Healthtronics, Inc (HTRN) - Description of business

Symbol:	HTRN
Type:	NASDAQ
State location:	TX
State of Inc:	GA
Phone:	512-328-2892
Fax:	512-328-8510
Web Site:	www.healthtronics.com
Full Time Employees:	413
Business Address:	1301 CAPITAL OF TEXAS HWY. SUITE B-200 AUSTIN TX 78746 512.328.2892
Mailing Address:	1301 CAPITAL OF TEXAS HWY. SUITE B-200 AUSTIN TX 78746

General

        HealthTronics Surgical Services, Inc. (may be referred to as, "HealthTronics", the "Company", "we", "us" or "our") is a Georgia corporation founded in 1995 for the purpose of providing state-of-the-art noninvasive treatment solutions for certain orthopaedic and urologic conditions. Through exclusive distribution agreements with HMT High Medical Technologies AG ("HMT"), the Company either forms operating partnerships with physicians or sells certain devices which are used to treat patients. These devices include the OssaTron® orthopaedic shock wave system, the LithoTron® kidney lithotripter and the LithoTron Ultra endourology workstation. In 2000, we also began to market the CystoTron™ urodiagnostic table. All of these devices have been approved by the Food and Drug Administration ("FDA") and are currently marketed throughout Europe. These products are currently manufactured by HMT of Switzerland and Philips Medical Systems of Germany.

        As part of its strategy, the Company provides Orthotripsy® extracorporeal shock wave therapy ("ESWT") and lithotripsy services to doctors, medical facilities and, increasingly, directly to patients. As a service provider, HealthTronics supplies the device, the technologist and the consumables required to perform lithotripsy or Orthotripsy ESWT treatment.

        Through the Company's acquisition of Litho Group, Inc. ("Litho Group") from Integrated Health Services, Inc. on December 11, 2001, the Company believes it provides more lithotripsy treatments on an annualized basis than any other provider in the United States. In addition, as the first mover in the fast growing Orthotripsy ESWT business, HealthTronics is currently the largest provider of this service. As of December 31, 2001, the Company had 100 lithotripsy devices and 48 OssaTron machines in operation throughout 40 states.

        The Company had 261 employees as of December 31, 2001, and management believes relations with the employees are good.

The Orthopaedic Market

The OssaTron is an extracorporeal (non-invasive) medical device, which uses high energy shock waves to treat chronic musculoskeletal injuries. Orthotripsy ESWT, the Company's name for this procedure, is the process by which shock waves are transmitted into the site of a chronic musculoskeletal injury. Most chronic injuries are characterized by scar and inflammatory tissue. When shock waves are applied to these tissues, controlled microscopic injuries are created within the already damaged tissues. Clinical studies by the Company and data currently available in Europe show that the resulting microscopic injuries stimulate the formation and growth of new blood vessels into the area. These new blood vessels bring with them bone-healing and tissue-healing cells which stimulate the healing process. The result is a physiologic repair of the musculoskeletal problem. The benefits to the patient are less associated pain, fewer complications, faster recovery and lower costs.

HealthTronics' OssaTron device has been used successfully in Europe since 1995 to treat a variety of orthopaedic disorders such as plantar fasciitis (heel pain), lateral epicondylitis (tennis elbow), Achilles tendonitis, patellar tendonitis, avascular necrosis, shoulder calcification and nonunion fractures. On October 12, 2000, the FDA granted a Class III pre-market approval ("PMA") for marketing of the OssaTron for the treatment of plantar fasciitis.

        HealthTronics is the first company to market orthopaedic shock wave technology in North America. Our OssaTron orthopaedic shock wave device was approved by the FDA on October 12, 2000 for the treatment of plantar fasciitis (commonly known as heel spurs or heel pain syndrome). There is no verifiable data on the number of cases of plantar fasciitis, but we estimate that about six and a half million new patients each year are afflicted with this condition. HealthTronics believes that up to 10% of these patients could be candidates for Orthotripsy ESWT with the OssaTron rather than undergo invasive surgery as a treatment.

        HealthTronics believes the OssaTron can be used to treat a variety of additional orthopaedic disorders. Other soft tissue indications for the OssaTron include lateral epicondylitis (also known as tennis elbow, for which we have completed an FDA study), Achilles tendonitis, patellar tendonitis and shoulder tendonitis. Although the Company is still compiling verifiable incidence data for these indications, we estimate that between three and four million people annually suffer from these conditions. The Company recently submitted a pre-market approval application to the FDA for the treatment of lateral epicondylitis. Future studies include the treatment of Achilles tendonitis, patellar tendonitis and shoulder tendonitis. The OssaTron has also exhibited the potential to stimulate healing of nonunion fractures and other pathologic conditions of the bone.

