Hanger Inc (HNGR) Q3 2021 Earnings Call Transcript

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Hanger Inc (HNGR)
Q3 2021 Earnings Call
Nov 9, 2021, 8:30 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Hello, and welcome to the Hanger's Third Quarter 2021 Earnings Conference Call. My name is Alex; I'll be coordinating the call today. [Operator Instructions]

I will now hand over to your host, Seth Frank, Vice President of Investor Relations. Frank, over to you.

Seth R. Frank -- Vice President, Treasury and Investor Relations

Good morning. Thank you. Welcome to Hanger's third quarter 2021 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 now let's hand the call over to Vinit.

Vinit K. Asar -- President and Chief Executive Officer

Thank you, Seth. Good morning, and thank you for joining Hanger's third quarter 2021 earnings call. I am pleased with our performance in Q3 despite the headwinds we faced as a result of the Delta Variant. Reviewing our consolidated results, net revenue totaled $289.8 million, reflecting a 12.9% growth over the same period last year. Adjusted EBITDA was $37.2 million compared to $27.9 million last year. These results reflect a continuing organic recovery in our patient care business, complemented by acquisitions of independent O&P clinics across the United States. As we have seen with other healthcare service companies, the impact of the Delta Variant adversely affected our Q3 results, especially in August and September, which we had anticipated would be stronger.

We believe there are three key pandemic driven factors that have affected our business and provide insight into how our patients and the O&P industry at large is faired. First, during this pandemic, there has been a significant reduction in both outpatient and inpatient procedures, which decreased the ability of patients to access our referral sources at ambulatory clinics. Personnel shortages and delayed appointment times have created further pressures in the rate of utilization within healthcare facilities for non-COVID related procedures.

This is an important data point as people with disabilities have been disproportionately impacted by the pandemic because of serious disruptions to the services they rely on. As access to outpatient clinics and elective procedures increase and return to normal levels, we believe our business at Hanger will be in a position to benefit from these improving trends. While the pace of this recovery may not be as swift as we would want it to be, we have confidence that it will occur over a period of time.

A second factor relates to patient hesitancy. Because of concerns about COVID-19, patients are avoiding or delaying both emergent and routine medical care. Many of these individuals predisposed by the nature of their health status and age or both have mobility challenges. Some patients who require orthotic and prosthetic care or therapeutic footwear are delaying appointments. Others are putting off the refurbishment or replacement of a device because they are hesitant.

As the pandemic continues to subside, patient hesitancy will diminish, and we will likely see increased patient visits as a result. The effect of the pandemic on the healthcare system and the resulting delays in healthcare has also had a harmful impact on people with diabetes related foot problems, resulting in more severe infections and will likely necessitate more amputations. While we cannot predict the pace and volume of these additional pandemic related amputations, we feel that the realization of this pent-up demand for our services will occur over time.

Third, for many of our patients, this hesitancy and the challenges associated with accessing medical services increases the mortality associated with both chronic and acute health conditions. We continue to review data to inform us of the impact that COVID has had and continues to have on the patients we serve. It is inevitable that a percentage of our patients and those with chronic core morbidities such as cardiovascular disease, hypertension, diabetes and pulmonary disease, have been more prone to severe and fatal COVID-19 outcomes.

In addition to these three factors, there are a number of capacity and personnel-related constraints, secondary to macroeconomic challenges impacting operations. As discussed on our Q2 call, we, along with many businesses in the broad economy, are facing a tight labor market, which primarily impacts us in the front office of our clinics, in our fabrication facilities and in our distribution centers. Supply chain logistics, such as longer delivery freight times are also a challenge, but are not alone determinative.

I would note, year-to-date, we have had relatively good success with the supply chain and are remaining vigilant on inflation. Overall, these are challenges that we believe Hanger is better positioned to deal with in the near-term than the broader O&P industry because of our scale and infrastructure as well as the talent pool we've assembled. Ultimately, these pandemic related challenges will subside.

