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Edited Transcript of HNGR earnings conference call or presentation 8-Aug-19 12:30pm GMT

Q2 2019 Hanger Inc Earnings Call

AUSTIN Aug 15, 2019 (Thomson StreetEvents) -- Edited Transcript of Hanger Inc earnings conference call or presentation Thursday, August 8, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Seth R. Frank

Hanger, Inc. - VP of Treasury & IR

* Thomas E. Kiraly

Hanger, Inc. - CFO & Executive VP

* Vinit K. Asar

Hanger, Inc. - CEO, President & Director

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Conference Call Participants

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* Brian Gil Tanquilut

Jefferies LLC, Research Division - Equity Analyst

* Lawrence Scott Solow

CJS Securities, Inc. - MD

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Presentation

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Operator [1]

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Greetings, and welcome to the Hanger's Second Quarter 2019 Earnings Call. (Operator Instructions) And as a reminder, this conference is being recorded. (Operator Instructions) It is now my pleasure to introduce your host, Seth Frank, Vice President of Treasury and Investor Relations. Thank you. You may begin.

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Seth R. Frank, Hanger, Inc. - VP of Treasury & IR [2]

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Good morning. Thank you. Welcome to Hanger's Second 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 statement's 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.

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Vinit K. Asar, Hanger, Inc. - CEO, President & Director [3]

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Thanks, Seth, and good morning, everyone. Thank you for joining us today. Hanger reported strong financial results for the second quarter. During Q2, net revenues of $281.1 million reflected growth of 5.3% from the prior year. Revenue growth on a same-clinic basis was 3%. Adjusted EBITDA totaled $37.4 million, growing 11.1% year-over-year.

The Patient Care segment led the way with solid margin increases. Our Products & Services segment also performed well, led by the distribution business, which exceeded our expectations.

Putting the second quarter in perspective, during the Q1 call in May, we discussed that the timing of some prosthetic deliveries pushed out into the second quarter. At that time, we noted April was a good month, and we remained optimistic about getting back on track during Q2. Ultimately, the quarter came in solid, driven by strong demand for O&P services across the board. As you will see, Hanger is executing well across our various operating metrics, and our year-to-date numbers align with our 2019 expectations here at the halfway mark. As a result, we are reaffirming both our net revenue and adjusted EBITDA outlook for 2019.

I am encouraged with the momentum in the business. During my recent travels to visit clinics, I can see the excitement and energy across the Hanger network as our clinicians and support teams see the indelible impact we are having on patients' lives, and how our efforts are translating into tangible results. I believe that the execution of our multi-point strategies and the investments we are making are driving these results. We continue to focus on differentiating Hanger in the O&P industry, emphasizing our outstanding patient care experience, strong business partnerships and an unrelenting focus on superior outcomes for the communities that we serve. The returns for shareholders from these efforts are being driven by keen focus in profitable, organic growth, supplemented with targeted, in-market O&P acquisitions at attractive valuations.

Taking a deeper dive into our results this quarter, our Patient Care segment was a standout. Net revenue grew 5.7%, driven by a strong quarter for prosthetics as well as continued growth in orthotics. In the second quarter, same clinic revenue per day, a key measure of Hanger's Patient Care segment organic growth, increased by 3% year-over-year. Prosthetics, excluding acquisitions, grew 4.3% in the second quarter, a significant positive swing from Q1. Orthotics as a category performed well again, growing 1.6% in Q2. As a reminder, we think about Hanger's orthotics business as consisting of 3 subcategories: custom orthotics, off-the-shelf orthotics; and shoes and inserts.

Custom orthotics is by far the largest subcategory, totaling approximately 60% of total orthotic revenue. Custom orthotics requires evaluation and custom fabrication by our clinicians, with a delivery model very similar to prosthetics. We continue to focus our investments on replicating the success we've achieved with above-market growth in prosthetics to the custom orthotics market. We are continuing to evaluate and optimize our delivery model for both off-the-shelf orthotics and shoes, which tend to be high-volume and lower average price per device categories.