        Our preferred marketing strategy is to place OssaTron devices into limited partnerships of which HT Orthotripsy Management Company, LLC, a wholly owned subsidiary of the Company, is the general partner. The Company capitalizes each partnership with an OssaTron and, at times, a truck and cash. We then negotiate with hospitals and surgery centers to provide Orthotripsy ESWT services within their facilities. We pay the hospital or surgery center a fee for access to their facility. The Company then bills the third party payors for the facility fee and the technical fee. A percentage of the limited partnership interest may be sold to physicians or other partners. Our goal with this arrangement is to generate recurring revenue for the Company for as long as the device is operational.

On January 29, 2002, Dornier Medical Systems received FDA approval for an orthopaedic shock wave device for the treatment of plantar fasciitis. The Company does not know what Dornier's strategy is for marketing its device, however we anticipate that this product will compete against the OssaTron orthopaedic shock wave device for the treatment of heel pain. We believe that Siemens GmbH is also in the process of conducting clinical studies with an orthopaedic shock wave device for the treatment of chronic orthopaedic injuries.

The Urology Market

        HealthTronics' primary urology product is the LithoTron lithotripter. The LithoTron was developed by HMT of Switzerland. Since 1996, HealthTronics has had the exclusive right to market this device in the United States, Canada, and Mexico.

        A lithotripter breaks kidney and ureter stones into pieces small enough to be passed from the body through the normal flow of urine. The LithoTron does this by sending precisely focused, high-energy

shock waves through the body to the kidney and ureter stones, pulverizing the stones into sandlike granules, which can be eliminated from the body normally.

        HealthTronics received FDA approval for the LithoTron on July 21, 1997, after completion of a four-site Investigational Device Exemption (IDE) study. Since that time, we believe HealthTronics has become one of the leading providers of new lithotripsy equipment in North America.

        One of the reasons for the overwhelming popularity of the LithoTron is its effectiveness. Our studies show that the LithoTron has one of the highest success rates (86.1%) and one of the lowest retreatment rates (4.1%) of any lithotripter on the market. In addition, the LithoTron is very safe for patients, easy for physicians and technologists to operate, and cost effective for healthcare facilities. These factors have also helped to make the LithoTron one of the top-selling lithotripters in North America.

        The LithoTron is small, modular and easy to move. Most LithoTrons are shared by several hospitals and surgery centers and are transported among them in small trucks. This high degree of mobility enables a LithoTron to serve multiple facilities. We estimate that approximately 50,000 patients were treated on LithoTron lithotripters in 2001.

        The LithoTron Ultra endourology workstation was developed jointly by HMT of Switzerland and Philips Medical Systems of Germany. HealthTronics has the exclusive right to market this product in the United States, Canada and Mexico. We received supplemental approval from the FDA to begin marketing the device in 1999.

        The LithoTron Ultra was designed for fixed site installation at hospitals and large surgery centers. To date, five of the largest lithotripsy centers in North America have installed the LithoTron Ultra. This device not only has the ability to disintegrate kidney stones in the same manner as the LithoTron but also has significant diagnostic capabilities. This multifunctional device can be used to perform a variety of urologic examinations, procedures and treatments.

        Among its many features, the LithoTron Ultra has a state of the art x-ray system, which produces better images than conventional x-ray techniques. In addition to its superb imaging, the x-ray system significantly reduces the amount of radiation exposure experienced by patients and medical staff. In some cases, radiation exposure can be decreased by as much as 95%.

        The CystoTron diagnostic urology table was developed by Philips Medical Systems of Germany. HealthTronics has the exclusive right to sell this device in the United States, Canada and Mexico, and began marketing this device in 2000. The CystoTron can be used to perform various urologic examinations, procedures and treatments. Like all of HealthTronics' products, the CystoTron provides comfort and safety for patients and physicians. The CystoTron is versatile, easy to operate and has the same state of the art x-ray system as the LithoTron Ultra.

Market Overview

        It is estimated by healthcare providers that approximately 600,000 patients per year are diagnosed with kidney stones in the United States. Of these, about 250,000 will be treated with lithotripsy, a non-surgical therapy for the disintegration of kidney stones that was developed in Germany in the late 1970's and early 1980's. At the end of 2001, it is estimated that approximately 550 to 600 lithotripter systems were in operation in the United States. These lithotripters either were installed in hospitals or outpatient centers or were operating as mobile/transportable devices. The majority of these lithotripsy devices were distributed by companies other than HealthTronics.

