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Hanger Inc (HNGR)
Q2Â 2020 Earnings Call
Aug 6, 2020, 8:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Greetings and welcome to Hanger's Second Quarter 2020 Earnings Call. Today all participants will be in a listen-only mode. [Operator Instructions] Today, we will have prepared remarks, followed by a question-and-answer session. Instructions for questions and answers, will be provided after the formal presentation. It is now my pleasure to introduce your host, Seth Frank, Vice President of Treasury and Investor Relations. Sir, you may proceed.
Seth Frank -- Vice President, Treasury and Investor Relations
Good morning. Thank you. Welcome to Hanger's second quarter 2020 earnings conference call. With us today are Vinit Asar, Hanger's President and Chief Executive Officer and Thomas Kiraly, Executive Vice President and Chief Financial Officer. Some of the information discussed today will include forward-looking statements 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 statements 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 that, let's hand the call over to Vinit.
Vinit K. Asar -- President and Chief Executive Officer
Thanks, Seth. Good morning everyone and thank you all for joining us. We hope those of you listening today are staying safe and in good health, especially during these times. Today, I will review our second quarter results and give you an update on our efforts to manage the business during COVID-19. Tom will then review the numbers in detail and we will take questions. If you ask me to describe the second quarter of 2020 in one word, I would have to say, remarkable. At the beginning of April, shelter in place orders, rising infection rates and uncertainty about the future were peaking. Managing our business was made all the more challenging by fragmented civic responses to the pandemic varying by state and in some cases by county. As we discussed during our last call, we at Hanger, took early and decisive action to expeditiously build an operational and financial plan, which would allow us to successfully navigate this global challenge. We executed on specific actions that maximize our opportunity to emerge on the other side of all of this on a strong footing to resume the momentum that we saw in the early days of 2020.
Our approach to managing through the pandemic and the year ahead, was and remains grounded in three imperatives. First, ensuring the safety and welfare of our patients and employees. Second, delivering on our purpose of empowering human potential together by ensuring uninterrupted access to essential O&P services. Part of this effort has included proactive communications with our referring physicians and patients to ensure they know that the Hanger team is accessible and open in person or via video consultation, providing safe high-quality O&P care. And third, ensuring that Hanger has adequate liquidity to endure a multi-quarter, potentially prolonged downturn in patient volumes. I am pleased to say that we are in a stronger liquidity position today than at the beginning of the year.
It is difficult to express the profound appreciation and gratitude I have for Hanger's approximately 4,900 employees. There are many examples across the organization of people stepping up and going above and beyond in their efforts to support our mission. The proof is how our patients view us. Since the onset of COVID-19, Hanger Clinic's patient experience net promoter score has increased from 84.3 to 84.9. In this environment, it is a phenomenal achievement. It is all the more remarkable that this collective effort occurred on the heels of the difficult actions we implemented to reduce costs, particularly salaries in the face of a pandemic of unknown duration.
As a reminder, salaries for all Hanger exempt employees were reduced by an average of 32% in April for a duration of up to 6 months. In addition, our senior leadership team and I, took a reduction in salaries ranging from approximately 47% to 100%. And our Board of Directors has foregone their cash retainers from the company for the same period. We also commenced furloughs, decreased non-exempt employee hours and temporarily suspended adding new headcount. In addition, we reduced other operating expenses related to travel, professional fees and other items. Finally, we suspended our supply chain and financial systems initiatives and reduced other capital expenditures. With the completion of the quarter, we can see that the early and decisive operational actions which we took as a result of the pandemic have been successful. Having said all of that, patient appointment volumes began to gradually improve each month since the approximately 40% reduction we saw in April. Based on this progression, we announced a restoration of one-third of salary reductions in June and a further one-third restoration went into effect in July. We anticipate the remaining 11% base salary reduction to be reinstated no later than the end of the third quarter. My salary, along with the Board cash retainer, will remain entirely suspended until employee salaries are fully restored to 100%.
A word of caution is in order. We are still in the early stages of a situation, which will likely be with us for some time. We are working under an assumption that volumes will remain suppressed due to COVID-19 for the remainder of 2020 and potentially into the first half of 2021. I will now turn to the second quarter results. Please keep in mind that adjusted EBITDA, adjusted net income and adjusted EPS exclude a $20.5 million CARES payment Hanger received from the Federal government in the second quarter of 2020. Revenue results were similarly not impacted by this grant. Net revenue in Q2 totaled $233.4 million, a decrease of 17% compared to the same period in 2019. Total adjusted EBITDA in the quarter decreased by $860,000.
In our Patient Care segment, we experienced appointment volume declines. The primary metric we use for managing and planning staffing levels of 33% during the quarter. As mentioned, appointment volume declined in April by approximately 40% and improved somewhat throughout the remainder of the period, finishing down 24% in June. Appointment volumes have remained at approximately that level as we entered the third quarter. From a net revenue perspective, net same-clinic revenue on a day-adjusted basis declined 18.7%. While net revenue declined, it did so at a rate significantly less than appointment volume. There are two primary reasons for this. First, because of the widespread shelter in place orders that occurred in March, we saw some prosthetic device deliveries that shifted from Q1 to Q2. Tom discussed this during the last earnings call, specifically as it related to quarter-end work-in-process inventory. Secondly, the demand for Hanger's prosthetic services proved to be more resilient relative to orthotics in the current environment. We certainly believed this would be the case and to-date it has become increasingly evident that prosthetic care is indeed a necessity and it's challenging for people to put off for a prolonged period.
Excluding acquisitions, for the second quarter, while orthotics declined 30.4%, prosthetics declined 8.9% compared to the prior year, which was better than what we had expected. Customer orthotics declined at more moderate rates than the off-the-shelf orthotic categories. These shifts brought the prosthetic mix of our Patient Care revenue to 61.3%, up from 54.8% during the prior-year quarter. We view all of this data as encouraging, regarding the essential and resilient nature of the majority of revenue generated within our clinics during unprecedented times. Higher prosthetic mix, improved collections and more significantly the temporary personnel cost reductions resulted in Patient Care adjusted EBITDA being significantly buffered relative to the drop in segment net revenues in the quarter.
To be clear, adjusted EBITDA for the company and segments should be viewed in tandem with our liquidity improvement in the quarter, driven by our deliberate intention to build cash as a defensive measure against potential future COVID-19 impacts on our business. The fact that volumes began to gradually return during Q2, allowed us to move quickly to partially restore salaries, begin to bring back furloughed employees and increase hours for non-exempt employees.
Looking at the Products and Services segment, O&P distribution declined significantly, while the decrease in therapeutic solutions revenue was more muted. Total segment net revenue declined 24.7% driven primarily by a 29.6% decline in O&P distribution. As in Q1, a portion of the reduction in distribution revenues was anticipated due to our decision in 2020 to exit the distribution of off-the-shelf orthotics into channels that were unprofitable. Excluding this effect, we estimate distribution revenue declined approximately 23% as independent providers scaled back their buying in response to lower patient volumes due to COVID.
A critical element in our success of providing uninterrupted, continuing access to O&P care has been the result of the many operational adjustments we made at Hanger to ensure patient and employee safety. Since its January inception, the Hanger COVID-19 task force has effectively managed all aspects of responding to the pandemic, including case surveillance and monitoring, employee communications, supply chain risk assessment, mandatory employee training and business continuity planning. We implemented consistent infection mitigation procedures across the entire organization at every clinic and facility. We are also focused on keeping employee morale as high as possible, encouraging paid time off and the use of benefits to support our employees and their families during these difficult days.
Finally, while we are very focused on the operational measures taken to navigate the pandemic, we continue to strengthen our strategic differentiators. Recently, Hanger, as part of a research group that includes the Veterans Administration of Minnesota,. The University of Washington and The University of Illinois at Chicago was awarded a $2 million research grant from the Department of Defense to study for-related [Phonetic] health outcomes in lower limb prosthetic users, including the largest clinical trial of microprocessor knees to date. Through landmark research studies such as this, Hanger in partnership with leading healthcare and academic institutions, continues to develop and implement industry-leading, evidence based clinical programs. We're also excited about our recently launched new website which among other things, enables us to communicate this information to help our patients, our care teams and communities we serve.
Coupled with our leadership and social media, this website will strengthen our marketing efforts, differentiating Hanger Clinic in a more efficient manner. This has been especially valuable during the pandemic, as digitally connecting with our audiences has never been more important. Another important strategic differentiator at Hanger is a revenue cycle function we built during the last few years. Tom will provide more details about the continuing strength demonstrated by our RCM team during this past quarter.
With regards to M&A, we completed and successfully integrated a leading regional O&P practice during the quarter. This was a notable achievement for us as we continue to utilize our capital to partner with outstanding independent O&P clinics to build our key geographies and clinical specialties. While transactions are temporarily paused, we continue our diligence and build relationships with independent O&P clinics around the country. Our value proposition as a partner for the best independence is nothing, if not clear and unlike any other partnership available in the O&P industry.
In closing my prepared remarks, I would reiterate the characterization of our second quarter results as remarkable, in light of the onset of COVID-19. It's important to note that our Q2 adjusted EBITDA primarily reflects the early and decisive cost savings actions we took to help us weather the storm and strengthen our liquidity. Our purpose and our values during this time have served us well. And I will close with what we share in all our internal meetings by saying, be safe, be kind and be strong. I sincerely appreciate your time and interest in Hanger. Now Tom will discuss the numbers in more detail. Tom?
Thomas E. Kiraly -- Executive Vice President and Chief Financial Officer
Good morning. Due to the early planning and implementation of cost reduction and liquidity enhancement measures in late March, as the results show, Hanger was able to successfully generate cash flow and build its available capital during the second quarter. In reviewing our results for the quarter, it is critical that they not be viewed in isolation, but rather as an integral part of our focus on establishing the financial resources necessary to endure the adversity of a prolonged pandemic. Primarily due to the adverse effects of COVID-19 on our business volumes, Hanger produced $233.4 million in revenue during the second quarter, which reflected a $47.7 million or 17% decrease as compared with the same period last year. However, due to cost reduction measures, the company was able to offset a meaningful portion of this revenue decrease and achieved adjusted EBITDA of $36.5 million. This reflected a moderate decrease of $860,000 or 2.3% as compared with the second quarter of 2019. These results do not include the favorable benefit of $20.5 million in provider grants, we received in connection with the CARES Act. The decrease in revenue was primarily driven by a $35.3 million decline in our Patient Care segment, which experienced an 18.7% reduction in same clinic revenue. As Vinit shared, although patient appointment volumes were down by an average of 33% during the quarter, due to higher relative price prosthetic devices declining at a lesser rate, the degree of the effect that patient appointment declines had on revenue was moderated by an increase in our prosthetic mix. We believe this favorable mix shift was due in part to the somewhat more acute nature of the injuries, conditions and impediments to mobility that lead to the need for Hanger's prosthetic services. This may have contributed to a greater proportion of prosthetic patients choosing to seek a central care in our clinics despite the pandemic.
Net revenue in this segment also benefited from favorable collection trends. Due to an exceptional performance by our revenue cycle management team, disallowances and patient non-payment fell to 3.3% of gross charges in the quarter, which compared favorably to the 5.4% we reported in the second quarter of last year.
I'll touch further on the favorable contribution to cash flow resulting from these collections trends later in my prepared remarks. Our Products and Services segment was also significantly affected by the pandemic. Revenues in this business segment declined by $12.4 million or 24.7% in the second quarter as compared with the same period in 2019. Distribution services constituted the greatest portion of this decline as it decreased by $11.1 million or 29.6% to $26.5 million.
When reviewing the company's earnings for the quarter, it's important to view them in the context of the benefit we received from the temporary cost reduction measures we implemented in March. During the quarter, in addition to a $21 million decrease in materials cost, we realized approximately $27 million in savings from exempt employee salary reductions, employee furloughs, reduced employee hours, benefits and associated payroll taxes. We also saved an approximate $8 million from reductions in travel, professional fees, advertising, bad debt and other operating expenses. The achievement of these reductions took exceptional companywide coordination and personal sacrifice by all Hanger employees. In viewing these savings, it's important to note that they were by design temporary. As was originally conceived, our multi-quarter plan for addressing the COVID-19 pandemic foresaw the second quarter as being the one where we could take extensive measures necessary to build the financial resources to withstand an extended pandemic.
Towards the end of the quarter, we commenced the restoration of our exempt employee wage reductions and have begun to bring back the majority of our furloughed employees. These restoration actions were in part in recognition of the stabilization of patient volumes, but more importantly they relate to the need for Hanger to support the livelihood of its invaluable employees. We believe these actions will position us to preserve our talented employee base in order to resume the company's growth in the post COVID-19 era. Between the months of June and July, we restored two-thirds of the wage reductions and have reduced approximately 60% of our employee furloughs. Because of these actions, we currently believe the third quarter will be burdened by an increase of roughly $15 million in labor costs. Given that we will likely be restoring the last one-third of exempt wages by October 1, we additionally foresee that the fourth quarter will likely reflect a return of labor cost to close to normal levels.
While we will continue to remain focused on managing our expenses during this demanding time, we think it's important that these sequential increases in our cost structure be taken into account when estimating the company's earnings for future quarters. From a cash flow perspective, in addition to the cash flow facilitated through cost reductions, the company also increased its available liquidity through substantial collections of accounts receivable, the deferral of certain obligations and from the CARES Act provider grants. During the first 6 months of this year, in addition to other favorable working capital effects, Hanger has generated $44.9 million in cash through the net decrease in accounts receivable, has received $5.1 million from inventory reductions and has benefited from approximately $9.5 million in changes in payable terms. These actions, when coupled with the CARES Act provider grants enabled the company to complete the quarter with $202.7 million in liquidity. This available capital was comprised of $129.9 million in cash and investments, coupled with $72.8 million in borrowing capacity under our revolving credit facility.
After considering this level of retained cash, net indebtedness was $422.5 million at the end of the quarter and reflected net leverage ratio of 3.6 times trailing-12 months adjusted EBITDA. In a manner similar to my prior comments regarding the temporary nature of our cost reductions, it's especially important to recognize that benefits from these working capital actions cannot be replicated in coming quarters as well. By June 30, our accounts receivable had declined to $115.6 million and reflected a DSO of 45 days. This constituted a decrease of $32.7 million or 22.1% in net accounts receivable and two days in DSO from the same time last year.
As revenues return, we will find it necessary to consume cash, as we rebuild those receivable balances. The same will be true for our inventory balances. While we expect to benefit to a certain extent from some of the supply chain efficiencies that have been put into place during the past year, we will nevertheless find it necessary to rebuild our stock levels. Additionally, we will be paying an $18.4 million seller note in the early October period that relates to a deferred portion of the purchase price for the acquisition we closed in early April. As a result of these factors and the natural payment timing of our other deferred payables and employee liabilities, we currently anticipate that we will consume a meaningful portion of the company's retained capital in order to fund our operations and our other obligations over at least the next three quarters.
Now, I'll provide you with some brief comments regarding the next 6 to 9 months. While we did experience some gradual sequential increases in patient appointments in April, May and June, I think we're all aware of the pressures which the recent summer surge in COVID-19 cases has placed on the country. Given this, it's currently difficult to estimate the company's near-term revenue trends. As a result, we're currently managing our business with the primary objective that we need to retain sufficient liquidity to operate at current business volumes for at least the next three quarters. If business volumes resume more quickly, then we would be in a position to respond and to capitalize on those favorable trends. Due to this continuing uncertainty we have chosen to not provide guidance at this time.
In summary, from a financial perspective, through the hard work of our employees, we were able to accomplish what we set out to do in the second quarter, which was to build the financial resources necessarily to be able to withstand the prolonged adverse effects of the COVID-19 pandemic and to do so with our own internal sources of capital. While we certainly believe we've demonstrated that we can act decisively and effectively in adverse circumstances, it is likely that the COVID-19 pandemic will continue to provide us with a difficult road to travel. I think it's fair to say that we've proven that we are prepared for that journey.
With that, I'll turn the call back over to the operator to open it up for any questions you may have.
Questions and Answers:
Operator
[Operator Instructions] Today's first question comes from Larry Solow with CJS Securities. Please proceed.
Larry Solow -- CJS Securities -- Analyst
Hi, good morning guys. Thanks for taking my question. So obviously a very -- quarter that certainly had a lots of challenges. I mean you guys -- commendable on the job you did on your cost cutting and actually kept EBITDA almost flat despite the significant volume declines. Can you maybe just discuss -- you discussed trends and all and obviously the mix was much greater than we expected. I'm trying to figure out, with such a much better performance on the bottom line, can you maybe discuss what you've learned from this experience and more importantly what this bodes for 2021 and beyond? I know -- I know in the last call you thought you lost about a year in terms of just growth in -- on the income statement. So maybe you can kind of discuss that as well. Thanks.
Vinit K. Asar -- President and Chief Executive Officer
Great, thanks, Larry. In terms of what we've learned through all of this, first of all, I can't help but emphasize how much impact the collective efforts of our employees had on the business. I mean we basically laid out what we needed to do for the quarter and our focus was on a couple of things. As I mentioned, the focus was on employee and patient safety and on building liquidity. And with all the efforts we put in, the sacrifices from our employees, that collective effort came shining through. And I think it's a result -- it's a reflection of our purpose, of our values, etc. So it's clear the company can rally when the need is there.
The other piece is, as Tom mentioned, on the prosthetic mix, for the prosthetic mix to jump to almost 61% for the quarter, kind of tells us a couple of things about the nature of our prosthetic services, especially if you compare them to off-the-shelf orthotics, in particular. There is no question our patients, our prosthetic users clearly need the service despite the shutdowns and the shelters in place etc. It was clear, is that, number one, they needed to come in and number two, we were able to figure out ways to provide the service, whether it was in our office, whether was in the parking lot, if we had to make a visit to their front-yard to service them, it was clear that need was essential. So a number of operational learnings across the businesses. Our Therapeutic Solutions business also did a lot of nice remote work and webinars etc., as did our Patient Care -- Patient Care business.
And then with regards to 2021, our view hasn't changed. I think if we look at 2021, we really view it as if we skipped 2020. So what we were expecting to do in 2020, we expect to do in 2021. The only caveat being the continuing length of the duration of this pandemic. If the effects filter into the first part of 2021, it could affect the operations for that period. But in general, we believe all the strategies, the investments we put in place are primed and ready for growth at the conclusion of the effects of this pandemic.
Larry Solow -- CJS Securities -- Analyst
Great. And then just a follow-up on that. Obviously, you guys are much bigger than your peers. So I'm just curious, through these challenging times, some of these more mom and pop type O&P facilities, are they able to maintain operations and -- and -- or are there cases where you guys maybe for -- Starz [Phonetic] potentially taking market share and then secondarily, maybe there comes more acquisition opportunities as we look out. Thanks.
Vinit K. Asar -- President and Chief Executive Officer
Sure. Yeah. We have a lot of respect for the independent providers, even the smaller and mid-sized regional players. And what we've seen is, in pockets of the country, a lot of them were not able to stay open or at full strength. And in those cases, a lot of their referral sources did actually end up sending Hanger those patients. So there is a likelihood that we picked up some market share at least on a temporary basis, while these smaller independent O&P players had scaled down their operations or their offerings.
Now, a lot of them also were able to take advantage of the PPP loans, which as you know we did not take advantage of or qualify forward for that matter. So they did also strengthen their balance sheet to an extent. So temporarily we likely picked up market share, the key here is the next 3, 6 months as operations begin to open up for these smaller players, how they're able to build up their pipeline and how much of that market share, we're able to retain, I think that's the bigger question and we're obviously monitoring that and all over that.
Larry Solow -- CJS Securities -- Analyst
Got it. Okay, great. Thanks, appreciate the color, Vinit.
Vinit K. Asar -- President and Chief Executive Officer
Thanks, Larry.
Operator
The next question comes from Brian Tanquilut with Jefferies. Please proceed.
Brian Tanquilut -- Jefferies -- Analyst
Hey, good morning guys. And good job in this past quarter. I guess, Vinit, my first question is for you. As I think about the volume recovery, right, so you've done a good job, going from 40% down to -- just down 24% in June. How are you thinking about the remaining opportunity or remaining runway for the bounce back, right? Is this something that has to be more macro driven or is there anything more proactive that you guys could do, whether it's a push, a sales effort push or just bringing people back more and opening more hours to recapture that, especially as we see. And broadly speaking, we look at hospitals and other areas of healthcare that I've seen recoveries in the 80% to 110% of pre-COVID levels in terms of medical activity. So just wondering on your thoughts on the pace of recovery that you see.
Vinit K. Asar -- President and Chief Executive Officer
Sure. And honestly, it's a -- it's a bit of both. So first of all, we will be dependent a little bit on the macro environment. If the reopening of different states do slow down, then that's going to affect the volume. But from a proactive perspective, I think the team has done just a wonderful job, actually a wonderful job on making sure that we're proactively reaching out to our referral sources, letting them know that our operations are open where available. We're also proactively reaching out to patients to let them know. We also have information on our website and letting our patients know the safety protocols we have in place at each of our clinics in a pretty detailed fashion. So it's a bit of both. We do expect the volumes to be suppressed for sure for the rest of the year. But as Tom pointed out, it's going to be difficult for us to put a stake in the ground and say it's going to be X percent for the remainder of the year. Coming into the third quarter, the patient volumes appear to be -- appointment volumes appear to have stabilized at about 24% below last year. And we haven't seen an uptick, neither have we seen a regression in the last few weeks.
Brian Tanquilut -- Jefferies -- Analyst
Got it. And then I guess [Indecipherable] Tom, as I think about your comments on the progression of earnings without giving guidance, obviously, right. So, is it safe to say, as you ramped up, reramped [Phonetic] expenses, presumably for most of this quarter we're going to gain back that $35 million of expenses that you guys pulled back on the wage side. And if the volumes stay kind of like in this down 24% range, let's just say for most of the quarter, that sequentially we should see EBITDA go down with the hope of recovery in Q4 and then basically back to the pre-COVID 2020 outlook, once you get to '21. Is that the right way to frame that?
Vinit K. Asar -- President and Chief Executive Officer
Yes, I think you articulated it fairly well. I think that the caution point is, it's very difficult to get a grasp on how the fourth quarter will play. We're going to be restoring the final third of the wages at the end of the quarter -- at the end of the third quarter. And so that's going to put additional cost into our operations in the fourth quarter. So a little bit of what happens in the fourth quarter is going to be dependent on whether we stay at around that 20% to 24% volume decline or not.
Brian Tanquilut -- Jefferies -- Analyst
Got it. And then, yeah, go ahead. And then I guess, Vinit, my last question. On ACP, obviously the SNF industry is struggling right now with COVID and it could be something that's probably more lasting. How are you thinking about that business as the end market struggles and probably struggles further?
Vinit K. Asar -- President and Chief Executive Officer
Yes, we're watching it closely, as you know, and we've made some significant enhancements to the offerings to the SNFs. A lot is going to be dependent now how the SNFs get through this environment. They certainly have received government funds and we're seeing a little bit of an impact of that. The offerings that ACP, the Therapeutic Solutions business has put out there, actually allows for more remote support, group therapy etc. So we're watching it closely. Not sure we can predict what's going to happen within the SNFs. But I'm really pleased with the team in terms of the different offerings they have come out with and some of the things they are planning on here for the next couple of quarters, which kind of should help the SNFs navigate the environment better than the prior years.
Brian Tanquilut -- Jefferies -- Analyst
All right. Got it. Thanks guys.
Vinit K. Asar -- President and Chief Executive Officer
Thanks, Brian.
Operator
[Operator Closing Remarks]
Duration: 36 minutes
Call participants:
Seth Frank -- Vice President, Treasury and Investor Relations
Vinit K. Asar -- President and Chief Executive Officer
Thomas E. Kiraly -- Executive Vice President and Chief Financial Officer
Larry Solow -- CJS Securities -- Analyst
Brian Tanquilut -- Jefferies -- Analyst
