The following is a discussion of our results of operations and financial condition for the periods described below. This discussion should be read in conjunction with our consolidated financial statements included elsewhere in this Form 10-K. Our discussion of our results of operations and financial condition includes various forward-looking statements about our markets, the demand for our products and services and our future results. These statements are based on our current expectations, which are inherently subject to risks and uncertainties. Our actual results and the timing of certain events may differ materially from those indicated in the forward looking statements.

Overview

We are the largest owner and operator of orthotic and prosthetic ("O&P") patient-care centers in the United States. Through our subsidiary, Southern Prosthetic Supply, Inc. ("SPS"), we are also the largest distributor of branded and private label O&P devices and components in the United States, all of which are manufactured by third parties. We also create products, through our subsidiary, Innovative Neurotronics, Inc. ("IN, Inc."), for sale in our patient-care centers, internationally through distribution agreements, and through a sales force. The first such product was available for sale starting May 1, 2006 for patients who have had a loss of mobility due to strokes, multiple sclerosis or other similar conditions. Another subsidiary, Linkia LLC ("Linkia"), is a provider network management company.

We have increased our net sales during the past two years principally through acquisitions of patient-care centers, increased distribution revenues, sales generated by the two national contracts signed by our Linkia subsidiary and by opening new patient-care centers. We strive to improve our local market position to enhance operating efficiencies and generate economies of scale. We generally acquire small and medium-sized O&P patient-care businesses and open new patient-care centers to achieve greater density in our existing markets.

We conduct our operations in two reportable segments-patient-care centers and distribution.

Patient Care

At December 31, 2008, we operated 668 O&P patient-care centers in 45 states and the District of Columbia and employed in excess of 1,000 revenue-generating O&P practitioners ("practitioners").

In our orthotics business, we design, fabricate, fit and maintain a wide range of standard and custom-made braces and other devices (such as spinal, knee and sports-medicine braces) that provide external support to patients suffering from musculoskeletal disorders, such as ailments of the back, extremities or joints and injuries from sports or other activities. In our prosthetics business, we design, fabricate, fit and maintain custom-made artificial limbs for patients who are without limbs as a result of traumatic injuries, vascular diseases, diabetes, cancer or congenital disorders. O&P devices are increasingly technologically advanced and are custom-designed to add functionality and comfort to patients' lives, shorten the rehabilitation process and lower the cost of rehabilitation.

Patients are referred to our local patient-care centers directly by physicians as a result of our reputation with them or through our agreements with managed care providers. Practitioners, technicians and office administrators staff our patient-care centers. Our practitioners generally design and fit patients with, and the technicians fabricate, O&P devices as prescribed by the referring physician. Following the initial design, fabrication and fitting of our O&P devices, our technicians conduct regular, periodic maintenance of O&P devices as needed.

Our practitioners are also responsible for managing and operating our patient-care centers and are compensated, in part, based on their success in managing costs and collecting accounts receivable. We provide centralized administrative, marketing and materials management services to take advantage of

economies of scale and to increase the time practitioners have to provide patient care. In areas where we have multiple patient-care centers, we also utilize shared fabrication facilities where technicians fabricate devices for practitioners in that region.

Distribution Services

We distribute O&P components to the O&P market as a whole and to our own patient-care centers through our wholly-owned subsidiary, SPS, which is the nation's largest O&P distributor. We are also a leading manufacturer and distributor of therapeutic footwear for diabetic patients in the podiatric market For the year ended December 31, 2008, 37.1% or approximately $80.7 million of SPS' distribution sales were to third-party O&P services providers, and the balance of approximately $136.7 million represented intercompany sales to our patient-care centers. SPS maintains in inventory approximately 25,000 O&P related items, all of which are manufactured by other companies. SPS maintains distribution facilities in California, Florida, Georgia, Pennsylvania, and Texas, which allows us to deliver products via ground shipment anywhere in the United States within two business days.

