Hanger, Inc.
Q2 2018 Earnings Call Transcript

Published: 10 Aug 2018

[Operator:]

Greetings, and welcome to the Hanger Incorporated Second Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over your host, Seth Frank, Hanger’s Vice President of Treasury and Investor Relations for Hanger. Thank you. You may begin.

[Seth Frank:]

Thanks, Dana. Good morning and welcome to Hanger's second quarter 2018 earnings conference call. With us today are Vinit Asar, Hanger's President and Chief Executive Officer; and Thomas Kiraly, Hanger's Chief Financial Officer. Some of the information discussed today will include forward-looking statements in the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause Hanger's actual results to materially differ from those we discuss today. Those risks include among others, matters we have identified in the forward-looking statement portion of our latest earnings release and in our filings with the SEC. Hanger disclaims any obligation to update forward-looking information discussed on this call. And with, I would like to introduce Hanger's President and Chief Executive Officer, Vinit Asar.

[Vinit Asar:]

Thank you, Seth, and good morning, everyone, and thank you for joining Hanger’s 2018 second quarter earnings call. I will start with an overview of the financial results, provide an operational update and discuss our view for the remainder of the year. Tom will then provide more detail on the numbers after which we will take your questions. Hanger’s second quarter financials reflect stability and improvement in the topline across the business, driven by the efforts we have made to stabilize the foundations of the company over the last three or so years. The results also reflect our continued investments in reinvigorating organic revenue growth. Year-to-date, we are on target with the initial revenue and adjusted EBITDA view we had provided in May and which we are reiterating today. In addition, operating cash flow increased significantly in the quarter and our balance sheet is healthy. Hanger’s total net revenue grew 1.4% year-over-year in the second quarter. It is important to note that both business segment showed growth which is a reversal from the decline we saw in the products and services segment during 2017 through the first quarter of 2018. We also generated significant increases in income from operations, net income and earnings per share from the prior year period. Let me now touch briefly on our two business segments; first, within patient care we saw revenues increase 0.9% or $1.9 million driven by our same clinic revenue growth of 1.7%, which is slightly higher than the 1.1% we saw in Q1. We continue to see strength in custom O&P services with Hanger achieving above market growth rates in prosthetics, as the segment revenue mix shifts to a greater amount being derived from prosthetic revenue. This evolution is strategic on our part, as we are determined to emphasize Hanger’s share of prosthetic and custom orthotic solutions and as previously disclosed, deemphasizing lower margin off-the-shelf orthotic solutions. Turning to the products and services segment; we saw revenue growth of $1.6 million or 3.5% in Q2. Our SPS distribution subsidiary within the segment had an exceptional quarter as we gained share via new accounts and increased business from existing accounts. This was an excellent performance and one of the best quarters of topline performance in recent years for the distribution business. Our therapeutic solutions business, the second piece of the products and services segment declined in the quarter as expected and at a slower rate than last year. Revenue in the quarter decreased 1.1 million or 7.1%. We consider this business to be in a transitional period, and as disclosed in our last call are focused on a stabilizing and maximizing value from it. Overall, as we think about the results for our two business segments, we are pleased that both are performing consistent with our expectations and those that we share with you when we began the year. As we continue our journey of re-emergence in the public market and we progress from a phase of stabilization to one of growth, we have begun to make specific investments that prepare us for the future. We believe strongly that we have to continue down the path of significantly differentiating ourselves as a specialty healthcare provider. During the second quarter, we have begun to explore various areas of growth at Hanger. We believe that the findings from this body of work which we expect to conclude in Q3, will help us fuel growth by further differentiating us from our competitors. There are five areas in particular that we have focused on as part of this effort. I would take a few minutes sharing these differentiators and discuss how we are focusing on them to further enhance our business model. First, our national network, as we think about our national network, we have the ability to care for patients around the country and 44 states and the District of Columbia as they travel or potentially relocate their place of residence. Our referral sources and payers tend to appreciate our network of clinics and in particular, this accessibility to patients. We strive to continue to strengthen our ability to provide access and care to our patients and have embarked on a study of what our network should look like in this era of the triple aim of healthcare and the provision of better health, better care for better value. Our second differentiator is our ability to engage patients and drive high satisfaction with our services. This is an exciting area for