Hanger Inc (HNGR) 2013 Q3 法說會逐字稿

Good morning. My name is Tiffany, and I will be your conference operator today. At this time, I would like to welcome everyone to the Hanger, Inc. third-quarter 2013 results conference call. (Operator Instructions). Russell Allen, Treasurer of Hanger, Inc., you may begin your conference.

Thank you, Tiffany. Good morning, and welcome, everyone, to Hanger's discussion of our third-quarter 2013 results. Before we start our discussion, I will review with you our declaration of forward-looking statements.

During this call, management will make forward-looking statements related to the Company's results of operations. The United States Private Securities Litigation Reform Act of 1995 provides a Safe Harbor for certain forward-looking statements. Statements related to future results of operations during this call reflect the views of management. However, various risks, uncertainties, and contingencies could cause actual results or performance to differ materially from those expressed or implied by these statements. This includes but are not limited to the Company's abilities to enter into and derive benefits from managed care contracts; demands for the Company's products and services; the impact of reviews, audits, investigations conducted from time to time by the government agencies; and other factors identified in the Company's periodic reports on Form 10-K and 10-Q, which are filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934. The Company disclaims any intent or obligation to update publicly these forward-looking statements whether as a result of new information, future events, or otherwise.

Now I will turn the call over to our Chief Executive Officer, Vinit Asar.

Thanks, Russell, and thank you all for joining us on our third-quarter 2013 earnings call. Let me begin by saying we're pleased with our results this quarter. Our net sales increased 11.8%; our adjusted diluted earnings per share increased 24%; and we saw a 3.8% increase in our same center revenues within our Patient Care segment. Our Products & Services segment grew revenues 16.2%, driven by the impact of a one-time sale as well as sequentially stronger ongoing sales in the quarter.

We also saw stabilization in the number of RAC and other Medicare audits during the quarter. However, due to a large backlog of appeals in the administrative law system, we're seeing a longer time required to resolve these audits. It is important to note that due to the focus and strength of our internal compliance and audit programs, we have maintained and 90% success rate in our appeals processes at final adjudication.

I would like to take a moment also to mention that even though this is the second consecutive quarter where we were impacted by sequestration, which is a 2% cut in all our Medicare revenues, our demonstrated strong results appropriately reflect the strength of our underlying business in this environment. I will provide some additional color on our operations later in the call, but first, let me turn the call over to George McHenry, our CFO, to review our financials in more detail.

Thank you, Vinit. Q3 was another solid quarter for the Company. My analysis of the Q3 results are as follows. Net sales increased by $28.6 million, or 11.8%. The Patient Care segment generated $21.6 million of the increase with acquisitions accounting for $14.2 million and comparable-store sales generating $7.4 million in sales. Comparable-store sales and Patient Care increase by 3.8%. Patient Care sales reflect the revision discussed in the press release. Products & Services generated a $7 million or 16.2% increase. The segment benefited by a stronger sales against weak comps in the prior year as well as the benefit of a one-time sale which we had previously expected to occur in both Q3 and Q4. The one-time sale involved a long-standing customer and includes a new long-term service agreement.

Adjusted EPS of $0.62 represents 24% growth over the prior year. Adjusted operating leverage increase by 30 basis points. Our com rate of 29.3% was 80 basis points lower than last year, reflecting success in our materials management efforts designed to provide patients with the best possible care in part by reducing the number of SKUs that we carry.

Personnel costs increase by $10.6 million compared to Q3 of 2012. $5.9 million of the change was due to costs associated with acquisitions; approximately $1.5 million of the change was due to annual merit increased and improved employee benefits. The remaining increase is due principally to a extra day of labor in 2013 compared to last year, as well as addition to our infrastructure to support the overall growth in our business.

Other operating expense for the quarter increased by $6.5 million to $47.8 million in 2013. Approximately $1.9 million of the increase was due to acquisitions; $900,000 was due to increase rent; $1.6 million was due to increase professional fees; and the balance was due principally to increased costs such as software license fees that are associated with the growth in the number of practices that we have.

Our effective tax rate improved to 36% for the quarter compared to 37.2% last year.