Our distribution business enables us to:

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º lower our material costs by negotiating purchasing discounts from manufacturers;

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º reduce our patient-care center inventory levels and improve inventory turns through centralized purchasing control;

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º quickly access prefabricated and finished O&P products;

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º perform inventory quality control;

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º encourage our patient-care centers to use clinically appropriate products that enhance our profit margins; and

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º coordinate new product development efforts with key vendor "partners".

This is accomplished at competitive prices as a result of our direct purchases from manufacturers.

Marketing of our distribution services is conducted on a national basis through a dedicated sales force, print and e-commerce catalogues and exhibits at industry and medical meetings and conventions. We direct specialized catalogues to segments of the healthcare industry, such as orthopedic surgeons and physical and occupational therapists and podiatrists.

Product Development

IN, Inc. specializes in product development principally in the field of functional electrical stimulation, IN, Inc. identifies emerging MyoOrthotics Technologies® developed at research centers and universities throughout the world that use neuromuscular stimulation to improve the functionality of an impaired limb. MyoOrthotics Technologies® represents the merging of orthotic technologies with electrical stimulation. Working with the inventors under licensing and consulting agreements, IN, Inc. commercializes the design, obtains regulatory approvals, develops clinical protocols for the technology, and then introduces the devices to the marketplace through a variety of distribution channels. IN, Inc's. first product, the WalkAide System ("WalkAide"), has received FDA approval, achieved ISO 13485:2004 and ISO 9001:2000 certification, as well as the European CE Mark, which are widely accepted quality management standards for medical devices and related services. Additionally, in September 2007 the WalkAide earned the esteemed da Vinci Award for Adaptive Technologies from the National Multiple Sclerosis Society which honors outstanding engineering achievements in adaptive and assistive technology that provide solutions to accessibility issues for people with disabilities. In November 2008, the Centers for Medicare and Medicaid Services overturned a non-coverage decision and assigned a specific E-code to the WalkAide, which is reimbursable for beneficiaries with foot drop

due to incomplete spinal cord injuries. The code was effective January 1, 2009. The WalkAide is sold in the United States through our patient care centers and SPS. IN, Inc. is also marketing the WalkAide internationally through licensed distributors.

Provider Network Management

Linkia is the first provider network management service company dedicated solely to serving the O&P market. Linkia is dedicated to managing the O&P services of national and regional insurance companies. Linkia partners with healthcare insurance companies by securing a national or regional contract either as a preferred provider or to manage their O&P network of providers. Linkia's network now totals over 1,000 O&P providers locations. As of December 31, 2008, Linkia had nine contracts with national and regional providers.

Results and Outlook

Net sales for the year ended December 31, 2008 increased by $65.7 million, or 10.3%, to $703.1 million from $637.4 million for the prior year. The sales growth was principally the result of a $41.3 million, or 7.3%, increase in same-center sales in our patient care business, an $11.9 million increase related to acquired entities, and an $11.5 million, or 19.1%, increase in sales by the Company's distribution segment. Cost of goods sold for the year ended December 31, 2008 increased by $35.4 million to $343.4 million, or 48.8% of net sales, compared to $308.0 million, or 48.3% of net sales, in the prior year. The increase in cost of goods sold was due to the increase in sales. As a percentage of net sales, cost of materials increased due to the increase in sales at SPS which have higher material costs and to a lesser extent an increase in costs in the patient care centers.

Income from operations increased by $9.7 million, or 14.3%, in 2008 to $77.7 million from $68.0 million in the prior year due principally to the sales increase. Income from operations as a percentage of net sales increased to 11.1% for the year ended December 31, 2008, from 10.7% in the prior year. This is a result of leveraging operating costs over increased sales, partially offset by increased material costs. Selling, general and administrative expenses increased by $19.3 million, however, they decreased 0.8% to 37.7% of net sales from 38.5% in 2007. The increase is primarily the result of $4.1 million of personnel costs, $2.9 million of merit pay increases to employees, $3.3 million of benefits costs, $3.7 million related to acquisitions, $3.1 million in variable compensation accruals, and $2.1 million of additional investment in growth initiatives.