us, as we build long-lasting patient relationships and often become a care provider for life for a large number of our patients helping to drive higher recurring revenue. Our program to engage and tell our patient stories via social media platforms has been very helpful in raising brand awareness of what we do. We have begun to engage in proactive reputation management as well to generate better online ratings and have already seen a sustained and significant improvement in positive ratings and a similar decrease in negative ratings over the last 12 months. In addition, we believe that building a culture where patients evangelize on our behalf is the most effective marketing approach available. Hanger Net Promoter Score or NPS is a key metric that we as a management team have begun to use to measure our patient engagement success. Through June of 2018, our NPS continues to trend at 81, which is significantly above health services industry benchmarks. Our third differentiator is Hanger’s focus on measuring, reporting and impacting patient outcomes. This is an area that we believe is critical to advance the contribution O&P can play in the emerging value based reimbursement environment. The foundation of Hanger’s outcomes initiative is our electronic health record platform which continues to be successfully implemented across our regions nationwide. As we’ve discussed before, we are investing about $1.2 million a quarter in training and other implementation costs for this initiative. As of late July, 83% of our patient care clinics are live on our EHR and we continue to anticipate completing the full rollout by mid-2019. In addition to core EHR for billing and clinical data capture, we are introducing tablets to digitalize the capture of NPS data, expand scheduling and leveraging mobile devices for outcomes measurements including our proprietary mobility score card that is individualized for each patient. We believe Hanger is building a valuable and robust O&P data repository for payers, researchers, referring physicians and others looking to determine the economics and quality of life benefits of excellent O&P care. We have begun to present our clinical outcomes programs to premier healthcare systems around the country and payers are recognizing the magnitude of our clinical dataset and its impact on the care we provide to patients. Our fourth differentiator is our proprietary expertise and systems within O&P revenue cycle management. As we discussed previously, Hanger has invested significantly in leadership systems and resources to build out a highly effective centralized revenue management platform in O&P. Since 2015 we have implemented a series of initiatives to consolidate our infrastructure to address increasing scrutiny of claim submission within our industry. These efforts in partnership with our administrative staff at the clinic level have dramatically lowered the rate of disallowed revenues and patient non-payments. This in turn has benefited our accounts receivable balances, DSO, and improved [ER] [ph] aging significantly. We have reduced disallowed revenues by 55% from 2014 through 2017. Also of note, patient non-payments have been reduced to less than 1% of our adjusted gross revenue, just $1.3 million in the second quarter down from 2.5 million in the second quarter of last year. And finally, our fifth differentiator that we have only just begun to explore is our enterprise supply chain as a productivity, efficiency and cost management lever. We have begun to analyze our supply chain in its entirety, and believe that we do have the opportunity to modernize our capabilities while optimizing our operations in the coming years. In this area, we are focusing on all aspects of the supply chain including freight costs, implementing new systems to speed ordering and efficiency while optimizing our cost of materials beyond the purchasing benefits we have today. By investing in capabilities related to these five differentiators, we are transforming Hanger and creating a highly differentiated and well positioned specialty healthcare services company. Before I hand the call to Tom, I want to update you on what to expect going forward. While we are making investments in the near term that are impacting adjusted EBITDA growth in 2018, I believe we are better positioned than we have ever been to grow organically. In addition to organic growth, we will evaluate select acquisitions within the O&P market to further support our growth and expand access to care for our patients. Our balance sheet is solid and we are generating good cash flow which combined with our lower interest rates as a result of our refinancing earlier this year and our continued reduction in third party fees that we have been paying in the last few years, gives us additional financial flexibility to reinvest as needed in the business to maximize shareholder returns. We continue to be confident in our outlook for 2018 as we head in to the back half, which is typically the strongest part of the year from a seasonal perspective. We are on-schedule to re-list our stock on the New York Stock Exchange in September and plan to announce a more specific date in the next several weeks. In advance of relisting, we look forward to seeing many of you as we go on the road in late August and September to reintroduce Hanger and help you better understand the business and our strategy. We are excited to meet with you and truly appreciate your interest in Hanger. Thank you for your attention to my comments, and now I will hand the call to Tom, so he can dive deeper in to the numbers. Tom?