Looking at the Patient Care business from a longitudinal perspective, we are seeing continued improvement in key operating metrics across the Hanger networks nationwide. I had mentioned last year, we were focused on lower-performing regions. Health care is of course local, and different parts of the country can have different challenges. As we look across our network of clinics, I am encouraged by the trends we are seeing, with demonstrable improvement in same clinic growth in previously lagging areas.

Looking at other operating metrics in Patient Care, our current Net Promoter Score through June of 2019 is 84 for Hanger clinic, an impressive uptick compared to 81 for the same period in 2018. I would also note, we saw these improvements across all of our regions quarter-to-quarter in 2019, which is notable, given the step-up in revenue, productivity and integration of acquisitions that is occurring. In addition, our ability to recruit and retain clinicians is improving, and we are seeing overwhelmingly positive rates of acceptance for job offers to new graduates of accredited O&P programs.

Regarding M&A, we completed a very small acquisition at the end of May that had no material impact on this quarter. We anticipate this acquisition will contribute less than $1 million of incremental revenue in 2019.

Looking ahead, we continue to see a strong pipeline of potential O&P clinic acquisitions to supplement our organic growth strategy. Integration of these clinics purchased year-to-date have gone largely as anticipated. Our model is intended to welcome new clinicians into Hanger and transition them as seamlessly as possible into our workflow, EHR systems and revenue cycle management tools so they can maximize their time focusing on patients.

Of additional note, Hanger continues to be at the forefront of clinical research with the Mobility Analysis of Amputees research studies. Recently, Hanger stood out as the only O&P provider at the American Diabetes Association meeting in San Francisco to present on clinical outcomes.

We presented our MAAT VI study, which detailed how diabetic dysvascular amputees, when provided with appropriate care and technology, enjoy a quality of life, satisfaction and mobility out to 7 years. The 5-year mortality post-op period for diabetics is routinely referenced in literature. The fact that we are showing diabetic amputees 7 years out, maintaining mobility and quality of life at a level similar to new amputees is significant. We are confident that this compendium of studies will continue to define the proper care pathways and outcomes, solidifying our leadership position in the clinical arena of O&P.

Turning to Products & Services, the segment posted another quarter of top line growth, driven by the O&P distribution business. Total Products & Services revenue grew 2.3% in Q2. Within this segment, O&P distribution grew 8.6% in the second quarter, which was ahead of our expectations. We continue to benefit from the addition of new products to our portfolio catalog as well as manufacturers' desire to shift much of the burden associated with logistics to Hanger, given our size and competency in supply chain management.

As a reminder, while we remain pleased with the performance of our distribution business, we would reemphasize that top line growth rates are most likely not sustainable long term, given the more moderate rates for overall industry growth. In addition, as our Patient Care segment continues to acquire O&P clinics, we may, in some cases, be acquiring an existing customer from our distribution business.

Also within the Products & Services segment, Hanger's therapeutic solutions performance is trending largely in line with our expectations. While revenue declined as expected in the quarter, the initiatives we have taken to reposition our therapeutic solutions business as a critical business partner to the skilled nursing industry appear to be helping from a business development perspective. Underlying trends with our customers indicate some signs of stabilizing financial conditions.

As we stated in our guidance, we continue to anticipate a total revenue decline of $5 million to $7 million for this business in 2019. While we see some encouraging signs, we maintain a cautious posture as the PDPM go-live date approaches in October.

Overall, as a company, we are pleased with our results through the first 6 months of the year. And while our business does reflect some volatility between quarters, we are encouraged by the momentum that our strategy of differentiation is having on our business results this year. We have been pleased with the results of our investments in revenue cycle management, the recently completed implementation of our EHR as well as the now near-complete rollout of our Net Promoter Score initiative across our network of clinics.

