Hanger, Inc.
Q1 2022 Earnings Call Transcript

Published: 8 May 2022

[Operator:]

Hello and welcome to the Hanger First Quarter 2022 Earnings Conference Call. My name is Juan and I will be coordinating the call today. I will now hand over to your host, Asher Dewhurst, Managing Director of Westwicke to begin. So Asher, please go ahead when you are ready.

[Asher Dewhurst:]

Good morning and welcome to Hanger’s first quarter 2022 earnings conference call. With us today are Vinit Asar, Hanger’s President and Chief Executive Officer and Thomas Kiraly, Executive Vice President and Chief Financial Officer. Some of the information discussed today will include forward-looking statements under the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to risks, uncertainties that can cause Hanger’s actual results to materially differ from those that we discuss today. Those risks include, among other things, matters that we have identified in our forward-looking statements portion of our latest earnings call and in our filings with the SEC. Hanger disclaims any obligation to update forward-looking information discussed on this call. And now I will hand the call over to Vinit.

[Vinit Asar:]

Thank you, Asher. Good morning and thank you all for joining Hanger’s first quarter 2022 earnings call. Joining me on today’s call is Tom Kiraly, Hanger’s Chief Financial Officer. This morning, I will provide some high level thoughts on our first quarter 2022 results, followed by an update on our business segment and operational performance. Tom will then discuss our financial results in more detail, after which we will open the call for questions. We finished Q1 with a solid top line performance despite starting the year facing the remnants of the Omicron surge and its effect on our operations. You will recall that the first 6 weeks of the year were significantly impacted by COVID related disruptions, which subsided towards the end of the quarter. First quarter revenue of $261.3 million reflected a strong top line growth of 10%. Our adjusted EBITDA of $8.9 million was impacted by a couple of short-term items that I’ll get into in a minute. A few things I’d like to note about our quarterly results. First, a solid 6.9% same clinic revenue performance in our patient care segment and an overall 10% revenue growth has given us a strong start to the year. It reflects the efforts put in by our teams around the country that navigated a difficult operating environment, especially during the first half of Q1. We were pleased to see these results, which reflect continued recovery and return to patient volumes in our clinics. It is important to note that the strong revenue growth in Q1 this year, compared to Q1 of last year was achieved despite the abnormally low revenue disallowance rate we had experienced last year. Tom will provide more color on the impact of this on our adjusted EBITDA comparisons in his prepared remarks. Second, as part of our supply chain strategy, we relocated one of our largest central fabrication centers into a purpose-built state-of-the-art 49,000 square foot central fabrication center in Phoenix. This new facility includes lean manufacturing, training and automation areas consisting of digital carvers, 3D printers and a robotic cell. This move, which experienced a delay during the quarter due to local permitting issues is now fully operational and will be extremely beneficial to our operations on a go-forward basis. Third, the impact of Omicron was especially significant in the first half of Q1 driven by elevated levels of sick leave during this period. The combination of this staffing shortage, as well as the temporary disruption caused by the delay of our fabrication center move, required an extensive use of higher cost, third party fabrication and temporary labor during this time. We expect the impact of these issues to subside in Q2. Fourth, during the quarter, despite the effects of Omicron, we were able to both deliver on the work in process that had built up at December 31, as well as replenish our RIP balance to level significantly higher than those we carried last year this time. This sets the stage for continued positive growth trends in Q2. Lastly, as some of you know, the first quarter is seasonally the lowest contributing quarter for our business and shouldn’t be used to extrapolate our performance for the full year. We expect earnings growth in the second quarter to accelerate, which follows our normal seasonality. Now, I will drill down into the results of our two business segments. During the first quarter, patient care revenue increased 12.3% year-over-year, driven by 6.9% same clinic revenue growth. Our prosthetics business in a segment edged up to 52.1% of our portfolio up from 51.7% compared to the same quarter in the prior year. On a same clinic basis, we were also pleased to see prosthetics revenue grow 7.7% in Q1 this year versus 2021. Products and services revenues of $41.5 million for the quarter remain largely in line with the prior year. While revenues in the distribution segment were slightly higher than the same period of 2021, we did see a margin degradation in the business driven by freight, the normalization of bad debt and other operating costs. Our therapeutic solutions business showed a slight decline in revenues, mirroring the pressures faced by their skilled nursing customers and their reduced census. Overall when we look at our results, we feel our first quarter patient care revenue growth of 12.3%, which constituted 84% of our revenues this quarter, establishes a solid foundation for the year as we return to normalcy. With regards to our progress on tuck-in acquisitions, we closed on one transaction during Q1, and our M&A pipeline remains robust as we expect deal activity to continue through the year. Our capital deployment strategy is diligent and balanced as we look to grow and add to our business in a creative manner, while also looking to reduce our leverage ratio as we keep a close eye on the interest rate environment. During our last update in early March, we discussed a number of strategic initiatives and clinical studies, which highlight their importance and value creation for Hanger. We continue to push forward with these initiatives, as we are convinced that this will help drive mind share and incremental business over the long run. Separately, in early April, we published a new ESG report, which highlights the initiatives and processes underway as part of our ESG journey. Given the combination of our values and the purpose-based nature of what we do, Hanger’s ESG philosophy aligns naturally with and is intended to support our core business strategy. You can access our ESG report at hanger.com. With regards to our full year 2022 guidance, given our solid revenue trends and strong patient volumes, we are maintaining our full-year outlook. Before I turn the call over to Tom to discuss our first quarter financial results, I want to thank our entire organization for their hard work and dedication that enabled us to generate these results. Together, we will continue to focus forward and unleash the full potential of Hanger, building on our efforts over the last several years while gaining share and providing the highest quality care for patients and customers. I want to thank everyone on the call for your interest in Hanger. And with that, I’ll turn the call over to Tom who will provide more details on our financial results and guidance. Tom?