Moving on to the year, consolidated sales increase by $63.4 million, or 9% for the first nine months; $42.9 million of the increase was due to acquisitions of O&P facilities; $15.9 million, or 2.8%, was due to an increase in comp sales in Patient Care; and $4.6 million, or 3.6%, was from an increase in sales in our Products & Services segment.

Adjusted EPS of $1.42 represents 12.7% growth over the prior year.

Our com rate of 29.5% was 70 basis points lower than last year, principally due to our continuing efforts to improve the management of materials in Patient Care as well as a change in the mix of sales favoring Patient Care, which has a lower com rate.

Operating leverage is down 20 basis points for the year. We expect to finish the year with a 20 to 40 basis point improvement based on the results in Q4.

Personnel costs increased by $29.2 million for the year; $17.1 million of the increase was due to the impact of acquisitions; $6.8 million was due to the impact of merit increases and other benefit improvements; and the remaining increase was due to the headcount increase to support growth in our business.

Other operating expenses increased by $11.3 million for the year. Approximately $5.3 million of that increase is due to acquisitions; $2.1 million was due to increased professional fees; $2.8 million was due to increased rent, principally in Patient Care; and the balance was due principally to expenses such as those software license fees that I mentioned before.

D&A increased by $2.6 million for the first nine months compared to last year principally due to a combination of the impact of acquisitions and a slightly higher rate of expenditures on capital additions.

Our effective tax rate for the first nine months improved to 36.4% compared to 36.7% for the same period in 2012. Our core rate for the year, for 2013, stands at 37%.

Moving onto the balance sheet and cash flow, our AR balance was $176.7 million at the end of September. DSOs were 61 days, which is 1 day higher than Q4 of 2012.

Now let's talk about our favorite subject, Medicare audits. When I refer to Medicare audits, I am referring to all audits including RAC, prepayment and CERT audits that Medicare performs. Total receivables related to those activities increased by $2.5 million to $13.9 million, of which $12.1 million was over 120 days old compared to $11.4 million at the end of Q2, of which $9.6 million was over 120 days old.

If you eliminate Medicare audits from the calculation of DSOs, they were 56 days in Q3 compared to 59 days at the end of the year. So our DSOs have actually improved versus the end of the year. Reserve changes from the audits at an approximate $300,000 negative impact on sales for the quarter.

In summary, our DSOs improved 3 days when you factor out the Medicare audits that we are still winning 90% of the time. With audits factored out of collections, they are very healthy and our reserves are a similar percentage of over 120-day old receivables compared to Q3 a year ago.

Inventory was $144.4 million at September 30; inventory turns were 3.9 times, which is a quarter turn faster than a year ago.

CapEx was $9.4 million for the quarter compared to a $8.9 million in 2012. That is a $0.5 million increased. Through nine months, CapEx was $27.5 million compared to $24.9 million in the first nine months of 2012. That is an increase of $2.6 million. The increase is due principally to expenditures related to the rollout of Janus.

Cash flow provided from operating activities for the quarter was $40.8 million, representing an $8.8 million increase compared to $32 million in 2012. For the first nine months, cash flow provided from operating activities was $68.5 million, a $9.5 million increase compared to last year. If you factored out the $10 million impact of the increase in RAC receivables on working capital, cash flow from operations for the first nine months would have increased by almost $20 million, so our cash flow is very strong.

Liquidity at the end of Q3 -- our total liquidity was $177.6 million, comprised of $7.2 million in cash and $170.4 million in availability on the revolver. Hanger has paid down almost $50 million in debt since the end of last year, and our total leverage reflects that, per the bank calculation, has declined to 2.5 times which is well below our covenant of 4 times and a significant drop from the 2.8 times we reported at the end of Q2.

Moving on to guidance, we are revising and narrowing our guidance for 2013 principally to reflect the impact of the revision on sales that I mentioned before. We expect net sales in a range of $1.045 billion to $1.055 billion; that is a 7% to 8% increase over 2012.

We expect our EPS in a range of $2.08 to $2.11. We expect Patient Care to grow 3% to 4% in 2013 and Products & Services to be slightly positive for the full year. Our guidance for improved operating margin remains as 20 to 40 basis points.

That concludes my comments, and I am now going to turn the call back over to Vinit Asar, our CEO, for his commentary.

