Hanger, Inc.
Q3 2019 Earnings Call Transcript

Published: 9 Nov 2019

[Operator:]

Greetings, and welcome to the Hanger’s Third Quarter 2019 Earnings Call. All participants will be in listen-only mode. And as a reminder, this conference is being recorded. Today, we will have prepared remarks, followed by a Q&A period. Instructions for questions and answers will be provided after the formal presentation. It is now my pleasure to introduce your host, Seth Frank, Vice President of Treasury and Investor Relations. You may begin your conference.

[Seth Frank:]

Good morning. Thank you, and welcome to Hanger’s Third Quarter 2019 Earnings Conference Call. With us today are Vinit Asar, Hanger’s President and Chief Executive Officer; Thomas Kiraly, Executive Vice President and Chief Financial Officer.

[Vinit Asar:]

Thanks, Seth, and good morning, everyone. Thank you for joining us for Hanger’s Third Quarter 2019 Conference Call. During my prepared comments, I will discuss our financial results for the third quarter, our financial outlook and close with an update on our business and the O&P industry. Hanger’s third quarter financial performance was strong. Total net revenue of $279.6 million reflected a solid 6.3% year-over-year increase for the quarter. I’m also pleased with the growth of 4.8% in adjusted EBITDA and 13.6% in adjusted earnings per share during the quarter. Turning to the segment results. Patient Care performed well, driven by solid organic growth, supplemented by our selective approach to M&A during 2019. Net revenue grew 7.9%, driven by another quarter -- another strong quarter in prosthetics. The segment generated 2.1% same-clinic day adjusted growth rate, which is a solid performance. It’s important to note that prosthetics, excluding acquisitions, grew 4% during the same period. We remain encouraged with the multi-tier strategies we have put in place to drive organic prosthetics growth. Net revenues in orthotics during the third quarter were consistent with the prior year period on a same-clinic day-adjusted basis, reflecting a slight decline in shoes and inserts with an offsetting modest increase in the rest of the orthotics category. We continue to focus on programs to drive growth in custom orthotics. As in Q2, patient volume and a stronger mix of custom devices drove margin improvement in this segment. At the clinic level, our patient engagement efforts continue to show results. Our Net Promoter Score through September of 2019 is 84 for Hanger Clinic, continuing the improvement we have seen throughout the year. On the M&A front, it has been a successful year thus far. On a year-to-date basis, acquisitions have contributed approximately $19 million to net revenue. This is consistent with the approximately $28 million in acquisition revenue built into our financial outlook for the full year 2019.

[Thomas Kiraly:]

Good morning. As Vinit shared, we are pleased with the revenue growth Hanger achieved in the third quarter and the fact that the company’s overall contribution on that increased revenue was consistent with what we had expected. Hanger reported $279.6 million in revenue, which reflected a total increase of 6.3% for the quarter. This equated to just under $17 million in revenue growth and was completely driven by our Patient Care segment, which posted a 7.9% increase in its revenue. Adjusted EBITDA was $32.6 million, which was an increase of 4.8% over the prior year period. These results reflected an adjusted EBITDA margin of 11.7% for the quarter, which was reasonably consistent with the same period last year. The segment performance trends for the most recent three months were consistent with those that we’ve seen and discussed throughout 2019. Patient Care demonstrated organic and inorganic revenue growth, which has contributed to good earnings increases and margin expansion in that segment. The Products & Services segment, on the other hand, has experienced overall stable revenues, along with a decrease in earnings and margin due to underlying declines in revenue from therapeutic solutions and increases in the cost structure of the distribution business. To go a little deeper, first, let’s discuss the Patient Care segment. The 7.9% rate of revenue growth was driven by the combination of 2.1% in same clinic growth coupled with revenue from acquisitions. This has brought our year-to-date total increase in revenue for the segment up to 5.1% as compared to just 1% for the year-to-date through September last year. Underlying same-clinic rate of growth has risen to 1.8% for the year-to-date as compared to 1.1% last year at this time. This growth has been the primary factor that’s led to an increase of 10.4% in segment-adjusted EBITDA contribution for the quarter and 8.3% for the year-to-date. For the 9 months ended September 30, Patient Care adjusted EBITDA has grown by $8.5 million, and its margin has increased by 50 basis points to 17%. Within these results, it’s important to note that the acquisitions which we completed late last year and early this year are contributing to the earnings growth of this segment. With that in mind, as we’ve discussed in prior calls, a portion of these earnings have been offset by planned increases in the annual run rate of the cost we are incurring for diligence, legal, integration and other M&A activities, some within the Patient Care segment itself and some in our corporate area.

