pre-certification, as well as non-collection. The non-billing party is generally entitled to its fees regardless of whether the billing party actually collects the non-physician fee. Accordingly, under the wholesale contracts where we are the non-billing party, the hospital generally receives a greater proportion of the total non-physician fee to compensate for its billing costs and collection risk. Conversely, under the retail contracts where we generally provide the billing services and bear the collection risk, we receive a greater portion of the total non-physician fee.

Although the non-physician fee under both retail and wholesale contracts varies widely based on geographical markets and the identity of the third party payor, we estimate that nationally, on average, our share of the non-physician fee was roughly $2,100, respectively, for both 2009 and 2008. At this time, we do not anticipate a material shift between our retail and wholesale arrangements, or a material change in our share of the non-physician fee.


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As the general partner of limited partnerships or the manager of other types of entities, we also provide services relating to operating our lithotripters, including scheduling, staffing, training, quality assurance, regulatory compliance, and contracting with payors, hospitals, and surgery centers.

Prostate treatment services. We provide treatments for benign and cancerous conditions of the prostate. In treating benign prostate disease, we deploy three technologies: (1) photo-selective vaporization of the prostate (“PVP”), (2) trans-urethral needle ablation (“TUNA”), and (3) trans-urethral microwave therapy (“TUMT”) in certain partnerships. All three technologies apply an energy source which reduces the size of the prostate gland. For treating prostate and other cancers, we use a procedure called cryosurgery, a process which uses lethal ice to destroy tissue such as tumors for therapeutic purposes. In April 2008, we acquired Advanced Medical Partners, Inc. (“AMPI”), which significantly expanded our cryosurgery partnership base. In July 2009, we acquired Endocare, Inc. (“Endocare”), which manufactures both the medical devices and related consumables utilized by our cryosurgery operations, and also provides cryosurgery treatments. Our prostate treatment services are provided principally by us using equipment that we lease from limited partnerships and other entities that we manage. Benign prostate disease and cryosurgery cancer treatment services are billed in the same manner as our lithotripsy services under either retail or wholesale contracts. We also provide services relating to operating the equipment, including scheduling, staffing, training, quality assurance, regulatory compliance, and contracting.

Radiation therapy services. We provide image guided radiation therapy (“IGRT”) technical services for cancer treatment centers. Our IGRT technical services may relate to providing the technical (non-physician) personnel to operate a physician practice group’s IGRT equipment, leasing IGRT equipment to a physician practice group, providing services related to helping a physician practice group establish an IGRT treatment center, or managing an IGRT treatment center.

Anatomical pathology services. We also provide anatomical pathology services primarily to the urology community. We have one pathology lab located in Georgia, Claripath Laboratories, that provides laboratory detection and diagnosis services to urologists throughout the United States. In addition, in July 2008, we acquired Uropath LLC, which managed pathology laboratories located at Uropath sites for physician practice groups located in Texas, Florida and Pennsylvania. Through Uropath, we continue to provide administrative services to in-office pathology labs for practice groups and provide pathology services to physicians and practice groups with our lab equipment and personnel at our Uropath laboratory sites.

Medical products manufacturing, sales and maintenance. We, through our Endocare acquisition, manufacture and sell medical devices focused on minimally invasive technologies for tissue and tumor ablation through cryoablation, which is the use of lethal ice to destroy tissue, such as tumors, for therapeutic purposes. We develop and manufacture these devices for the treatment of prostate and renal cancers and we believe that our proprietary technologies have broad applications across a number of markets, including the ablation of tumors in the lung and liver and palliative intervention (treatment of pain associated with metastases). We also manufacture the related spare parts and consumables for these devices. We also sell and maintain lithotripters and related spare parts and consumables.


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Revenue Recognition

We recognize revenue primarily from the following sources:


 

Fees for urology treatments . A substantial majority of our revenue is derived from fees related to lithotripsy treatments performed using our lithotripters. For lithotripsy and prostate treatment services, we, through our partnerships and other entities, facilitate the use of our equipment and provide other support services in connection with these treatments at hospitals and other health care facilities. The professional fee payable to the physician performing the procedure is generally billed and collected by the physician. We recognize revenue for these services when the services are provided. IGRT technical services are billed monthly and the related revenues are recognized as the related services are provided.

 
 

Fees for managing the operation of our lithotripters and prostate treatment devices. Through our partnerships and otherwise directly by us, we provide services related to operating our lithotripters and prostate treatment equipment and receive a management fee for performing these services. We recognize revenue for these services as the services are provided.

 
 

Fees for maintenance services. We provide equipment maintenance services to our partnerships as well as outside parties. These services are billed either on a time and material basis or at a fixed contractual rate, payable monthly, quarterly, or annually. Revenues from these services are recorded when the related maintenance services are performed.

 
 

Fees for equipment sales, consumable sales and licensing applications. We manufacture and sell medical devices focused on minimally invasive technologies for tissue and tumor ablation through cryosurgery, and their related consumables. We also sell and maintain lithotripters and manufacture and sell consumables related to the lithotripters. We distribute the Revolix laser and consumables related to the laser. With respect to some lithotripter sales, in addition to the original sales price, we receive a licensing fee from the buyer of the lithotripter for each patient treated with such lithotripter. In exchange for this licensing fee, we provide the buyer of the lithotripter with certain consumables. All the sales for equipment and consumables are recognized when the related items are delivered. Revenues from licensing fees are recorded when the patient is treated. In some cases, we lease certain equipment to our partnerships as well as third parties. Revenues from these leases are recognized on a monthly basis or as procedures are performed.

 
 

Fees for anatomical pathology services. We provide anatomical pathology services primarily to the urology community. Revenues from these services are recorded when the related laboratory procedures are performed.

 

Recent Developments

We continue to look at strategic acquisition opportunities and believe conditions in the market favor our strong financial position, national platform of urologist relationships, and diversification within the urologist services space.

On July 27, 2009, we completed our acquisition of Endocare, Inc., pursuant to the Agreement and Plan of Merger (“Merger Agreement”), dated as of June 7, 2009, among us, HT Acquisition, Inc., a wholly-owned subsidiary of ours, and Endocare. Endocare is a medical device company focused on developing, manufacturing and selling cryoablation products that have the potential to assist physicians in improving and extending life by use in the treatment of cancer and other tumors. In accordance with the terms and conditions of the Merger Agreement, Endocare shareholders had the option to receive the following consideration for each share of Endocare common stock they owned: (i) $1.35 in cash, without interest, or (ii) 0.7764 of a share of our common stock, in each case subject to proration. In the acquisition, we paid approximately $4.2 million in cash and issued approximately 7.3 million shares of our common stock to acquire Endocare.


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Critical Accounting Policies and Estimates

Management has identified the following critical accounting policies and estimates:

Impairments of goodwill and other intangible assets are both a critical accounting policy and estimate that require judgment and are based on assumptions of future operations. We are required to test for impairments at least annually or if circumstances change that would reduce the fair value of a reporting unit below its carrying value. We test for impairment of goodwill during the fourth quarter. As of December 31, 2009, we have two reporting units, urology services and anatomical pathology services. As of December 31, 2008, we had two reporting units, urology services and medical products. The fair value of each reporting unit is estimated using a combination of the income, or discounted cash flows, approach and the market approach, which utilizes comparable companies’ data. Because we have recognized goodwill based solely on our controlling interest, the fair value of each reporting unit also relates only to our controlling interest. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. The second step of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with the carrying value of that goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. That is, the fair value of the reporting unit is allocated to all of the assets and liabilities of that unit as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the purchase price paid to acquire the reporting unit. Both the income approach and the market approach require significant assumptions to determine the fair value of each reporting unit. The significant assumptions used in the income approach include estimates of our future revenues, profits, capital expenditures, working capital requirements, operating plans, industry data and other relevant factors. The significant assumptions utilized in the market approach include the determination of appropriate market comparables, the estimated multiples of revenue, EBIT and EBITDA a willing buyer is likely to pay, and the estimated control premium a willing buyer is likely to pay. For a discussion of our 2008 goodwill impairment and the specific assumptions used in the income and market approaches in the 2009 and 2008 analyses, see footnote C to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

A second critical accounting policy and estimate which requires judgment of management is the estimated allowance for doubtful accounts and contractual adjustments. We have based our estimates on historical collection amounts, current contracts with payors, current changes of the facts and circumstances relating to these matters and certain negotiations with related payors.

A third critical accounting policy is consolidation of our investments in partnerships or limited liability companies (LLCs) where we, as the general partner or managing member, exercise effective control, even though our ownership is less than 50%. The consolidated financial statements include our accounts, our wholly-owned subsidiaries, and entities more than 50% owned and limited partnerships or LLCs where we, as the general partner or managing member, exercise effective control, even though our ownership is less than 50%. The related agreements provide us with broad powers. The other parties do not participate in the management of the entity and do not have the substantial ability to remove us. Investment in entities in which our investment is less than 50% ownership and we do not have significant control are accounted for by the equity method if ownership is between 20%–50%, or by the cost method if ownership is less than 20%. We have reviewed each of the underlying agreements and determined we have effective control; however, if it was determined this control did not exist, these investments would be reflected on the equity method of accounting. Although this would change individual line items within our consolidated financial statements, it would have no effect on our net income and/or total stockholders’ equity attributable to common shareholders.


28


Year ended December 31, 2009 compared to the year ended December 31, 2008

Our total revenues for the year ended December 31, 2009 increased $19,388,000 as compared to the same period in 2008. Revenues from our lithotripsy business increased $1,615,000 in 2009 as compared to 2008, and revenues from our prostate business increased $5,262,000 for the year ended December 31, 2009 as compared to the same period in 2008. Prostate revenues from a full year of our AMPI operations were a significant driver of the increased prostate revenues in 2009, as we acquired AMPI in April 2008. Lithotripsy revenues on a same store basis in 2009 were consistent with revenues from the same period in 2008. Manufacturing and consumable revenues for the year ending December 31, 2009 increased $4,965,000 from the same period in 2008. This increase is driven entirely by sales to external customers from our new Endocare subsidiary. Revenues from our laboratory operations increased $3,769,000 in 2009 as compared to the same period in 2008. This increase resulted primarily from our Uropath operations, as we acquired Uropath in July 2008. Revenues from our IGRT operations increased by $3,512,000 in 2009, primarily from our Ocean acquisition in late 2008.

Our cost of revenues increased $14,981,000 (20%) in 2009 as compared to the same period in 2008. The primary causes of this increase relate to: 1) increased cost of revenues attributable to our AMPI and IGRT operations totaling $3,580,000 due to a full year of operations in 2009, 2) increased costs related to our lab operations totaling $4,268,000 related primarily to a full year of Uropath activities, and 3) cost of revenues associated with our new Endocare subsidiary’s operations, which totaled $7,586,000 since we acquired Endocare. Approximately $3.8 million of Endocare’s costs of revenue related to incremental cost of goods sold from our write up of Endocare’s inventory to fair value as part of our purchase accounting. Our selling, general and administrative costs for the year ended December 31, 2009 increased $4,040,000 over the same period in 2008. This increase was primarily driven by acquisition costs related to our Endocare acquisition, which are required to be expensed when incurred beginning in 2009.

Depreciation and amortization expense increased $2,181,000 in 2009 compared to 2008, primarily due to the Endocare acquisition and a full year of amortization on an IGRT services agreement which was acquired in November of 2008.

Net income attributable to noncontrolling interest for the year ended December 31, 2009 increased $1,425,000 compared to the same period in 2008, as a result of increases in income at our existing partnerships, primarily as a result of having a full year of activity from our AMPI partnerships, which was partially offset by noncontrolling interest expense of $986,000 related to the restructuring of our partnerships as noted in the discussion on government regulation and supervision in Item 1.

Provision for income taxes for the year ended December 31, 2009 increased $14,353,000 compared to the same period in 2008. The variance is primarily related to the tax effect of the impairment charge in 2008. Our income tax expense for 2009 reflects the expense related to the recording of a full valuation allowance for all deferred tax assets since we have been in a cumulative loss position for the last three years due to non-cash goodwill impairments recorded in prior years. For the next several years, we will only be an alternative minimum tax payer as we will utilize our existing net operating loss carryforwards to offset any current taxes payable. Accordingly, we expect our effective tax rate and our provision for income taxes in future periods to decrease as compared to 2009.


29


Year ended December 31, 2008 compared to the year ended December 31, 2007

Our total revenues increased $25,524,000 as compared to 2007. Revenues from our lithotripsy business increased $5,193,000 (4.8%) as compared to 2007, while revenues from our prostate business increased $17,336,000 in 2008 as compared to 2007. Revenues from our AMPI acquisition, which was effective April 1, 2008, were the primary driver in the increased prostate revenues. Prostate revenues from AMPI entities totaled $18.4 million in 2008. The actual number of lithotripsy procedures performed in 2008 increased by 3% compared to 2007. The average rate per procedure increased by 1% in 2008, as compared to 2007. We sold five lithotripters and one table in 2008. We sold eight lithotripters and 28 tables during the same period in 2007. We discontinued the sale of tables in 2007. Revenues from our Claripath laboratory which commenced operations in January 2006, totaled $5,113,000 and $3,418,000 for the years ended December 31, 2008 and 2007, respectively. Revenues from our Uropath acquisition, which was effective July, 10, 2008 totaled $1,993,000 in 2008.

Our cost of revenues increased $10,964,000 (17%) in 2008 as compared to the same period in 2007. The primary causes of this increase relate to: 1) the cost of services at our new AMPI entities, whose costs totaled $12,964,000 in 2008, partially offset by an overall decrease in cost of services attributed to our organic urology business. This decrease in our organic business costs is primarily related to the write off of a certain payable at one of our partnerships in the first quarter of 2008 of approximately $700,000 which was recorded against operating expenses and $250,000 of insurance reimbursements received at one of our partnerships related to damages suffered during hurricane Katrina; 2) our cost of services associated with our manufacturing and consumables sales for 2008, which decreased as compared to 2007 primarily due to lower cost of sales on fewer device sales in the period, which was partially offset by approximately $1 million in restructuring and moving costs related to moving our manufacturing and service operations from Kennesaw, Georgia to Austin, Texas; and 3) our cost of services associated with our anatomical pathology lab operations increased $2,658,000 in 2008 over 2007. We had approximately $740,000 in increased expenses at our Claripath lab, which has experienced significant growth year over year, and $1,888,000 in expenses at our new Uropath labs.

Our selling, general and administrative costs for the year ended December 31, 2008 increased $4,122,000 compared to the same period in 2007. This increase primarily relates to increased compensation expenses of $1.8 million related to restricted stock grants to employees which vested as performance goals were reached in the second and third quarters of 2008 and approximately $1 million in increases in sales and marketing expenses associated with our Claripath lab in 2008. In addition, we received approximately $900,000 as a result of our former Swiss manufacturing subsidiary’s insolvency proceedings in 2007, which was recorded against selling, general and administrative expenses.