[Thomas Kiraly:]

Good morning. As Vinit shared, we are pleased with the progress we made during the second quarter. From a finance perspective, the quarter was notable for several positive reasons. In addition to continuing our revenue growth trend, we reported significant increases in income from operations, net income and operating cash flow. In addition to further elaborating on these items, during my portion of this call, I’ll also share some background on other key financial elements that drove our results. First, when reviewing revenue for the quarter, while 1.4% total net revenue growth is modest, we have now established a consistent trend of same clinic revenue growth in our patient care segment. We were additionally pleased to report 3.5% in total revenue growth in our product and services segment despite the decreases we’ve been experiencing in therapeutic solutions revenue. In our patient care segment, the 1.7% same clinic revenue growth rate we reported brought the segment to 1.4% for the year-to-date, which is in line with our targeted overall growth rate for the current year. We are achieving nice gains in our prosthetic business which increased to 54% of revenue during the quarter. This shift has primarily been due to our de-emphasis on shoes and inserts and other lower margin orthotics. As we discussed in our May 15 investor call, in contrast to 2017 in recent years, we haven’t seen and don’t currently expect any significant benefit from improvements in payer disallowances during 2018. For the year-to-date these stand at 4.4% of adjusted gross revenue for the patient care segment, which is identical to the prior year. Additionally, as you review net revenue, please bear in mind that in connection with our implementation of ASC 606, the revenue accounting standard this year, we have reclassified what we previously disclosed as bad debt expense within this segment to be treated as a reduction of revenue. While this has no effect on the company’s income, it has decreased comparative revenue growth by 1.3 million in the quarter and 2.2 million for the year-to-date. Now, I’ll turn to a discussion of our business segment performance. Overall, while our two primary business segments both produced revenue growth, their individual contribution to earnings was essentially flat as compared to the second quarter of 2017, with the patient care segment producing 41 million in adjusted EBITDA and the product and services segment producing just under 10 million. The key story then for a comparative quarter-over-quarter performance in the second quarter relates to our corporate and other segment which reported a $2.6 million cost increase on an adjusted EBITDA basis. Now in performing this quarter-over-quarter comparison, we’ve excluded a $2.2 million benefit related to two favorable settlements which serve to partially offset our underlying expenses. These related to a $1.7 million net settlement payment we received in connection with the 2010 Deepwater Horizon disaster and secondarily to a $0.5 million associated with our settlement of unclaimed property claims with the State of Delaware dating from 2001 to 2017. Excluding these favorable items, when viewing our corporate and other expenses from a non-GAAP adjusted EBITDA perspective, while our underlying expenses were on track with the company’s plan for the quarter at 17 million, we did experience a 2.6 million increase in this non-business unit related expense. This primarily related to 1.7 million for professional fees and other costs we incurred related to growth at other corporate initiatives. As Vinit discussed, we are currently undertaking projects and activities designed to structurally implement a fundamental differentiation of Hanger from the rest of the O&P provider market and to support our future growth. We currently believe that the majority of this corporate project related spend will culminate by the fourth quarter. In further analyzing our corporate expenses, it’s important to bear in mind that we moved up the effective date for our annual merit increases from June in 2017 to April in 2018. This created an adverse comparison in our salary expenses and also affected the flow-through on revenue growth within our two business segments during the quarter. In addition to the effects of this change in timing on annual salary increases, flow-through had a revenue growth within the patient care segment was also mitigated by increased employee benefit expenses of 1.2 million, as well as a $700,000 increase in materials cost relative to revenue. We believe that the salary and benefits expenses are primarily a timing consideration. With respect to the cost of materials increase, while we’ve seen an increase in prosthetics mix and devices that generally carry higher relative materials costs, all things being equal, prosthetics typically have higher total contribution margins after considering clinician and other costs. These shifts should be