[Operator:]

We will now begin the question-and-answer session. The first question comes from Brian Tanquilut of Jefferies. Please go ahead.

[Brian Tanquilut:]

Hey. Good morning, guys. Congrats on a good quarter. But I guess my first question from an industry perspective, I’ve seen a couple of instances where O&P device manufacturers have gotten into the clinics business. How are you thinking about that? And then what do you think is your strategy? And is this something that we could see them try to do on a bigger scale?

[Vinit Asar:]

Yes. Thanks, Brian. Look, I think it doesn’t change our strategy, the fact that a manufacturer has decided to acquire an O&P clinic or O&P clinics. Our strategy, we’re pretty -- we’re very focused on the things that we’ve been doing. We feel very confident that our focus on clinical outcomes, on patient engagement, our investments in revenue-cycle management make us stronger than we’ve ever been before. So it doesn’t really change our strategy and our focus on organic growth, supplemented with the tuck-in acquisitions. I can’t comment on their strategy, certainly is curious. But we feel also comfortable that our clinicians have the advantage of being objective about what devices they pick and they choose for our -- for their patients, so they can provide the best outcomes as opposed to a clinician that may be influenced by a device manufacturer. So we’re feeling good about our strategy at this point.

[Brian Tanquilut:]

Okay. And then, I guess, shifting gears to the last part of Tom’s comments. So from the Board level, how are you guys thinking about leverage? Obviously, it is a key investor focus, but sacrificing near-term leverage for long-term EBITDA growth. Like how do you guys view balancing those 2 different goals?

[Thomas Kiraly:]

Obviously, it’s a delicate balance. We’re very committed to bringing leverage down. The challenge we have is that these opportunities on the supply chain and with some of the acquisitions, our immediate-term items that we really feel will bring the shareholders a value. So to set those aside strictly to bring the leverage down a bit earlier is something that we’ve elected to go ahead and trade for the higher return. It is nevertheless an area that we’re all very conscious of and talk about frequently and is a big part of our financial plans.

[Brian Tanquilut:]

Got it. And then I guess, Tom, tying that into the supply chain discussion, right? If you don’t mind just walking us through how and where the benefits will come from. And then where exactly is the money going to be spent? And what sort of improvements -- what are the KPIs you guys are going to look from 2021 going forward?

[Thomas Kiraly:]

Well, as we outlined in the 10-Q, there’s two real components to the spend. One is the capital expenditures that we’re under -- that we’re putting into place for the actual facilities. Were going through an upgrade of our key distribution facility in Alpharetta to really modernize that facility and to bring in warehouse management technology and other systems that will really enable us to serve our customers better. And that’s both our internal clinicians as well as really our external customers. Secondly, there is an ERP component or a financial systems component that ties into this as well. Those capital items, obviously, will be a burden to cash flow this coming year, but we’ll have, what we think, a very moderate effect on the company’s earnings going forward. Meanwhile, the savings are going to come in areas such as freight, being much more efficient in terms of the number of packages that we send instead of multiple boxes. We’ll be able to box things in a more organized fashion with fewer shipments. We’ll be smarter about how those boxes are packed. We’ll be able to really support our manufacture partners with the consignment of their inventory and how we coordinate their distribution through our distribution services or in fashions that will be supportive of their mission. So those returns will come, the ones that we outlined, that Vinit outlined and I outlined, are primarily the freight and what we’ll call the operational costs and efficiencies of the DCs, we think there’s some upside to this as we look at our distribution business and look at our relationships with manufacturers.