Net income increased to $26.7 million in 2008 from $19.3 million the prior year primarily due to increased sales volume and a related increase in income from operations, as well as a $4.4 million reduction in interest expense resulting from lower interest rates in the financial markets.

For the year ended December 31, 2008 cash flow from operations increased by $1.5 million to $53.2 million compared to $51.7 million in the prior year. We continue to improve collections, and day sales outstanding, which is the number of days between the billing of our revenues and the date of receipt of payment, decreased to 51 days at the end of 2008 compared to 56 days at the end of 2007.

The Company had total liquidity of $96.6 million, comprised of $58.4 million of cash and $38.2 million available under its revolving credit facility at December 31, 2008. The Company believes that it has sufficient liquidity to conduct its normal operations and fund its acquisition plan in 2009.

For 2009, the Company expects revenues to be between $750 million and $760 million which would result in growth of 6.7% to 8.1% compared to 2008. The Company also expects diluted earnings per share for 2009 to be in the range of $0.96 to $0.98, which would represent a 23.1% to 25.6% increase over 2008 diluted earnings per share.

Critical Accounting Policies and Estimates

Our analysis and discussion of our financial condition and results of operations is based upon our Consolidated Financial Statements that have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. GAAP provides the framework from which to make these estimates, assumptions and disclosures. We have chosen accounting policies within GAAP that management believes are appropriate to accurately and fairly report our operating results and financial position in a consistent manner. Management regularly assesses these policies in light of current and forecasted economic conditions. Our accounting policies are stated in Note B to the Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K. We believe the following accounting policies are critical to understanding our results of operations and the more significant judgments and estimates used in the preparation of our Consolidated Financial Statements.

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º Revenue Recognition: Revenues from the sale of orthotic and prosthetic devices and associated services to patients are recorded when the device is accepted by the patient, provided that (i) delivery has occurred or services have been rendered; (ii) persuasive evidence of an arrangement exists; (iii) the sales price is fixed or determinable; and (iv) collectibility is reasonably assured. Revenues from the sale of orthotic and prosthetic devices to customers by our distribution segment are recorded upon the shipment of products, in accordance with the terms of the invoice, net of merchandise returns received and the amount established for anticipated returns. Discounted sales are recorded at net realizable value. Deferred revenue represents prepaid tuition and fees received from students enrolled in our practitioner education program.

Revenue at our patient-care centers segment is recorded net of all governmental adjustments, contractual adjustments and discounts. We employ a systematic process to ensure that our sales are recorded at net realizable value and that any required adjustments are recorded on a timely basis. The contracting module of our centralized, computerized billing system is designed to record revenue at net realizable value based on our contract with the patient's insurance company. Updated billing information is received periodically from payors and is uploaded into our centralized contract module and then disseminated to all patient-care centers electronically.

The following represents the composition of our patient-care segment's accounts receivable balance by payor:

        December 31, 2008                                       Over
        (In thousands)          0-60 days     61-120 days     120 days      Total
        Commercial and other    $   44,206    $      8,212    $   5,904   $  58,322
        Private pay                  3,478           2,324        1,161       6,963
        Medicaid                     9,660           3,068        1,507      14,235
        Medicare                    21,728           2,112        1,324      25,164
        VA                           1,021             200           55       1,276

                                $   80,093    $     15,916    $   9,951   $ 105,960

     December 31, 2007
     (In thousands)          0-60 days     61-120 days     Over 120 days      Total
     Commercial and other    $   41,806    $      9,561    $        6,836   $  58,203
     Private pay                  3,124           1,326             1,266       5,716
     Medicaid                     8,506           2,320             2,084      12,910
     Medicare                    20,557           2,622             1,603      24,782
     VA                           1,140             196               135       1,471

                             $   75,133    $     16,025    $       11,924   $ 103,082

Disallowed sales generally relate to billings to payors with whom we do not have a formal contract. In these situations, we record the sale at usual and customary rates and simultaneously record an estimate to reduce the sale to net realizable value, based on our historical experience with the payor in question. Disallowed sales may also result if the payor rejects or adjusts certain billing codes. Billing codes are frequently updated within our industry. As soon as updates are received, we reflect the change in our centralized billing system.