In the fourth quarter of 2008, in connection with our annual goodwill impairment test, we recorded an impairment to our urology services unit goodwill totaling $144 million. Although our core operations remain stable and reflect growth over the prior year, we adjusted certain assumptions in our discounted cash flow model to address the recent declines in our market capitalization, which had fallen significantly below our consolidated net assets. In addition, the market comparables component of our impairment test was negatively impacted by the current global economic crisis and global decline in the stock markets. In the fourth quarter of 2007, in connection with our annual goodwill impairment test, we recorded an impairment to our urology services unit goodwill totaling $20.8 million. This impairment was due to a decrease in our estimated future discounted cash flows for the urology services unit. This decrease was primarily caused by lower projected growth rates for our laser operations as well as the timing of certain future growth for our IGRT operations.

In 2007, we had a loss from discontinued operations of $147,000 attributable to our RMPT and HIFU operations. This loss included a gain of $450,000 from the sale of our RMPT business, which closed September 28, 2007.


30


Depreciation and amortization expense increased $1,256,000 in 2008 compared to 2007, primarily due to the addition of our new AMPI entities and the amortization on our Ocean services agreement.

Income attributable to noncontrolling interest for 2008 increased $8,691,000 (19%) compared to 2007, as a result of increases in noncontrolling interest percentages at certain partnerships, combined with an increase in income at our existing urology partnerships and noncontrolling interest expense at our new AMPI entities.

Provision for income taxes in 2008 decreased $8,662,000 compared to 2007 due to the decrease in our taxable net income primarily as a result of the goodwill impairment recorded in the fourth quarter. Our effective tax rate was also impacted by the addition of a full valuation allowance on our deferred tax assets. For the next several years, we will only be an alternative minimum tax payer as we will utilize our existing net operating loss carry forwards to offset any current taxes payable.

Liquidity and Capital Resources

Cash Flows

Our cash and cash equivalents were $8,412,000 and $22,854,000 at December 31, 2009 and 2008, respectively. Beginning in 2009, our subsidiaries began distributing available cash on a monthly basis, after establishing reserves for estimated capital expenditures and working capital. Prior to 2009, they generally distributed all of their available cash quarterly, which lead to an accumulated cash balance at the end of each quarter. For the years ended December 31, 2009 and 2008, our subsidiaries distributed cash of approximately $62,020,000 and $53,757,000, respectively, to noncontrolling interest holders.

Cash provided by our operating activities, after noncontrolling interest, was $61,940,000 for the period ended December 31, 2009 and $70,845,000 for the period ended December 31, 2008. From 2008 to 2009, fee and other revenue collected increased by $19,963,000 due primarily to increased revenues from our acquisitions as well as timing of the collections of accounts receivable. Cash paid to employees, suppliers of goods and others increased by $16,679,000 in 2009. This fluctuation is primarily attributable to increased operating expenses from our acquisitions and timing of payments. Cash paid for acquisition related costs totaled $10,458,000 in 2009, primarily related to our Endocare acquisition. Per ASC No. 805, Business Combinations (“ASC 805”), (formerly SFAS 141R, Business Combinations), these acquisition related costs are now included in operating activities beginning January 1, 2009. In prior years, prior to the implementation of ASC 805, these costs were included in purchase of entities which is an investing activity.

Cash used by our investing activities for the year ended December 31, 2009, was $14,136,000. We purchased equipment and leasehold improvements totaling $11,702,000 in 2009. We used $3,528,000 to acquire Endocare (which is net of cash acquired) and to complete certain smaller acquisitions. Cash used by our investing activities for the year ended December 31, 2008, was $52,311,000. We used approximately $17 million to acquire our interest in AMPI and Uropath, as well as increase other partnership interests in certain litho partnerships and we used approximately $35 million to acquire the Ocean services contract. In addition, we purchased equipment and leasehold improvements totaling $11,779,000 in 2008.

Cash used in our financing activities for the year ended December 31, 2009, was $62,246,000, primarily due to distributions to noncontrolling interests of $62,020,000 and payments on notes payable of $10,986,000 partially offset by borrowings on notes payable of $12,997,000. Cash used in our financing activities for the year ended December 31, 2008, was $20,878,000, primarily due to distributions to noncontrolling interests of $53,757,000 and payments on notes payable of $14,508,000 partially offset by borrowings on our revolving line of credit of $50 million and on notes payable of $1,747,000.


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Accounts receivable as of December 31, 2009 has increased $4,893,000 from December 31, 2008. This increase relates primarily to our Endocare acquisition, which increased accounts receivable by approximately $3.4 million, and significant growth across our Uropath and Claripath lab operations, as well as increases related primarily to higher revenues and the timing of collections.

Inventory as of December 31, 2009 totaled $12,498,000 and increased $3,655,000 from December 31, 2008, entirely related to our Endocare acquisition.

Senior Credit Facility

In March 2005, we refinanced our then existing revolving credit facility with a $175 million senior credit facility comprised of a five year $50 million revolver due in March 2010 and a $125 million senior secured term loan B (“term loan B”), due 2011. This loan bore interest at a variable rate equal to LIBOR + 1.25 to 2.25% or prime + .25 to 1.25%. We repaid the term loan B in July 2006 in full. In April 2008, we increased the revolving line of credit from $50 million to $60 million. In December 2009, we amended and restated our senior credit facility.

The amended and restated credit agreement extended the maturity date of the revolver to December 31, 2012, increased the borrowing rate, eliminated the interest coverage ratio covenant and replaced it with a fixed charge coverage ratio covenant, increased the dollar limit on stock repurchases by us from $10 million to $20 million (but making repurchases subject to our maintaining a total leverage ratio of 2.00 to 1.00), and other minor amendments. Except as described above, the terms of our original senior credit facility remain in effect under the amended and restated credit agreement.

As of December 31, 2009, we have drawn $44 million on the revolver. Our senior credit facility contains covenants that, among other things, limit our ability to incur debt, create liens, make investments, sell assets, pay dividends, make capital expenditures, make restricted payments, enter into transactions with affiliates, and make acquisitions. In addition, our facility requires us to maintain certain financial ratios. Our assets and the stock of our subsidiaries collateralize the revolving credit facility. We were in compliance with the covenants under our senior credit facility as of December 31, 2009.

Other

Other long term debt. As of December 31, 2009, we had notes totaling $4.5 million related to equipment purchased by our limited partnerships. These notes are paid from the cash flows of the related partnerships. They bear interest at either a fixed rate ranging from four to nine percent or LIBOR or prime plus a certain premium and are due over the next four years.

Other long term obligations. At December 31, 2009, we had a long term obligation of $252,000 related to payments of $10,534 a month until December 2011 as consideration for a noncompetition agreement with a previous employee of our Endocare division and an obligation totaling $22,000 related to payments of $3,333 per month until July 15, 2010 as consideration for a noncompetition agreement with a previous employee.


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General

The following table presents our contractual obligations as of December 31, 2009 (in thousands):


Payments due by period
Contractual Obligations
Total
Less than 1 year
1-3 years
3-5 years
More than 5 years
    Long Term Debt (1)     $ 48,519   $ 2,556   $ 45,442   $ 136   $ 385  
   Operating Leases (2)    11,445    3,011    4,999    2,681    754  
   Other contracts (3)    274    148    126    --    --  
   Total   $ 60,238   $ 5,715   $ 50,567   $ 2,817   $ 1,139  

_____________________


  (1) Represents long term debt as discussed above.
 (2) Represents operating leases in the ordinary course of our business.
 (3) Represents non-compete obligations of $274, as described above.

In addition, the scheduled principal repayments for all long term debt as of December 31, 2009 are payable as follows:


($ in thousands)
  2010     $ 2,556  
  2011    1,106  
  2012    44,336  
  2013    81  
  2014    55  
  Thereafter    385  
 
  Total   $48,519  

Our primary sources of cash are cash flows from operations and borrowings under our senior credit facility. Our cash flows from operations and therefore our ability to make scheduled payments of principal, or to pay the interest on, or to refinance, our indebtedness, or to fund planned capital expenditures, will depend on our future performance, which is subject to general economic, financial competitive, legislative, regulatory and other factors discussed under “Risk Factors” under Part I. Likewise, our ability to borrow under our senior credit facility will depend on these factors, which will affect our ability to comply with the covenants in our facility and our ability to obtain waivers for, or otherwise address, any noncompliance with the terms of our facility with our lenders.

We intend to increase our urology services operations primarily through forming new operating partnerships in new markets, expanding our IGRT customer base and by acquisitions. We seek opportunities to grow our medical products operations by expanding our anatomical pathology lab operations and acquisitions. We intend to fund the purchase price for future acquisitions and developments using borrowings under our senior credit facility and cash flows from our operations. In addition, we may use shares of our common stock in such acquisitions where we deem appropriate.

Based upon the current level of our operations and anticipated cost savings and revenue growth, we believe that cash flows from our operations and available cash, together with available borrowings under our senior credit facility, will be adequate to meet our future liquidity needs both for the short term and for at least the next several years. However, there can be no assurance that our business will generate sufficient cash flows from operations, that we will realize our anticipated revenue growth and operating improvements or that future borrowings will be available under our senior credit facility in an amount sufficient to enable us to service our indebtedness or to fund our other liquidity needs.


33


Inflation

Our operations are not significantly affected by inflation because we are not required to make large investments in fixed assets. However, the rate of inflation will affect certain of our expenses, such as employee compensation and benefits.

Recently Issued Accounting Pronouncements

In October 2009, the FASB updated FASB Accounting Standards Codification (“ASC”) 605, Revenue Recognition (“ASC 605”) that amended the criteria for separating consideration in multiple-deliverable arrangements. The amendments establish a selling price hierarchy for determining the selling price of a deliverable. The selling price used for each deliverable will be based on vendor-specific objective evidence if available, third–party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific objective evidence nor third-party evidence is available. The amendments will eliminate the residual method of allocation and require that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. The relative selling price method allocates any discount in the arrangement proportionally to each deliverable on the basis of each deliverable’s selling price. This update will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted. We are currently evaluating the requirements of this update and have not yet determined the impact on our consolidated financial statements.

In June 2009, the FASB issued ASC 105, Generally Accepted Accounting Principles (“ASC 105”), (formerly SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles). ASC 105 establishes the FASB ASC as the single source of authoritative nongovernmental U.S. generally accepted accounting principles (“GAAP”). The standard is effective for interim and annual periods ending after September 15, 2009. The adoption of ASC 105 did not have a material impact on our financial statements.

In June 2009, the FASB issued accounting guidance contained within ASC 810, Consolidation (“ASC 810”), regarding the consolidation of variable interest entities (formerly SFAS No. 167, Amendments to FASB Interpretation No. 46(R)). ASC 810 is intended to improve financial reporting by providing additional guidance to companies involved with variable interest entities and by requiring additional disclosures about a company’s involvement in variable interest entities. This standard is effective for interim and annual periods beginning after November 15, 2009. The adoption of this standard is not expected to have a material impact on our financial statements.

In June 2009, the FASB issued ASC 860, Transfers and Servicing (“ASC 860”), (formerly SFAS No. 166, Accounting for Transfers of Financial Assets). ASC 860 requires more information about transfers of financial assets and where companies have continuing exposure to the risk related to transferred financial assets. It eliminates the concept of a qualifying special purpose entity, changes the requirements for derecognizing financial assets, and requires additional disclosure. This standard is effective for interim and annual periods beginning after November 15, 2009. We will adopt this standard on January 1, 2010. The adoption of this standard is not expected to have a material impact on our financial statements.

In May 2009, the FASB issued ASC 855, Subsequent Events (“ASC 855”), (formerly SFAS No. 165, Subsequent Events). ASC 855 should be applied to the accounting for and disclosure of subsequent events. This Statement does not apply to subsequent events or transactions that are within the scope of other applicable GAAP that provide different guidance on the accounting treatment for subsequent events or transactions. ASC 855 would apply to both interim financial statements and annual financial statements. The objective of ASC 855 is to establish general standards of accounting for and disclosures of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. In particular, this Statement sets forth: 1) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; 2) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and, 3) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. ASC 855 is effective for interim or annual financial periods ending after June 15, 2009. We adopted ASC 855 during the second quarter of 2009 and its application did not affect our consolidated financial position, results of operations, or cash flows. We evaluated subsequent events through the date the accompanying financial statements were issued.


34


In April 2009, the FASB issued ASC 825, Financial Instruments (“ASC 825”), (formerly FASB Staff Position 107-1, Interim Disclosures about Fair Value of Financial Instruments). ASC 825 requires disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This standard also requires those disclosures in summarized financial information at interim reporting periods beginning after March 15, 2009. The adoption of this ASC did not affect our consolidated financial position, results of operations, or cash flows.

In June 2008, the FASB issued ASC 260, Earnings Per Share (“ASC 260”), (formerly FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities). ASC 260 concluded that instruments containing rights to nonforfeitable dividends granted in share-based payment transactions are participating securities prior to vesting and, therefore, should be included in the earnings allocations in computing basic earnings per share (EPS) under the two-class method. This ASC is effective for financial statements issued for fiscal years beginning after December 15, 2008, with prior period retrospective application. Our adoption of this ASC on January 1, 2009 had no material impact on our consolidated financial statements.

In April 2008, the FASB issued ASC 350-30, General Intangibles Other Than Goodwill (“ASC 350-30”), (formerly FSP No. 142-3, Determination of the Useful Life of Intangible Assets). ASC 350-30 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. ASC 350-30 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. The adoption of ASC 350-30 did not have a material impact on our financial position or results of operations.

In December 2007, the FASB issued ASC 805, Business Combinations (“ASC 805”), (formerly SFAS 141R, Business Combinations). ASC 805 will significantly change current practices regarding business combinations. Among the more significant changes, ASC 805 expands the definition of a business and a business combination; requires the acquirer to recognize the assets acquired, liabilities assumed and noncontrolling interests (including goodwill), measured at fair value at the acquisition date; requires acquisition-related expenses and restructuring costs to be recognized separately from the business combination; and requires in-process research and development to be capitalized at fair value as an indefinite-lived intangible asset. ASC 805 is effective for financial statements issued for fiscal years beginning after December 15, 2008. The impact of adopting ASC 805 will continue to be dependent on the future business combinations that we may pursue after its effective date. In 2009, we expensed approximately $2.4 million, of transaction costs related to acquisitions.







35


In December 2007, the FASB issued accounting guidance contained within ASC 810, Consolidation (“ASC 810-10-65”), (formerly SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements) regarding noncontrolling interests. ASC 810-10-65 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. The adoption of ASC 810-10-65 revised our presentation of consolidated financial statements and further impact will continue to be dependent on our future changes in ownership in subsidiaries after the effective date.