[Brian Tanquilut:]

All right. And then, Tom, I guess my last question, as I think about these allowances during the quarter, I noticed that there’s still an elevated amount of disallowances. And your same-store probably would have been at least 100 basis points higher if not where that above average level of disallowances. Is there anything you can call out on that? And then how are you thinking about driving some improvement there over the next 12 months?

[Thomas Kiraly:]

Yes. That slight pressure is on the patient nonpayment side. We are seeing a more -- an increased portion of the payments that relate to private payment or pace the patient portion of planned payment. We think that relates a little bit to mix. The higher prosthetic mix is carrying a bit of that. We’re also seeing a little bit of credit, credit decrease in not dissimilar to what other providers of care are seeing with individual payments. Overall, we continue to feel that the patient on payment, which was about 1.3% in the quarter, will settle down around 1% on the longer term. And that what we’re seeing is sort of a short-term effect on that side. Meanwhile the disallowed themselves are actually down a bit, about 200 basis points from the prior year, which we see as a positive event.

[Brian Tanquilut:]

Yes. I appreciate it. I guess if I may just throw in one last for Vinit. As I think about growth, prosthetic grew 4% this quarter. Is there any reason why the other sides of the O&P clinics business will not should not grow at that pace, at least, the custom side, whether it’s orthotics? And then what’s the sustainability, do you think of that prosthetics growth rate?

[Vinit Asar:]

Yes. In terms of growth, I’ll answer the latter part of your question first, the sustainability of the prosthetic side. We’re pretty pleased with what we’re seeing on the prosthetic side. And we believe it’s a direct result of the effort our clinics and our marketing teams have made over the last few years on all the prosthetics programs have gone in. So last year, in 2018, we had a 3.3% prosthetic growth. So we expect that level to sustain given what we’ve been seeing, and we’re pleased with that. On the orthotics side, just as a reminder, there are elements to the orthotics business that include the off-the-shelf orthotics, shoes and inserts and custom orthotics. The heavy focus we’ve put in over the last year or so has been the custom orthotic side. And so we’re pleased with what we’re seeing on the customer orthotics side with the education programs and the training we’ve been implementing across our clinics. With regards to off-the-shelf and shoes and inserts, it is something that we’ll continue to offer our referral sources and patients. But as we’ve mentioned before, it’s low or no margins. So we’re not really focused on those areas at this time.

[Brian Tanquilut:]

Got it. Thanks guys.

[Thomas Kiraly:]

Thanks Brian.

[Operator:]

The next question comes from Larry Solow of CJS Securities. Please go ahead.

[Larry Solow:]

Great thanks guys. Good morning. Just a few follow-ups to Brian’s question. Just on the revenue growth. So you are getting a little bit of benefit from pricing, right, at least on the prosthetic side. Is that maybe responsible for some of the bump-up? And then part 2 of that, I would hope that maybe not only sustainable, but maybe over time, we could see even a little bit of a bump-up on the volume side in the prosthetics, and maybe even solely on orthotic so we can sort of get back to like a 3% volume growth. Is that a fair target, at least, without putting a time line on it?

[Thomas Kiraly:]

Well, listen, Larry, on the pricing part, yes, obviously, we did have a good Medicare increase this year, it was around 2.3%. When you weighted into our average rate including the commercial side, we figure that we’re probably about 1.3% to 1.4% rate. The key thing that I would point out was something that Brian alluded to, which is because of the higher patient non-payment, our net growth is 2.1% on the same-clinic basis. But if you were to normalize for that increase in patient non-payment, the underlying growth was actually 3%. And so we’re sitting on average, included prosthetics and orthotics in Q3, at about 1.6%, which is showing some volume growth. Now sustainable, we certainly are hopeful for that and believe that, that -- our differentiation is going to contribute to that. But we’re pleased with this intermediate step that we seem to be seeing so good volume on that side.