        At the end of 2001, there were approximately 100 HealthTronics urology devices operating in North America.

The kidney lithotripsy market is extremely competitive and, therefore, we have a multifaceted marketing strategy. Our primary focus is the creation of lithotripsy partnerships with urologists. Within these partnerships we may be the manager, general partner or minority partner. These partnerships generally either act as a vendor of lithotripsy services to hospitals and surgery centers on a per patient charge basis.

The Company also leases equipment to hospitals and doctors with whom we have no affiliation. Additionally, we sell equipment directly to non-affiliates.

        Our competitors in the field of kidney lithotripsy include companies such as Dornier Medical Systems, Siemens GmbH, Medstone International, Inc., Storz Medical Systems, Prime Medical Services, Inc. and American Kidney Stone Management. All of these companies have been operating in the kidney lithotripsy business longer than HealthTronics.

Technology Services

        HealthTronics formed its own Technology Services Division ("HTSD") in 1999. Since that time, HTSD has been providing installation, maintenance, service and technical support for our products. The service provided includes warranty work on new equipment as well as post-warranty service. Post-warranty service is provided on either a contractual or a time and materials basis.

        All HTSD service engineers meet the stringent certification prerequisites of the manufacturer HMT and HealthTronics. Their certification aids in compliance with all Good Manufacturing Practice ("GMP") requirements of HMT. Annual re-certification of our engineers ensures they have the most current knowledge of our products and that all service performed meets the manufacturer's conditions for GMP.

        Through the acquisition of Litho Group, the Company also acquired ServiceTrends, Inc. ServiceTrends provides service, maintenance, installation and technical support for many of Litho Group's devices as well as for additional machines that are not related to the Company. We will continue to operate ServiceTrends and will continue services to all parties, related and non-related, for the foreseeable future.

        The equipment service business is very competitive, and it is entirely possible that other national or local medical device service companies will also attempt to capture a share of this business.

Risk Factors

        Each of the following risk factors could adversely affect our business, financial condition and operating results, as well as the value of an investment in our common stock.

We are entirely dependent on HMT to manufacture certain products we distribute. If HMT ceased operations we might not find a suitable alternative manufacturer.

        Our main products are manufactured by HMT, a privately held company that is not required to publish any financial information. If HMT experiences financial, manufacturing or development difficulties or if there are adverse developments in our relationship with HMT, we may be required to find an alternative manufacturer or to manufacture our products on our own. We may not be able to

find an alternative source to develop or manufacture our products on a timely basis or on terms acceptable to us. We do not own or operate any manufacturing facilities.

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

        Our success in developing and assisting in the operation of lithotripsy and Orthotripsy partnerships in which we hold an interest will depend on our ability to develop and maintain relationships with physician groups and hospitals, consistent with government regulations affecting these relationships. We cannot ensure that we will be successful in identifying and establishing relationships with physicians or hospitals, nor can we ensure that affiliated physician groups will maintain successful medical practices or that any particular key member of a physician group will continue to practice with an affiliated partnership. Furthermore, disputes may arise periodically between physicians or hospitals and us regarding the management or operation of any of the partnerships in which we have an interest. Other factors that could interfere with our relationships with physicians include dissatisfaction with our medical devices, regulatory changes, retirement of physician investors and efforts by our competitors.

Because of extensive healthcare regulation, we may not be able to enter into certain transactions with healthcare professionals or facilities to place our products in service.

        Our operations and those of healthcare professionals and facilities with which we do business are subject to extensive regulation by federal and state governments. Such regulations may force us to delay, modify or avoid certain transactions that would otherwise benefit the Company.

        The Medicare and Medicaid Anti-Kickback Statute ("Anti-Kickback Statute") prohibits certain business practices and relationships under Medicare, Medicaid and other federal healthcare programs. Prohibited practices include the payment, receipt, offer or solicitation of money in connection with the referral of patients for services covered by a federal or state healthcare program. We contract with physicians under a variety of financial arrangements, and physicians have ownership interests in some entities in which we too have an interest. If we are found to have failed to comply with any of these laws, we could suffer criminal and civil penalties and/or exclusion from participating Medicare, Medicaid or other governmental healthcare programs and possible license revocation.