36


ITEM 7A.      QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk

As of December 31, 2009, we had long-term debt (including current portion) totaling $48,519,000, of which $3,928,000 had fixed rates of 4% to 9%, and $44,591,000 incurred interest at a variable rate equal to a specified prime rate. We are exposed to some market risk due to the remaining floating interest rate debt totaling $44,591,000. We make monthly or quarterly payments of principal and interest on $14,000 of the floating rate debt. An increase in interest rates of 1% would result in a $446,000 annual increase in interest expense on this existing principal balance.


ITEM 8.      FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The information required by this item is contained in Appendix A attached hereto.


ITEM 9.      CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
                    ACCOUNTING AND FINANCIAL DISCLOSURE

None.


ITEM 9A.      CONTROLS AND PROCEDURES

(a)   Disclosure Controls and Procedures

As of December 31, 2009, under the supervision and with the participation of our management, including our Chief Executive Officer (our principal executive officer) and our Chief Financial Officer (our principal financial officer), we evaluated the effectiveness of our disclosure controls and procedures (as defined under Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that, as of December 31, 2009, our disclosure controls and procedures were effective.

(b)   Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining effective internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance to our management and Board of Directors regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of the effectiveness of internal control over financial reporting to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.

Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2009 based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in its report entitled Internal Control—Integrated Framework.

Based on this assessment, our management concluded that, as of December 31, 2009, our internal control over financial reporting was effective based on those criteria.


37


Management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Endocare, Inc., which is included in the 2009 consolidated financial statements of HealthTronics, Inc. and constituted 8% of total assets as of December 31, 2009 and 4% of revenues for the year then ended.

Ernst & Young, LLP, our independent registered public accounting firm, has audited our internal controls over financial reporting. The attestation report of Ernst & Young, LLP is included herein.

(c)   Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting that occurred during the three months ended December 31, 2009 that have materially affected, or are reasonably likely to materially affect, such internal control over financial reporting.


38


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


The Board of Directors and Shareholders
of HealthTronics, Inc.:

We have audited HealthTronics, Inc. and subsidiaries internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). HealthTronics, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

As indicated in the accompanying Management’s Report on Internal Control over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Endocare, Inc., which is included in the 2009 consolidated financial statements of HealthTronics, Inc. and subsidiaries and constituted 8% of total assets as of December 31, 2009 and 4% of revenues for the year then ended. Our audit of internal control over financial reporting of HealthTronics, Inc. and subsidiaries also did not include an evaluation of the internal control over financial reporting of Endocare, Inc.

In our opinion, HealthTronics, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of HealthTronics, Inc. and subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009 of HealthTronics, Inc. and subsidiaries and our report dated March 8, 2010 expressed an unqualified opinion thereon.


/s/ Ernst & Young LLP


Austin, Texas
March 8, 2010


39


PART III

ITEM 10.      DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information required by this item will be contained in our definitive proxy statement to be filed in connection with our 2010 annual meeting of stockholders, except for the information regarding our executive officers, which is presented in Part I of this Form 10-K. The information required by this item contained in our definitive proxy statement is incorporated herein by reference.


ITEM 11.      EXECUTIVE COMPENSATION

The information required by this item will be contained in our definitive proxy statement to be filed in connection with our 2010 annual meeting of stockholders and is incorporated herein by reference.


ITEM 12.      SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
                      MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by this item will be contained in our definitive proxy statement to be filed in connection with our 2010 annual meeting of stockholders and is incorporated herein by reference.


ITEM 13.      CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
                      INDEPENDENCE

The information required by this item will be contained in our definitive proxy statement to be filed in connection with our 2010 annual meeting of stockholders and is incorporated herein by reference.


ITEM 14.      PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by this item will be contained in our definitive proxy statement to be filed in connection with our 2010 annual meeting of stockholders and is incorporated herein by reference.


40


PART IV

ITEM 15.      EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a) 1. Financial Statements.

          The information required by this item is contained in Appendix A attached hereto.

(b) Exhibits. (1)

3.1
             
             
3.2
             
             
3.3
             
4.1
             
4.2              

4.3              

10.1              
             

10.2
             
             
10.3*
             

10.4*
             
             
10.5*
             
10.6*
             
             
10.7*
             
             
10.8*
             
10.9*
             
10.10*
             
10.11*
Amended and Restated Articles of Incorporation of the Company (incorporated by
reference to Annex D to the Rule 424(b)(3) joint proxy statement/prospectus, dated
October 6, 2004, filed by HealthTronics with the SEC on October 7, 2004).
Amended and Restated Bylaws of the Company (incorporated by reference to Annex
E to the Rule 424(b)(3) joint proxy statement/prospectus, dated October 6, 2004, filed
by HealthTronics with the SEC on October 7, 2004).
First Amendment to Bylaws of HealthTronics, Inc. (incorporated by reference to
Exhibit 3.1 of HealthTronics’ Current Report Form 8-K filed on December 17, 2007).
Specimen of Common Stock Certificate (filed as an Exhibit to the HSS Registration
Statement on Form S-4 (Registration No. 33-56900)).
Form of Series A Warrant (incorporated by reference to Exhibit 4.1 to Endocare, Inc.’s
Current Report on Form 8-K filed on March 16, 2005).
Form of Series B Warrant (incorporated by reference to Exhibit 4.2 to Endocare, Inc.’s
Current Report on Form 8-K filed on March 16, 2005).
Form of Indemnification Agreement dated October 11, 1993 between the Company
and certain of its officers and directors (filed as an Exhibit to the Current Report on
Form 8-K of Prime dated October 18, 1993).
Release and Severance Agreement dated December 30, 2001 by and between Prime
Medical Services Inc. and Kenneth S. Shifrin (filed as an Exhibit to the Annual
Report on Form 10-K of Prime for the year ended December 31, 2001).
Amended and Restated 1993 Stock Option Plan, as amended June 18, 2002 (filed as
an Exhibit to the Annual Report on Form 10-K of Prime for the year ended
December 31, 2002).
Prime Medical Services, Inc., 2003 Stock Option Plan (incorporated by reference to
Annex D of the Rule 424(b)(3) joint proxy statement/prospectus, dated January 7,
2004, filed by Prime with the SEC on January 8, 2004).
HealthTronics 2004 Equity Incentive Plan (incorporated by reference to Exhibit 10.2
to HealthTronics’ Current Report on Form 8-K filed on January 25, 2005).
Form of Board Service and Release Agreement by and between HealthTronics and
Argil J. Wheelock, M.D. (filed as Exhibit 10.22 to the HSS Registration Statement
on Form S-4 (Registration No. 333-117102)).
Board Service, Amendment and Release Agreement by and between HealthTronics
and Kenneth S. Shifrin (incorporated by reference to the HSS Registration Statement
on Form S-4 (Registration No. 333-117102)).
HSS Stock Option Plan - 2002 (incorporated by reference to Exhibit 10.1 of
HealthTronics’ Current Report on Form 8-K filed on January 25, 2005).
HSS Stock Option Plan - 2001 (incorporated by reference to Appendix A to HSS’
proxy statement filed with the SEC on April 18, 2001).
HSS Stock Option Plan - 2000 (incorporated by reference to Appendix A to HSS’
proxy statement filed with the SEC on April 25, 2000).
First Amendment to the HealthTronics, Inc. 2004 Equity Incentive Plan (incorporated
by reference to Exhibit 10.1 to HealthTronics’ Quarterly Report on Form 10-Q for
the quarter ended June 30, 2005, filed on August 5, 2005).
41


10.12


10.13*
             
             

10.14*
            
            
10.15
            
            

10.16
            
            


10.17*
            
            
10.18
            


            
10.19
            

            
10.20
            
            
            
10.21*
            
            
            
10.22
            
            
            
10.23*
            
            
            
10.24*
            
            
            
            
Form of Indemnification Agreement for directors and certain officers of
HealthTronics (incorporated by reference to Exhibit 99.1 to HealthTronics’ Current
Report on Form 8-K filed on June 1, 2005).
First Amendment to Board Service and Release Agreement, dated as of March 2,
2006, by and between HealthTronics and Argil J. Wheelock, M.D. (incorporated by
reference to Exhibit 10.1 of HealthTronics’ Current Report on Form 8-K filed on
March 8, 2006).
Second Amendment to the Company’s 2004 Equity Incentive Plan (incorporated by
reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with
the Securities and Exchange Commission on June 14, 2006).
Amended and Restated Distribution Agreement, dated as of February 28, 2007, by
and among HealthTronics, Inc., Lisa Laser USA, Inc., and LISA laser products OHG
(incorporated by reference to Exhibit 10.1 to the Company’s Current Report on
Form 8-K filed with the Securities and Exchange Commission on March 6, 2007).
Stock Purchase Agreement, dated as of March 18, 2008, by and among
HealthTronics, Inc., Litho Management, Inc., Advanced Medical Partners, Inc. and
the stockholders of Advanced Medical Partners, Inc. (incorporated by reference to
Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Securities
and Exchange Commission on March 20, 2008).
Third Amendment to the 2004 Equity Incentive Plan (incorporated by reference to
Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Securities
and Exchange Commission on May 14, 2008).
Earnest Money Contract—Commercial Improved Property (Office Condominiums)
dated as of April 1, 2008 (as amended on each of April 15, 2008 and May 12, 2008)
by and between HealthTronics, Inc. and HPI Acquisition Company, LLC.
(incorporated by reference to Exhibit 10.1 to the Company’s Current Report on
Form 8-K filed with the Securities and Exchange Commission on June 20, 2008).
Lease Agreement dated May 19, 2008, by and between HealthTronics, Inc. and HEP-
Davis Spring, L.P. (incorporated by reference to Exhibit 10.2 to the Company’s
Current Report on Form 8-K filed with the Securities and Exchange Commission on
June 20, 2008).
Stock Purchase Agreement, dated as of October 10, 2008, by and between
HealthTronics, Inc. and Atlantic Urological Associates, P.A (incorporated by
reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with
the Securities and Exchange Commission on October 15, 2008).
Executive Employment Agreement, effective August 15, 2007, by and between
HealthTronics, Inc. and Clayton H. Duncan (incorporated by reference to
Exhibit 10.35 of the Company’s 10-K filed with the Securities and Exchange
Commission on March 10, 2009).
Agreement and Plan of Merger, dated as of June 7, 2009, by and among Endocare,
Inc., HT Acquisition, Inc., and HealthTronics, Inc. (incorporated by reference to
Exhibit 2.1 to the Company’s Current Report on Form 8-K filed with the Securities
and Exchange Commission on June 8, 2009).
Termination and Consulting Agreement, dated June 16, 2009, by and between
HealthTronics, Inc. and Robert A. Yonke (incorporated by reference to Exhibit 10.1
to the Company’s Current Report on Form 8-K filed with the Securities and
Exchange Commission on June 17, 2009).
Executive Employment Agreement, effective July 30, 2009, by and between
HealthTronics, Inc. and Clint B. Davis (incorporated by reference to Exhibit 10.1 of
the Company’s 10-Q filed with the Securities and Exchange Commission on
November 6, 2009).
42


10.25
            
            
            
10.26*
            
            

10.27*
            
            
            
10.28
            
            
            
            
            
10.29*
            
10.30*
            
10.31*             
10.32*             
10.33*             
10.34*             
21.1
23.1
31.1
31.2
32.1
32.2
Second Amendment to Lease Agreement, dated as of August 20, 2009, between
HEP-Davis Spring, L.P. as landlord and HealthTronics, Inc. as tenant (incorporated
by reference to Exhibit 10.2 of the Company’s 10-Q filed with the Securities and
Exchange Commission on November 6, 2009).
Amended and Restated Executive Employment Agreement, dated as of November 5,
2009, by and between HealthTronics, Inc. and James Whittenburg (incorporated by
reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with
the Securities and Exchange Commission on November 5, 2009).
Executive Employment Agreement, dated as of November 30, 2009, by and between
HealthTronics, Inc. and Richard A. Rusk (incorporated by reference to Exhibit 10.1
to the Company’s Current Report on Form 8-K filed with the Securities and
Exchange Commission on November 30, 2009).
Credit Agreement, dated as of December 29, 2009, among HealthTronics, Inc., the
lenders party thereto, JPMorgan Chase Bank, National Association, as Administrative
Agent, J.P. Morgan Securities, Inc., as Arranger, and Bank of America, N.A., as
Syndication Agent (incorporated by reference to Exhibit 10.1 to the Company’s
Current Report on Form 8-K filed with the Securities and Exchange Commission on
December 29, 2009).
Executive Employment Agreement, effective November 23, 2009, by and between
HealthTronics, Inc. and Scott Herz (filed herewith).
Executive Employment Agreement, effective December 21, 2009, by and between
HealthTronics, Inc. and Laura Miller (filed herewith).
Form of Incentive Stock Option Agreement (filed herewith).
Form of Nonstatutory Stock Option Agreement (filed herewith).
Form of Restricted Stock Award Agreement (filed herewith).
Form of Director Restricted Stock Award Agreement (filed herewith).
List of subsidiaries of the Company (filed herewith).
Consent of Independent Registered Public Accounting Firm (filed herewith).
Certification of Chief Executive Officer (filed herewith).
Certification of Chief Financial Officer (filed herewith).
Certification of Chief Executive Officer (filed herewith).
Certification of Chief Financial Officer (filed herewith).

_____________________
* Executive compensation plans and arrangements.


  (1)

The exhibits listed above will be furnished to any security holder upon written request for such exhibit to Richard A. Rusk, HealthTronics, Inc., 9825 Spectrum Drive, Austin, Texas 78717. The Securities and Exchange Commission (the “SEC”) maintains a website that contains reports, proxy and information statements and other information regarding registrants that file electronically with the SEC at “http://www.sec.gov”.




43


SIGNATURES


Pursuant to the requirements of Section 13 or 15(d) 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, INC.







By: /s/ James S. B. Whittenburg                                
        James S. B. Whittenburg,
       Chief Executive Officer and
        President (Principal Executive Officer)

       Date: March 8, 2010







Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.


By:
         





Date:





By:
         




Date:





By:
         


Date:



By:
         


Date:



By:
         


Date:



By:
         


Date:
/s/ James S. B. Whittenburg
James S. B. Whittenburg,
Chief Executive Officer and
President (Principal Executive Officer)
and Director


March 8, 2010





/s/ Richard A. Rusk
Richard A. Rusk,
Chief Financial Officer
(Principal Financial and Accounting Officer)


March 8, 2010





/s/ R. Steven Hicks
R. Steven Hicks, Non-executive Chairman of the Board


March 8, 2010



/s/ Donny R. Jackson
Donny R. Jackson, Director


March 8, 2010



/s/ Timothy J. Lindgren
Timothy J. Lindgren, Director


March 8, 2010



/s/ Ken S. Shifrin
Ken S. Shifrin, Director


March 8, 2010
44


By:
         


Date:





/s/ Argil J. Wheelock, M.D.
Argil J. Wheelock, M.D., Director


March 8, 2010
45


APPENDIX A


INDEX

  Page
 
Report of Independent Registered Public Accounting Firm

Consolidated Financial Statements:

     Consolidated Statements of Income for the years ended December 31, 2009, 2008

    and 2007.