As part of our preauthorization process with payors, we validate our ability to bill the payor for the service we are providing before we deliver the device. Subsequent to billing for our devices and services, there may be problems with pre-authorization or with other insurance coverage issues with payors. If there has been a lapse in coverage, the patient is financially responsible for the charges related to the devices and services received. If we do not collect from the patient, we record bad debt expense. Occasionally, a portion of a bill is rejected by a payor due to a coding error on our part and we are prevented from pursuing payment from the patient due to the terms of our contract with the insurance company. We appeal these types of decisions and are generally successful. This activity is factored into our methodology to determine the estimate for the allowance for doubtful accounts. We immediately record, as a reduction of sales, a disallowed sale for any claims that we know we will not recover and adjust our future estimates accordingly.

Certain accounts receivable may be uncollectible, even if properly pre-authorized and billed. Regardless of the balance, accounts receivable amounts are periodically evaluated to assess collectibility. In addition to the actual bad debt expense recognized during collection activities, we estimate the amount of potential bad debt expense that may occur in the future. This estimate is based upon our historical experience as well as a review of our receivable balances. On a quarterly basis, we evaluate cash collections, accounts receivable balances and write-off activity to assess the adequacy of our allowance for doubtful accounts. Additionally, a company-wide evaluation of collectibility of receivable balances older than 180 days is performed at least semi-annually, the results of which are used in the next allowance analysis. In these detailed reviews, the account's net realizable value is estimated after considering the customer's payment history, past efforts to collect on the balance and the outstanding balance, and a specific reserve is recorded if needed. From time to time, the Company may outsource the collection of such accounts to collection agencies after internal collection efforts are exhausted. In the cases when valid accounts receivable cannot be collected, the uncollectible account is written off to bad debt expense.

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º Inventories: Inventories, which consist principally of raw materials, work in process and finished goods, are stated at the lower of cost or market using the first-in, first-out method. At our patient-care centers segment, we calculate cost of goods sold in accordance with the gross profit method for all reporting periods. We base the estimates used in applying the gross profit method on the actual results of the most recently completed physical inventory and other factors, such as sales mix and purchasing trends among other factors, affecting cost of goods sold during the interim reporting periods. Cost of goods sold during the period is adjusted when the annual physical inventory is taken. We treat these inventory adjustments as changes in accounting estimates. At our distribution segment, a perpetual inventory is maintained. Management adjusts

our reserve for inventory obsolescence whenever the facts and circumstances indicate that the carrying cost of certain inventory items is in excess of its market price. Shipping and handling costs are included in cost of goods sold.

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º Fair Value: Effective January 1, 2008, the Company adopted Statement of Financial Accounting Standard No. 157, Fair Value Measurements, or SFAS 157, which establishes a framework for measuring fair value and requires enhanced disclosures about fair value measurements. SFAS 157 requires disclosure about how fair value is determined for assets and liabilities and establishes a hierarchy for which these assets and liabilities must be grouped, based on significant levels of inputs as follows:

                 Level 1   quoted prices in active markets for
                           identical assets or liabilities;
                 Level 2   quoted prices in active markets for
                           similar assets and liabilities and
                           inputs that are observable for the
                           asset or liability;
                 Level 3   unobservable inputs, such as
                           discounted cash flow models and
                           valuations.

The determination of where assets and liabilities fall within this hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

Effective January 1, 2008, the Company adopted Statement of Financial Accounting Standard No. 159, or SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities Fair Value Measurements ("SFAS 159"). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings.

