Hanger Inc (HNGR) 2002 Q3 法說會逐字稿

Good morning. My name is April and I will be your conference facilitator today. At this time I would like to welcome everyone to the Hanger Orthopedic Group Third Quarter Operating Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question and answer period. If you’d like to ask a question during that time, simply press star, then the number 1 on your telephone keypad. If you would like to withdraw your question, press star, then the number 2 on your telephone keypad. Thank you. Mr. Sabel, you may begin your conference.

Thank you. Good morning everyone. Due to a potential technical glitch, some of you may have not yet received our press release. So, as has been our tradition, I will read that and I will expect that you will be receiving the press release momentarily.

Hanger Orthopedic Group, Inc. announces third quarter net income of 30 cents per diluted share. Net sales for the quarter ended September 30, 2002, increased by 4.4 million or 3.4% to 134 million from 129.6 million in the prior years comparable quarter.

The sales growth was primarily the result of a 4.6% increase in same center sales and the Companies O&P practices offset by 1.5 million, or a 1.2% reduction in net sales as a result of the October 2001 sale of Seattle Orthopedic Group.

Gross profit for the third quarter of 2002 was $74.0 million, or 55.2% of net sales, compared to $68.0 million, or 52.5% of net sales, in the third quarter of the prior year. The improvement in gross profit, in both dollars and as a percentage of net sales, was due to a reduction in labor and material costs. Income from operations for the third quarter of 2002 improved, by $8.7 million, to $23.1 million from $14.4 million in the prior year's comparable quarter.

The increase in income from operations is the result of a combination of increased sales, gross profit and the elimination of both unusual charges and the amortization of goodwill that were reported in the third quarter of 2001.

Net income applicable to common stock for the third quarter of 2002 was $6.5 million, or 30 cents per diluted share, on 21.9 million weighted average shares outstanding, an improvement of $7.7 million over the comparable period last year. For the corresponding period of the prior year, Hanger had a net loss applicable to common stock of 1.2 million, or 7 cents per diluted share, on 18.9 million weighted average shares outstanding.

Net sales for the nine months ended September 30, 2002 increased by 11.1 million, or 2.9%, to 390.5 million from 379.4 million in the prior year's comparable period. The sales growth was primarily the result of a 5.1% increase in same center sales in the Company's O&P practices, offset by a 4.7 million or 1.2% reduction in net sales as result of the sale of our Seattle Orthopedic Group. Gross profit for the first nine months of 2002 was 209.7 million, or 53.7% of net sales, compared to 191.4 million, or 50.4% of net sales, in the prior year. The improvement in gross profit, in both dollars and as a percentage of net sales, was due to a reduction in labor and material costs. Income from operations for the first nine months of 2002 increased by 37.3 million to 62.4 million from 25.1 million in the prior year's comparable period. The increase in income from operations is the result of increased sales, gross profit and the elimination of both unusual charges and the amortization of goodwill that were reported in the prior year. Net income applicable to common stock before extraordinary item for the first nine months of 2002 was $16 million, or 74 cents per diluted share on 21.5 million weighted average shares outstanding, an improvement of $24.2 million over the comparable period last year. For the corresponding period of the prior year, Hanger had a net loss applicable to common stock of 8.2 million, or 44 cents per diluted share, on 18.9 million weighted average shares outstanding. Net income applicable to common stock was 13.2 million, or 61 cents per share, in the first nine months of 2002, compared to a net loss of 8.2 million, or 44 cents per share, in the prior year. The 2.8 million extraordinary loss on the early extinguishment of debt in the nine months ended September 30, 2002, was recorded in this year's first quarter in connection with the Company's refinancing of it’s bank debt. The unusual charges of 1.4 million and 16.2 million recorded in the third quarter ended September 30, 2001 and the nine-month period then ended, respectively, consisted of restructuring and performance improvement costs as well as the loss on disposal of assets. As reported on the Company's Annual Report on Form 10-K for the year ended December 31, 2001, SFAS 142 was adopted as of January 1, 2002. Accordingly, amortization of goodwill ceased in the quarter ended March 31, 2002. The Company reported 3.3 million in amortization of goodwill for the quarter ended September 30, 2001 and 9.9 million for the nine months ended September 30, 2001.

I was quoted as saying, "The results of our employees' diligent efforts to continually improve our operations, is very evident. We have integrated all of our ongoing re-engineering improvements into our daily work processes and will continue our focus on enhancing shareholder value."