[Thomas Kiraly:]

Thanks, Vinit and good morning. We are pleased to be off to a solid start from a revenue growth perspective with strong same-clinic growth and continuing increases in the company’s work and process balances. During my portion of the call, I will provide you with additional insight into the inherent strength and sustainability of that growth and will also spend some time reviewing the items in the period that had a bearing on the company’s reported earnings. As Vinit shared, the patient care segment reported 12.3%, total growth and 6.9%, same clinic growth during the quarter. These results are even more impressive considering the normally low rate of disallowances in the previous year period. Our total disallowance rate was 4.4% in the first quarter of this year. This compares with a rate of 2.9% reported during the same period last year. As we discussed during last year’s first quarter call, we felt that the low disallowances at that time, may have reflected a COVID-19 related benefit and were likely to return to this more normal trend as they have. This period over period swing in disallowance resulted in approximately $3.5 million in lower net revenue and earnings in the first quarter of 2022 as compared with the first quarter of 2021. In analyzing this further, as of the end of March, total disallowed revenue was 4.3% on a trailing 12-month basis, which is in line with what we reported in the first quarter. However, it’s also important to point out that underlying same-clinic disallowances were 3.7% in the quarter and have generally been running about 35 basis points lower than total disallowances during the past 12 months as acquisitions join us with an inherently higher rate of disallowed revenue prior to their integration. Based on this, we believe it’s reasonable to expect that disallowed revenue could decrease to approximately 4% as acquisitions are integrated into the company and they gravitate to our underlying core rate. Additionally, in looking at the patient care segment 6.9% same clinic rate of growth, if you adjust put a swing in disallowances, the underlying same clinic growth rate during the first quarter was 7.9%. We estimate that approximately 2.7% related to rate and 5.2% related to volume growth. In addition to a strong rate of growth in the period, the patient care segment has also experienced further significant increases in patient demand as evidenced by a 16% increase in same clinic work and process inventory is compared with March 31, 2021. These results are made all the more remarkable by the fact that Hanger encountered significant adversity from the Omicron variant during the first months of the quarter and experienced higher employee sick time. Despite this, our clinics were able to deliver for our patients in the quarter and entered the second quarter with an increased level of WIP. Before I turn to earnings, I should note that the net revenue in our products and services segment was essentially consistent with a level reported during the first quarter of 2021. We did experience a modest $700,000 in growth in our distribution services net revenue. It was offset by $1 million decline in therapeutic solutions revenues. Overall, Hanger grew revenues by $23.8 million or 10% during the quarter. Now, let’s turn to the company’s earnings for the quarter. In total, the company produced $8.9 million an adjusted EBITDA in the first quarter, which reflected a $4.6 million decline from the same period in 2021. Patient care accounted for $1.9 million of this decrease, products and services constituted $2 million and the remaining $700,000 related to increases in corporate expenses. In reviewing these results, it’s important to note that due to the seasonality of our business, the unique nature of the events that affected operations in the first quarter and an inherently fixed cost structure, Hanger’s first quarter earnings have always been highly volatile and are not a useful indication of the company’s performance trends for the full year. In particular, this has been the case during the last 3 years. In reviewing patient care results, there are 3 key items to take into consideration. First, $3.5 million of the earnings variance relates directly to the swing from a favorable 2.9% disallowance rate in the first quarter of 2021, to a more normal rate of 4.4% in the first quarter of 2022. Secondly, as Vinit shared, given the effects of COVID-19 on our personnel and the delay in the opening of our Phoenix, Arizona fabrication facility in January, we found it necessary to increase our reliance on higher-cost third-party fabrication providers. Due to these costs, our total fabrication network expenses increased on a percent of revenue basis and drove $1.2 million and higher operating costs, with $900,000 affecting adjusted EBITDA. This was a primary driver of the increase experienced in material costs during