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º Investments: Investment securities available-for-sale consist of auction rate securities accounted for in accordance with Statement of Financial Accounting Standards No. 115 ("FAS 115"), "Accounting for Certain Investments in Debt and Equity Securities." Available-for-sale securities are reported at fair value with unrealized gains and losses excluded from earnings and reported in shareholders' equity. Under FAS 115, securities purchased to be held for indeterminate periods of time and not intended at the time of purchase to be held until maturity are classified as available-for-sale securities with any unrealized gains and losses reported as a separate component of accumulated other comprehensive loss. We continually evaluate whether any marketable investments have been impaired and, if so, whether such impairment is temporary or other than temporary.

Our investments consist of two auction rate securities ("ARS") with a credit rating of either A2 or AAA. ARS are securities that are structured with short-term interest rate reset dates which generally occur every 28 days and are linked to LIBOR. At the reset date, investors can attempt to sell via auction or continue to hold the securities at par. As of December 31, 2008, both investments failed at auction due to sell orders exceeding buy orders. The funds associated with these securities will not be accessible until a successful auction occurs, a buyer is found outside of the auction process, the issuer refinances the underlying debt, or the underlying security matures. The Company's ARS are reported at fair value.

The fair values of our ARSs were estimated through use of discounted cash flow models. These models consider, among other things, the timing of expected future successful auctions, collateralization of underlying security investments and the credit worthiness of the issuer. Since these inputs were not observable, they are classified as level 3 inputs under the fair value accounting rules discussed below under "Fair Value".

Due to lack of liquidity in the ARS market and not as a result of the quality of the underlying collateral, for the twelve months ended December 31, 2008, we recorded an unrealized loss of $1.0 million related to the ARS which has a par value of $2.5 million and is classified as long term. This loss is reflected in other comprehensive income in our consolidated balance sheet.

On November 4, 2008, the Company agreed to accept Auction Rate Security Rights ("the Rights") from UBS offered through a prospectus filed on October 7, 2008. The Rights permit us to sell, or put, our auction rate securities back to UBS at par value, which is $5.0 million, at any time during the period from June 30, 2010 through July 2, 2012. The Company expects to exercise our Rights and put our auction rate securities back to UBS on June 30, 2010, the earliest date allowable under the Rights.

By accepting the Rights, we can no longer assert that we have the intent to hold the auction rate securities until anticipated recovery. Therefore, we recognized an other-than-temporary impairment charge of approximately $1.0 million during the year ending December 31, 2008 to adjust the value of the ARS to its fair value of $4.0 million. Under the Rights agreement the Company is permitted to put the auction rate securities back to UBS at par value, accordingly the Company has accounted for the Rights, under SFAS 159, as a separate asset with a fair value of $1.0 million. The fair value of the Rights was determined by utilizing a discounted cash flow models adjusted for the economic ability of UBS to meet the obligation. Recordation of the Rights asset resulted in a gain of $1.0 million during the year ended December 31, 2008. The charge related to the impairment and the gain resulting from the Rights asset are reflected as components of earnings.

The Company has elected to classify the Rights and reclassify our investments in auction rate securities as trading securities, as defined by FAS 115. As a result, the Company will be required to assess the fair value of these two individual assets and record changes each period until the Rights are exercised or the auction rate securities are redeemed.

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º Interest rate swaps: In May 2008, the Company entered into two interest rate swap agreements under which $150.0 million of the Company's variable rate Term Loans were converted to a fixed rate of 5.4%. The agreements, which expire April 2011, qualify as cash flow hedges in accordance with Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, or SFAS 133. The fair value of the interest rate swaps is an estimate of the present value of expected future cash flows the Company is to receive under the interest rate swap agreement. The valuation models used to determine the fair value of the interest rate swap are based upon forward yield curve of one month LIBOR (level 2 inputs), the hedged interest rate. There was ineffectiveness relating to the interest rate swaps for the twelve months ended December 31, 2008 of $0.7 million, which is reported as unrealized loss from the interest rate swap on the income statement. Unrealized losses, related to the effective portion of the interest rate swap, of $6.5 million are reported in accumulated other comprehensive income, a component of shareholders' equity. The interest rate swap current liability of $3.7 million is reported in accrued expenses, while the interest rate swap long-term liability of $3.5 million is reported in other . . .