At this point, I’d like to turn it over to George McHenry, our Chief Financial Officer, who will highlight the quarter’s results for you.

Thank you, Van, and thank you all for joining us this morning. For the quarter, our sales were on target. Our comp sales at 4.6% were strong when you consider that our Medicare CPI last year, was back-end loaded into the second half of the year, due to some computer issues that they had in terms of loading the new schedule. Mathematically, that caused a one-time impact this year, where our reimbursement level actually dropped in the third and fourth quarters. So we feel that that 4.6% was a strong result.

Our cost of sales; the material cost is basically where we expected it year-to-date – it’s in for the quarter, and it was roughly $1 million less than it was last year. Our direct labor was $600,000 less than last year. And that’s the main reason, along with our strong collections, for the increase in our SG&A, is that those two items are the main components of the practitioners bonus plan.

Our SG&A was $2.8 million higher than last year. And, as I just mentioned, $2.4 million of that was tied into an increased bonus accrual for the practitioners. The balance of the change was due to some non-cash write-offs of leaseholds that were associated with some rehabs, relocations and mergers of our practices, so, just normal operating transactions with the practices.

Our depreciation was $900,000 less than last year, and that was due, both to the elimination of some amortization of separate intangibles that were folded into our goodwill when we did our FAS 142 implementation, and our additions last year were less than we expected. And this year, about $3 million of our additions are associated with our new billing system, which is not yet in service. So, we’re not depreciating those assets yet. We will, first quarter, when we start rolling that out.

Our interest was $900,000 less than last year. Our borrowings are down and variable interest rates continue to stay low.

On the balance sheet; our cash is strong at $22 million, due to $25 million in free cash flow from operations this quarter, and $41 million year-to-date. We did make an interim payment on our practitioner bonus on 10/1, of about $12 million, but our cash balance has since popped up to almost $12 million, as our cash collections remain strong.

Our AOR only increased .9 million, which in view of our sales increase, is a good result. And our DSO’s are down a day, compared to 12/31 to 73.8 days.

Our inventory was down by 1.4 million compared to year-end and our turns remained constant at 2.5 times. And our cap ex for the quarter was 2.7 million and is at 6.6 million for the year.

With that I’d like to turn the call over to Tom to talk about operations.

Thank you, George. A pleasure to be with you this morning. I’d like to pick up on the [post] that Van mentioned to you a few minutes ago and that is that our work, in terms of the original initiatives, while continuing, has been fully integrated into our operations. And, I think that’s evident if we were to look at our quarter’s results and if we took the percentage of the cost of goods from last year in the comparable quarter, and compare it to this years sales, we can see an improvement of about $2.5 million.

If we use the period for the first nine months of the year and compare it to the comparable period from last year, it’s almost $13 million better. And that’s a direct result of, as Van had said, our employees hard and diligent efforts, as well as some of the process improvements that we’ve made. And, so we feel, at this point, since these are integrated into the way we do our work that it is ridiculous and a bit redundant to try to split them out, so they are apparent in the results.

And on a go forward basis, obviously, we’re going to continue to make improvements in these processes, as well as look for other opportunity where we can find room to improve our shareholder value. A couple of examples of that is that we’re going to continue [technical difficulty] across the range of our patient care centers to identify those that are, perhaps, under-performing, relative to the metrics that we’ve established for them and find ways to support those and increase their performance.

As well as, there are four major areas that we will continue to focus on and that’s looking at some other areas for process improvement, looking for areas for revenue enhancement, selective acquisition programs, and, of course, the organizational development program that we began earlier this year.

George had mentioned that a key process improvement, our billings and collection system entering in the fourth quarter here, extensive in house testing with a roll-our plan the beginning of next year, we anticipate that that roll-out will take approximately six months.

After that’s in place and functioning, we will go back and revisit the process improvement to see if there is an opportunity for centralization of billing and collection after that system is in place. We have taken the first steps in examining and improving our fabrication, which includes bringing in-house, some products that we’ve bought on the outside. We are making advancements in looking at these national products programs and also advancements in the way which we use fabrications to support our patient care business. And we will continue to do that.

This year, during our annual inventory, the physical count; we employed the beginnings of the new inventory process improvement. We are going to continue to refine that throughout 2003, as we continue to take steps to try to have a more visible inventory.