And as they do, we anticipate an above-market growth trajectory based on our organic growth strategy and our previously discussed differentiators, supplemented by a prudent deployment of capital for acquisitions. Let me take a few moments and share more details on our progress within the business during Q3. In our patient care business, revenues grew 14.9% compared to prior year as reported. On a same clinic basis, segment net revenue grew 10.7% for the quarter compared to a year ago.

When we look at quarterly net revenue trends for this segment compared to pre-pandemic levels on a same clinic basis, patient care improved to approximately 99% of the comparable quarter in 2019. Although we are pleased with the recovery, we had anticipated stronger results. There is a clear trend showing recovery in prosthetics and customer orthotics and a decline in the lower margin off-the-shelf for orthotic products. This decline is more pronounced than anticipated.

As an example, revenues for our higher technology devices for lower extremity prosthetic patients are at 107% of pre-pandemic levels, while our lower-margin off-the-shelf for orthotic products are at 77%. We believe that the reduction in elective procedures and the previously announced competitive bidding process of select codes is driving this lighting trend in off-the-shelf orthotics. On the acquisition front, we acquired four additional independent O&P clinic businesses during the quarter.

These new clinics are located in Minnesota, Montana, Texas and our first site in Alaska. We welcome these associates and their patience to Hanger. With the transactions completed thus far, we are on track for a significant year of acquisitions. This is a reflection of the unparalleled value proposition that Hanger brings to independent O&P providers. Shifting to the products and services segment, revenue growth was 3.4% compared to the third quarter of 2020.

Within the segment, our O&P distribution business grew by 6% on a reported basis, implying a continued gradual recovery from 2020 in the rest of the O&P industry. Relative to 2019, on a pro forma basis, adjusting for new distribution clients we acquired and the exit of low-margin channels, we estimate 2021 third quarter revenue to be running at approximately 94% of pre-pandemic levels. This marks a continued improvement from 89% in the second quarter of this year. Regarding our overall business results.

As I stated earlier, we are satisfied with the quarter, yet, our lower-than-anticipated exit rate from the quarter due to the Delta Variant points to a softer second half than we would have liked. Given that we had assumed COVID-19 to have been behind us by the end of Q2 in our original guidance for this year, we are adjusting our outlook to reflect this lingering impact on our business for the back half of 2021. Tom will walk you through this and other financials in detail.

Meanwhile, as you heard today, there are additional pressures on independent O&P providers above and beyond normal reimbursement challenges and the complexity of administering their business. Current patient volume shortfalls, supply chain and personnel issues are further taxing independent providers, which we believe will catalyze an accelerated movement of legacy providers to partner or leave the business altogether.

Hanger is ideally positioned to deploy our capital and acquire independent O&P businesses that provide a sound, strategic, cultural and geographic fit within our network, while providing shareholders an excellent long-term return through earnings growth and increased scale. We have closed 10 different transactions through the third quarter this year, and we see meaningful additional activity in the fourth quarter and into 2022.

To wrap up, I am truly appreciative of the efforts put forth by our teams nationwide through the pandemic, and now particularly in light of the recent delta surge. We believe several transient pandemic related factors have impacted the rate of our recovery back to pre-pandemic levels. Because we have learned so much during this painful time, I am more confident in the soundness of our strategy and overall market positions. Thank you for your interest in us.

I will now turn the call over to Tom, so we can get more detail on the financials. Tom?

Thomas E. Kiraly -- Executive Vice President and Chief Financial Officer

Thanks, Vinit, and good morning. Through the first three quarters of 2021, Hanger has produced results to reflect a positive recovery from the COVID affected periods of 2020, despite the effects of the Delta Variant in the third quarter. Net revenue for the quarter was $289.8 million, which reflect a 12.9% increase from the same period last year. Adjusted EBITDA was $37.2 million, reflecting a 33.5% growth over the third quarter of last year.

In addition to comparing favorably to last year's pandemic affected results, the quarter's revenue and adjusted EBITDA also reflected positive growth when compared with the third quarter of 2019. Third quarter net revenue increased by $10.2 million, and adjusted EBITDA grew by $4.6 million over the pre-pandemic third quarter results we reported two years ago. Reviewing the quarter's performance by business segment, patient care reported $244.4 million in revenue, which reflected a $31.7 million increase over the third quarter of 2020.