        The Federal Self-Referral Law prohibits a physician from referring a patient to an entity with which he or she (or a family member) has a financial relationship if the referral involves a "designated health service" reimbursable under the Medicare or Medicaid programs. The term "designated health services" does not specifically include orthopaedic ESWT. However, lithotripsy procedures are currently required to be billed to Medicare as hospital services. Inpatient and outpatient hospital services are expressly included among designated health services covered under the statute. Accordingly, lithotripsy could be covered under the Federal Self-Referral Law as well. If orthopaedic ESWT procedures are performed under arrangements with hospitals, then they may be covered under the Federal Self-Referral Law as well. If orthopaedic ESWT is deemed covered under the statute because such services are required to be billed through a hospital or on some other basis and no exception is provided, referrals of Medicare and Medicaid patients by physicians with an ownership interest in, or a compensation arrangement with, a partnership, or with a hospital or ambulatory surgery center ("ASC") with which the Partnership had leasing arrangements, may be prohibited. The final regulations do provide that a rental arrangement that otherwise satisfies a lease exception may provide for payment on a per-treatment or usage basis, even if physicians own the equipment and refer their patients for treatments using the equipment.

        In addition to these federal laws, many states have adopted similar laws. Some of these laws apply even if the payment for care does not come from the government. While there is little precedent for the interpretation or enforcement of these state laws, we cannot assure you that these laws will not be enforced against us or that our attempts to structure our financial relationships with physicians and others in light of these laws will be effective.

Third-party payors could refuse to reimburse healthcare providers for use of our current or future products, which could make our revenues decline.

        Third-party payors are increasingly attempting to contain healthcare costs by limiting both coverage and the level of reimbursement of new medical procedures and treatments. Consequently, significant uncertainty exists as to the reimbursement status of newly approved healthcare products. The hospitals and surgery centers to which we currently provide lithotripsy services are reimbursed for lithotripsy services under various federal and state programs, including Medicare and Medicaid, primarily at fixed rates. These programs are subject to statutory and regulatory changes, administrative rulings, interpretations of policy and governmental funding restrictions, 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 and adverse effect on us.

        With respect to the OssaTron, we cannot ensure that third-party payors will establish and maintain price levels sufficient for us to realize an appropriate return on our investment. Furthermore, physicians, hospitals and other healthcare providers may be reluctant to purchase our products if they do not receive sufficient reimbursement for the cost of the procedures using our products.

We face intense competition and rapid technological change that could result in products that are superior to the products we are commercializing or developing.

        The medical device industry is subject to rapid and significant technological change. Our competitors may develop technologies and products that are more effective or less costly than any of our current or future products or that could render our products obsolete or noncompetitive. Many of these competitors have substantially greater resources and marketing capabilities than we do.

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

        Our business exposes us to potential product liability risks that are inherent in the testing, manufacturing, marketing and selling of medical devices, including those which may arise from misuse or malfunction of, or design flaws in, our products. We may be held liable if any of our products causes injury or is found otherwise unsuitable during product testing, manufacturing, marketing or sale. Treatment with ESWT may result in a variety of complications, in particular, post-treatment pain and neurological symptoms. We cannot ensure that we will be able to avoid product liability exposure. Product liability insurance for the medical technology industry is generally expensive, if available at all. We cannot assure that our present insurance coverage is adequate or that we can obtain adequate insurance coverage at a reasonable cost in the future.

The failure to integrate Litho Group, Inc. and its subsidiary partnerships successfully may result in the Company not achieving the anticipated benefits of the merger.

        In integrating Litho Group, the Company will face challenges in consolidating functions, integrating its organizations, procedures, and operations in a timely and efficient manner and retaining key personnel. These challenges will result principally because Litho Group, Inc.:

        As a result, the integration will be complex and will require additional attention from members of management. The diversion of management attention and any difficulties encountered in the transition and integration process could have a material adverse effect on the Company's revenues, level of expenses and operating results.

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 has claimed 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 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. Our Chairman, Dr. Argil Wheelock, is a urologist whose management ability and relationships with our physician partners are extremely important to the Company. The loss of services of any of these persons could adversely affect the commercialization of our current products and our ability to develop and commercialize future products. There is intense competition for qualified staff, and we cannot assure 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.

We have incurred a significant amount of indebtedness.

        The Company has incurred debt to finance the acquisition of Litho Group, Inc. In order to comply with the debt covenants, the Company must use a significant portion of its ongoing income to meet scheduled payment terms. At December 31, 2001, we had debt outstanding of approximately $53,000,000 and shareholders' equity of $21,900,000. The Company may continue to borrow funds to finance acquisitions as well as for other purposes.

        Such a large amount of debt could have negative consequences for us, including without limitation:

The failure to comply with the covenants in the agreement governing the terms of our indebtedness could be an event of default and could accelerate the payment obligations. Certain covenants also limit our ability to take certain actions without lender approval.