On the revenue enhancement side, we have two key programs under way, the first of which is to use all of our functional areas to support our product evaluation committee. And that is simply looking for new and better products. For example, the Hanger computerized leg, which uses a computer knee, is a very good application of how the committee’s bring to bear new technologies into the market place. We’re continuing to work with key manufacturers on the outside to evaluate and commercialize new products to enhance our revenue.

And the other area is, we had mentioned to you earlier, that we were building out a marketing capability. [where] populating that organization have made some substantial improvements across several fronts; our marketing management focusing on our referral sources and our patients have been populated; our business development field force has grown and they’ve put in their plans for bringing the proper educational message to key referral sources out in the field; And, thirdly, we’re conducting an extensive review of all of our contracts. That work will be on going in ’03.

And we are, at the same time, continuing to evaluate on a very selective basis, key acquisitions where they make sense, and we believe that will be accretive to the Company and will also support our geographic profile.

And, finally, our organizational development efforts have been launched. We are rolling out our process of skills assessment throughout the Company and that is cascading down through the various levels. And, to support that, we have put into place an online development program, which we call the Hanger e-Versity, making training and development available throughout the various disciplines online, so that those who need enhancement in critical skills and can step up to higher levels of responsibility, can find that online. That effort has begun and will continue, also, throughout 2003. Thank you.

Thank you, Tom. April, we’re ready to open it up for questions and answers.

At this time, I’d like to remind everyone, if you’d like to ask a question, please press star, then the number 1 on your telephone keypad. Your first question comes form David McDonald from [Lee, Rink, Swan].

Congratulations on the quarter. A couple of questions, George, I was wondering first, if you have this number, what the same-store number, or same-center number would have been if you’d normalized the reimbursement year-over-year?

That probably cost us a point in our comps.

Okay, and Tom, could you just touch base on the I.T. rollout? When you say you’re testing it internally, once that’s tested and you guys are comfortable with it, would this be rolled-out regionally first, to make sure it works in the field, and then rolled out to all of the practices? Or exactly how is that process going to work?

The testing – two big blocks of testing. The first is in the laboratory condition of putting all of the modules together and making sure that they’re linked with the other systems. And we call that the user acceptance testing. That’s underway in here. We will, in November, December and early January – we’ve identified seven sites on the outside and we’ll actually install it and run it in a real life condition within those patient care centers to make sure that it works, that it is consistent with the work practices that are utilized out in those areas, and we’ve taken selected regions so we get a good geographic mix here.

Then we will actually begin the rollout, obviously, this is a very disciplined and planned rollout where, as this is an update and an improved functionality of an existing system, we’ll begin to look and balance two things; where does it make sense to put it in, in terms of the systems that are in place. We’re going to start with our existing TOPS practices because the conversion of those practices will be the easiest in that the people that are accustomed to TOPS will not have great difficulty adapting to this.

And, since this is almost a –the trainer approach, we want to be geographically smart at the same time, so we can roll it out for effective utilization of our people. So, as we begin the rollout, it’s going to take a full six months as we roll across the U.S. on a geographic / existing systems basis.

Okay, and one other question. On the contracts that you guys are reviewing, is that more on the manufacturer side in terms of your purchasing, or is that managed care relationships where you think you can get a little bit better pricing? Just a little bit more color on that.

That’s on the payer side, the managed care side. And it’s to ensure that, one; we’re getting the value of the deal that we bargained for when we put the contracts in place. And, secondly, that they’re current on all of their terms and conditions in terms of matching the fee schedules of what the contract allows us to bill.

Okay, guys, last question. Could you just tackle the cash flow? Cash flow was significantly stronger in the quarter. You’ve obviously made a payout in Q4. I was wondering if you could just give a range in terms of what you would expect cash from operations to be in Q4?

In Q4, we’d expect the cash flow is not going to be that high because we have some on-payments – we’re still predicting about that $40 million number that we’re at right now. So we ought to be about cash flow break-even.

Dave, two things that are coming up. Obviously, everyone knows on December 15, we make our second half coupon payment on [technical difficulty]. And on October 1, we made a bonus payment to the practitioners.

Your next question comes from Andrea [Beesey] from Salomon Smith Barney.

Good morning. My question relates to receivables. What percentage of your receivables are over 120 days past due?

That is holding steady. It’s improved a little bit. At this point, we’re down about 29.5%.

Twenty-nine point five. Were you at 28.9 in June?

I don’t have the answer to that in front me. I hope we were a little higher in June. I think it actually improved a little bit. I think we were up around 29%? I’m sorry, about 30% in June. So I think we improved about a half a point.