beneficial overtime, however given that our labor cost are typically static from one quarter to the next, the flow-through from this shift is not something we experienced in the second quarter. Now I’ll touch on a couple of other key expenses categories. First let’s focus on professional accounting and legal fees. As you know, a substantial majority of these fees have related to our past financial restatement work and more recently to our process of catching up on filings of remediating our control environment. While we exclude these costs for purposes of our non-GAAP adjusted EBITDA measure, on a GAAP basis, we are pleased that our professional fees dropped to half the level they were in the second quarter of last year. We continue to be on track to spend approximately 13 million in excess professional third party fees related to these financial statement activities in 2018. Another key item, I’d like to draw your attention to is our other operating expenses which decreased by 1.3 million as compared to the prior year quarter. This decrease relates primarily to the reclassification of bad debt expense to being treated as an offset to revenue in connection with the new revenue accounting standard I spoke of earlier. Had it been treated under the old accounting standard, we would have had 1.3 million in higher net revenue during the quarter and would have reported essentially no change in other operating expenses. A final key expense line item to focus on is our interest expenses. These decreased from 14.1 million in the second quarter of last year to 7.3 million this year. A greater majority of this decrease was the result of our March 2018 refinancing of the company’s indebtedness. We currently pay an average cash interest rate of approximately 6% and incur approximately 33 million in annualized cash interest, which reflects a substantial decrease from the approximately 10% rate of interest we paid last year. Two-thirds of our 525 million of indebtedness is fixed rate or hedged in to fix rate. And then looking at our interest expense for the quarter, it’s also helpful to note that we recorded 1.5 million one-time reduction to interest expense associated with the unclaimed property tax settlement with Delaware. Given that we structured the agreement as a voluntary disclosure agreement, we avoided the pain in a previously accrued interest on the claims that were the subject of the settlement. Improvements in our professional accounting and legal expenses, depreciation and amortization expenses and interest expense were the primary drivers for a sizeable increase in net income during the quarter. We produced 12.9 million in net income or $0.35 per diluted share as compared with 1.6 million in net income in the prior period or just $0.04 per diluted share. On a non-GAAP basis, excluding the favorable settlements, third party professional fees and amortization expense, our adjusted net income increased to 10.5 million from 7.6 million in the prior year, resulting in adjusted EPS of $0.28 per diluted share versus $0.21 in the second quarter of 2017. Now I’ll turn to our cash flows; during the quarter, we produced 25.4 million in operating cash flow. This reflects a $20.1 million increase as compared with a 5.3 million we reported in the second quarter of 2017. This significant growth was primarily the result of lower interest expense, reductions in third party fees, and favorable inventory and other working capital trends. From an accounts receivable perspective, our day sales outstanding was 45 days which was one day better than the 46 days we reported for the second quarter of 2017. When reviewing our investing activities, capital expenditures were 8.7 million during the quarter, which reflected an increase of 3.9 million over the second quarter of last year. We stepped up our capital investment and clinic operations as well as in our therapeutic solutions business and currently estimate that full year capital expenditures will be in the $30 million to $35 million range. We completed no clinic acquisitions in the quarter and currently do not foresee closing in in the third quarter. Hanger’s strong quarter of operating cash flow has lifted our overall cash and liquidity balances. At quarter’s end, we had 48.8 million in cash and cash equivalents and 142.9 million in available liquidity. The decreases we’ve achieved in interest expense and professional fees, coupled with a favorable change in the federal tax law should position us for continuing favorable cash flow trends. In closing, I’ll make a few comments regarding our outlook for the full year of 2018. Given that we are tracking with our internal budget and are essentially consistent with the prior year performance for the year-to-date, we continue to believe that Hanger’s on track to provide revenue and adjusted EBITDA that is generally consistent with the amounts we reported for 2017. With that I’ll turn the call back over to the operator to take questions.