As we have stated in the past, our next area of investment will revolve around our supply chain and financial systems. We are soon embarking on plans to focus on Hanger's opportunities in the area of optimizing our supply chain management. Supply chain is a core area of strategic differentiation for Hanger, similar to revenue cycle, patient experience and outcomes. You will hear more details on upcoming earnings calls as we finalize our approach to this important differentiator.

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

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Thomas E. Kiraly, Hanger, Inc. - CFO & Executive VP [4]

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Thank you, Vinit. Good morning. During the second quarter, Hanger reported $281.1 million in revenue and $37.4 million in adjusted EBITDA. This reflected a $14.1 million or 5.3% increase in revenue and a $3.7 million or 11.1% increase in adjusted EBITDA as compared with the second quarter of last year.

Our revenue and earnings growth for the quarter were driven by the Patient Care segment, which provided $13 million of our $14.1 million in revenue growth. This segment's adjusted EBITDA grew by $6.1 million or 14.9%, and reflected a positive flow-through of approximately 47%. As anticipated, our second quarter results benefited from a shift in prosthetic deliveries from the first quarter into the second as compared with the first half of last year. This was a key factor that contributed to the 4.3% in prosthetic growth that we reported for the period and was a primary driver in our overall 3% same clinic growth rate. On a year-to-date basis, prosthetics have grown by 2%, and orthotics have increased by 1.2%. This has resulted in an average overall same clinic growth rate of 1.6% for the first half of the year.

As Vinit shared, we are pleased that we've begun to show positive increases in the orthotics portion of our business to complement the somewhat stronger relative growth we've achieved over the past 2 years in prosthetics. Over the last 9 quarters, the average organic growth rate of prosthetics has been 3.1% while orthotics revenue has been relatively stable.

During the quarter, while our disallowance rate of 4% reflected a 50 basis point decrease from the second quarter of 2018, we did see an offsetting increase of 80 basis points in our patient nonpayment rate, which brought that rate up to 1.4%; this growth in patient nonpayment related to increased write-offs and aging of patient accounts, a favorable prior year experience rate as well as the effects of systems conversions. In future periods, we currently believe patient nonpayment will settle at around 1%.

Our expansion in Patient Care EBITDA and margin during the quarter was primarily a benefit of the fixed cost nature of this business segment. Patient Care reflected a slight improvement in its materials' cost, which declined from 30.2% of net revenue to 29.9%, which we believe was primarily the result of increases in our reimbursement rate.

Personnel costs declined to 33.9% of revenue in the segment as compared with 35.2% in the prior year period. In addition to benefiting from higher revenue on a relatively fixed number of FTEs, personnel and other expenses also benefited from a decrease in the cost of some of our internal support organizations. These factors contributed to an increase in the EBITDA margin for the segment from 18.9% in the prior year period to 20.5% in the second quarter of 2019.

For the year-to-date, Patient Care's margin has increased by 50 basis points to 16.3%. Now please bear in mind that our Patient Care business is highly seasonal, with the first quarter being our lowest earnings and margin quarter and the fourth quarter being our highest. With these trends in mind, we currently anticipate that we will demonstrate margin expansion in the Patient Care segment for the full year, over the 17.6% that we reported in 2018.

A final note to our Patient Care results. In reviewing our financial filings, you will notice that our work-in-process or WIP inventory at the end of the quarter reflected an increase of approximately $1 million as compared with the balance as of June 30, 2018. Unlike the first quarter, the majority of this increase relates to WIP associated with acquired clinics. So the underlying third quarter revenue related to these devices is not likely to contribute to third quarter same clinic sales in the same manner that we saw in the second quarter.

Our strong Patient Care results were partially offset by the decline in earnings of our Products & Services segment. While revenue from distribution services grew by $3 million or 8.6%, lower margins in that business, coupled with the decline of $1.9 million in revenue from therapeutic solutions, drove an overall decrease of $2 million in adjusted EBITDA for the segment. The margin in this segment was 15.6% for the quarter and 15.3% for the year-to-date.