Okay, and then, if you had to characterize linking the gross margin improvement to the operational initiatives, such as best value, inventory management, share fabrication and you know, just overall business optimization, which initiative do you think contributed the greatest?

Well, at the gross profit level, we would be focused on the operational improvements, and probably the three key ones there, Andrea, would be on the material side, our best value, the restructuring and focusing of our distribution business would be key. And then bringing in-house of some of the products that were purchased on the outside, we’re now making within our fabrication area. And of those three, I would rank the best value number one; the shared fab number two and distribution number three.

Great. And what should we look for? Distribution has bounced around a bit. What should we look for in terms of sort of a distribution revenue growth going forward?

As we mentioned to you in the first half of the year, there’s some pretty strong competitive conditions out there. We took some aggressive actions to make us a bit more pro-active in the market place, and so our performance has come up a bit as we were in third quarter. And we’re expecting that fourth quarter will be similar in terms of the revenue split – probably account for about 6% of our overall sales, Andrea.

Great. Thanks very much.

Andrea, it’s also key to know that in the third quarter, SPS launched a new catalog, which stimulates a lot of new sales. And they also put a couple of more people on the ground on the sales force. Q3 was probably a little bit higher than what we expect to see in Q4.

Are there any trade shows or anything coming up?

No, in Q4 the whole [indiscernible] for our business in general.

Your next question comes from Kevin [Fishbach] from Lehman Brothers.

I had a follow-up question about what Tom was talking about as far as bringing in-house manufacturing on some of those products that you do now. I was wondering if you could us some of the examples – I think you talked about body jackets. I was wondering if you could give a number for that and maybe some other products that you would have [indiscernible]

Thank you, Kevin. I would say this is really in two buckets here. The first is the bringing in-house of some of the ordinary and usual work that we do. We’ve made a very focused effort over the past 18 months to make sure that when it was appropriate that we did the work with our own technicians and our practitioners.

In addition to that, and that was merely just make it internally instead of buying it on the outside because we had the resources. In addition to that, we designated some of our fabrication centers as national centers of excellence. And, as a result, we made some capital investment in those and we began on a test-basis to see if we could make a line of products that, previously, we were buying on the outside. If we could bring that in house, meet the same quality standards and delivery times as our practitioners were accustomed to having on the outside.

And so when we talk about bringing in-house, it’s a combination of both of those. And the key one, as you mentioned, of course, is our body jacket program that we are bringing up. That’s one of those national programs we are rolling in on a market-by-market basis, the participation of our practitioners and we’ve gone through, roughly, the first three on an integrated basis, and we practically, weekly, are rolling in the others of those. And so, we think that while the campaign will stay in place to bring in the usual and customary, the types of work that we can do, we will be escalating the program in terms of the national products.

Okay. You also talked about bringing up margins on under-performing facilities. I wondered if you could quantify that a little bit, where the margins are, where you expect them to get to?

Well, our goal, which we have announced in some of the meetings, is to try to get all of our patient care center, up to a 25% EBITDA to sales level, that’s in the field. That’s before divisional and our corporate overhead. Right now we’re a couple of points under that. And so we see the route to making that happen, as to not only help the good ones get better, but to help some of the ones that are struggling to come up, as well. So, we have, as an overall goal, of trying to bring this up another two to three percentage points.

And if you could maybe give the top two ways that you would be able to do that?

Each one’s a bit unique. We have to really go in and understand the competitive circumstances of that practice in the market, as well as maybe a practice that’s having a materials area problem, or a labor area problem. And so it’s through the, what we would call our best practices program, where we’re sharing the knowledge by trying to team up some of the practitioners that are in the under-performing areas with those that are doing well, so we can share our best practices recently.

And just to support that, we had a group demonstrate and we taped some processes for making various devices and that tape is available that we’re going to disseminate out – provides a quality product but is faster and less expensive. So it’s really a sharing of knowledge program and having people work with each other so that they can learn those best practices.

Each one is a bit different, Kevin. Sometimes it’s labor, sometimes it’s materials, sometimes it’s sales. And we have to look at each one individually.

Your next question comes from [Henin Rucall] from Georgia Bank.

Hi. Just a couple of quick questions. First is, I know you had made the payment out for the bonus accrual on October 1, but what was cash at the end of the quarter? And the second one is, I think you had 4.6% same-store sales growth this quarter over last, what would – do you expect to see it at this level or maybe picking up a little bit next quarter and the couple of quarters after that?