     Consolidated Balance Sheets at December 31, 2009 and 2008.

     Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2009,

     2008 and 2007.

     Consolidated Statements of Cash Flows for the years ended December 31, 2009, 2008 and 2007.

     Notes to Consolidated Financial Statements.
A-2



A-3



A-4

A-6



A-7

A-10





A-1


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


The Board of Directors and Stockholders
of HealthTronics, Inc.:

We have audited the accompanying consolidated balance sheets of HealthTronics, Inc. and subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of HealthTronics, Inc. and subsidiaries at December 31, 2009 and 2008, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2009, in conformity with U.S. generally accepted accounting principles.

As discussed in Note B to the consolidated financial statements, the Company changed its method of accounting for business combinations with the adoption of the guidance originally issued in FASB Statement No. 141(R), Business Combinations (codified in FASB ASC Topic 805, Business Combinations) effective January 1, 2009.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), HealthTronics, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 8, 2010, expressed an unqualified opinion thereon.

/s/: Ernst & Young LLP   



Austin, Texas
March 8, 2010


A-2


HEALTHTRONICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME


($ in thousands, except per share data)
Years Ended December 31,
2009
2008
2007
Revenues     $ 185,330   $ 165,942   $ 140,418  
Cost of revenues (exclusive of depreciation and  
     amortization shown separately below)    90,660    75,679    64,715  
        Gross profit    94,670    90,263    75,703  
 
Operating expenses:  
     Selling, general and administrative    24,046    20,006    15,884  
     Impairment charges    --    144,000    20,800  
     Depreciation and amortization    14,544    12,363    11,107  
        Total operating expenses    38,590    176,369    47,791  
 
Operating income (loss)    56,080    (86,106 )  27,912  
 
Other income (expenses):  
     Interest and dividends    101    1,233    1,146  
     Interest expense    (1,576 )  (1,077 )  (829 )
     (1,475 )  156    317  
Income (loss) from continuing operations before provision  
     for income taxes    54,605    (85,950 )  28,229  
 
Provision for income taxes    2,837    (11,516 )  (2,854 )
 
Consolidated net income (loss) from continuing operations    51,768    (74,434 )  31,083  
 
Loss from discontinued operations, net of tax    --    --    (147 )
 
Consolidated net income (loss)    51,768    (74,434 )  30,936  
 
Less: Net income attributable to noncontrolling interest    (55,684 )  (54,259 )  (45,568 )
 
Net loss attributable to HealthTronics, Inc.   $ (3,916 ) $ (128,693 ) $ (14,632 )
 
Basic earnings per share attributable to HealthTronics, Inc.:  
     Loss from continuing operations   $ (0.10 ) $ (3.53 ) $ (0.41 )
     Loss from discontinued operations    --    --    --  
        Net loss attributable to HealthTronics, Inc.   $ (0.10 ) $ (3.53 ) $ (0.41 )
     Weighted average shares outstanding    39,135    36,499    35,421  
 
Diluted earnings per share attributable to HealthTronics, Inc.:  
     Loss from continuing operations   $ (0.10 ) $ (3.53 ) $ (0.41 )
     Loss from discontinued operations    --    --    --  
        Net loss attributable to HealthTronics, Inc.   $ (0.10 ) $ (3.53 ) $ (0.41 )
     Weighted average shares outstanding    39,135    36,499    35,421  

See accompanying notes to consolidated financial statements.


A-3



HEALTHTRONICS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

December 31,
($ in thousands)

2009
2008
ASSETS            
 
Current assets:  
     Cash and cash equivalents   $ 8,412   $ 22,854  
     Accounts receivable, less allowance for doubtful  
         accounts of $2,722 in 2009 and $2,485 in 2008    32,580    27,687  
     Other receivables    1,207    1,410  
     Prepaid expenses and other current assets    3,306    2,895  
     Inventory    12,498    8,843  
         Total current assets    58,003    63,689  
 
Property and equipment:  
     Equipment, furniture and fixtures    60,696    55,050  
     Building and leasehold improvements    9,139    8,254  
     69,835    63,304  
     Less accumulated depreciation and  
         amortization    (36,954 )  (30,535 )
         Property and equipment, net    32,881    32,769  
 
Other investments    1,850    1,819  
Goodwill    103,282    93,620  
Intangible assets, net    48,993    40,278  
Other noncurrent assets    4,110    2,211  
    $ 249,119   $ 234,386  


See accompanying notes to consolidated financial statements.



A-4



HEALTHTRONICS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (continued)

($ in thousands, except share data)

December 31,
2009
2008
LIABILITIES            
 
Current liabilities:  
     Current portion of long-term debt   $ 2,556   $ 2,490  
     Accounts payable    4,679    6,468  
     Accrued expenses    13,130    9,316  
         Total current liabilities    20,365    18,274  
 
Long-term debt, net of current portion    45,963    43,897  
Other long term obligations    3,373    1,765  
Deferred income taxes    6,002    3,355  
         Total liabilities    75,703    67,291  
 
STOCKHOLDERS' EQUITY  
Preferred stock, $.01 par value, 30,000,000 shares authorized: none outstanding  
Common stock, no par value, 70,000,000 shares authorized: 47,556,430 shares  
     issued and 45,584,108 shares outstanding in 2009 and 39,494,314 shares  
     issued and 37,618,206 shares outstanding in 2008    226,722    211,667  
Accumulated deficit    (91,768 )  (87,852 )
Treasury stock, at cost, 1,972,322 shares in 2009 and 1,876,108 shares in 2008    (4,564 )  (4,443 )
         Total HealthTronics, Inc. shareholders' equity    130,390    119,372  
Noncontrolling interest    43,026    47,723  
         Total Equity    173,416    167,095  
    $ 249,119   $ 234,386  


See accompanying notes to consolidated financial statements.



A-5



HEALTHTRONICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the years ended December 31, 2009, 2008 and 2007



($ in thousands, except share data) Issued Common Stock
  Treasury Stock
Shares
Amount
Accumulated
Earnings
(Deficit)

Shares
Amount
Non-
Controlling
Interest

Total
Balance, December 31, 2006      35,475,236   $ 200,941   $ 55,473    (95,405 ) $ (897 ) $ 30,104   $ 285,621  
    Net Income (loss)    --    --    (14,632 )  --    --    45,568    30,936  
    Distributions paid to noncontrolling interest    --    --    --    --    --    (35,210 )  (35,210 )
    Sale of subsidiary interest to  
       noncontrolling interest    --    --    --    --    --    3,253    3,253  
    Purchase of subsidiary interest from  
       noncontrolling interest    --    --    --    --    --    (2,062 )  (2,062 )
    Contribution of treasury stock    --    --    --    45,266    425    --    425  
    Share-based compensation      135,000    1,108    --    --    --    --    1,108  
 
Balance, December 31, 2007    35,610,236    202,049    40,841    (50,139 )  (472 )  41,653    284,071  
    Net Income (loss)    --    --    (128,693 )  --    --    54,259    (74,434 )
    Distributions paid to noncontrolling interest    --    --    --    --    --    (53,626 )  (53,626 )
    Sale of subsidiary interest to  
       noncontrolling interest    --    --    --    --    --    6,725    6,725  
    Purchase of subsidiary interest from  
       noncontrolling interest    --    --    --    --    --    (1,288 )  (1,288 )
    Issuance of stock for acquisitions    1,987,486    6,737    --    --    --    --    6,737  
    Purchase of treasury stock    --    --    --    (1,763,580 )  (3,971 )  --    (3,971 )
    Share-based compensation       1,896,592     2,881     --     (62,389 )   --     --     2,881  
 
Balance, December 31, 2008    39,494,314    211,667    (87,852 )  (1,876,108 )  (4,443 )  47,723    167,095  
    Net Income (loss)    --    --    (3,916 )  --    --    55,684    51,768  
    Distributions paid to noncontrolling interest    --    --    --    --    --    (62,388 )  (62,388 )
    Sale of subsidiary interest to  
       noncontrolling interest    --    --    --    --    --    5,324    5,324  
    Purchase of subsidiary interest from  
       noncontrolling interest    --    (1,162 )  --    --    --    (3,317 )  (4,479 )
    Issuance of stock for acquisitions    7,398,396    13,217    --    --    --    --    13,217  
    Purchase of treasury stock    --    --    --    (51,714 )  (121 )  --    (121 )
    Share-based compensation       663,720     3,000     --     (44,500 )   --     --     3,000  
 
Balance, December 31, 2009       47,556,430   $ 226,722   $ (91,768 )   (1,972,322 ) $ (4,564 ) $ 43,026   $ 173,416  


See accompanying notes to consolidated financial statements.




A-6



HEALTHTRONICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31,
($ in thousands)

2009
2008
2007
CASH FLOWS FROM OPERATING ACTIVITIES:                
     Fee and other revenue collected   $ 187,828   $ 167,865   $ 144,821  
     Cash paid to employees, suppliers of goods and others    (112,618 )  (95,939 )  (82,361 )
     Cash paid for acquisition related costs    (10,458 )  --    --  
     Interest received    101    1,233    1,146  
     Interest paid    (1,517 )  (990 )  (835 )
     Taxes paid    (1,396 )  (1,324 )  (538 )
     Discontinued operations    --    --    (356 )
        Net cash provided by operating activities    61,940    70,845    61,877  
 
CASH FLOWS FROM INVESTING ACTIVITIES:  
     Purchase of entities, net of cash acquired    (3,528 )  (49,487 )  (11,829 )
     Purchases of equipment and leasehold improvements    (11,702 )  (11,779 )  (9,469 )
     Proceeds from sales of assets    1,125    9,165    1,224  
     Other    (31 )  (210 )  (18 )
     Discontinued operations    --    --    1,335  
        Net cash used in investing activities    (14,136 )  (52,311 )  (18,757 )
 
CASH FLOWS FROM FINANCING ACTIVITIES:  
     Borrowings on notes payable    12,997    51,747    2,546  
     Payments on notes payable, exclusive of interest    (10,986 )  (14,508 )  (5,760 )
     Distributions to noncontrolling interest    (62,020 )  (53,757 )  (42,736 )
     Contributions by noncontrolling interest, net of buyouts    (2,116 )  (389 )  389  
     Purchase of treasury stock    (121 )  (3,971 )  --  
     Discontinued operations    --    --    (20 )
        Net cash used in financing activities    (62,246 )  (20,878 )  (45,581 )
 
NET DECREASE IN CASH AND CASH EQUIVALENTS    (14,442 )  (2,344 )  (2,461 )
Cash and cash equivalents, beginning of period, includes cash  
     from discontinued operations of $(198) for 2007    22,854    25,198    27,659  
Cash and cash equivalents, end of period   $ 8,412   $ 22,854   $ 25,198  


See accompanying notes to consolidated financial statements.




A-7



HEALTHTRONICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

($ in thousands)

Years Ended December 31,
2009
2008
2007
Reconciliation of net income (loss) to net cash provided by operating activities:                
     Net income (loss)   $ 51,768   $ (74,434 ) $ 30,936  
     Adjustments to reconcile net income (loss) to cash provided  
         by operating activities:  
            Depreciation and amortization    14,544    12,363    11,107  
            Provision for uncollectible accounts    522    145    (108 )
            Provision for deferred income taxes    2,647    (12,180 )  (624 )
            Non-cash share-based compensation    3,000    2,881    1,534  
            Impairment charges    --    144,000    20,800  
            Other    295    (1,112 )  70  
     Discontinued Operations    --    --    (117 )
     Changes in operating assets and liabilities,  
         net of effect of purchase transactions:  
            Accounts receivable    (526 )  (1,360 )  1,008  
            Other receivables    250    1,399    (1,124 )
            Inventory    3,344    242    1,282  
            Other assets    608    900    744  
            Accounts payable    (5,665 )  (1,314 )  (579 )
            Accrued expenses    (8,847 )  (685 )  (3,052 )
     Total adjustments    10,172    145,279    30,941  
Net cash provided by operating activities   $ 61,940   $ 70,845   $ 61,877  


See accompanying notes to consolidated financial statements.




A-8



HEALTHTRONICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

($ in thousands)

Years Ended December 31,
2009
2008
2007
SUPPLEMENTAL INFORMATION OF NON-CASH                
     INVESTING AND FINANCING ACTIVITIES:  
At December 31, the Company had accrued distributions payable  
     to noncontrolling interests. The effect of this transaction was as follows:  
        Current liabilities increased by   $ 40   $ 95   $ 226  
        Noncontrolling interest decreased by    40    95    226  
 
In 2009, the Company acquired three cryosurgical partnerships  
     and a company that manufactures devices, consumables and  
     provides related services for the cryosurgical industry. The net assets  
     and liabilities acquired were as follows:  
        Current assets increased by    14,766    --    --  
        Noncurrent assets increased by    13,160    --    --  
        Goodwill increased by    9,662    --    --  
        Current liabilities increased by    16,810    --    --  
        Other long-term obligations increased by    1,443    --    --  
 
In 2008, the Company acquired three lithotripsy partnerships,  
     a cryosurgical company, a pathology lab and an IGRT  
     services operation. The net assets and  
     liabilities acquired were as follows:  
        Current assets increased by    --    6,456    --  
        Noncurrent assets increased by    --    3,812    --  
        Goodwill increased by    --    26,995    --  
        Current liabilities increased by    --    4,941    --  
        Other long-term obligations increased by    --    906    --  
        Noncontrolling interest increased by    --    5,825    --  
 
In 2007, the Company acquired two lithotripsy partnerships and sold  
     three lithotripsy partnerships. The net assets and  
     liabilities acquired/sold were as follows:  
        Current assets increased by    --    --    580  
        Noncurrent assets increased by    --    --    1,816  
        Goodwill increased by    --    --    9,044  
        Current liabilities increased by    --    --    380  
        Other long-term obligations decreased by    --    --    354  
        Noncontrolling interest increased by    --    --    802  


See accompanying notes to consolidated financial statements.




A-9



HEALTHTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

A.   ORGANIZATION AND OPERATION OF THE COMPANY

We provide healthcare services and medical devices, primarily for the urology community.

Lithotripsy Services. Our lithotripsy services are provided principally through limited partnerships and other entities that we manage, which use lithotripsy devices. In 2009, physicians who are affiliated with us used our lithotripters to perform approximately 50,000 procedures in the U.S. We do not render any medical services. Rather, the physicians do.

As the general partner of limited partnerships or the manager of other types of entities, we also provide services relating to operating our lithotripters, including scheduling, staffing, training, quality assurance, regulatory compliance, and contracting with payors, hospitals, and surgery centers.