Thank you, George. Let me provide some color on our operations this quarter.

We were pleased with the overall strong double-digit top-line and bottom-line growth this quarter. Our 10.8% growth in the Patient Care segment is a testament to our strategy of driving organic growth in our existing Patient Care clinics, supplemented with our successful acquisition program.

Our investments over the years in pilot programs and clinical programs of excellence, such as upper extremity, lower extremity, and our national orthotics program, all continue to bear fruit. This is evidenced by results in an environment that demands high-quality patient care provided in an economic and value-added manner with increased regulatory requirements.

We are also very pleased with the efforts of our team at Linkia that continues to engage in the appropriate conversations with our payers, including those that are going to be managing parts of the many state and federal exchanges.

Our materials management initiative, which entails stronger partnerships with key supply-chain partners and fewer SKUs, is also beginning to show the results that we had expected on our cost of materials line.

Our acquisition pipeline remains healthy with a robust number of interested sellers. As we talk to these potential sellers, we are seeing increased levels of financial distress on their end. Our approach in acquisitions over the years has always included an in-depth, due diligence process which includes a detailed look into items such as potential compliance issues, financial trends, and employment agreements. This approach has never been more important. Our focus remains on acquiring high-quality businesses with high-quality clinicians and staff since these are the traits that have made our acquisition program successful over the years. We remain on track to meet our acquisition target of approximately $20 million in revenues this year.

Switching gears a bit to our investment in Janus, which is our next generation clinic management system. The implementation of Janus continues to progress well. We have begun the national rollout of the system which is expected to continue for roughly the next two years or so as we convert all of our 740 locations to this new platform.

Now, let me spend a few minutes on the issue of Medicare audits. Firstly, I think it is important to note that Medicare audits come in many forms, RAC audits being one of them that appeared to spike heavily earlier this year. As a reminder, RACs, or Recovery Audit Contractors, are commissioned by CMS to conduct post-payment audits to look back at already-paid claims to make sure that all coverage criteria and other claim requirements in effect at the time of payment were met. The look-back period can be up to three years from the date of claim payment. When we aggregate all the Medicare audits that occur in general for us, post-payment RACs and prepayment audits, we saw the overall number of new audits slow down in Q3 compared to Q2. All Medicare audit activity has the same or similar appeals process and what we are now seeing is that the backlog of appeals that the administrative law judge levels appears so severe that there is now a notice on the US Department of Health and Human Services website, or HHS.gov, that states based on our current workload and volume of new requests, we anticipate that assignment of your request for hearing to ALJ, or administrative law judge, may be delayed for up to 28 months.

As a company and as an industry, we will continue to appeal to the appropriate lawmakers and administrators to figure out ways that are not so burdensome on those of us that have such high levels of success in these appeals.

Our Products & Services segment revenue growth this quarter benefited in part by a one-time sale combined with continued sequential growth in the segment. As George indicated, the one-time sale that we had projected to occur over a couple of quarters actually all materialized in Q3 and was associated with a new agreement with a long-term customer within our rehab business.

Given that a large part of the sale was previously planned in the fourth quarter, the net impact of our full-year revenue and earnings is minimal. In addition to the one-time sale, our rehab business continues to show year-over-year improvements in operations. For the first time this year, but also as expected, our distribution business as shown year-over-year revenue stabilization, especially when you adjust out the impact of the customers that our Hanger Clinic acquired during last year.

The team within the distribution business has been successfully working on new and effective marketing programs to attract more business from existing customers as well as bring in new customers.

Our customer base of independent OMP businesses continue to operate in a state of caution on their spending, given the regulatory and reimbursement environment that we are in. These customers continue to reduce their purchases of higher-technology prosthetic devices in exchange for lower-technology devices.

Overall, at Hanger we continue to demonstrate the strength of our business fundamentals, despite the challenges faced by us and other healthcare service businesses. Our balance sheet continues to get stronger, as we are projecting to generate $90 million to $100 million of cash flow this year. And as George pointed out, our leverage ratios and debt levels continue to show improvement. These factors, combined with our strong operating results, position us very well to make continued investments that will drive profitable growth in support of quality patient care and shareholder value.

That concludes our prepared remarks. And at this time, operator, please, can you open the call for questions?