Henry, the cash flow was $22 million at the end of the quarter.

Well, as far as the same-store sales growth, Henry, as George pointed out earlier, we had a – from CMS, about a 6.4% increase in reimbursement in the latter half, the third and fourth quarter of last year. Because CMS, when the increase, the CPI increase, was granted us, was not prepared to put it into their system, so it was all back-loaded.

So the same-store sales growth that you see here, third quarter over third quarter, is significant because we had the advantage last year of, for 40% of our business, of better than a 6% increase. You will see the same thing in Q4 because then it will start to normalize as we go into the ’03 year, in terms of comparable sales, quarter-over-quarter.

And you said the Medicare impact was about one point off the top line, so it actually saw a little acceleration, I think.

Exactly, Henry. And I would anticipate that you’ll see something comparable in Q4 because we had the same phenomenon last year. We’re currently scheduled, and unless this is changed, which I’m not anticipating that it will, to get another CPI increase January 1 of ’03. Now that will probably equate to something less than 2% in terms of the CPI increase, but we’ll take whatever we can get.

Okay. Is that scheduled, or is that –

That is currently scheduled, and unless Congress were to repeal that, that’s what we’re currently scheduled to get.

Your next question comes from Barbara [Mehan] from [BNP Saravit]

It looks like you paid down about 6.7 million of debt in the quarter. I was wondering what the announced outstanding was at quarter-end under the revolver and your seller notes?

Hi Barbara, it’s Jason. The pay-down was actually a little bit more than that. At quarter end, there was $26 million left outstanding on the revolver, which means we paid down $10 million during the quarter. The seller debt, it was just over 13 million at end of second quarter. It was 10.9 million at the end of third quarter.

Okay. And on August 15, S&P changed their outlook to positive. Do you have any scheduled meetings with them coming up?

We continually review quarterly results with S&P and we’ve been in discussions really since the bond meeting about looking for an increase, or an up tick in our ratings. And we continually discuss our results with them.

Okay, and then finally, the acquisitions – what’s the timing of this? Is this fourth quarter or will this be pushed into ’03? And then, how much do you anticipate spending on acquisitions in ’03? Thank you.

The acquisition program will be ongoing into ’03. And, as our focus is geared toward the market place, what we’re really looking at is buying small practices, in the range, anywhere from a million, probably up to five million. So it’s not going to be all in one big dose. We see this as a continuous pipeline where people approach us because they’re looking for an exit strategy. And if it makes sense then we, naturally, enter into the process of evaluating the business and trying to construct a fair offer and to consummate an agreement.

On a go-forward basis, what we’d like to see us be, is in the purchase of somewhere between 20 to 23, $25 million worth of annualized sales and bring those into the Company. On an immediate basis, we may be looking at somewhere between 4 to $5 million worth of annualized sales coming into the Company in the fourth quarter. And if you remember that, we do finance these out of our internal cash flow, 50% cash, 50% seller notes that are paid out over five years. So we don’t see a big aggressive program here. This is supplementing a good network and just making it a little better.

Your next question is a follow-up question from Andrea Beesey from Salomon Smith Barney.

Yes, can you discuss – it looks like the practitioner number was the same year-over-year but there were probably some additions in the quarter – looks like there were 26 more. Can you provide a little bit more light on that, with respect to any additional certifications from your ‘grow your own’ program and hires and resignations?

Sure Andrea.. At the end of second quarter we had 859 practitioners. During the quarter we hired 34, we had 12 of our practitioners that reached certification and then there were 20 resignations, 10 terminations and 2 other subtractions.

So we ended the quarter with 873, which year-over-year is spot on. If you look at gross turnover, and not adding back at the people we hired, last year, calendar year 2001 we were at 10%. If you look at the last four quarters, that number has dropped to 7%. And then if you look at net practitioner turn over, it’s roughly zero.

So it looks like the way – is this the proper way to think about it to adjust for the ebbs and flows? A trailing 12-month basis, it looks like, on the same number of practitioners, productivity increased about 8% based on revenue per practitioner.

Yes, it’s up to about $155,000 per practitioner per quarter. And if we track that back over the last two years, it’s between an 8 and 9% annual compound growth rate.

There are no further questions at this time.

Thank you, April. Well I want to thank everyone for participating this morning and your continued support. We had an excellent quarter. We look forward to continuing this trend, and I hope you all have a good day. Thank you.

This concludes today’s teleconference. You may now disconnect.