Prostate treatment services. We provide treatments for benign and cancerous conditions of the prostate. In treating benign prostate disease, we deploy three technologies: (1) photo-selective vaporization of the prostate (PVP), (2) trans-urethral needle ablation (TUNA), and (3) trans-urethral microwave therapy (TUMT) in certain partnerships. All three technologies apply an energy source which reduces the size of the prostate gland. For treating prostate and other cancers, we use a procedure called cryosurgery, a process which uses a double freeze thaw cycle to destroy cancer cells. In April 2008, we acquired Advanced Medical Partners, Inc. (“AMPI”), which significantly expanded our cryosurgery partnership base. In July 2009, we acquired Endocare, Inc. (“Endocare”) which is a medical device company focused on developing, manufacturing and selling cryoablation products. Our prostate treatment services are also provided principally through limited partnerships and other entities that we manage, which use equipment to perform the treatments. Benign prostate disease and cryosurgery cancer treatment services are billed in the same manner as our lithotripsy services under either retail or wholesale contracts. We also provide services relating to operating the equipment, including scheduling, staffing, training, quality assurance, regulatory compliance and contracting.

Radiation therapy services. We also provide image guided radiation therapy (IGRT) technical services for cancer treatment centers. Our IGRT technical services may relate to providing the technical (non-physician) personnel to operate a physician practice group’s IGRT equipment, leasing IGRT equipment to a physician practice group, providing services related to helping a physician practice group establish an IGRT treatment center, or managing an IGRT treatment center.

Anatomical pathology services. We also provide anatomical pathology services primarily to the urology community. We have one pathology lab located in Georgia, Claripath Laboratories, that provides laboratory detection and diagnosis services to urologists throughout the United States. In addition, in July 2008, we acquired Uropath LLC, which managed pathology laboratories located at Uropath sites for physician practice groups located in Texas, Florida and Pennsylvania. Through Uropath, we continue to provide administrative services to in-office pathology labs for practice groups and provide pathology services to physicians and practice groups with our lab equipment and personnel at our Uropath laboratory sites.

Medical products manufacturing, sales and maintenance. We, through our Endocare acquisition, manufacture and sell medical devices focused on minimally invasive technologies for tissue and tumor ablation through cryoablation, which is the use of lethal ice to destroy tissue, such as tumors, for therapeutic purposes. We develop and manufacture these devices for the treatment of prostate and renal cancers and we believe that our proprietary technologies have broad applications across a number of markets, including the ablation of tumors in the lung and liver and palliative intervention (treatment of pain associated with metastases). We also manufacture the related spare parts and consumables for these devices. We also sell and maintain lithotripters and related spare parts and consumables.


A-10



HEALTHTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

We are headquartered in Austin, Texas and provide urology services in approximately 46 states.

In December 2007, the Financial Accounting Standards Board (“FASB”) issued accounting guidance contained within ASC 810, Consolidation, (“ASC 810”), regarding noncontrolling interests, (formerly SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements). As a result of the adoption of ASC 810, certain reclassifications have been made to 2008 and 2007 information to be consistent with the 2009 presentation. ASC 810 requires companies to report a noncontrolling interest in a subsidiary as equity. Additionally, companies are required to include amounts attributable to both the parent and the noncontrolling interest in the consolidated net income and provide disclosure of net income attributable to the parent and to the noncontrolling interest on the face of the consolidated statement of income.

B.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Consolidation

The consolidated financial statements include our accounts, our wholly-owned subsidiaries, and entities more than 50% owned and limited partnerships or LLCs where we, as the general partner or managing member, exercise effective control, even though our ownership is less than 50%. The related governing agreements provide us with broad powers. The other parties do not participate in the management of the entity and do not have the substantial ability to remove us. Investment in entities in which our investment is less than 50% ownership and we do not have significant control are accounted for by the equity method if ownership is between 20%–50%, or by the cost method if ownership is less than 20%. We have reviewed each of the underlying agreements and determined we have effective control; however, if it was determined this control did not exist, these investments would be reflected on the equity method of accounting. Although this would change individual line items within our consolidated financial statements, it would have no effect on our net income and/or total stockholders’ equity attributable to common shareholders.

Cash Equivalents

We consider as cash equivalents demand deposits and all short-term investments with a maturity at date of purchase of three months or less.

Property and Equipment

Property and equipment are stated at cost. Major betterments are capitalized while normal maintenance and repairs are charged to operations. Depreciation is computed by the straight-line method using estimated useful lives of three to twenty years. Leasehold improvements are generally amortized over ten years or the term of the lease, whichever is shorter. When assets are sold or retired, the corresponding cost and accumulated depreciation or amortization are removed from the related accounts and any gain or loss is credited or charged to operations. Depreciation expense for property and equipment was $11,678,000, $11,076,000 and $10,079,000 for the years ended December 31, 2009, 2008 and 2007, respectively.


A-11



HEALTHTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Impairment of long-lived assets

We review long-lived assets, other than goodwill and other intangible assets with indefinite lives, for impairment whenever facts and circumstances indicate that the carrying amounts of the assets may not be recoverable. An impairment loss is recognized only if the carrying amount of the asset is not recoverable and exceeds its fair value. Recoverability of assets to be held and used is measured by comparing the carrying amount of an asset to the estimated undiscounted future net cash flows expected to be generated by the asset. If the asset’s carrying value is not recoverable, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds its fair value. We determine fair values by using a combination of comparable market values and discounted cash flows, as appropriate.

Goodwill and Other Intangible Assets

Impairments of goodwill and other intangible assets are both a critical accounting policy and estimate that require judgment and are based on assumptions of future operations. We are required to test for impairments at least annually or if circumstances change that would reduce the fair value of a reporting unit below its carrying value. We test for impairment of goodwill during the fourth quarter. The fair value of each reporting unit was estimated using a combination of the income, or discounted cash flows, approach and the market approach, which utilizes comparable companies’ data. Because we have recognized goodwill based solely on our controlling interest, the fair value of each reporting unit also relates only to our controlling interest. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. The second step of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with the carrying value of that goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. That is, the fair value of the reporting unit is allocated to all of the assets and liabilities of that unit as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the purchase price paid to acquire the reporting unit. Both the income approach and the market approach require significant assumptions to determine the fair value of each reporting unit. The significant assumptions used in the income approach include estimates of our future revenues, profits, capital expenditures, working capital requirements, operating plans, industry data, and other relevant factors. The significant assumptions utilized in the market approach include the determination of appropriate market comparables, the estimated multiples of revenue, EBIT and EBITDA, and the estimated control premium a willing buyer is likely to pay.

Revenue Recognition

Our fees for urology services are recorded when the procedure is performed and are based on a contracted rate with a hospital (wholesale contract) or based on a contractual rate with commercial insurance carriers (retail contract), individual or state and federal health care agencies, net of contractual fee reduction. Management fees from limited partnerships are recorded monthly when earned. Distributions from cost basis investments are recorded when received and totaled $1,566,000, $1,508,000 and $1,321,000 in 2009, 2008 and 2007, respectively.

Sales of medical devices including related accessories (which started in February 2004 with the acquisition of Medstone International, Inc. (“Medstone”)) are recorded when delivered to the customer and any trial period ends. There are no post-shipment obligations after revenue is recognized except a possible maintenance equipment contract. If the sale includes maintenance services over a period of time, we defer the fair value of the maintenance services and recognize it ratably over the contract period. Fair value of undelivered elements is determined based on prices when the items are sold separately. Licensing fees (which started with the acquisition of Medstone in February 2004) are recorded when the related lithotripsy procedure is performed on the equipment we sold to third parties; leasing fees and revenues from maintenance contracts are recorded monthly as the related services are provided; sales of consumable products are recorded when delivered to the customer.


A-12



HEALTHTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

We provide anatomical pathology services primarily to the urology market place. Revenues from these services are recorded when the related laboratory procedures are performed. IGRT technical services are billed monthly and the related revenues are recognized as the related services are provided.

Major Customers and Credit Concentrations

For the years ending December 31, 2009, 2008 and 2007, we had no customers who exceeded 10% of consolidated revenues. Concentrations of credit risk with respect to cash relate to deposits held with banks in excess of insurance provided. Generally, these deposits may be redeemed upon demand and, therefore, in the opinion of management, bear minimal risk. Concentrations of credit risk with respect to receivables are limited due to the wide variety of customers, as well as their dispersion across many geographic areas. Other than as disclosed below, we do not consider ourselves to have any significant concentrations of credit risk. At December 31, 2009, approximately 18% relate to units in New York, 10% of accounts receivable relate to units operating in Texas, 8% relate to units operating in Georgia, 6% relate to units operating in Florida, 6% relate to units operating in Indiana, 6% relate to units operating in Pennsylvania, 5% relate to units in Louisiana, and 5% relate to units in Minnesota. At December 31, 2008, approximately 16% of accounts receivable relate to units operating in New York, 6% relate to units in Florida, 5% relate to units operating in Virginia, 5% relate to units operating in Minnesota, 5% related to units in Louisiana, and 5% relate to units in Indiana.

Income Tax

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

Accounts Receivable

Accounts receivable are recorded based on revenues, net of contractual fee reductions and less an estimated allowance for doubtful accounts. The allowance for doubtful accounts is based on our assessment of the collectibility of customer accounts. We regularly review the allowance by considering factors such as historical experience, credit quality, age of the accounts receivable balances, and current economic conditions that may affect a customer’s ability to pay. The following is a summary of accounts receivable allowances:


A-13



HEALTHTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

($ in thousands)

Balance at
Beginning of
Year

Costs and
Expenses

Deductions
Other
Balance at
End of Year

Allowance for Doubtful Accounts:

    2009     $ 2,485   $ 771   $ (249 ) $ (285 ) $ 2,722  
   2008   $ 2,368   $ 285   $ (140 ) $ (28 ) $ 2,485  
   2007   $ 2,166   $ 329   $ (437 ) $ 310   $ 2,368  

Inventory

Inventory is stated at the lower of cost or market. Cost is determined using the average cost method and the first-in, first-out method in 2009 and the average cost method in 2008. Certain components that meet our manufacturing requirements are only available from a limited number of suppliers. The inability to obtain components as required or to develop alternative sources, if and as required in the future, could result in delays or reduction in product shipments, which in turn could have a material adverse effect on our manufacturing business, financial condition and results of operations.

As of December 31, 2009 and 2008, inventory consists of the following:


($ in thousands)

December 31,
2009

December 31,
2008

    Raw Materials     $ 7,381   $ 5,993  
    Work in process     414   --  
   Finished Goods    4,703    2,850  
        $12,498   $ 8,843

Stock-Based Compensation

On January 1, 2006, we adopted ASC 718, Stock Compensation (“ASC 718”), (formerly SFAS 123(R), Share-Based Payment), which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including stock option grants based on estimated fair values. ASC 718 requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the award’s portion that is ultimately expected to vest is recognized as expense over the requisite service periods. Prior to the adoption of ASC 718, we accounted for share-based awards to employees and directors using the intrinsic value method. Under the intrinsic value method, share-based compensation expense was only recognized by us if the exercise price of the stock option was less than the fair market value of the underlying stock at the date of grant.

Under ASC 718, nonvested stock awards are awards that the employee has not yet earned the right to sell and are subject to forfeiture if the terms of service are not satisfied. These awards should be measured based on the market prices of otherwise identical (i.e., identical except for the vesting condition) common stock at the grant date. A nonvested equity share awarded to an employee shall be measured at its fair value as if it were vested and issued on the grant date. The vesting restrictions are taken into account by recognizing compensation cost only for awards for which the employee has rendered the requisite service (i.e., vested).

We have elected to use the modified prospective application method whereby ASC 718 applies to new awards, the unvested portion of existing awards and to awards modified, repurchased or canceled after the effective date.


A-14



HEALTHTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Debt Issuance Costs

We expense debt issuance costs as incurred.

Advertising costs

Costs related to advertising are expensed as incurred.

Research and Development

Research and development costs are expensed as incurred and are not material in any of the periods presented.

Estimates Used to Prepare Consolidated Financial Statements

Management uses estimates and assumptions in preparing financial statements in accordance with U.S. generally accepted accounting principles. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Actual results could vary from the estimates that were assumed in preparing the consolidated financial statements.

Earnings Per Share

Basic earnings per share is based on the weighted average shares outstanding without any dilutive effects considered. Diluted earnings per share reflects dilution from all contingently issuable shares, including options and non-vested stock awards. A reconciliation of such earnings per share data is as follows:


(In thousands, except per share data)

Net Loss
Wtd. Avg.
No. of Shares

Per Share
Amounts

    For the year ended December 31, 2009                
 
   Basic   $ (3,916 )  39,135   $ (0.10 )
   Effect of dilutive securities:  
        Options and non-vested shares             --     --  
   Diluted   $ (3,916 )  39,135   $ (0.10 )
 
   For the year ended December 31, 2008  
 
   Basic   $ (128,693 )  36,499   $ (3.53 )
   Effect of dilutive securities:  
         Options and non-vested shares             --     --  
   Diluted   $ (128,693 )  36,499   $ (3.53 )
  
 
   For the year ended December 31, 2007  
 
   Basic   $ (14,632 )  35,421   $ (0.41 )
   Effect of dilutive securities:  
        Options and non-vested shares             --     --  
   Diluted   $ (14,632 )  35,421   $ (0.41 )

Unexercised employee stock options and non-vested shares to purchase 3,699,000, 2,783,000 and 3,329,000 shares of our common stock as of December 31, 2009, 2008 and 2007, respectively, were not included in the computations of diluted EPS because the exercise prices were greater than the average market price of our common stock during the respective periods or we had a net loss in the respective period.

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HEALTHTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Recently Issued Pronouncements

In October 2009, the FASB updated FASB Accounting Standards Codification (“ASC”) 605, Revenue Recognition (“ASC 605”) that amended the criteria for separating consideration in multiple-deliverable arrangements. The amendments establish a selling price hierarchy for determining the selling price of a deliverable. The selling price used for each deliverable will be based on vendor-specific objective evidence if available, third–party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific objective evidence nor third-party evidence is available. The amendments will eliminate the residual method of allocation and require that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. The relative selling price method allocates any discount in the arrangement proportionally to each deliverable on the basis of each deliverable’s selling price. This update will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted. We are currently evaluating the requirements of this update and have not yet determined the impact on our consolidated financial statements.

In June 2009, the FASB issued ASC 105, Generally Accepted Accounting Principles (“ASC 105”), (formerly SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles). ASC 105 establishes the FASB ASC as the single source of authoritative nongovernmental U.S. generally accepted accounting principles (“GAAP”). The standard is effective for interim and annual periods ending after September 15, 2009. The adoption of ASC 105 did not have a material impact on our financial statements.

In June 2009, the FASB issued accounting guidance contained within ASC 810, Consolidation (“ASC 810”), regarding the consolidation of variable interest entities (formerly SFAS No. 167, Amendments to FASB Interpretation No. 46(R)). ASC 810 is intended to improve financial reporting by providing additional guidance to companies involved with variable interest entities and by requiring additional disclosures about a company’s involvement in variable interest entities. This standard is effective for interim and annual periods beginning after November 15, 2009. The adoption of this standard is not expected to have a material impact on our financial statements.

