Q2 2006 Hanger Orthopedic Group Earnings Conference Call - Final.

Original Source: FD (FAIR DISCLOSURE) WIRE

OPERATOR: At this time I would like to welcome everyone to Hanger's second-quarter results conference call. (OPERATOR INSTRUCTIONS). At this time I would like to turn the call over to Mr. Ivan Sabel, Chairman and CEO. Please go ahead, sir.

IVAN SABEL, CHAIRMAN AND CEO, HANGER ORTHOPEDIC GROUP, INC.: Thank you. Good morning, everyone, and thank you for participating in our second quarter 2006 earnings conference call. Before we get started I need to read our Safe Harbor statement.

This document contains forward-looking statements relating to the Company's results of operations. The United States Private Securities Litigation Reform Act of 1995 provides a Safe Harbor for certain forward-looking statements. Statements relating to future results of operations in this call reflect the current views of management. However, various risks, uncertainties and contingencies could cause actual results or performance to differ materially from those expressed in or implied by these statements, including the Company's ability to enter into and derive benefits from managed care contracts, the demand for the Company's orthotic and prosthetic services and products, and the other factors identified in the Company's periodic reports on Form 10-K and Form 10-Q filed with the Securities and Exchange Commission under the Securities and Exchange Act of 1934. The Company disclaims any intent or obligation to update publicly these forward-looking statements, whether as a result of new information, future events or otherwise.

Now, on to the results of our second quarter. Pleased to say that our revenue reached its highest level ever at 152.9 million. Our sales growth was the result of 0.2 million, or a 0.1% increase, in same-center sales in our patient care business, and a 3.4 million increase, or 31% increase in sales at our SPS distribution unit. These results were in line with our expectations, in particular at our patient care division, where we were comping off a record second quarter revenue in the same quarter in 2005.

We also ended the quarter with a very strong work-in-process backlog that exceeded the same period last year. In addition, as you know, we completed a global refinancing of all of our debt in the second quarter, and put in place a more flexible and accretive capital structure with extended maturities that will allow us to concentrate on achieving our long-term goals, including selective densification of existing market areas through acquisitions. We recently completed one of these and we are currently investigating others to determine if they meet our market-based strategies.

We also recently announced a Linkia contract with Great-West which will go into effect August 1st, and coupled with our Cigna Linkia contract, we now have two full network management contracts in place. As we told you last quarter, Cigna has already approved our provider network strategy, and they actually have begun sending out termination notices for the providers that will not remain in the network. We, of course, continue to see interest and are having ongoing discussions with other providers in considering similar relationships.

At our Innovative Neurotronics division, we completed our training program on its first product, the WalkAide, and now we have over 550 of our practitioners that are credentialed to fit this device to patients. Tom Kirk will, of course, go into further details on our national and international sales and marketing efforts during his presentation.

Our collections remain strong. DSOs continue to be at historically-low levels, and our free cash flows, when adjusted for interest payment related to the refinance on our new quarterly variable compensation payment, are actually higher than last year.

We continue to feel that although there are still challenges, that our programs and projects that we have invested in are gaining traction, as evidenced by our performance here in Q2.

Of particular note, the government has just announced that the CPIU for 2007 will be 4.3%. Many of you know that we are mandated to have that increase in next year's fee schedules, and the only way that will not happen is if Congress would take action to reduce that amount as they consider the overall needs of all healthcare providers within the Medicare system. Obviously, we are working closely with our trade associations, and in particular, key members of Congress, to explain the importance of this increase in order to maintain quality patient care and a healthy O&P profession. Whatever increase we are granted, it will have an immediate impact in '07 on about 40% of our book of business, with the balance phasing in over the next several years based on contract renewal dates.

I'd like to now turn it over to George, who will go into the details of our financials.

GEORGE MCHENRY, CFO, HANGER ORTHOPEDIC GROUP, INC.: Thank you, Van. Good morning, everyone. I'm going to start off my comments on the quarter. Since Van gave a pretty thorough analysis of Q1 sales, I'm going to begin with the cost of goods sold.

As a percentage of sales they increased by 1.4%, principally due to an increase in the cost of materials. Our labor costs increased by $500,000 the current quarter, due to a reduction in headcount and lower commissions.

The material costs accounted for the increase in the cost of sales. Both in dollars and as a percentage of sales they increased by $4.1 million compared to 2005. Approximately 2.8 million of that increase was due to the $3.4 million sales increase at our distribution entity, SPS, which because it's a distributor has a higher material cost, roughly 82.3% of sales, and the balance of the change was due to a slight change in our sales mix.

SG&A decreased by $700,000 in Q2 compared to the prior year, principally due to a $900,000 reduction in bad debt and a reduction of 500,000 in labor costs, which was offset by a $700,000 increase in our investment in our Linkia and Innovative Neurotronics [growth] strategies.

EBITDA, as a result, was $19.8 million, a $400,000 increase compared to the prior year. And the principal reason for that increase was our effective cost control. Our interest was $500,000 higher than last year, principally due to the impact of the refinance and increased variable interest rates. The Company did pay some duplicate interest on approximately $10 million of the old debt that was not liquidated in the tender offer. The remaining bonds were called in June, and were actually just liquidated last week in July. (indiscernible) total debt increased by approximately $30 million as a result of the finance refinance, in order to finance approximately $15 million of the preferred call and to pay costs and fees associated with the refinance.

Income taxes -- we recorded a benefit of $4.6 million for the quarter. That was the result -- and -- as compared to a provision of $2.8 million for the same period in the prior year. The benefit recorded in 2006 was a result of the loss generated by the $16.4 million in costs related to the refinance. The refinance caused the effective tax rate for the quarter to increase to 44.6%, compared to 42% in the prior year.

The cost of the extinguishment of debt caused a decrease in our estimated taxable income for the year, which caused certain addbacks in the tax provisions, such as (indiscernible), to have a greater relationship to total taxable income, and that in turn increased our rate. I'm …