On an adjusted EBITDA basis, our corporate expenses increased by $400,000 in the quarter and $1.4 million for the year-to-date. The primary factor in our increased corporate costs for the current year relates to our initial planning and design for the implementation of new financial and supply chain systems. In connection with this project, we've expended $1.5 million for the year-to-date and currently anticipate that we will expense a total of approximately $3.8 million for the full year. We estimate that this, when coupled with the $800,000 we incurred in our EHR implementation in the first quarter, will result in $4.6 million in combined expense associated with these major systems implementations in 2019. We currently anticipate that we will continue to incur approximately $5 million in annual implementation-related expenses for our financial and supply chain systems during each of 2020 and 2021.

In addition to these implementation expenses, in 2020, we also anticipate an increase in our capital outlay for both the financial and supply chain systems' implementation as well as in connection with a reconfiguration of distribution centers. Our financial systems and supply chain initiatives are expected to provide expense efficiencies and corresponding increases in our contribution margin commencing in 2022. We plan to provide you with additional color regarding these investments and the returns in future calls.

When reviewing our reported results for the second quarter, we believe it is also important to bear in mind that we recorded a $2.2 million gain in operations and a total $3.7 million pretax gain from favorable settlements recognized during the second quarter of 2018. These gains from settlements were excluded from our non-GAAP results in the second quarter of last year.

Now I'll spend a few minutes discussing our cash flows and indebtedness. During the quarter, Hanger produced $29.3 million in operating cash flow, which reflected an increase of $3.9 million as compared to the prior year. This growth was primarily driven by the company's increase in adjusted EBITDA during the period.

Capital expenditures, including the purchase of therapeutic equipment, were $10 million, which reflected an increase of $1.3 million over the prior year period. We continue to estimate that we will spend approximately $35 million in capital expenditures for the full year of 2019.

We did not complete any significant acquisitions during the second quarter. And as we approach the end of the year, any acquisitions that we do close would not be expected to add significant earnings or operating cash flows to our 2019 results.

As a result of an accumulation of free cash flow, cash balances increased by $17.7 million to $38.2 million at the end of the quarter. This brought our net indebtedness down to $469 million, which equates to a leverage ratio of approximately 3.8x adjusted EBITDA.

At the end of the quarter, we had total liquidity of $133 million, which reflected the combination of our retained cash of $38.2 million and our untapped revolving credit facility capacity of $94.8 million.

Now I'd like to spend a few minutes discussing our outlook for the balance of 2019. As our performance during the first and second quarters have demonstrated, it is the nature of Hanger's business that due to its inherently fixed cost structure and seasonality, it produces significant quarterly swings in earnings that can be both positive and negative. While we're certainly pleased with our positive second quarter results, we also believe that when viewed in the combination with our first quarter results, they underscore the importance of not viewing Hanger's trends in the context of any one quarter. Our year-to-date results through June have brought us directly in line with our original outlook range for the year. So our strong second quarter results have not altered our original view, they've instead served to reinforce it. We continue to believe that Hanger will provide revenue in the range of $1.075 billion and $1.105 billion, and that our adjusted EBITDA will be in the range of $121 million to $126 million.

From a quarterly perspective, as you will recall, the third quarter of last year was a significantly positive quarter as well. And as such, we believe it will present a tight comparison for the coming quarter. Accordingly, we currently believe that our earnings growth for the year will come in the fourth quarter, which is by far our strongest seasonal quarter and the one for which we will have a more reasonable comparison to our prior year performance.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Brian Tanquilut with Jefferies.

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Brian Gil Tanquilut, Jefferies LLC, Research Division - Equity Analyst [2]

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Congratulations on a good quarter. So I guess my first question, Vinit, for you is, as I think about the 3% same store you put up this quarter, 5% top line growth, translated to 11% EBITDA. I know in the past you've talked about kind of like the algorithm for the translation of organic growth or same-store growth to EBITDA, I mean is this a good way to think about the earnings power of the company, where if you're putting up 3% same store, you can get to double-digit EBITDA growth?

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Vinit K. Asar, Hanger, Inc. - CEO, President & Director [3]

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Yes. That's basically how we look at it. We think about organic growth, 3% to 5%, should get us in this range of EBITDA growth.

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Brian Gil Tanquilut, Jefferies LLC, Research Division - Equity Analyst [4]

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Got you. And then, I guess, taking a step back from that point, in the past you've talked about all the initiatives you've laid out, whether it's technology, marketing and using your scale and all these things, where are we in the process of rolling those out and also seeing the benefits? I mean, are we about to see the inflection or the acceleration in organic growth do you think?

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Vinit K. Asar, Hanger, Inc. - CEO, President & Director [5]

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I think we're beginning to see the effect of those investments. Certainly, if you take the first half of the year this year in 2019, organic growth rate is about 1.6% compared to last year. The full year organic same clinic growth rate was 0.9%. So we're beginning to see it. I think there's still work to be done, but we're feeling good about the results we're seeing so far.

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Brian Gil Tanquilut, Jefferies LLC, Research Division - Equity Analyst [6]

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Got it. And then I guess my last question is on the M&A front, nothing big this quarter, but how are you feeling about the deals that you've done year-to-date? I know there are some deals earlier in the year, in terms of the integration of those deals and the strategic value that they've added to the business and what does the pipeline look like for you guys?

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Vinit K. Asar, Hanger, Inc. - CEO, President & Director [7]

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Yes. We're pleased with the folks that we've brought into Hanger this year and late last year. Really, the first year of these businesses that come into Hanger, we focus on integration, so putting them on our EHR system and the like. So we're pleased with how that's working out in terms of the pipeline. We're also very happy with the discussions we are having with folks that are interested in joining Hanger. So the pipeline still remains strong, and we'll, obviously, keep you updated as we close more deals.

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Operator [8]

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(Operator Instructions) The next question comes from Larry Solow with CJS.

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Lawrence Scott Solow, CJS Securities, Inc. - MD [9]

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Obviously, you had a big improvement in the quarter. Some of it looks like on the prosthetic side was some carryover from Q1 into Q2. But could you just maybe discuss without going into specifics, do you think sort of prosthetic growth in the 3% to 4% range, which you've sort of done over the last, I think, 2 years, is that a sustainable number? And then also on the Orthotics side, obviously a nice improvement from the slow declines to a slow improvement, do you see that picking up even more as we go forward?

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Vinit K. Asar, Hanger, Inc. - CEO, President & Director [10]

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Yes. I think the observation is exactly right, Larry. In terms of the last couple of years, our prosthetic growth has been averaging about 3%. And we think that's achievable on a go-forward basis. And just a reminder, it could get lumpy. You could get a high number one quarter, you could get a low number the next quarter, and that's why we try and look at it for the longer term. And going back to the previous question that was asked as well, we think all the initiatives we've put in focusing on prosthetics are beginning to show on the prosthetic side. And as I said in my prepared remarks, we've begun to focus on the custom orthotics piece, which is showing this nice uptick in custom orthotics. So I think it remains to be seen when we see a further uptick, but today we're feeling very good about the results of the investments we've put in on the prosthetic side and on the custom orthotics side.

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Lawrence Scott Solow, CJS Securities, Inc. - MD [11]

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And on the -- obviously, as Brian pointed out, the reflection and the power of the operating model with the 15% EBITDA growth on 3% same-store sales growth, did the acquisitions have any contribution to the bottom line? I know that for the full year you sort of had said that they're basically close to breakeven. But in the quarter, did that help at all on the year-over-year operating margin or segment margin, EBITDA margin?

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Thomas E. Kiraly, Hanger, Inc. - CFO & Executive VP [12]

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Yes. So the -- yes. Larry, this is Tom. Yes. The acquisitions certainly are contributing, but not very meaningfully. It's a very low amount of earnings flow-through coming from them at this point, primarily because of the integration activities that Vinit described.

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Lawrence Scott Solow, CJS Securities, Inc. - MD [13]

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Okay. And then going forward, obviously, we do -- as we look out into next year, I would assume that these acquisitions, should they start performing sort of in line with historical and corporate performance?

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Thomas E. Kiraly, Hanger, Inc. - CFO & Executive VP [14]

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Yes. We believe so.

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Lawrence Scott Solow, CJS Securities, Inc. - MD [15]

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Okay. How much is the -- how about an update on the industry? Obviously, it's been going through some -- the last few years, pretty turbulent times with increased regulatory and paper trail requirements for reimbursement. How do your competitors shake out? I don't know if you have any real read-through on them, but just from a global level, how is the industry doing relative to, say, a couple of years ago?

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Vinit K. Asar, Hanger, Inc. - CEO, President & Director [16]

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Yes. I think what's -- what we are seeing is there is kind of a settling of that overall industry growth rate of that 1.5% to 2%. I mean it might have been higher many years ago, but I think it's settling at 1.5% to 2% is what we're seeing.

In terms of the regulatory reimbursement environment, every once in a while you're going hear things such as there's a competitive bidding piece out there for the lower off-the-shelf type devices, and some parts of the industry that focus heavily on orthotics or off-the-shelf type of orthotics, they're going to have a little bit of a tougher time going forward. I think this view that we're taking is we're focusing on our custom side of the portfolio right now. Custom prosthetics and custom orthotics I think, we believe, is the right thing to do, but we don't want to lose sight that we do want to be a full service provider to our referral sources.

So from Hanger's perspective, we will be figuring out how we actually deliver those low-end orthotics and shoes and inserts as well. But for now, we're pleased with the focus we put on the custom side with clinical outcomes and the patient engagement pieces.

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Lawrence Scott Solow, CJS Securities, Inc. - MD [17]

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Okay. Then just switching gears real fast, on the Products & Services segment, EBITDA declined, I believe, $2 million, although sales were actually -- revenue actually grew slightly. I assume that decline is primarily related to the therapeutic services. But could you maybe just give us a little bit more color on that and what's the outlook? Do you expect declines will continue?

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Thomas E. Kiraly, Hanger, Inc. - CFO & Executive VP [18]

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Larry -- yes. This is Tom. There's really 3 factors that are contributing to the decline. First of all, we're very pleased with the growth we're showing in distribution. Some of that growth, though, is coming with higher volume accounts where there may be certain margin differences in those accounts.

Secondly, this year we have invested and have a larger support for this distribution business given its growth. That's affected the margins of that segment or that business. And that's a part of that difference in year-over-year contribution from the segment.

And then thirdly, as you stated, therapeutic solutions revenue is down, and that certainly is a part of why you see this year-over-year decrease of $2 million in the segment. Now as -- for the second part of the question, do we foresee that continuing decline, certainly, our belief is that going forward that segment, at some point, will stabilize. And when it does, the growth that we're seeing and the economics that we're seeing on the larger segment, the Patient Care segment, will shine through even a bit more. I think we could all see what earnings would have done this quarter had we not had the decline in that segment, and we're hopeful that we can demonstrate that in future years.

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Operator [19]

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(Operator Instructions) This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

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Vinit K. Asar, Hanger, Inc. - CEO, President & Director [20]

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Great. Thank you all for your questions. Look, to sum it up, we're pleased with the second quarter results and where we sit on a year-to-date basis relative to our plan. And we're seeing encouraging signs of momentum in the Patient Care segment, as you could see. We're confident our strategy is the right one, and we're making the appropriate investments to further build a sustainable competitive advantage for Hanger as really the national leader in orthotics and prosthetics.

We're also determined to continue to focus on executing our strategy of clinical, operational and financial differentiation to drive organic growth. And we believe our markets remain highly attractive, and our position is the strongest it's ever been. I'm confident that by staying true to our values and our mission as a company and maintaining the course, we will create a sustainable long-term value for patients and shareholders.

And we appreciate your participation today and look forward to seeing many of you at conferences and meetings around the country during the next 1.5 months, so thanks very much.

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Operator [21]

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And thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.