In June 2009, the FASB issued ASC 860, Transfers and Servicing (“ASC 860”), (formerly SFAS No. 166, Accounting for Transfers of Financial Assets). ASC 860 requires more information about transfers of financial assets and where companies have continuing exposure to the risk related to transferred financial assets. It eliminates the concept of a qualifying special purpose entity, changes the requirements for derecognizing financial assets, and requires additional disclosure. This standard is effective for interim and annual periods beginning after November 15, 2009. We will adopt this standard on January 1, 2010. The adoption of this standard is not expected to have a material impact on our financial statements.

In May 2009, the FASB issued ASC 855, Subsequent Events (“ASC 855”), (formerly SFAS No. 165, Subsequent Events). ASC 855 should be applied to the accounting for and disclosure of subsequent events. This Statement does not apply to subsequent events or transactions that are within the scope of other applicable GAAP that provide different guidance on the accounting treatment for subsequent events or transactions. ASC 855 would apply to both interim financial statements and annual financial statements. The objective of ASC 855 is to establish general standards of accounting for and disclosures of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. In particular, this Statement sets forth: 1) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; 2) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and, 3) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. ASC 855 is effective for interim or annual financial periods ending after June 15, 2009. We adopted ASC 855 during the second quarter of 2009 and its application did not affect our consolidated financial position, results of operations, or cash flows. We evaluated subsequent events through the date the accompanying financial statements were issued.


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HEALTHTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

In April 2009, the FASB issued ASC 825, Financial Instruments (“ASC 825”), (formerly FASB Staff Position 107-1, Interim Disclosures about Fair Value of Financial Instruments). ASC 825 requires disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This standard also requires those disclosures in summarized financial information at interim reporting periods beginning after March 15, 2009. The adoption of this ASC did not affect our consolidated financial position, results of operations, or cash flows.

In June 2008, the FASB issued ASC 260, Earnings Per Share (“ASC 260”), (formerly FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities). ASC 260 concluded that instruments containing rights to nonforfeitable dividends granted in share-based payment transactions are participating securities prior to vesting and, therefore, should be included in the earnings allocations in computing basic earnings per share (EPS) under the two-class method. This ASC is effective for financial statements issued for fiscal years beginning after December 15, 2008, with prior period retrospective application. Our adoption of this ASC on January 1, 2009 had no material impact on our consolidated financial statements.

In April 2008, the FASB issued ASC 350-30, General Intangibles Other Than Goodwill (“ASC 350-30”), (formerly FSP No. 142-3, Determination of the Useful Life of Intangible Assets). ASC 350-30 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. ASC 350-30 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. The adoption of ASC 350-30 did not have a material impact on our financial position or results of operations.

In December 2007, the FASB issued ASC 805, Business Combinations (“ASC 805”), (formerly SFAS 141R, Business Combinations). ASC 805 will significantly change current practices regarding business combinations. Among the more significant changes, ASC 805 expands the definition of a business and a business combination; requires the acquirer to recognize the assets acquired, liabilities assumed and noncontrolling interests (including goodwill), measured at fair value at the acquisition date; requires acquisition-related expenses and restructuring costs to be recognized separately from the business combination; and requires in-process research and development to be capitalized at fair value as an indefinite-lived intangible asset. ASC 805 is effective for financial statements issued for fiscal years beginning after December 15, 2008. The impact of adopting ASC 805 will continue to be dependent on the future business combinations that we may pursue after its effective date. In 2009, we expensed approximately $2.4 million, of transaction costs related to acquisitions.

In December 2007, the FASB issued accounting guidance contained within ASC 810, Consolidation (“ASC 810-10-65”), (formerly SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements) regarding noncontrolling interests. ASC 810-10-65 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. The adoption of ASC 810-10-65 revised our presentation of consolidated financial statements and further impact will continue to be dependent on our future changes in ownership in subsidiaries after the effective date.


A-17



HEALTHTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

C.    GOODWILL AND OTHER INTANGIBLE ASSETS

We adopted ASC 350, Goodwill and Other Intangible Assets (“ASC 350”), (formerly, SFAS No. 142 Goodwill and Other Intangible Assets) effective January 1, 2002. Under this standard, we no longer amortize goodwill and indefinite life intangible assets, but those assets are subject to annual impairment tests.

The net carrying value of goodwill as of December 31, 2009 and 2008 is comprised of the following:


(in thousands)

Total
    Balance, December 31, 2007     $ 217,505  
       Additions    26,995  
       Deletions    (6,880 )
       Impairments    (144,000 )
   Balance, December 31, 2008   $ 93,620  
       Additions    9,662  
       Deletions    --  
       Impairments    --  
   Balance, December 31, 2009   $ 103,282  

In the fourth quarter of 2008, in connection with our annual goodwill impairment test, we recorded a goodwill impairment to our urology services reporting unit totaling $144 million. Although our core operations remain stable and reflect growth over the prior year, we adjusted certain assumptions in our discounted cash flow model to address the recent declines in our market capitalization, which had fallen significantly below our consolidated net assets. In addition, the market comparables component of our impairment test was negatively impacted by the current global economic crisis and global decline in the stock markets.

We record as goodwill the excess of the purchase price over the fair value of the net assets associated with acquired businesses. Goodwill and intangible assets with indefinite useful lives are not amortized, but instead are tested for impairment at least annually. Intangible assets with definite useful lives are amortized over their respective estimated useful lives to their estimated residual values. As of December 31, 2009, we have two reporting units, urology services and anatomical pathology services. As of December 31, 2008, we had two reporting units, urology services and medical products. We test for impairment of goodwill at least annually, during the fourth quarter, at the reporting unit level by comparing the reporting unit’s carrying amount, including goodwill, to the fair value of the reporting unit. The fair values of the are estimated using a combination of the income, or discounted cash flows, approach and the market approach, which utilizes comparable companies’ data. Because we have recognized goodwill based only on our controlling interest, the fair value also relates only to our controlling interest.

If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. The second step of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. That is, the fair value of the reporting unit is allocated to all of the assets and liabilities of that unit as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the purchase price paid to acquire the reporting unit.


A-18



HEALTHTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Our discounted cash flow projections for each reporting unit were based on five-year financial forecasts. The five-year forecasts and all amounts and assumptions used in preparing the financial forecasts were based on annual financial forecasts developed internally by management for use in managing our business. Our independent valuation firm utilized this information to assist us in calculating the fair value of the company. For our December 31, 2009 forecast, the significant assumptions of these five-year forecasts included annual revenue growth rates ranging from 3.5% to 8.2% and from 5.0% to 116% for the urology services and anatomical pathology reporting units, respectively. The future cash flows were discounted to present value using a mid-year convention and a discount rate of 13% for the urology services and 15.0% for the anatomical pathology reporting unit. Terminal values for the reporting units were calculated using a Gordon growth methodology with a long-term growth rate of 3.0% for the urology services reporting unit and 4.0% for the anatomical pathology reporting unit. The future terminal values of the urology services and anatomical pathology reporting units were $253 million and $39 million respectively at December 31, 2009.

For our December 31, 2008 forecast, the significant assumptions of these five-year forecasts included annual revenue growth rates ranging from 2.9% to 4.5% and from 10.4% to 20% for the urology services and medical products reporting units, respectively. The future cash flows were discounted to present value using a mid-year convention and a discount rate of 13% for the urology services and the medical products reporting units. Terminal values for both reporting units were calculated using a Gordon growth methodology with a long-term growth rate of 3.0%. The future terminal values of the urology services and medical products reporting units were $153 million and $61 million respectively at December 31, 2008.

The significant assumptions used in determining fair values of reporting units using comparable company market values include the determination of appropriate market comparables, the estimated multiples of revenue, EBIT, and EBITDA, and the estimated control premium a willing buyer is likely to pay.

As of December 31, 2009 and 2008, we had $4 million in indefinite life intangible assets related to the HealthTronics brand name. Other intangible assets as of December 31, 2009 and 2008, subject to amortization expense, are comprised of the following (in thousands):


A-19



HEALTHTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Weighted
Average Life
(years)

Gross
Carrying
Amount

Accumulated
Amortization

Net
December 31, 2009                    
Finite life intangibles:  
    IGRT services contract    20 .0 $35,245   $2,195   $33,050  
    Endocare brand name,  
      patents, and other    12 .8  10,845    391    10,454  
    Non-compete agreements, hospital  
      contracts, and patents    2 .1  3,914    2,425    1,489  
      Total     $50,004   $5,011   $44,993  
 
December 31, 2008   
Finite life intangibles:  
    IGRT services contract    20 .0 $35,245   $617   $34,628  
    Non-compete agreements, hospital  
      contracts, and patents    4 .3  3,751    2,101    1,650  
    Total     $38,996   $2,718   $36,278  

Amortization expense for other intangible assets with finite lives was $2,866,000, $1,286,000 and $1,028,000 for the years ended December 31, 2009, 2008 and 2007, respectively. We estimate annual amortization expense for each of the five succeeding fiscal years as follows (in thousands):


Year
Amount
    2010     $ 3,410  
   2011    3,116  
   2012    2,913  
   2013    2,770  
   2014    2,742  
   Thereafter    30,042  

D.   ACQUISITIONS

On July 27, 2009, we completed our acquisition of Endocare, pursuant to the Agreement and Plan of Merger (“Merger Agreement”), dated as of June 7, 2009, among us, HT Acquisition, Inc., a wholly-owned subsidiary of ours, and Endocare. Endocare is a medical device company focused on developing, manufacturing and selling cryoablation products which have the potential to assist physicians in improving and extending life by use in the treatment of cancer and other tumors. In accordance with the terms and conditions of the Merger Agreement, Endocare shareholders had the option to receive the following consideration for each share of Endocare common stock they owned: (i) $1.35 in cash, without interest, or (ii) 0.7764 of a share of our common stock, in each case subject to proration. The aggregate amount of cash paid was approximately $4.2 million and the aggregate number of shares of our common stock issued was approximately 7.3 million shares. Based upon our allocation of the purchase price, we recognized $6.8 million of goodwill related to this transaction, none of which is tax deductible.

Endocare’s revenues from the date the acquisition closed to December 31, 2009 were $7.4 million. Endocare had a pre-tax loss of $1 million for the same period. As a result of the acquisition, we recognized the following assets and liabilities:




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HEALTHTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(in thousands)

Endocare
    Current assets     $ 14,447  
   Property and equipment    1,506  
   Intangible assets    11,161  
   Goodwill    6,751  
   Other noncurrent assets    72  
   Total assets acquired    33,937  
 
   Current liabilities    16,630  
   Long-term liabilities    93  
   Total liabilities assumed    16,723  
   Net assets acquired   $ 17,214  

The factors contributing to the recognition of goodwill are based upon several strategic and synergistic benefits that are expected to be realized from the combination of HealthTronics and Endocare. These benefits include the expectation that HealthTronics’ complementary products and technologies will broaden the urology platform and increase prominence in the urology market and increase HealthTronics’ position as a leading provider of urology services. HealthTronics also expects to realize substantial synergies and operating efficiencies. The combination should enable the combined company to operate on a more cost efficient and effective basis with anticipated cost reductions in administration, facilities, and services. The acquisition provides HealthTronics broader coverage within the United States, as well as increased scale and scope for further expanding operations through product development and complementary strategic transactions.

On September 25, 2009, we acquired US Surgical Services, LLC (“US Surgical”) for $400,000 in cash and an earn-out provision pursuant to which we could issue up to $1,350,000 in shares of our common stock. The actual number of shares issued, if any, cannot be determined until it is determined whether the earn-out provision requirements are met. Randy Wheelock, who is the brother of Argil Wheelock, one of the members of our Board of Directors, was one of the two 50% owners of US Surgical. Thus, in exchange for his 50% ownership interest in US Surgical, Randy Wheelock was paid $200,000 in cash and will be entitled to 50% of any earn-out consideration paid. In addition, in connection with this acquisition, we entered into a consulting agreement with Randy Wheelock pursuant to which he will provide consulting services to us for 15 months following closing in exchange for a payment of $10,000 per month. Based on our allocation of the purchase price, we recognized $1,750,000 of goodwill related to this transaction, all of which is tax deductible.

On September 30, 2009, we acquired INnMED, LLC (“INnMED”) for $784,000. INnMED is a company that provides cryoablation-related services to urologists and cryosurgical partnerships. Based upon our allocation of the purchase price, we recognized $350,000 of goodwill related to this transaction, all of which is tax deductible.

On October 10, 2008, we entered into a Stock Purchase Agreement with Atlantic Urological Associates (“AUA”), pursuant to which we purchased the outstanding shares of capital stock of Ocean Radiation Therapy, Inc., a wholly-owned subsidiary of AUA (“Ocean”), for a purchase price of approximately $35 million in cash. Ocean provides image guided radiation therapy (“IGRT”) technical services to AUA’s IGRT cancer treatment center. The Ocean entity was formed concurrent with and as a result of the purchase. Ocean’s only asset was the IGRT services agreement valued at approximately $35 million which is recorded in intangible assets. We have estimated that this service agreement has a 20 year useful life and we are amortizing that asset over that life.




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HEALTHTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

On July 15, 2008, we acquired UroPath, LLC (“UroPath”) for $7.5 million in cash. Founded in 2003, UroPath is a leading provider of anatomical pathology laboratory services in the U.S. with locations in Florida, Texas, and Pennsylvania. Based on our allocation of the purchase price, we recorded approximately $7.4 million of goodwill related to this transaction, all of which is tax deductible.

On April 17, 2008, we completed the acquisition of Advance Medical Partners, Inc. (“AMPI”) pursuant to the Stock Purchase Agreement dated March 18, 2008 between us, Litho Management, Inc., AMPI and the stockholders of AMPI. Founded in 2003, AMPI is a leading provider of urological cryosurgery services in the U.S. with operations in 46 states. We acquired the outstanding shares of capital stock of AMPI (other than shares already held by us) for an aggregate purchase price of approximately $13 million, consisting of $6.9 million in cash and approximately 1.8 million shares of our common stock, plus a two-year earn-out based on the achievement of EBITDA. We determined the value of our common stock by using an average closing price for the two trading days prior to and after the public announcement of the merger. The first earn-out payment was paid in May 2009, totaling $219,000 in cash and 134,356 shares of HealthTronics stock valued at $219,000. Based upon our allocation of the purchase price, we recognized $12.7 million of goodwill related to this transaction, none of which is tax deductible.

In 2008, we purchased three partnerships, increased our ownership in three existing partnerships and purchased a small service company for an aggregate purchase price of approximately $6.4 million. We recorded approximately $7.2 million of goodwill related to these transactions, all of which is tax deductible.