Our same clinic revenue growth was 10.7% during the quarter, and same clinic revenues equaled 99% of the third quarter of 2019. Patient care produced $47.2 million in adjusted EBITDA, which reflected a margin of 19.3%, which compares favorably to the 18.4% margin we reported in the third quarter of 2020 as well as the 18.3% margin we reported in the same period during 2019. Our Products & Services segment grew its revenue by 3.4% during the quarter as we reported $45.5 million in net revenue.

Adjusted EBITDA for this segment was $6.8 million, which reflected a decrease of $1.3 million from the same period last year due to the temporary cost reduction measures we took during the height of the pandemic. Within this segment's revenue, our distribution business grew by 5.9% to $34.7 million, and the therapeutic solutions business remained largely stable at $10.8 million in revenue. During the year, we have been monitoring the growing effects of inflation and to date, have been able to manage them.

In reviewing material costs, our diverse sources and supply chain strategies have enabled increases in overall componentry costs to be modest. With respect to our labor cost, as have other employers, we have found it necessary to increase the wages of non-exempt employees in our distribution centers as well as the salaries of our technician and our clinic administrative personnel in order to attract and retain them. To date, this has not had an adverse impact on our performance.

However, managing our material and labor costs are critical areas, we are highly focused on as the new year approaches. From a reimbursement perspective, our rate structure from Medicare related and Medicare indexed revenue and contracts, which constitute approximately half of our contracts, inherently incorporate inflation trends into our reimbursement rates. With respect to our other reimbursement contracts, we plan to step up our focus on rates with commercial payers who do not directly index to inflation.

With an overall objective of achieving, reimbursement commensurate with increases in our costs. Through this combined focus on cost management and changes to reimbursement, we intend to work toward the mitigation of pressures that we experience in this new inflationary environment. Now I'll provide some comments on the company's cash flow from operations. In analyzing Hanger's cash flows, it's important to remember that during 2020, we undertook a number of initiatives to build liquidity in light of the risks we face due to the pandemic.

These included implementing temporary compensation and other operating cost reductions as well as a number of actions that reduced our net working capital to lower than normal levels in the prior year. As we left 2020, when excluding cash, taxes receivable and the current portion of debt, Hanger's net working capital had been temporarily reduced by $59.7 million during the prior year. During 2021, as business volumes have returned, our investment in working capital has expanded by virtually an identical amount.

For the year-to-date, we have increased our working capital by $56.8 million, returning it to more normalized levels. This reinvestment in working capital during 2021 has served as an offset to our underlying cash flow from operations. A key favorable factor in our financial performance, working capital and cash flows throughout the current year has been provided by decreases in disallowed revenue and days sales outstanding.

During the quarter, disallowed revenue and patient non-payment were 3.7% of gross charges, which compared favorably to 4.6% reported during the third quarter of last year. For the year-to-date, disallowed revenue and patient non-payment have been 3.4% of gross charges, which reflects a reduction from the 4.3% rate reported for the year-to-date last year. As of the end of the third quarter, the company's days sales outstanding decreased to 42 days as compared to 43 days at the same time last year.

In the quarter, we expended $3.9 million in cash for the acquisition of O&P clinics and $4.7 million for capital expenditures and finished the period with $171 million in total liquidity. This level of liquidity was consistent with what we had reported at the end of the second quarter. From an indebtedness perspective, Hanger had $437.6 million in net indebtedness as of September 30. This reflected a leverage level of 3.7 times on a trailing 12-month adjusted EBITDA basis.

Our underlying net leverage level is closer to 3.5 times when adjusting for the effect of COVID-19 on the fourth quarter earnings for 2020. Now I'll spend some time on our overall outlook for 2021 and the company's anticipated trends as we enter 2022. Hanger has produced solid revenue and adjusted EBITDA growth trends as it has recovered from the peak effects of the pandemic experienced in 2020. However, when we established our guidance for 2021, we did not foresee that the COVID-19 virus would continue to affect the business environment and our industry after the second quarter of this year as it has with the delta surge.