[Operator:]

[Operator Instructions] our first question comes from the line of Larry Solow from CJS Securities. Please proceed with your question.

[Larry Solow:]

Just a couple of high level questions perhaps on the same store sales growth, 1.7% obviously incremental improvement, could you just maybe discuss sort of, maybe your outlook for the next couple of quarters, but as you look out over the next two to three years, certainly looks like the industry has recovered from its – when it was maybe flat to down a couple of years back with the increase in reimbursement needs and what not, but requirements. But maybe your outlook on what the industry is doing and can we get sort of back to that 2% to 3% volume growth over the next couple of years.

[Thomas Kiraly:]

So our estimation of the industry growth this year is somewhere 1.5% and 2% or 2.2%, and I think as we’ve said earlier, we expect this years’ results to be somewhat in line with last years’ result. Some of the initiatives that we’re working on are positioning us to make sure that we outpace that industry growth in the coming years. So that’s how we’re looking at it. We certainly are focusing more on the custom side of the business or prosthetics and custom orthotics. So we believe we should at least be pacing with the industry this year and beginning to outpace starting in the next year or two.

[Larry Solow:]

And in terms of the investments you’re making, sort of you spoke of several things to sort of differentiate yourself and sort of reinvigorate that organic growth. Historically you guys have outpaced the industry, but I think one concern that I am hearing from some guys is, obviously through those last few years you certainly look like you are under invested in some of your systems and what not. Are you confident that this sort of increase that looks like we’ll add a little bit more to this year’s numbers in terms of the cost side? You sort of culminated that by the end of this year and you won’t continue to sort of need higher investments and what not as we look out in to ’19 and ’20 that will sort of impact the dropdown because obviously historically the patient services has been - the incremental margin on that business has been very good. So is there any reason to believe that won’t return to those historical levels as we look out?

[Thomas Kiraly:]

Well Larry I’ll take the first part of that. So when you look at our spend through the P&L as we talked about in the 10-Q and Vinit referenced when he talked about our NextGen implementation in his remarks. We’re spending about 4.7 million through the P&L right now that’s training implementation and other sort of non-recurring costs. We’re going to be completing NextGen in the first half of next year. And at that point it’s likely that we would go and redeploy that spend towards other initiatives, other systems initiatives. We’re certainly mindful that we need to manage that and that system spend in light of what we want to go ahead and demonstrate to Wall Street from an overall earnings growth. But I don’t think at this point we could say that we’re done with the company’s overall agenda from a systems perspective.

[Vinit Asar:]

Larry, in terms of the focus on some of these things that we’re working on, we feel pretty good that we are focused on the right things to get that growth to outpace the market growth at this point.

[Operator:]

Our next question comes from the line of Brian Tanquilut from Jefferies. Please proceed with your question.

[Brian Tanquilut:]

Vinit just to follow-up on that last comment, so as you make these investments, what exactly do you need to do to drive debt acceleration and organic growth. I know you’ve been spending some money on G&A and just trying to strengthen the clinics. So operationally, what needs to change for us to start seeing that pickup or acceleration in organic?

[Vinit Asar:]

Sure Brian. So some of the things you’re already seeing and we started disclosing a few of those already that had already have been completed, things like we’re focusing our clinics more and more on spending time directly with the patients and extracting out some of the administrative work. So the revenue cycle management etcetera, we start extracting out of the clinic for the most part. So the patient care clinic, the administrative staff and the clinicians can focus more on patient care, going out and doing business development with the referral sources. The other piece is, we have put a direct focus on generating and capturing clinical outcome so that also takes in investment, actually capturing the outcomes and we’re building one of the largest datasets in the industry today for O&P patient care. And so we take this data and we can have these conversations with the medical directors at the large payer groups, the folks at the healthcare systems, so they can understand how we’re actually impacting patient care. And then just focusing on making sure that we’re in contact and communicating directly with patients. We have this initiative where we want to be and we believe we’re getting there very quickly. The most connected O&P company to our patients. So things like our social media platform, our net promoter score, and recently we also announced that we have a new platform that allows patients to look, to experience our virtual reality technology. So those are the sorts of things we’re working on. We’re also looking at what our overall clinic network should look like and where we should be strategically by MSA within the country.

[Brian Tanquilut:]

That makes a lot of sense. Now, as we get closer to the completion of the NextGen implementation, how should we be thinking about the dollars that you guys are spending there right now in terms of where going forward you could be spending those dollars or will that be pulling back and just hitting the EBITDA line going forward after the rollout.

[Thomas Kiraly:]

So those dollars are likely to be redeployed, so I don’t think you can count on that in 2019 or even 2020 that the company would suddenly have that with the release of that money back to income. The primary emphasis I think Vinit alluded to is going to be on what we call our frontend systems and some of the underlying account systems that relate to those systems which is in the supply chain area is what we’re currently targeting. Now, I don’t think you’re going to see anything dramatic there. It’s just the company’s desire to go ahead and really try to leverage the supply chain over the next couple of years and to further strengthen the underlying accounting systems that the company relies upon.