the quarter. The use of third-party fabrication returned to more normal levels by March after COVID subsided and our new facility was opened. We chose to meet the needs of our patients during the quarter despite these adversities and to bear these additional costs in the process. Finally, an additional cost item that affected our materials cost in the patient care segment during the quarter related to $630,000 in increased freight costs, primarily relating to increase fuel and container costs. While we do not necessarily view this particular item to be temporary, we currently believe that favorable reimbursement rate trends as compared to our original forecast will enable us to more than offset it. In total, these three items affected comparative patient care adjusted EBITDA results by $5 million, of which only the $630,000 and frayed was not transitory in nature. Another important point is that absence of transitory items and the acquisition effects on the comparative periods, patient cares underlined margin in Q1 2022 was the same as its margin in Q1, 2021. In other words, after taking these and other smaller into consideration, during the quarter, inflation and material costs and salaries, was generally consistent with the patient care segments underlying increase in reimbursement rate. During 2021 and for the year-to-date, Hanger has been able to manage underlying inflation. In the case of material costs, this has been due primarily to our purchasing scale, ability to emphasize preferential skews and the investment we’ve made in advancing our supply chain operations. In the case of labor cost, while we have encountered some constraints in the areas of office administration, technician and distribution center roles, these are a relatively smaller and lower compensated portion of our employee base. In contrast to other health care firms you may be more familiar with, Hanger does not employ nurses and as accordingly, not had to endure the significant cost increase you’ve heard about in the hospital and related sectors. As a result of these factors, to date, patient care has not experienced a notable change in its margin due to inflation. Turning to the products and services segment, in a manner similar to patient care, comparative results for this segment also reflect some items that were beneficial to the first quarter 2021 results as well as items specific to Q1, 2022. However, as Vinit shared, we have experienced a decrease in the underlying margin of this portion of our business. Fortunately, we anticipated much of this in our plan for the year. In summarizing the company’s total earnings performance during the quarter, in recent years Hanger’s first quarter adjusted EBITDA as a percentage of the total year has ranged from 5% to 10% of full-year results. Given the strong same clinic rate growth rates being achieved and the inherent nature of the items that cause volatility to earnings, we believe 2022 to follow this same pattern. Now I’ll spend a few minutes on the company’s cash flows. Due to seasonality in the payment of annual incentive compensation, Hanger normally consumes operating cash flow in the first quarter. This year, due to lower incentive payments, lower accounts payable consumption and decreases in cash outflows for inventory, we consumed $34.1 million less operating cash flow during the first quarter of 2022 as compared with the first quarter of 2021. Capital expenditures and purchases of therapeutic equipment were also favorable to trend as we expanded just $4.5 million in the current year as contrasted to $6.9 million in the prior year. On a trailing 12-month basis, our capital expenditures have run $22.4 million. As of March 31, 2022, we had $167.2 million in total liquidity, which is up by $2.1 million as compared to March 31, 2021. We are currently sitting with a leverage ratio of 3.7x the midpoint of our 2022 guidance. In closing, I’ll provide a few comments regarding our outlook for 2022. As we progress through the second quarter, we are highly encouraged by the strong rates of same clinic revenue growth and increases in work in process reflected on our results. We currently believe those trends are more than sufficient to offset the structural cost items that were not specific to the quarter, such as freight costs, as well as the trends in our products and services segment. Given these factors, we are maintaining our original outlook at this time. As we originally announced on February 7, we estimate that 2022 net revenue will be in a range between $1.19 billion to $1.22 billion and adjusted EBITDA will be in a range between $127 million to $132 million. Overall, patient care revenue growth will be aided by approximately $35 million in the annualized revenue effect of acquisitions completed in 2021. With that, I will turn the call back over to the operator to open it up for any questions that you may have.

[Operator:]

Thank you. And the first question comes from the line of Brian Tanquilut from Jefferies. Please, Brian. Your line is now open.

[Brian Tanquilut:]

Hey, good morning, guys. Thanks for the questions here. So I guess, Tom, my first question, as I think about the non-recurring or what feels like transient issues during the quarter, maybe just give us a little more color, like how does that work out or how did that play out with the use of the third-party fabs? Because normally when we see quarantines of employees, it’s the top line where that hits in terms of capacity. So just maybe, if you can explain how that all played out and what you are seeing currently in terms of the utilization of third-parties?

[Thomas Kiraly:]

Yes, Brian. So, it’s normally Hanger does use third-parties for certain of its fabrication and in the first quarter, we found that we just had to use significantly more because of the disruption of our own operations. It really didn’t affect revenues. I think you could see revenues were very robust because we were able to deliver for patients, but it did affect our expenses because we had to rely on these third-party fabs in addition to carrying the overheads associated with the employees that we were unable to use.

[Brian Tanquilut:]

Got it. No, I appreciate that. And then you maintained guidance obviously and I get the top line driven confidence there, but maybe just anything you can share with us that would give us confidence in the numbers that you are maintaining today. I know that obviously, there is a high contribution margin to revenue, so just thought if you could share with us anything that – any color that you can share that would give us that level of confidence?

[Vinit Asar:]

Sure, yes. The first quarter revenues clearly came in strong. We are really pleased with it. We have talked about some of the initiatives and programs we put in place over the last couple of years and we see them bearing fruit right now. So we feel very good about the top line and as Tom mentioned in his prepared remarks, that the WIP ending the first quarter also was pretty strong. So for the remainder of the year, we are feeling pretty good about the top line growth. And then when you combine that with these couple of transitory items, it’s really two transitory items that affected Q1. It’s this swing in the disallowance rate, which was abnormally low last year and then it’s these higher third-party fab spend in Q1 of this year. When you adjust for all of that, we are feeling very good about where we are.

[Brian Tanquilut:]

Got it. And then Tom just to clarify, you don’t have acquisitions in the guidance, right?

[Thomas Kiraly:]

That’s correct. We have only the 2021 acquisitions the effect on revenue this year. It’s not comparable to the prior year, which is around $35 million. So anything we close in 2022 would be something that we would eventually have to adjust guidance for.

[Brian Tanquilut:]

Alright. Got it. Thank you.

[Vinit Asar:]

Thanks, Brian.

[Operator:]

Thank you. Our next question comes from the line of Larry Solow from CJS Securities. Please Larry, your line is now open.