As a result, while Hanger's trends are clearly positive in 2021, as we are exiting the year, they are not as strong as we had originally anticipated. Based on this, we are adjusting our guidance for 2021 to now reflect an estimate of net revenues in the range of $1.115 billion to $1.140 billion and adjusted EBITDA of $124 million to $128 million. This includes the benefit of approximately $42 million in revenue from acquisitions completed in 2020 or closed during the current year.

And looking forward to 2022, we currently believe that our achieved revenues in 2021 will service the new base for future revenue growth and that our organic revenue will grow at a rate of 2% to 3% on a same clinic basis. While we feel that there may be an inherent benefit from pent-up demand, given the extended passage of time associated with the effects of COVID and changing economic conditions. We're not currently in a position to incorporate that possible positive effect into our outlook.

In addition to this organic growth, the annualized effect of acquisitions we have completed in 2021 should add approximately $35 million to our revenue growth. In total, this would bring patient care's rate of revenue growth to close to 6% and our total revenue growth, including both segments to approximately 5%. We currently plan to provide you with our full year guidance on revenue and earnings for 2022 when we release our final 2021 results.

With that, I'll turn the call back over to the operator to open it up for any questions that you may have.

Questions and Answers:

Operator

Thank you. We will now proceed to the Q&A. [Operator Instructions] Our first question today comes from Larry Solow from CJS Securities. Your line is now open.

Pete Lucas -- CJS Securities -- Analyst

Yes, hi, good morning. It's Pete Lucas for Larry. You covered a lot in the call. Just a couple of questions on the cost side. If you could just talk a little bit more about labor. Obviously, a tight market. You mentioned increasing wages so far has not impacted performance. Can you just kind of talk about what are the major issues you're seeing? Is it all in the cost side of that? Or is it hiring and retaining? Just kind of from a big picture, what are the main issues you're seeing there?

Vinit K. Asar -- President and Chief Executive Officer

Yes. This is Tom. The main issue I would say is in the hiring and retaining. And we felt constrained in terms of our ability to hire certain of the technical labor jobs and certain of the office administrative jobs. We've been able to go ahead and keep up with the volume as it's presented, but it's definitely been an area that our recruiting team has been focused on.

Pete Lucas -- CJS Securities -- Analyst

And then just last one for me, and staying on the cost side here. Material costs, you mentioned increases have been modest. Don't appear to escalate much in the P&L. Can you give us a little color on the supply -- on the supply chain? And additionally, can you remind us where we stand for planned investments in the supply chain and expected benefits, which may have been delayed due to COVID?

Vinit K. Asar -- President and Chief Executive Officer

Yes, certainly. So we're fortunate and that we have a variety of different manufacturers and suppliers for each category of componentry. That's given us some diversification against the risk of out of stocks. Approximately 20% of our purchases come from Asia, that's primarily shoes. So far, we haven't really encountered a constraint in terms of access. We have bought ahead in a couple of key categories, and our overall contractual arrangements and working with manufacturers in total have really enabled us to go ahead and manage the situation well in 2021. Certainly, as we go to 2022, as I described, we're going to be monitoring overall inflation trends for componentry and ensuring that we are focused on matching those to the revenue and reimbursement.

From a standpoint of the supply chain investment, the company throughout COVID did continue in the background to work on some of the key elements of its supply chain strategy. I think as you recall from our calls last year, the company was successful in undertaking some major freight renegotiation that brought significant savings along with other procedural changes. And in total, we had about $4 million of savings last year, which was pretty much the bulk or this line share of what we expected from the supply chain initiative.

We also continued the investment last year and into this year of our Alpharetta facility, which opened up in the second quarter of this year, and now we're fully operational there. And that has brought some incremental savings of which we're recognizing into the P&L this year. So while we do have the last component, which is the technology, we still want to bring our procurement technology onto Oracle, which is something we're planning on doing in 2022. That should bring some savings, but I would say that the line share are baked into the company's overall run rate.