[Vinit Asar:]

Brian the other way to think about it is, if you think about the last few years, our focus was on making sure we stabilize the company and address the restatement issues. All that in our mind is in the rearview mirror. Right now we’re focused on some of these business development issues and certainly getting rid of the existing material weaknesses that remain. So the focus is a little bit different than the last few years.

[Brian Tanquilut:]

That makes sense. Last question from me, Tom cash was obviously strong during the quarter. Just any thoughts on what drove that, anything to call out, and then how are you expecting cash flow trends for the rest of the year?

[Thomas Kiraly:]

Brian, the substantial part of that was really the reduction in interest expenses and then reduction in third party fee payments. So, those we would always view as having been temporary for the company, the interest was high because we’re going through a period of bridging and defensive maneuvers on the borrowing side and of course the third party fees are, we view something that’s a temporary spend item. So those are permanent improvements that we see in the underlying core cash flows of the company. We also had some very favorable working capital trends in the quarter, when it relates to AP, our inventory trends and of course our AR was very nice too. So we think it was a strong quarter and I think that what we’re really seeing is just more of an alignment with the company’s underlying cash flow with its free cash flow when you look at EBITDA.

[Operator:]

[Operator Instructions] our next question comes from the line of Dana Hambly from Stephens. Please proceed with your question.

[Dana Hambly:]

Vinit a question, as you build the referral network, how has the sales and marketing process evolved over time to deliver the method?

[Vinit Asar:]

We have changed our leadership in sales and marketing over the last year, different focus as well. We are actually combining the efforts when we generate the clinical outcomes from the clinical group along with the sales and marketing groups. So, today our sales and marketing folks when they present our story to the referral sources, they are not just talking about our network and access to care, but they are actually equipped with talking about our patient outcomes. And each of these referral sources are beginning to see what the outcomes are for their particular patients as well. So it’s a very different dialog today than it was years ago, and it’s partly because of our investment in outcomes as well as our increased investment in sales and marketing.

[Dana Hambly:]

And then as we measure your success, obviously the same store sales is the biggest indicator. But what are some of the other metrics that we should be looking at every quarter, is it net promoter score, the prosthetic mix and the higher mix, Medicare was up a bit, is that something we should be paying attention to?

[Vinit Asar:]

I think that the same clinic revenue growth will be the primary indicator going forward as well. Internally here clearly we have other metrics we looked at such as how are we doing with referral sources, what sort of new referral sources are we getting etcetera. But as far as your concern, I would still continue to focus on the same clinic growth. Tom?

[Thomas Kiraly:]

I would agree with that. I don’t think there’s any other external metric that would be as meaningful as that one.

[Dana Hambly:]

And then you did talk about or you didn’t talk about employee retention and I know for healthcare companies obviously nurse wage inflation has been a big issue. But maybe could you just talk about becoming the employer of choice and is wage inflation as much of an issue for you guys as it is for maybe some other services companies?

[Vinit Asar:]

We might be slightly different from the nursing shortage industry. I mean for us even through some of the tougher years in the last few years, we didn’t experience a spike of any sort in terms of clinician attrition. But we are focusing now very heavily on attracting clinicians to Hanger and also back to Hanger as well, given where we are as a company. So there’s a big focus on that, we have beefed up a little bit our recruiting group as well. So that’s how to look at it.

[Dana Hambly:]

And last one from me on the therapeutic solutions, I know you’re making big investment in that this year. How does the value proposition of that service hold up and the new payment model that’s come in for the skilled nursing industry?

[Vinit Asar:]

That’s one of the pivots that we’re doing as re-looking at the value proposition and making sure that we make some adjustments to what the skilled nursing facilities need and that’s what we’re working through this year is making the adjustment to the value proposition itself. Operator Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to management for closing remarks.

[Vinit Asar:]

Just want to say thank you every one for joining the call, and we appreciate the interest in Hanger and we look forward to talking to you next quarter.

[Operator:]

This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation.