Hanger, Inc.

Vinit Asar - President, Chief Executive Officer Thomas Kiraly - Executive Vice President, Chief Financial Officer Seth Frank - Vice President, Treasury and Investor Relations

Thanks. And good morning.

Welcome to Hanger’s First Quarter 2019 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.

With that, I would like to hand the call over to Vinit.

Thanks, Seth and good morning everyone. Thank you for joining us today.

During Q1, we achieved net revenues of $236.4 million, an increase of 1% from the prior year and flat on a same clinic day adjusted basis. Adjusted EBITDA of $11.9 million reflected a decline of $4.3 million in the quarter.

Revenue growth in the quarter was below our expectations, and we believe this relates primarily to the timing of our prosthetics deliveries in our Patient Care segment. We remain positive in our view of the demand for our O&P services, the strength in our referral patterns and the overall industry fundamentals.

As a result, we are reaffirming both, our revenue and earnings guidance for 2019. When comparing Q1 to the year ago quarter, there are three factors that impacted our results: First, revenue growth in our Patient Care segment was lower than anticipated; second, margins in Products & Services saw an expected decrease; and third, expenses in our Patient Care segment saw an expected increase.

I will provide color on the first factor and Tom will elaborate on the other two. Let me know walk you through how we view the Q1 dynamics on growth.

First and foremost, we had a late start to the build of our prosthetic patient pipeline this year. January is by far our slowest revenue month of the year.

Annual health benefits for many of our patients generally reset on January 1, also resetting their annual deductibles. As a result, we typically don’t see a lot of patient flow in our clinics until early February.

In a typical year’s Q1 business cycle, we spend the month of February and March doing most of the prosthetic patient evaluations, followed by fabricating devices and then fitting the patients. This year, we did not see the prosthetic patient pipeline building until later in February, which pushed some production and delivery of devices to our prosthetic patients into April.

Secondly, we had a challenging comparable, prior year quarter for prosthetics with high prior year growth of 6%. Both these factors resulted in our overall same clinic growth, staying relatively flat to the prior year and our prosthetic business showing a modest decline of 0.7% on a day adjusted basis.

Now when we think about Q1 in general, it’s also important to understand that seasonality in our business has a profound impact on the quarter. As I mentioned earlier, with the health benefit reset for many of our patients at the start of the year, the first quarter is always our lowest relative net revenue quarter.

This phenomenon is much more acute as it pertains to earnings production. Based on our cost structure and certain expenses that occur only during Q1, we generally produce less than 15% of our annual adjusted EBITDA during this quarter.

While our seasonality is a known factor, and had been incorporated into our estimates, it is an important backdrop for our first quarter results and full year expectations. At this time, despite the slow start in prosthetics, we believe there are good reasons to remain optimistic regarding our outlook for the full year.

We see no evidence of a cyclical turn in demand for our O&P solutions. We also believe there is nothing we have seen in our analytics that would indicate a loss of market share or shift in patients away from us at a macro level.

I would note April was a good month, and we clearly saw a spillover of patients that we were not able to fit with devices in March, resulting in a positive revenue balance. It is for all those reasons and based on how we see the rest of the year, we are maintaining our 2019 outlook and staying focused on our strategies to boost profitable, sustainable growth.

Looking at the business by segment, starting with Patient Care, let me provide some color on our fundamentals. We remain confident that our portfolio of growth initiatives and outcomes research, clinical technology, patient experience, supply chain and revenue cycle management will generate meaningful returns.

Our business development momentum is strong. While we are focused intensely on new patient acquisitions, we are also pursuing new programs to ensure existing Hanger patients are returning to our clinics, receiving evaluations and ensuring optimal outcomes from their devices.

Approximately 70% of our visits are existing patients. So it is critical to make sure patients are getting maximum utility and satisfaction through our services.

Of note, we saw an improvement in our orthotics, which represented 49% of our Patient Care revenue in the quarter. This is a result of new clinically driven programs focused on our custom orthotics categories.

Overall, orthotics grew on a day-adjusted basis by 0.9%, an encouraging sign as we continue to balance the appropriate provision of custom orthotics devices, against the declines in lower margin off the shelf devices. We continue to evaluate new source of growth and believe the areas we are focusing on will pay long term dividends.

Our outcomes research team is gaining broad recognition based on the increasingly robust body of work we have published through the MAAT series, also known as the Mobility Analysis of AmpuTees, which currently is comprised of five published multicenter research study reports. This year at our education fair, we announced a new commercial collaboration aimed at upper limb prosthetics.

Hanger is working with U.K. based Open Bionics’ Hero Arm, a first of its kind 3D printed myoelectric system developed especially for patients with below elbow, limb loss or limb difference.

This prosthetic is designed for, and fit on users as young as eight years old and provides an affordable, lightweight, multi grip prosthetic arm option, something that has been missing for this age demographic. We view this partnership as unique and exciting, opening up and expanding our addressable market.

Our focus on patient experience, revenue cycle management and ever increasing reimbursement compliance requirements are clearly showing progress. Our current net promoter score of 85 versus 81 a year ago is a significant improvement.

In revenue cycle, our disallowance rate remains stable at 4.2% in Q1. I’m proud of the work our compliance team in coordination with the revenue cycle group has done to help Hanger set the standard for clean claim submissions to payers and a reputation in the industry as a preferred business partner.

We continue to raise the bar for good claim submissions, practices with our patient community, and we see opportunities to capture incremental business. In addition to these organic growth initiatives that differentiate Hanger as a leader in O&P care, acquisitions remain an active component of our long term strategy to drive a scalable and sustainable growth platform.

We are feeling good about the available opportunities and also encouraged by the successful integration of the businesses we’ve acquired thus far into our national network. Turning to Products & Services.

Our distribution business performed well from a revenue perspective in the quarter, posting 5.9% top line growth. We continue to be pleased with our market leadership and client satisfaction across the independent O&P provider community.

Growth has been driven by the addition of new SKUs, independent provider’s desire to work with a single source supplier, fulfillment quality and service levels. Our therapeutic solutions business is performing as expected, and we believe this niche market is showing some early signs of stability, although it is too soon to call a downturn complete.

We are seeing good uptake with our revised value proposition in this business. It is built around a refreshed therapeutic equipment portfolio for rehabilitation, as well as fully integrated clinical protocols, pathways and education programs designed to ensure that our clients succeed in the new reimbursement model, which is effective October 1 of this year, called PDPM, or the Patient Driven Payment Model.

From an overall segment perspective, we have seen modest growth in revenues driven by the distribution business and a decline in overall margins across this segment as we expected. So to summarize from a macro perspective, we had a slower than expected start to the year that resulted in lower patient care revenue.

Q1 is always the lowest quarter in terms of both revenue and earnings production and not a definitive indicator of our prospects for the year. Additionally, we had challenging earnings year-on-year comparisons, particularly health care benefit expenses and the continued decline in therapeutic solutions, both of which we had incorporated into our outlook.

We are determined to continue to focus on executing our strategy of clinical, operational and financial differentiation to drive organic growth. Our markets remain highly attractive and our position is the strongest it has ever been.

I believe the dynamics in the quarter are not indicative of economic or cyclical issues. I’m confident that by staying true to our values and mission as a company and maintaining the course, we will create sustainable long-term value for our patients and shareholders.

Now I would like to hand the call over to Tom to go through the numbers in detail. Tom.

Good morning. In reviewing Hanger’s earnings for the quarter, the company reported adjusted EBITDA of $11.9 million on revenue of $236.4 million.

This reflected a decrease of $4.3 million and adjusted EBITDA on a $2.4 million increase in revenue. As Vinit shared, we believe there are three primary factors that impacted our results: First, growth in Patient Care revenue was lower than expected; second, the margins in our Products & Services segment decreased; and third, Patient Care’s expenses increased.

In our guidance and in our prior earnings call remarks we fully expected the last two of these factors. It is the first factor, lower Patient Care revenue growth that we did not anticipate.

Vinit focused his remarks on our analysis and view regarding the temporary nature of the prosthetic revenue growth trend in the first quarter. So, I will use my portion of the call to provide you with some additional background on the other two factors affecting our results.

Additionally, I will discuss our cash flows and finish up with some comments regarding the company’s outlook for the full year First, with respect to the Patient Care segment: As discussed in the release after adjusting for $4.8 million in acquisition related revenue and the effect of there being one less revenue day, same clinic net revenue was essentially equivalent to the last year’s first quarter. Nevertheless, due to a $1.5 million increase in benefits expense and a $900,000 increase in rent expense, which is partially offset by favorable items, the adjusted EBITDA for this segment decreased by $1.6 million.

With respect to benefit expenses, the total company wide impact was a $1.8 million increase in costs. As discussed in our March conference call, in the first quarter of 2018, we experienced an overall favorable employee medical claims level that was a key factor in the $1.9 million growth in adjusted EBITDA that we reported for that period over the prior year first quarter.

As a result of this, first quarter 2019 results were inherently burdened as medical claims returned to a higher comparative level. Of the company’s total increase of $1.0 million in rent expense, in addition to normal lease activity, the $900,000 increase in this segment was partially due to the effects of our adoption of the new lease accounting standard, (ASC) 842, which increased expenses by $300,000 in the quarter as well as due to $200,000 in lease costs related to acquisitions.

In addition to the income statement effect, in connection with the implementation of (ASC) 842, Hanger established $103.4 million in operating lease right of use assets effective as of January 1, 2019, and a $117.1 million of operating lease liabilities, with a difference in these two amounts relating primarily to landlord funded leasehold improvements. During the quarter, we also expended approximately $800,000 in connection with the completion of our implementation of the electronic health record and patient management system at our existing clinics.

In concluding my comments, on the results of our Patient Care segment, I cannot stress enough the effects which variability in our revenue growth rates could have on our quarterly earnings due to the high fixed cost nature of this segment. In any given quarter, our personnel, lease and other costs are effectively static, irrespective of patient volumes.

The only direct quarterly variations and expense relate to our cost to materials, and to a lesser extent, our variable incentive compensation. For the year, our annual incentive plans play a more pronounced role in moderating swings in our revenue and earnings growth.

This dynamic can work to our benefit and our detriment. In our third quarter call last year, we benefited from this inherently high flow through when the company demonstrated strong earnings growth as compared to the prior year quarter.

At that time, we shared in our call that due to the quarter to quarter variation in our earnings, it was important to view them over a number of quarters in order to better appreciate the underlying trends. For these reasons, I expect we will be discussing this variation, both positive and negative, in future quarters as well.

With respect to the Products & Services segment; the trends in this segment have been continued to track with what we discussed during our calls last year and earlier this year. As anticipated, we’re seeing favorable revenue growth in our distribution services that is being offset by declines in our therapeutic solutions, with an overall decrease in segment margin.

Distribution services revenue grew by $1.8 million or 5.9%, while therapeutic solutions revenue declined by $1.5 million or 10.7%. Our segment margin declined from 19% to 15% in the quarter due primarily to new revenues from therapeutic solutions being attained at lower relative prices and to increases in operating cost related to distribution services.

We currently expect to see these trends continue throughout 2019. Before I turn to cash flow, I’d like to share a few comments regarding our corporate and other expenses.

In the quarter, our corporate expenses increased by $1 million. Within this amount, we expended approximately $300,000 in connection with the planning and design of our new financial and supply chain systems implementation.

In total, after including the $800,000 we spent on electronic health record systems implementations in the Patient Care segment, we expended $1.1 million for systems implementations during the quarter. We currently expect that we will spend a further $3 million to $3.5 million in connection with systems implementations during the balance of the year.

These overall spend levels are roughly equivalent to our expenses for implementations incurred during 2018. With respect to cash flows, as discussed in prior calls, due to the seasonality of our business and our use of cash in connection with our annual incentive programs, during the first quarter of each year, we usually consume cash.

In the first quarter, we expended $36.5 million for the payment of annual incentive bonuses, payable taxes on stock vesting and our annual 401(k) match. We additionally paid $27.7 million in cash in connection with the acquisition we closed in January at approximately $5.6 million in net reductions of our accounts payable.

As anticipated, our cash balances were at $20.5 million at the end of the quarter, and after including our available borrowings under our revolver, our liquidity was $115.3 million. As of March 31, Hanger had net indebtedness of $488.1 million, and after giving pro-forma effect to the earnings of the acquisitions, we carried a net leverage ratio of approximately 4 times.

Given the seasonal nature of our cash flows, during the next three quarters, we would expect favorable cash flows to build and to bring our net leverage back down into the 3.5 times range that we demonstrated as of December 31, 2018. As discussed in our prior calls, our capital structure plans involve a seeking to balance both the deployment of free cash flow towards in-market acquisitions as well as of the achievement of a continuing reduction in our net leverage.

Our capital expenditures for the quarter, which relate to both the purchase of property, plant and equipment as well as therapeutic equipment, were about $8.3 million. This step up from the prior year relates primarily to planned increases on our clinically sold expenditures and technology infrastructure.

We continue to estimate that our capital expenditures for the full year will be in the $35 million range. Now I’ll finish my portion of the call with some additional commentary relating to our outlook for 2019.

As Vinit discussed, we view the low revenue growth reported in the first quarter to be temporary. Additionally, the first quarter is our lowest revenue and earnings quarter of the year; they constitute only 13% of our adjusted EBITDA in 2018 and 12% in 2017.

Given that we currently do not see a reason to believe that the revenue trends we experienced in the quarter were caused by a cyclical, competitive or other prolonged impact, and that the first quarter normally does not constitute a significant portion of our annual earnings, we have reaffirmed our 2019 financial outlook. With that, I’ll turn the call back over to the operator to open it up for any questions that you may have.

Hey good morning guys. Vinit, just to hit on the revenue shortfall for the quarter first.

So a few things, are you seeing the bounce back of that already, or are you seeing a big uptick in April as basically the demand has shifted by a month or so from early February to late February? Is that a good way to think about that in terms of your, visibility and confidence and your ability to pick back up a lot of the revenue that you missed in Q1?

Yes, we are seeing that bounce back in April, and we feel good about what we saw in April for sure, and we do attribute it to deliveries that didn’t occur in March.

Okay. And then kind of just to clarify, when you say deliveries that didn’t occur, I mean this is not - this is really more of just the timing of prescriptions coming in right, it’s not like a supply chain issue, it’s not a delay on your part in terms of your ability to deliver, right?

Correct. Yeah, when we refer to delivers, we’re talking about actually fitting the patients, the actual patient fitting process.

So, as I mentioned in my remarks that our patient pipeline build started later in the year than normal, so it started later in February than normal. So the general process, the way to think about it, is we evaluate the patients and then we fabricate and then we fit.

So it really has nothing to do with the supply chain as much as the patient pipeline build started later in the year.

Got it. And then Tom, as I think about cadence for earnings during the year, I mean I know Q1 is your smallest, I think it’s like what 12% of the year.

How should we be thinking about, how the year will progress without giving guidance to the quarters?

You know, Brian as you know, the bulk of our revenues and the growth typically occurs later in the year, particularly in the fourth quarter. And with the high flow through that the company has I think from an earnings perspective, you’d really be seeing the earnings growth, you know in the back half, particularly in the fourth quarter as well.

All right, got it. All right, thanks guys.

Great, good morning guys. Just a couple of follow-ups just on the - little bit of the shortfall there.

On the sort of late build, was there any weather impact? I know January was sort of a rough month, I know you guys don’t like to call it weather, but was that may be an impact and are patients potentially sort of just deferring with deductibles and all, little bit more over the last few years?

Have you noticed any shift out? Or do you think that’s sort of an anomaly?

Yes, I think there is probably a couple of factors in terms of the actual timing and what caused the delay build in the patient pipeline. I’d say weather certainly was a factor, but I would say that was not the only factor because typically, Larry as you know we have weather every year during the first quarter.

Right.

This year, what did happen, we saw it in a couple of regions, you know like the mid-west and the north-west. We had extended weather patterns, where clinics were closed for, you know a week at a stretch.

And then when you think of our patients, our prosthetic patients especially, sometimes it’s difficult for them to get to appointments even when the clinics are open. So I’d say weather, you know was certainly a factor but not the only factor.

Okay. And then in terms of any change you’ve seen in the last few years, in terms of patients sort of deferring a little bit, because of the sort of employers putting, you know, sort of you know more responsibility in their hands of high deductibles and co-pays?

Has that really changed your business at all, or..?

Yes, we haven’t seen changes in those sorts of trends with payers, etcetera. You know there was another factor.

I would say, those again a minor factor where you know, every year we do have our annual education fair where we pull about 900 of our clinicians out of the field, that happens every year to do their training. This year, we did it slightly later in February than normal that likely was another factor.

So, there is a bunch of small things that occurred that caused us to believe that this was a timing issue.

Okay. And then just lastly, you mentioned sort of, you know some strength in your sort of confidence, encouraged by strength in your referral patterns.

Obviously, you’ve had a lot of initiatives going on over the last couple of years to sort of differentiate yourself. In terms of referral ‘patterns’ any more qualification you can give us there on that?

Yes, certainly. You know we feel very good about the programs that we’ve put in place over the last 1.5 year, especially the prosthetic programs that now had, you know we’ve had time to see how we are doing.

And we are seeing, you know wins in the new patient acquisitions. In new amputees, we’re certainly seeing our message resonate with the referral sources.

The focus we are putting now is on the existing patients and actually gaining market share. So, though we are seeing the prosthetic programs really be effective, as new amputees and now we are beginning to look at market share, how do you take that patient, that’s had the same prosthetics for the last five or ten years with an independent or an existing prosthetics and how do you convert that patient over is what we’re focusing on.

All right. And just lastly, I know you guys don’t guide, you know on prosthetics versus orthotics, but I think, you know encouraging to see the orthotics piece sort of, you know always come back to flat in a seasonally slower quarter.

Just on the prosthetics piece, you mentioned a very difficult comp, 6% plus growth in Q1 last year. Do you still feel sort of confident in your, again I know you don’t guide specifically, but I think it grew little over 3% last year?

Do you see a similar, you know or it may be potentially modestly better performance in prosthetics in ‘19 despite the slow start?

Yes, overall, we feel very good about the programs, as I mentioned for prosthetics. We’ve just started the programs in orthotics, and I think the custom orthotics piece did show, you know the growth, so we’re happy with that.

And overall, on a same clinic basis, you know we are confident that we will see an improvement overall in 2019 versus 2018.

Okay, got you. Thank you very much.

Thanks Larry.

Hey good morning. Maybe just a little more context on the prosthetic deliveries.

Just, the sheer number of deliveries, and I’m coming up with a number may be, you know several hundred, which kind of implies less than one delivery per clinic. So, it doesn’t seem that [inaudible] to me for you to be able to pick that up.

Am I thinking about that right if not, what am I missing?

Yes, Dana that’s how we’re thinking about it as well. You know, whether you look at our network of 800 clinics or you look at our 1,500 clinicians, you know if it’s a couple of hundred deliveries, and your math is right, that’s how we look at it as well, you know couple of hundred deliveries, couple of hundred prosthetic devices, you know causes that swing that way less than one per clinic.

That, it didn’t get through, again it goes back to the patient pipeline build. So that’s why we believe it’s certainly not interminable, and we are seeing some of that come back in April.

Okay. And then on the orthotics, pretty good growth.

Did you break that up between the custom and then the off-the-shelf and the braces?

No, we didn’t, and we generally don’t.

Okay.

I mean it’s safe to say that the customer orthotics programs that we have put in place, we’re feeling positive about it.

Okay. And then just lastly, I know it’s still early innings on the acquisitions that closed kind of late January, but how is the - you hadn’t done one of these in a while, big one anyway.

How is that integration progressing?

Yeah, we are feeling good about the integration. You know everything is going exactly per plan, and we are happy with some of the resources we put in place also to facilitate that integration, which is new for us.

We never had a group that helped with integrations before and now we’ve put that group in place and we’re feeling good.

Great. All right, thanks very much.

Thanks Dana.

Great. Thanks, Michelle.

Well thank you all for joining today. Look, in closing I want to reiterate, we believe that the dynamics in the quarter are certainly not indicative of any economic or cyclical issues based on what we’re seeing.

And as I said earlier, you know we’re confident that by staying true to our values and mission of the company and certainly maintaining the course, you know we will create sustainable long-term value for both patients and shareholders. So on that note, we look forward to speaking with you at our next earnings call.

Thanks very much.