Pete Lucas -- CJS Securities -- Analyst

Very helpful, thank you.

Vinit K. Asar -- President and Chief Executive Officer

Thank you. Thank you, Larry.

Operator

Our next question for today comes from Brian Tanquilut from Jefferies. Your line is now open.

Brian Tanquilut -- Jefferies -- Analyst

Good morning. Thanks. Thanks for. Let me ask questions. I guess, Tom, I'll hit first on the 2022 commentary that you made. So just curious, I mean, I get the 2% to 3% organic growth, but not incorporating pent-up demand, while also saying that you're at 77% on off-the-shelf orthotics. Just curious, I mean, is that a little bit of prudent conservatism at this point? And what's your view on the ability to recover in some of the business lines that are still trying to get pre-COVID, below pre-COVID levels?

Vinit K. Asar -- President and Chief Executive Officer

So if you go back to 2019, we were just under $50 million in the off-the-shelf category, and we're currently running around $35 million to $37 million in off-the-shelf. And so overall, it's about a 25% drop in the off-the-shelf category. And that's a more sizable drop than what we've seen in some of the other categories at this point. And as we delve into that, a very small portion of that is seabed, but the remainder is something that we're monitoring very closely. And so it's that focus and belief that maybe there's been something structural that's changed and that it's lagging.

That's caused us to temper our enthusiasm going into 2022 with regards to that particular category. And really, overall, I think as we've articulated, we're just at a point where after two years, and we're changing economic conditions, we'd be speculating as to what pent-up demand could be and how to go ahead and really measure and put that forth at this point. So we're trying to be cautious at this point and would really like to see something before we start to bake it in.

Brian Tanquilut -- Jefferies -- Analyst

And then as I think about just the guidance adjustment for today, right, or for Q4, you normally have good visibility into your quarter by this point of the year. Curious, obviously, you're adjusting the guidance, but any observations you can share with us in terms of the backlog building in, in the business?

Vinit K. Asar -- President and Chief Executive Officer

So we're sitting here in the middle of the fourth quarter almost. And I think, as you know, and as most of our investors know, a large part of our volume in the quarter comes in the latter part of the quarter, especially in the last quarter of the year where a lot of our patients strive to meet their deductibles. So far, we haven't seen a big change in trajectory through the first month of the quarter and fourth quarter. But again, the large part of the volume comes in, in the second part of this quarter, which is what we're monitoring.

Thomas E. Kiraly -- Executive Vice President and Chief Financial Officer

And then, Brian, I'll just add, from a standpoint of the work in process, I think we disclosed that in our financial statements in the 10-Q, and it has grown pretty substantially. We're currently sitting at about $19 million in work in process, which is a pretty peak level. So we're hopeful that, that bodes well for future periods, but we've got to be able to translate that into revenue and through productivity in the clinics before we would be able to realize that.

Brian Tanquilut -- Jefferies -- Analyst

And then last question from me, Vinit. As I think about growth, your guidance is sort of a 2% to 3% organic number for next year. Is this the right kind of normalized long-term growth rate, the organic growth rate that we should be thinking about for Hanger?

Vinit K. Asar -- President and Chief Executive Officer

No, it's not. I think it's important that we reinforce. What we're thinking right now is and what we've shared -- what Tom shared in his prepared remarks, this 2%, 3% is based on what we're seeing today. What it doesn't include is things like share gain and any release of pent-up demand. And also any acquisitions that we might do that supplement, the organic growth for 2022 and beyond. So we feel pretty comfortable that the investments we've made in our differentiators over the years. We're literally just waiting now for the lingering impact of COVID to die down and then pick up where we left off. So the short answer is, no, we don't believe that's the long-term rate.

Operator

[Operator Closing Remarks]

Duration: 29 minutes

Call participants:

Seth R. 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

Pete Lucas -- CJS Securities -- Analyst

Brian Tanquilut -- Jefferies -- Analyst

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