(Operator Instructions) David MacDonald, SunTrust.

First, was wondering if you could just give us a quick update on the WalkAide, how we're doing there in terms of peer review. Is that pretty late in the game? And just any detail you can provide there.

We are in the midst of conversations with a peer review journal, and we're just going back and forth in terms of questions and answers with them. So our plan is still --we're still planning on completing that process and submitting to CMS this year.

Okay. And then could you guys just give a little bit more detail on the one-time sale? George, more just a question of when we think about modeling 2014, how much revenue comes out if you look at this on a full-year basis? Essentially trying to get a sense of what the real revenue run rate is -- how much that's comes down tied to this. Just more of mass around it as we're trying to do modeling in 2014 and beyond.

Well, Dave, as we said before in our comments, this is a sale we expected to happen in Q3 and Q4. Just to look at the current year impact on Q3, our sales were about $4 million higher than we expected. Our EPS was about $0.03 higher than expected. And as we mentioned, Vinit mentioned specifically that this is a long-term customer and we did enter into a new long-term agreement that both included the sale and service agreement.

So when you look into 2014 -- obviously we're not going to be giving guidance on 2014 until we announce Q4 -- but we don't expect a material change when you are modeling it is not going to make a significant difference on how you should look at growth in the Products & Services segment.

Okay. And then just say a couple more questions, guys. With regards to Janus, can you give us a sense of the timing of the rollout? In other words, how many facilities do you expect this to be in at year end, over the first 12 months? Is it going to be rolled out pretty ratably? Just any color you've got there.

Sure, Dave. Our plan right now, as I mentioned, we are in the midst of the national rollout. We just began that over the summer.

When we close out this year, we will likely to be in 50 to 60 clinics at the end of this year. When we close out next year, we should be in close to half of all our total clinics. So, that is the run rate that we are operating in. And as we roll more and more clinics, our rate will probably start increasing next year as we begin to streamline the training processes, et cetera.

Okay. And then guys, just last question, I was wondering, can you give us a sense of what the growth rate was at Linkia this quarter? And are you, Vinit, tied to your commentary, you guys seeing any juice in that business tied to the potential rollout of exchanges and things like that? Are people giving that division a harder look these days?

Well, let me answer the second part of the question first, and then George can jump in with the numbers.

Certainly, we're engaged in more and more dialogue with these exchanges. People are looking at Linkia as a strong point, because I think the buzzword these days is narrow networks and Linkia certainly exemplifies what a narrow network used in terms of the support system for these payers. So, the conversations certainly are increasing.

Dave, the growth numbers -- actually it was the best quarter of the year, 14.3% for the quarter and Linkia revenues, which of course are principally reported through Patient Care are up 12.5% for the year. So, they are doing well.

And George, was there any noticeable contract that rolled in this quarter or is that strength across the board?

It is strength across the board.

Okay. Thanks, guys.

Larry Solow, CJS Securities.

Wondered if you guys can just give us a little bit more color just on the reason for the revision on the bad debt expenses. It seems like it's pretty small nominal change. Just a little more color on why you did it. Is it have to do with some of the things the SEC was looking at? Any color there? And does this put you in line with what competitors do?

First of all, this is something that we self reported. There is a relationship to the investigation in the sense that we were looking at all our practices of what we have done in the past from a computational standpoint in this area to make sure we were happy with the process as we were answering their questions. And this was an area where when we looked at it, we've historically been writing older commercial and government items off to bad expenses instead of sales. When -- just in the last few months we learned that most companies were most healthcare companies were writing off things like RAC audits against sales; we had been writing those off to a bad debt expense. And that made us think that perhaps we should look at that whole practice. And we looked at it and determined it was more appropriate and in line with what other healthcare companies are doing to write those expenses off against -- all those reserves off against the sales. So we made that change. It was deemed to be immaterial, so it is being reported as a revision.

So it's not directly related to the agency's investigation, but it's something we thought it was the right thing to do.

Okay. And in terms of the RAC audits, does the increasing length of the appeals process, at the end of the date does that really cost you guys more? Or does it just -- obviously, it takes longer to get resolved, so I guess it's longer outstanding on the books. But does it end up costing you more?

Well, in a sense it costs us overhead, but it's mostly people who are already in place in our organization who are -- the people that are really responsible for us having such a great success rate, because they monitor and administer the excellent program that we have to ensure that we comply with the billing rules.

So it uses up their time, which we wish wasn't happening, but I don't think it's costing us other than the interest costs on the borrowings that we have to make on the revolver to cover it.

Right. And I guess the increased headaches for the people doing this stuff -- I realize it's more of a burden and a pain.

Any comment just on the environment both on the customer side and competitors? Obviously they are dealing with these same RAC audits, certainly on the competitor side, so how is that -- it sounds like it has been worsening for them over the last few quarters. So if you can give us an update on that and then also on the customer side and what you're seeing. Any changes or is it pretty much status quo? Thanks.

Sure, Larry. On the competitor side, certainly the independent O&P providers are having -- they are facing the same issues as we are and as you can imagine, there some providers that have a higher success rate than others. But in general, when it is a smaller independent O&P operator, it's difficult for that operator to conduct their business and at the same time fill out the documents or fill out the appeals et cetera, to do that. And that is why there's so much distress in the industry at this point, especially with the smaller, independent O&Ps. So that continues for them.

In terms of our patients that are walking in the door, it is a status quo in the sense we still are taking market share we believe on a national level from our competitors. And there's also more patient flow coming in.

In some cases, we are providing higher-end prosthetic devices that are, despite the RAC audits, our communication with our clinicians is, guys, do what is right for the patient first. We will fight those appeals as they come in. And our policy is that we're going to appeal every RAC audit that comes in just because of the confidence we have in our processes.

Great. Thank you very much.

Brian Tanquilut, Jefferies.

Congratulations. George, just wanted to ask -- the com rate improve this quarter. And I'm guessing it's because of the initiatives that you guys have put in. But how should we think about the opportunity that is remaining with the supply rationalization initiative?

Well, we think we have an excellent opportunity from a cost standpoint while improving our ability to provide care. Because we are still -- when you look at the things we are doing, we are negotiating new national contracts; we are pretty far along with those kind of things. But we're putting in an enterprise-wide system to make it easier for our -- this is a system that looks like Amazon.com. And it makes it easier for our practitioners to order all the products they need to service their patients and look up things.

And that is going to enable us to really put better controls around what we do, and then invariably look at the breadth of the SKUs that we have and narrow those a bit more.

So we think we have quite a bit of opportunity over the next really several years to continue to refine how we manage our materials.

Got it. And then, Vinit, I know you are generally reluctant to talk about WalkAide, but just wondering, if you don't mind just sharing with us what is left to do with WalkAide in terms of internal activities or processes that you guys have to accomplish before the submission to CMS later this year.

Sure, Brian. As I said, we are in the midst of our discussions with a peer review journal. We're hoping to get that behind us soon. But in parallel we're also preparing the application to CMS, so our thinking is that once we get the results published in a peer review journal we will very shortly after that be submitting our application to CMS for reimbursement for the stroke indication. And that is pretty much it, Brian. Once we make that submission, it can take as long as CMS wants to prove that application -- ballpark, in the past you could say that timeframe was about nine months. But these days with everything that is going on in CMS and the government, not quite sure how long that would take.

I got it. And then last one, George, I know you mentioned the revenue from the sale of the products in the ACP division. Just wondering what kind of margin should we assign to that sale?

It is typical for the margins that that company, that the overall segment has.

Got it.

I think you can back into that from the impact on EPS that we discussed.

Okay, got it. Thanks, guys. Congrats again.

Dana Hambly, Stephens.

George, just so I get revenue for the year and last year straight, do you have what the reclassification did for last year? What it has done year to date this year and then what your expectation for the full year is, just the impact to revenue?

Well, the impact on revenue is embodied in our revised guidance. So, we had to make an estimate, of course, on what the impact on Q4 this year would be. That estimate for the current year was roughly $16 million. So we are estimating about $2.5 million impact on the fourth quarter. The impact on last year was for the full year was $11 million, with $2.6 million of that being in the fourth quarter. So the rest happened in the first nine months.

Okay, and just so I've got in the right place, when I think about same-store sales, this is all -- the revenue impact would presumably be mostly on the same patient center sales?

Yes it would, yes.

Okay, all right. That makes sense.

And I think, Vinit, can you just talk about the Janus roll out? Would we expect any disruption at the facility level? How are we thinking about that and how quickly can these centers be turned on?

That is a great question and very topical in that what we saw during our pilot phase of the Janus program and also the first 10 or 20 sites that we started rolling out on the national phase, what we're seeing is probably the 4 or 5 days leading up to the actual crossover, the implementation, there is some disruption because there's some training and hardware changes happening. And then the scheduling slows down for about anywhere between three and six weeks. We do see a slight slowdown in patient schedules. And that is how we have started to see the schedule as we roll out Janus. And we're baking that into our thinking obviously for the remainder of this year and we will bake that into our thinking for next year, as well.

Once we get through the four or six weeks after the implementation we are seeing those patients come back. But we are seeing a slight dip in those individual clinics for that period of time.

Okay, that makes sense. And then I think, George, the CapEx, the full-year outlook you reduced that maybe about $10 million.

Yes, we did. Based on where we are year to date, we are just slightly over last year. We reduced it to a range that is pretty consistent with last year's range.

Is there anything -- should we think about pushing that into next year or was there anyone particular project you just decided to hold off on?

We've just been cautious as we always are in terms of how we put everybody through pretty rigorous process of proving out the return on investment that we make into this area. So we slowed it down internally. We're going to our budget process right now, and I would anticipate we're probably going to tell you that the range for next year is close to what the initial range was for this year. Because the rollout of Janus will be in full swing. So we would expect a little higher CapEx next year than this year.

Okay, that is great. Thank you.

Mike Petusky, Noble Financial.

Can you give me the actual revenue related to Linkia? I know it is captured within Patient Care but you actually have the revenue or at least a range -- a rough number there as far as what was generated in the quarter?

It is on this report with really small numbers that they gave these. Q3 was $7 million and year to date were $17 million.

Okay. You mean in terms of incremental revenue there?

You are reading the incremental.

Yes.

Where is the total right here for 2013?

Year to date it is $157 million and the third quarter it is $57 million.

Sorry about that. That was the incremental increase.

Okay. So what is driving -- is it new customers that is driving that great growth? Or is it penetration of existing customers? What is going on there? That's really strong numbers.

It is really principally penetration. It's across the board. The strength is really across the board in all of our major contractual relationships.

All rights. And then can you -- and if I missed this earlier, forgive -- but can you remind me and everybody else as far as what price looks like in Medicare next year?

Well, price in Medicare, I don't have -- Vinit, do you know the commercial --?

Yes, we are expecting it to be very similar to this year. You know, net of the productivity adjustment it should be slightly south of 1% is what we're thinking. But that final number hasn't come out yet, so we're expecting at any day now.

Typically later in the year.

All right, great. And again, if you commented on this earlier, I may have missed, but in terms of the Medicare audits and what it's doing, especially to all our providers, are you guys seeing any pickup in terms of folks calling you interested in you looking at their assets? Or are you seeing anything in terms of multiples that you have to pay for those assets? Can you just comment on that?

We are seeing more people calling us than we have before. So we are in more dialog than we have been in before with interested potential interested sellers in terms of multiples.

Our focus is really on the high-quality clinicians and high-quality businesses. We are just focusing on those businesses that we know are in good shape and we will pay the appropriate multiple for those businesses. So if a business does come in and the financials are weak or we see some red flags on their compliance activities or they don't have adequate employment agreements et cetera, then we will pass. Or we will ask them to fix it and come back to us.

And approximately how much more acquired revenue do you need to get to your target of $20 million-plus?

We had announced $10 million at the end of July and we're on track to make the $20 million. So we should be -- we feel pretty good that we well get to the $20 million this year.

Okay. All rights, very good. Thanks, guys. Great job.

Thank you.

There are no further questions in queue at this time. I would now like to turn the conference over to CEO, Vinit Asar.

Thanks. Just want to close out by saying we were pleased with the quarter. We liked what we saw in terms of our same-center sales for our Patient Care segment and our total top- and bottom-line growth. And we appreciate your interest. And we will talk to you at the next call. Thanks very much.

This concludes today's conference call. You may now disconnect.