Our unaudited proforma combined income data for the periods ended December 31, 2009 and 2008, assuming the acquisitions were effective January 1 of each period, is as follows:


($ in thousands, except per share data)

2009
2008
    Total revenues     $ 197,797   $ 207,735  
   Total expenses    207,853    340,086
        Net loss attributable to HealthTronics, Inc.   $ (10,056 ) $ (132,351 )
        Diluted earnings per share   $ (0.22 ) $ (2.98 )



E.   FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying amounts and estimated fair values of our significant financial instruments as of December 31, 2009 and 2008 are as follows:


2009
2008
( $ in thousands)

Carrying Amount
Fair Value
Carrying Amount
Fair Value
    Financial assets:                    
        Cash and cash equivalents   $ 8,412   $ 8,412   $ 22,854   $ 22,854  
        Warrants/Common Stock    --    --    290    290  
 
   Financial liabilities:  
        Debt   $ 48,519   $ 48,519   $ 46,387   $ 46,387  
        Other long-term obligations    3,373    3,305    1,765    1,727  

The following methods and assumptions were used by us in estimating our fair value disclosures for financial instruments.




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HEALTHTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Cash and Cash Equivalents

The carrying amounts for cash and cash equivalents approximate fair value because they mature in less than 90 days and do not present unanticipated credit concerns.

Debt

The carrying amount of our debt approximates fair value because it has a floating interest rate which reflects market changes in interest rates and contains variable interest premiums based on certain debt compliance ratios.

Other Long-Term Obligations

At December 31, 2009, we had $1,569,000 in long term deferred rent related to leaseholds at our new corporate office space in Austin, Texas. We are amortizing this deferred rent at a rate of $22,569 per month. At December 31, 2009, we had a long term obligation totaling $328,000 for restructuring costs related to the vacating of a leased property. Lease payments, net of the projected sublease income, totaling approximately $560,000 will continue until February 2013. At December 31, 2009, we had a long-term obligation of $1,350,000 representing our best estimate of an earn-out payment due in January of 2011 relating to an acquisition. At December 31, 2009, we had a long term obligation of $126,000 related to payments of $10,534 a month until December 2011 as consideration for a noncompetition agreement with a previous employee of our Endocare division. Leases have been recorded at fair value. We estimated the fair value of our long term obligations based on discounted cash flows, which is a level three analysis.

Warrants

In November, 2006, we announced our decision to discontinue our involvement in the clinical trials of the Ablatherm device manufactured by EDAP TMS S.A. (EDAP). This decision results in our forfeiting the exclusive rights to distribute such device in the United States, when and if a Pre-Market Approval of such device is granted by the FDA and forfeits our rights to vest in additional warrants to EDAP common stock. During 2007, we exercised these warrants and in the third quarter of 2009 we sold these shares. The stock had been valued based on a quoted market price, which was a level one analysis.

Limitations

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. Fair value estimates are based on existing balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the aforementioned estimates.


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HEALTHTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

F.   ACCRUED EXPENSES

Accrued expenses consist of the following:


December 31,
($ in thousands)

2009
2008
    Accrued group insurance costs     $ 421   $ 304  
   Compensation and payroll related expense    7,120    3,339  
   Accrued interest    152    94  
   Accrued taxes    1,024    613  
   Accrued professional fees    246    317  
   Unearned revenues    1,213    1,181  
   Deferred Rent    226    396  
   Accrued distributions    109    95  
   Other    2,619    2,977  
        $13,130   $ 9,316  

G.   INDEBTEDNESS

Long-term debt is as follows:


($ in thousands) December 31,
Interest Rates
Maturities
2009
2008
    Floating     2009-2012     $ 44,591   $ 41,528      
   4%-9%   2009-2012   3,928    4,859      
            $48,519 $46,387    
   Less current portion of long-term debt        2,556  2,490
            $ 45,963 $43,897    

Senior Credit Facility

In March 2005, we refinanced our then existing revolving credit facility with a $175 million senior credit facility comprised of a five year $50 million revolver due in March 2010 and a $125 million senior secured term loan B (“term loan B”), due 2011. This loan bore interest at a variable rate equal to LIBOR + 1.25 to 2.25% or prime + .25 to 1.25%. We repaid the term loan B in July of 2006 in full. In April of 2008, we increased the revolving line of credit from $50 million to $60 million. In December 2009, we amended and restated our senior credit facility.

The amended and restated credit agreement extended the maturity date of the revolver to December 31, 2012, increased the borrowing rate, eliminated the interest coverage ratio covenant and replaced it with a fixed charge coverage ratio covenant, increased the dollar limit on stock repurchases by us from $10 million to $20 million (but making repurchases subject to our maintaining a total leverage ratio of 2.00 to 1.00), and other minor amendments. Except as described above, the terms of our original senior credit facility remain in effect under the amended and restated credit agreement.

As of December 31, 2009, we have drawn $44 million on the revolver. Our senior credit facility contains covenants that, among other things, limit our ability to incur debt, create liens, make investments, sell assets, pay dividends, make capital expenditures, make restricted payments, enter into transactions with affiliates, and make acquisitions. In addition, our facility requires us to maintain certain financial ratios. Our assets and the stock of our subsidiaries collateralize the revolving credit facility. We were in compliance with the covenants under our senior credit facility as of December 31, 2009.




A-24



HEALTHTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Other long term debt

As of December 31, 2009, we had notes totaling $4.5 million related to equipment purchased by our limited partnerships, which indebtedness we believe will be repaid from the cash flows of the partnerships. They bear interest at either a fixed rate of four to nine percent or LIBOR or prime plus a certain premium and are due over the next four years.

The stated principal repayments for all indebtedness as of December 31, 2009 are payable as follows (in thousands):


Year
Amount
    2010     $ 2,556  
   2011    1,106  
   2012    44,336  
   2013    81  
   2014    55  
   Thereafter    385  

H. COMMITMENTS AND CONTINGENCIES

We are involved in various claims and legal actions that have arisen in the ordinary course of business. Management believes that any liabilities arising from these actions will not have a material adverse effect on our financial condition, results of operations or cash flows.

We sponsor a partially self-insured group medical insurance plan. The plan is designed to provide a specified level of coverage, with stop-loss coverage provided by a commercial insurer. Our maximum claim exposure is limited to $110,000 per person per policy year. At December 31, 2009, we had 350 employees enrolled in the plan. The plan provides non-contributory coverage for employees and contributory coverage for dependents. Our contributions totaled $3,722,000, $2,781,000 and $2,852,000, in 2009, 2008 and 2007 respectively.

We lease office space in several locations. Rent expense totaled $2,714,000, $2,445,000 and $1,757,000 for the years ended December 31, 2009, 2008 and 2007. Future annual rent expense under all noncancelable operating leases are as follows:


($ in thousands)
Year

Amount
    2010     $ 2,785  
   2011    2,327  
   2012    2,080  
   2013    1,129  
   2014    849  
   Thereafter    480  

I. STOCK BASED COMPENSATION

On January 1, 2006, we adopted ASC 718, Stock Compensation (“ASC 718”), (formerly SFAS 123(R), Share-Based Payment), which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including stock option grants based on estimated fair values. ASC 718 requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the award’s portion that is ultimately expected to vest is recognized as expense over the requisite service periods. Prior to the adoption of ASC 718, we accounted for share-based awards to employees and directors using the intrinsic valued method. Under the intrinsic value method, share-based compensation expense was only recognized by us if the exercise price of the stock option was less than the fair market value of the underlying stock at the date of grant. We have elected to use the modified prospective application method such that ASC 718 applies to new awards, the unvested portion of existing awards and to awards modified, repurchased or canceled after the effective date.


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HEALTHTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Under ASC 718, nonvested stock awards are awards that the employee has not yet earned the right to sell, and are subject to forfeiture if the terms of service are not satisfied. These awards should be measured based on the market prices of otherwise identical (i.e., identical except for the vesting condition) common stock at the grant date. A nonvested equity share awarded to an employee shall be measured at its fair value as if it were vested and issued on the grant date. The vesting restrictions are taken into account by recognizing compensation cost only for awards for which the employee has rendered the requisite service (i.e., vested).

Share-based compensation expense recognized during the years ended December 31, 2009, 2008, and 2007 is related to awards granted prior to, but not yet fully vested as of, January 1, 2006 and awards granted subsequent to December 31, 2005. We have historically and continue to estimate the fair value of stock options using the Black-Scholes-Merton (“Black Scholes”) option-pricing model. For our performance-based non-vested stock awards, we relied upon a closed-form barrier option valuation model, which is a derivation of the Black Scholes model to determine the fair value of the awards and utilized a lattice model to analyze the appropriate service period. For our service-based non-vested stock awards, fair value is based on the fair value at the grant date.

Equity Incentive Plans

At December 31, 2009, we had seven separate equity compensation plans: the Prime Medical Services, Inc. (“Prime”) 1993 and 2003 stock option plans, the HealthTronics Surgical Services, Inc. (“HSS”) general, 2000, 2001 and 2002 stock option plans, and the HSS 2004 equity incentive plan. The plans, and all amendments thereto, had been approved by Prime’s and HSS’ shareholders, as the case may be. On November 10, 2004, Prime completed a merger with HSS pursuant to which Prime merged with and into HSS with HealthTronics, Inc. as the surviving corporation. Options granted under the plans shall terminate no later than ten years from the date the option is granted, unless the option terminates sooner by reason of termination of employment, disability or death. Options may vest immediately or over one to five years.

The following table sets forth certain information as of December 31, 2009 about our equity compensation plans:


A-26



HEALTHTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(a)
(b)
(c)
 





Plan Category




Number of shares of our
common stock to be issued
upon exercise of
outstanding options






Weighted-average exercise
price of outstanding options

Number of shares of our
common stock remaining
available for future
issuance under equity
compensation plans
(exceeding securities
reflected in column (a))

Prime 1993 stock option plan      65,666   $ 7 .79  --  
 
  Prime 2003 stock option plan    69,000   $ 5 .61  --  
 
  HSS equity incentive plan and stock  
       option plans    2,653,283   $ 5 .93  1,776,237  
 
  Other equity compensation plans  
      approved by our security holders    N/A    N/A    N/A  

To calculate the compensation cost that was recognized under ASC 718 for the three years ended December 31, 2009, 2008, and 2007, we used the Black-Scholes option-pricing model with the following weighted-average assumptions for equity awards granted. For December 31, 2009 and 2007, respectively: risk-free interest rates were 0.65% and 4.6%; dividend yields were 0%; volatility factors of the expected market price of our common stock were 65% and 47%; and a weighted-average expected life of the option of 6 years. There were no options granted in the year ended December 31, 2008.

The risk-free interest rate is based on the implied yield available on U.S. Treasury issues with an equivalent expected term. We have not paid dividends in the past and do not plan to pay any dividends in the future. We utilized the guidelines of Staff Accounting Bulletin No. 107 (SAB 107) of the Securities and Exchange Commission, (the SEC Staff’s interpretation of ASC 718) relative to “plain vanilla” options in determining the expected term of option grants. SAB 107 permits the expected term of “plain vanilla” options to be calculated as the average of the option’s vesting term and contractual period. This simplified method is based on the vesting period and the contractual term for each grant or for each vesting tranche for awards with graded vesting. The mid-point between the vesting date and the expiration date is used as the expected term under this method. We have used this method in determining the expected term of all options granted after December 31, 2005. We have determined volatility using historical stock prices over a period consistent with the expected term of the option. We recognize compensation cost for awards with graded vesting on a straight-line basis over the requisite service period for the entire award. The amount of compensation expense recognized at any date is at least equal to the portion of the grant date value of the award that is vested at that date.

As of December 31, 2009, total unrecognized share-based compensation cost related to unvested stock options was approximately $1.2 million, which is expected to be recognized over a weighted average period of approximately 2.0 years. We also had $2.2 million of unrecognized compensation costs related to non-vested stock awards as of December 31, 2009, which is expected to be recognized over a weighted average period of approximately 1.5 years. For the years ended December 31, 2009, 2008, and 2007, we have included approximately $3,000,000, $2,881,000, and $1,108,000, respectively, for share-based compensation cost in the accompanying consolidated statement of income.

In 2009, we granted a total of 619,733 of non-vested shares under our 2004 Equity Incentive Plan. 386,975 shares vest 25% on each of the first four anniversaries of the grant date. 151,293 shares vest based on the achievement of the performance targets outlined below. 81,465 shares vest 25% on each of the first four anniversaries of the grant date; however, their vesting can be accelerated if the following performance targets are reached. All of the shares granted in 2009 that vest per the performance targets below have a two year service requirement regardless of the performance targets being met. In 2009, 43,987 shares were issued to board members for board related fees.


A-27



HEALTHTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

In 2008, we granted a total of 1,896,592 of non-vested shares under our 2004 Equity Incentive Plan. 170,449 shares vest 25% on each of the first four anniversaries of the grant date. 1,121,993 shares vest based on the achievement of the performance targets outlined below. 604,150 shares vest 25% on each of the first four anniversaries of the grant date; however, their vesting can be accelerated if the following performance targets are reached. 735,136 of the shares that vest per the performance targets below have a two year service requirement regardless of the performance targets being met.


Percent of
Grant Vesting

Performance Target
(% increase over grant price)

      25%  15 %
     25%  30 %
     25%  45 %
     25%  60 %

On May 5, 2008, the first performance target related to one of the grants was met and as a result 92,862 of the non-vested stock awards vested, which resulted in the recognition of approximately $307,000 in share based compensation cost. On August 25, 2008, the second performance target was met resulting in the vesting of an additional 92,862 shares and the recognition of approximately $118,000 in share based compensation cost.

Activity and pricing information regarding all stock options to purchase shares of our common stock are summarized as follows:




2009
2008
2007
Options (000)
Weighted
Average
Exercise Price

Options (000)
Weighted
Average
Exercise Price

Options (000)
Weighted
Average
Exercise Price

Outstanding at beginning of year      2,559   $ 7.03  3,194   $ 7.07  3,908   $ 7.32
Granted    650    2.44  --    --  245    5.82
Exercised    --  -- --  --   --   --
Cancelled    (387 )  7.26  (399 )  7.60  (552 )  8.07
Forfeited    (34 )  3.98   (236 )   6.61   (407 )   7.38
Outstanding at end of year    2,788   $ 5.97  2,559   $ 7.03  3,194   $ 7.07
Exercisable at end of year    2,029   $ 7.04  2,182   $ 7.13  2,049   $ 7.35
Weighted-average fair value of
   options granted during the period    $1.45     N/A     $2.99    

During the year ended December 31, 2009, there were no exercises of options to purchase common stock and the total fair value of shares vested during 2009 was $793,000. During the year ended December 31, 2008, there were no exercises of options to purchase common stock and the total fair value of shares vested during 2008 was $1,153,000. During the year ended December 31, 2007, there were no exercises of options to purchase common stock and the total fair value of shares vested during 2007 was $966,000.

During the year ended December 31, 2009, 2008, and 2007 there was no financing cash generated from share-based compensation arrangements for the purchase of shares upon exercise of options. We issue new shares upon exercise of options to purchase our common stock.