[Larry Solow:]

Okay. And then on the acquisition front, just one thing, can you repeat -- did you say -- I missed that. I had to step away for a second, on the contribution as we bridge from ‘19 to ‘20 from the acquisitions you did earlier in this year. Was that what you’re referring to, when you say, don’t expect a step-up?

[Thomas Kiraly:]

Yes. I really -- I don’t think we will see a step-up primarily because the growth, when you look at the earnings growth on the patient care side in addition to the organic contribution to EBITDA, the acquisitions are contributing to EBITDA. And really what’s happening for the company on a consolidated basis is, that’s being offset to a certain extent by the Product & Services segment and its decline.

[Larry Solow:]

Okay. And as you complete further acquisitions, though, do you think that you’re more well positioned to get benefit from those -- from the profit from those deliver, I mean, pretty soon after they’re completed?

[Thomas Kiraly:]

Yes. We would like to believe so. We -- really, when you look at these acquisitions, we’re very conscious of making sure that we pay fair multiples and that the company receives the benefit of their earnings.

[Larry Solow:]

Right. Okay. Turning to just on the supply chain investments. So you called out the $22 million to $27 million, I think $13 million to $15 million for the supply chain, another $12 million to the ERP. Will there be any -- just -- is this the brunt of the expense? Is that pretty much all the expense? So essentially, the 25 bps or up to 35 bps, which is, what, $2 million to $4 million or $2.5 million to $4 million would be like a 10% to 15% kind of targeted ROIC. Is that about right?

[Thomas Kiraly:]

Yes. A little bit -- maybe a little higher. I think when we do the math, we’re up around 15% to 20% pretax ROI on the program. There is an additional 6% to 8% that we outlined in the Q that occurs in 2021. And but no, this is a pretty comprehensive statement as to how much we believe we’ll spend in total for those programs.

[Larry Solow:]

Got it. And then just switching gears real fast, just on the ACP or therapeutics business. I realize it’s the 5% of revenue. So pretty small, obviously, but a good amount of cash flow or CapEx spent on that business to refresh the product line. Is that a number that can be brought down a little bit over time? And then part two of that question, one on the operating side of it. It sounds like perhaps you see some light at the end of the tunnel where maybe the business could stabilize? Thanks.

[Thomas Kiraly:]

Yeah. So from a capital expenditure standpoint, we definitely do believe that, that can be moderated as you go into 2020. That’s a part of our plan on the CapEx side. They are through a lot of the refresh programs. They still will have a reasonable degree of new investment every year, but there is an expectation that we’ll see a little bit of a decrease in that area.

[Vinit Asar:]

Yeah. And I can take the second part of the question in terms of the operational side, Larry. What we’re seeing is, it’s the business, the results of the business are a reflection also of what’s going on within the SNF industry over and above the enhancements that the team at therapeutic solutions is working on and we do see a stabilization, a sort of stabilization in therapeutics in the skilled nursing facilities. As you know, PDPM went live on October 1. Things appear to have stabilized, leading up to it and after that. We are seeing a lot of our customers, when about one or two years ago, they were having a hard time paying their bills to us or some of them going bankrupt. We’re seeing less and less of that. So that’s what gives us optimism going forward.

[Larry Solow:]

Okay, great. Thanks.

[Thomas Kiraly:]

Thanks, Larry.

[Operator:]

This concludes our question-and-answer session. I would like to turn the conference back over to Vinit Asar for any closing remarks.

[Vinit Asar:]

Great. Thank you all for your questions. We are pleased with where we are with the business. And really excited about where we’re going. I hope you can see that while we have plenty of work ahead, we are in an enviable and strong position given our leadership position in the O&P industry. We look forward to seeing you at conferences and in your offices in the coming weeks. And look forward to speaking again to review our year-end results and provide our 2020 financial outlook early in the New Year. Thanks very much.

[Operator:]

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.