[Larry Solow:]

Great. Good morning, guys. Picking up on just Brian’s line of thinking on the acquisitions, maybe if you could discuss the pipeline of opportunities, I feel like during COVID in the last couple of years, maybe there are more companies who could use a larger, bigger hand for help? And then how do you weigh sort of your longer term goals maybe to bring down your leverage a little bit to like degenerating? It looks like in the last 12 months you got $50 million in free cash flow, which is a solid number, but I don’t see that number really growing that much above that. How do you sort of take that $50 million in free cash flow, maybe the idea of trying to reduce your leverage a little bit mixing that with the opportunities on the acquisition front? Thanks.

[Vinit Asar:]

Sure, Larry. I will take the first part of the question and then Tom can pick up on the second part. In terms of the acquisition pipeline as we have mentioned, we closed on one deal in the first quarter. We are feeling great about the pipeline, especially because we are able to have conversations now with a lot of O&P independent providers that do want to partner with us and we are able to actually pick out and partner with those that are stronger than others. So, today I don’t think there is a dearth of opportunities out there, we are just being very selective in who we partner with. We have a very strict criteria. We want to make sure that outside of the obvious financials and the geography. We also make sure the cultural fit is there and the compliance issues. So when we take all of this into account, we are able to be selective and we have a solid pipeline now.

[Thomas Kiraly:]

And when you look at it Larry, the underlying $50 million of trailing 12 months free cash flow, we should point out that much of that period was during a COVID-affected period of operations and as earnings increased with capital expenditures running favorable to our forecast down into $20 million to $25 million range, we do think there is some opportunity to see some increased free cash flow in the company, which – some of which we could potentially use to address that underlying leverage question.

[Larry Solow:]

Okay, fair. And then just another question, just sort of higher level longer term question, you guys have a lot of multiple initiatives and certainly differentiating yourself from probably all the other providers out there and I think in your last update in your annual report, you certainly look like you have taken some market share at least through on the acquisition side of the story? Do you feel like you are taking share, I know it’s sort of a hard way to look at this, there probably aren’t many, not great data, aggregate data on the industry, but do you feel like– is there a way to kind of look and see if you are actually growing faster than the industry and actually taking share from competitors? Because it does seem like qualitatively you are doing a lot of things that are much better, more value-add and patients and doctors alike?

[Vinit Asar:]

Yes, Larry. On both fronts, on the organic front and the inorganic front, we believe we are taking share on the inorganic front. It’s pretty obvious as these businesses join us, but on the organic side when you look at our same-clinic numbers, especially this quarter and in the prior year, it’s clear that we are growing faster than the market. If you look at the market growth of 2% to 3% depending on pre-COVID or during COVID, irrespective on a same-clinic basis, we know we are going faster than the market and picking up market share. And you are right, it goes back to all the different investments and differentiators we put in place over the last few years, whether it’s clinical outcomes, whether it’s a revenue cycle management, whether it’s our supply chain or leadership. So, we feel very good about picking up market share on both fronts, organic and inorganic.

[Larry Solow:]

Okay. Appreciate that color. Thanks, guys.

[Vinit Asar:]

Thanks, Larry.

[Operator:]

Thank you. We have another question from the line of Brian Tanquilut from Jefferies. Please Brian, your line is now open.

[Brian Tanquilut:]

Hey, guys. Thanks for letting us follow-up. I guess, Tom, you mentioned how Q1 is normally your weakest EBITDA quarter 5% to 10% of total, but any thoughts you can share with us on how we should be thinking about the cadence for earnings for this year given some of the challenges that you have seen, but also the strong top line and pipeline expectation?

[Thomas Kiraly:]

Yes. I mean, when you look at the overall cadence, Brian, in past years, I think it can serve as a pretty indicative way to think about the current year, typically the first quarter, as we said, 5% to 10%. When you go to the fourth quarter, we are typically 30% to 35%, 36%. And so, it’s a big swing from Q1 to Q4 with the intervening quarters being probably a bit more ratable in terms of the way that you look at it on a percent of earnings basis. So I think our historical trends really serve as a good foundation for thinking about the current year.

[Brian Tanquilut:]

Alright. Got it. Thank you.

[Vinit Asar:]

Thanks, Brian.

[Operator:]

Thank you. We currently have no further questions. So this concludes today’s conference call. Thank you so much for joining. You may now disconnect your lines.