A-28



HEALTHTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Additional information regarding options outstanding for all plans as of December 31, 2009, is as follows:


Outstanding Options
Exercisable Options
Range of Exercise Prices

Options (000)
Weighted
Average
Remaining
Contractual
Life

Weighted
Average
Exercise Price

Options (000)
Weighted
Average
Remaining
Contractual
Life

Weighted
Average
Exercise Price

$0.00 - $4.24      633   9.9 years     $ 2 .44  --   N/A     $ --
$4.25 - $6.49      254   5.2 years     5 .87  209   4.8 years     5 .94
$6.50 - $6.99    1,242   4.7 years    6 .64  1,185   4.6 years    6 .64
$7.00 - $7.50    355   5.7 years    7 .38  331   5.7 years    7 .39
$7.51 - $9.50    140   4.1 years    7 .85  140   4.1 years    7 .85
$9.51 - $13.69    164   3.3 years    9 .93  164   3.3 years      9 .93
     2,788     $5 .97  2,029      $ 7 .04
Aggregate intrinsic value (in thousands)   $ 127         $--

The aggregate intrinsic value in the table above is based on our closing stock price of $2.64 per share as of December 31, 2009.

A summary of the status of our nonvested shares as of December 31, 2009 and changes during the years ended December 31, 2009, 2008 and 2007 is as follows:


Nonvested Shares
  Shares (000)
  Weighted-Average
Grant-Date Fair Value

 
    Nonvested at January 1, 2007      --   $ --  
   Granted    135    4.75
   Vested    --    --  
   Forfeited    --    --  
   Nonvested at December 31, 2007    135   $ 4.75
   Granted    1,897    2.52
   Vested    (220 )  3.52
   Forfeited    (62 )  3.22
   Nonvested at December 31, 2008    1,750   $ 2.55
   Granted    619    1.93
   Vested    (278 )  2.50
   Forfeited    (50 )  3.34
   Nonvested at December 31, 2009    2,041   $ 2.34

J.   INCOME TAXES

We file a consolidated tax return with our wholly-owned subsidiaries and also own varying interests in numerous partnerships. A substantial portion of consolidated book income from continuing operations before provision for income taxes and noncontrolling interest is not taxed at the corporate level as it represents income attributable to other partners who are responsible for the tax on that income. Accordingly, only the portion of income from these partnerships attributable to our ownership interests is included in taxable income in the consolidated tax return and financial statements.


A-29



HEALTHTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Income tax expense (benefit) consists of the following:




Years Ended December 31,
($ in thousands)

2009
2008
2007
    Federal:                
        Current   $ --   $ --   $ --  
        Deferred    2,803  (8,147 )  (2,878 )
   State:  
        Current    190    202    212  
        Deferred    (193 )  (3,643 )  (401 )
   Foreign  
        Current    --    --    --  
        Deferred    37    72    213
        $ 2,837 $ (11,516 ) $ (2,854 )

A reconciliation between the statutory rate and the effective tax rate on income from operations for the years ended December 31, 2009, 2008 and 2007 is as follows:


Years Ended December 31,


2009
2008
2007
    Stautory Rate      35.0 %  35.0 %  35.0 %
   Foreign jurisdiction statutory income tax rate    0.1 %  --    (0.3 )%
   State taxes, net of federal tax effect    --    2.6 %  --  
   Change in valuation allowance    5.1 %  (17.3 )%  --  
   Goodwill impairment    --    (28.7 )%  12.7 %
   Other    0.5 %  0.2 %  (1.0 )%
   Effective tax rate (excluding noncontrolling interests)    40.7 %  (8.2 )%  46.4 %
   (Income) Loss attributable to noncontrolling interests    (35.5 )%  21.6 %  (56.5 )%
        5.2 %  13.4 %  (10.1 )%

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows:


December 31,
($ in thousands)

2009
2008
Deferred tax assets:            
    Net operating loss carryforward   $ 44,804   $ 34,395  
    Capital loss carryforward    180    --  
    Allowance for bad debts    21    32  
    State deferred taxes    3,826    3,792  
    FAS 123(R) expense    1,771    1,129  
    AMT Credit    789    789  
    HTRN acquired built-in losses    2,787    4,331  
    Capitalized costs    4,536    1,384  
    Accrued expenses deductible for tax purposes when paid    1,591    733  
        Total gross deferred tax assets    60,305    46,585  
        Less valuation allowance    (54,275 )  (46,585 )
        Net deferred tax assets    6,030    --  
 
Deferred tax liabilities:  
    Property and equipment, principally due to differences in depreciation    (2,982 )  (1,212 )
    Intangible assets, principally due to differences in amortization periods for tax purposes    (9,050 )  (2,143 )
    Total gross deferred tax liability    (12,032 )  (3,355 )
    Net deferred tax liability   $ (6,002 ) $ (3,355 )




A-30



HEALTHTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

In assessing the realizablity of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversals of deferred tax liabilities (including the impact of available carry back and carry forward periods), projected future taxable income and tax planning strategies in making this assessment. In the fourth quarter of 2008, primarily as a result of a goodwill impairment charge, the Company incurred a cumulative book loss for the most recent three year period. Management considers a cumulative loss for the most recent three year period to be a negative indicator as to the realizability of deferred tax assets based upon future taxable income. In 2009, the Company continued to have a cumulative book loss for the most recent three year period. Based on these criteria, management believes it will not realize the benefits of these deductible differences; accordingly, we have recorded a full valuation allowance at December 31, 2009 and 2008.

At December 31, 2009 and 2008, we have federal net operating loss carry forwards of $112,245,000 and $107,544,000, respectively, which are available to offset future taxable income, if any, through 2029. These federal net operating losses are a combination of losses that we acquired through the acquisition of other companies and through our own operations. In addition, we have an alternative minimum tax credit carry forward at December 31, 2009 of $511,000, which is available to offset future federal regular income taxes, if any, over an indefinite period. We also have state net operating loss carry forwards that are available to offset future state taxable income, if any.

In 2009, we acquired Endocare, Inc. As a part of the acquisition, we acquired Endocare’s federal net operating loss of $145 million. Due to the change in ownership, our utilization of the net operating loss is limited under Section 382 of the Internal Revenue Code. When applying the Section 382 limits, our utilization of Endocare’s net operating loss is limited to $771,000 per year through 2029.

In 2004, we acquired HealthTronics Surgical Services, Inc. (HealthTronics). As a part of the acquisition, we acquired HealthTronics’ federal net operating losses and other built-in losses. At December 31, 2009, the federal net operating losses and other built-in losses were $20.6 million and $7.7 million, respectively. Due to the change in ownership in 2004, our utilization of the net operating loss and other built-in losses were limited under Section 382 of the Internal Revenue Code. When applying the Section 382 limits, our utilization of HealthTronics’ net operating losses is limited to $2,014,500 per year through 2027.

The federal net operating losses that we have generated through our own operations total $91.4 million. These net operating losses are available to offset future taxable income, if any, through 2029.

In 2008, the Internal Revenue Service completed examinations of our income tax returns for 2000 to 2006. The examination of these returns was the result of an examination of refund claims we submitted to the Internal Revenue Service totaling $4.3 million related to HealthTronics filings. In October 2008, we received $5.2 million from the Internal Revenue Service representing $4.3 million for our refund claim and $0.9 million in interest income. The tax refund of $4.3 million and interest income of $0.2 million was recorded as a reduction of goodwill while the interest income earned subsequent to the acquisition of HealthTronics, totaling $0.7 million, was recorded as interest income in the income statement. As a result of the completion of the examination of these returns in 2008, we recorded tax benefits of $31.70 million in net operating losses and built-in losses with a corresponding valuation allowance related to HealthTronics.





A-31



HEALTHTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Effective January 1, 2007, we adopted ASC 740-10, Accounting for Uncertainty in Income Taxes (“ASC 740-10”), (formerly FIN No. 48 Accounting for Uncertainty in Income Taxes). ASC 740-10 specifies the way public companies are to account for uncertainties in income tax reporting, and prescribes a methodology for recognizing, reversing, and measuring the tax benefits of a tax position taken, or expected to be taken, in a tax return. Adoption of ASC 740-10 on January 1, 2007 did not result in a cumulative effect adjustment to our retained earnings.

At January1, 2008, we had an unrecognized tax benefit of $2.3 million. As a result of the Internal Revenue Service examination in 2008, this amount was settled. Accordingly, there were no unrecognized tax benefits at December 31, 2009 or 2008.

Our continuing practice is to recognize interest and penalty expense in operating expenses. We expensed no penalties and interest for the years ended December 31, 2009 and 2008. Our federal returns for 2007, 2008 and 2009 are subject to examination by the Internal Revenue Service. Additionally, various state income tax returns are subject to examinations for years 2006, 2007, 2008, and 2009.

Deferred taxes are not provided on undistributed earnings of foreign subsidiaries because such earnings are expected to be indefinitely reinvested outside the United States. If these amounts were not considered permanently reinvested, a cumulative deferred tax liability approximating $50,000 and $87,000 would be provided for in 2009 and 2008, respectively.

K.   SEGMENT REPORTING

In the fourth quarter of 2008, our Medical Products division relocated from Kennesaw, Georgia to our corporate headquarters in Austin, Texas. Concurrent with this relocation, we made certain changes within our Medical Products management team so that these operations now report to the President of our Urology Services operations. After making these changes, we redesigned our internal financial reporting materials provided to our chief operating decision maker, as well as our executive management team. As of the first quarter of 2009, we do not have any operating segments, except our Urology Services operations, that meet the quantitative requirements of ASC 280, Segment Reporting (“ASC 280”), (formerly Statement of Financial Accounting Standards (“SFAS”) 131, Disclosures about Segments of an Enterprise and Related Information).

L.   DISCONTINUED OPERATIONS

In November, 2006 we announced our decision to discontinue our involvement in the clinical trials of the Ablatherm device manufactured by EDAP TMS S.A. (EDAP). This decision results in our forfeiting the exclusive rights in the United States, when and if a Pre-Market Approval is granted by the FDA and forfeits our rights to earn additional warrants to EDAP common stock. We have accordingly included our costs related to the clinical trials in discontinued operations in the accompanying consolidated statements of income.

In the fourth quarter of 2006, we committed to a plan to sell our Rocky Mountain Prostate Thermotherapies (“RMPT”) business. In July 2007, we entered into a purchase agreement to sell the RMPT business for $1.35 million. This sale closed on September 28, 2007. Accordingly, we have included its results from operations in discontinued operations.





A-32



HEALTHTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

The following table details selected financial information included in loss from discontinued operations in the consolidated statements of income for December 31, 2007.



Consolidated Statements of Income

 
($ in thousands)

2007
    For the Year Ended December 31        
 
   Revenue  
       Rocky Mountain Prostate Thermotherapies   $ 3,268  
       HIFU    --  
   Cost of services  
       Rocky Mountain Prostate Thermotherapies    (3,739 )
       HIFU    (216 )
   Depreciation and amortization  
       Rocky Mountain Prostate Thermotherapies    --  
       HIFU    (3 )
   Income (loss) from discontinued operations   $ (690 )



 
($ in thousands)

2007
    Gain on Sale of Rocky Mountain Prostate Thermotherapy     $ 451  
   Loss from discontinued operations    (690 )
   Income tax benefit on discontinued operations    92  
   Loss from discontinued operations, net of tax   $ (147 )

The gain on sale of Rocky Mountain Prostate Thermotherapy, noted above, includes a charge to goodwill of $3.25 million.

As part of the merger between Prime and HSS in November 2004, HSS had a minority owned Swiss subsidiary, HMT Holding AG (“HMT”), which was in a net liability position at the date of acquisition. In December 2004, we decided to no longer fund the operations of HMT as part of our plan to rationalize its acquired manufacturing activities. Also in December 2004, the directors of HMT received a letter from their external auditors informing them HMT was over-indebted. Based on this action, the directors had a statutory obligation to initiate insolvency proceedings and in January 2005 filed for relief under Swiss insolvency laws. We deconsolidated the operations of HMT in December 2004.

We purchased debt of HMT AG in the first quarter of 2005. We paid $1.3 million and incurred certain contingent obligations in the amount of $350,000 in return for assignment of a $5.1 million claim against HMT AG held by a foreign bank. In addition to the claim, we also received an assignment from the bank of a pledge of HMT AG’s accounts receivable that secured the $5.1 million claim. Through December 31, 2009, we had recovered approximately $2.8 million. Any additional recoveries in the future will be recorded as income when received.

K.   VARIABLE INTEREST ENTITIES

We have determined that one of our consolidated partnerships, acquired in the HSS merger and in which we have a 20% interest, has certain related party relationships with two Variable Interest Entities (VIE), and in accordance with ASC 810, has consolidated those entities. As a result of consolidating the VIEs, of which the partnership is the primary beneficiary, we have recognized noncontrolling interest of approximately $800,000 on our consolidated balance sheets at December 31, 2009 and 2008, which represents the difference between the assets and the liabilities recorded upon the consolidation of the VIEs. The liabilities recognized as a result of consolidating the VIEs do not represent additional claims on our general assets. Rather, they represent claims against the specific assets of the consolidated VIEs. Conversely, assets recognized as a result of consolidating these VIEs do not represent additional assets that could be used to satisfy claims against our general assets. Reflected on our consolidated balance sheet as of December 31, 2009 and 2008 are $4.3 million and $4 million, respectively, of VIE assets, representing all of the assets of the VIEs. The VIEs assist the partnership in providing urological services, minimally invasive prostate treatments, and other services in the Greater New York metropolitan area.





A-33



HEALTHTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

N.   RELATED PARTY TRANSACTIONS

On September 17, 2008, Ross A. Goolsby resigned, effective on September 30, 2008, from his position as Senior Vice President and Chief Financial Officer. In connection with Mr. Goolsby’s departure, the Company entered into a Termination and Consulting Agreement with Mr. Goolsby whereby (1) we will pay Mr. Goolsby $95,000 on September 30, 2008 in lieu of participation in our annual incentive compensation program for 2008, (2) Mr. Goolsby agreed to provide consulting services until January 7, 2009 and we will make semi-monthly payments of $11,458 to Mr. Goolsby during this period for these consulting services, (3) Mr. Goolsby will be eligible to continue to participate in our employee benefit plans made generally available to our employees (to the extent permitted by law and the terms of the plans) until the earlier of January 7, 2009 or the termination of Mr. Goolsby’s consultancy, and (4) we will reimburse COBRA expenses of Mr. Goolsby for his continued coverage under the our medical plan until the earlier of (i) the expiration of the period of coverage under COBRA, and (ii) the date Mr. Goolsby is eligible for participation in a new employer’s group plans. The Termination and Consulting Agreement also provides that the nonsolicitation provision set forth in Mr. Goolsby’s Executive Employment Agreement will continue in full force and effect and that such Executive Employment Agreement is otherwise terminated.




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