CRH Medical Corp
Q3 2018 Earnings Call Transcript

Published: 5 Nov 2018

[Operator:]

Thank you for standing by. This is the conference operator. Welcome to the CRH Medical Third Quarter 2018 Conference Call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. [Operator Instructions] I would now like to turn the conference over to Ms. Kettina Cordero, Director, Investor Relations. Please go ahead, Ms. Cordero.

[Kettina Cordero:]

Thank you, operator and good morning everyone. I am joined today by our CEO, Edward Wright; our CFO, Richard Bear; and the President of CRH Anesthesia, Jay Kreger. Before we start, I would like to remind everyone that certain statements you will hear today constitute forward-looking statements within the meaning of applicable securities laws. For important assumptions, definitions and cautionary statements about forward-looking information and the risk inherent to our business, please refer to the cautionary notes in our financial report for the quarter and 9 months ended September 30, 2018 and the risk factors section in our most recent Annual Information Form. During this call, we will discuss non-IFRS measures as indicators of our performance. You can refer to our management’s disclosure and analysis for the quarter and 9 months ended September 30, 2018 for reconciliations of non-IFRS measures to reported IFRS measures. These documents are available on SEDAR and on the Investors section of our website. In addition, please note that we use the abbreviation GI to refer to gastroenterology. Finally, please be advised that our reporting and functional currency is the U.S. dollar and that all dollar figures referenced today are in U.S. dollars. Now, I leave you with Edward Wright.

[Edward Wright:]

Thank you, Kettina. Yesterday, we announced solid results for the third quarter of 2018. This outcome is due to the successful execution of our operational objectives and the integration of recently acquired anesthesia practices, including the two acquisitions we completed in the third quarter, Lake Washington Anesthesia, which we announced in July and Lake Erie Sedation, which we announced in September. Yesterday, we also announced our second agreement to develop a Monitored Anesthesia Care program in North Carolina. By virtue of this new agreement, we will develop an in-house GI anesthesia practice for our new partner, Digestive Health Specialists and retain an option to acquire a majority interest of the new practice at a future date. Digestive Health Specialists is an existing rating customer. As our teams work together to expand our anesthesia acquisition pipeline, we continue to benefit from the strong relationships with GIs, who have adopted the CRH O’Regan system and the increased awareness among non-CRH O’Regan customers for our anesthesia offering. At September 30, 2018, we had approximately $31 million available on our credit facility. This combined with our free cash flow provides us ample funds to continue executing on our growth strategy. Our results clearly demonstrate how strong our business is despite the CMS changes that were introduced in January 2018. I will now turn it over to Richard for his commentary.

[Richard Bear:]

Thank you, Edward and good morning to all. I would like to start by reminding everyone that in accordance with International Financial Reporting Standards also known as IFRS, we report consolidated financial statements, which means that our financial statements include those of the subsidiaries in which we hold a controlling interest, such as the anesthesia practices we own or in which we own a majority interest. This practice is in keeping with current accounting standards. In addition, please note that effective January 1, 2018, the company adopted IFRS 15. As a result, we restated prior year revenue and operating expenses. The restatement had no impact on net income or any other forms of income. Please refer to Note 3 of our un-audited interim financial statements for more information on this. During the third quarter of 2018, we reported total revenue of $28.7 million. Anesthesia revenue grew 35% year-over-year to $26.1 million. Average revenue per case for the third quarter was $367. During the third quarter of 2018, we serviced 71,044 patient cases, which is a 45% increase over the same period in 2017. Sales of the O’Regan System during the third quarter were $2.7 million compared to $2.9 million for the same period of 2017. Total adjusted operating EBITDA for the third quarter was $13.5 million, a 24% increase compared to the same period in 2017. Operating EBITDA margin for the third quarter was 47%. Adjusted operating EBITDA attributable to our shareholders was $8.5 million. As of September 30, 2018, we had $6.8 million in cash and $13.4 million in working capital. Our acquisitions continue to be financed through these internally generated cash flows along with our $100 million credit facility, which has an interest rate of LIBOR plus 2.50%. At quarter end, we had $31 million available on our credit facility to fund future growth. With that, I will leave you with Jay for his update.

[Jay Kreger:]

Thank you, Richard. During the third quarter, we spent $9.2 million on two acquisitions as previously stated. We acquired a majority interest in Lake Washington Anesthesia. It was our first acquisition in Washington State and represents the completion of our first business developed under our Monitored Anesthesia Care, or MAC program. In addition, we expanded on our existing footprint in the State of Ohio, with the acquisition of Lake Erie Sedation Associates. We are very encouraged by the announcement of our second signed MAC agreement with Digestive Health Specialists in North Carolina, which was announced yesterday. It is similar to the MAC program developed for Lake Washington. DHS owns multiple ASCs in the Winston-Salem area with a total of 6 procedure rooms. The pipeline remains robust and we will be adding additional business development resources as part of our commitment and our confidence in our ability to continue to grow. We will continue to leverage our relationships borne out of the O’Regan business as well as utilize our now referenceable cachet of high-quality practices and physicians that we have already partnered with. On the operations front, we continue to find ways to improve our processes. Our platform is evolving as we continue to position ourselves as the GI anesthesia partner of choice. I will now leave you back with Edward for his closing remarks.

[Edward Wright:]

Thanks, Jay. I think with that, we will just open it up for questions. Thank you.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from Richard Close with Canaccord Genuity. Please go ahead.

[Richard Close:]

Yes, thanks. Congratulations on the third quarter. Question, Richard, with respect to the case rate or pricing per case continues to come in significantly above I guess what we were modeling. How should we think about case rate in terms of the level of the – or the impact of the reimbursement cut that went into effect at the beginning of the year and just your thoughts about the case rate trends as we think about the fourth quarter as well as into 2019?

[Richard Bear:]

Good question. So, the case rate has been declining from Q1 to Q2 to Q3 of this year as a result and compared to previous year. As compared to previous year, the primary decrease, which is about 10.5% relates to CMS change. Other changes relate from – moving from non-contracted to contracted, we ended Q3 at about $367 per case for the quarter. With what we have in line in terms of contract, I would expect that to decrease slightly as we end up in the fourth quarter then begin to stabilize into 2019.

[Richard Close:]

Okay. So, like a 360, 370 number for 2019 seems plausible?

[Richard Bear:]

Yes, I think in that range seems plausible, yes.

[Richard Close:]

Okay, great. I had a follow-up question maybe for Jay here. You talk about the pipeline remaining robust and then you said something with respect to adding resources. I wonder if you could dive into that a little bit deeper and then what you are seeing on the operations front, your comment was seeking ways to improve processes. Anything specific that you can call out there?

[Jay Kreger:]

Sure. Thanks Richard for the questions. As far as resources go, I think our commitment is to make sure that we are casting a wide net and be able to answer every inquiry and every potential customer that’s out there. We have added some resources in the back-end of our business development team this year and we plan to add more just so we can reach out not only for acquisitions, but more MAC development programs like what we just announced last week.

[Richard Close:]

And anything specific on process improvement that you mentioned in your comment?

[Jay Kreger:]

Process improvement on the operation side?

[Richard Close:]

Yes.

[Jay Kreger:]

Just – we put a lot of new things and this just comes from scale having 10 states that we are now in, we have got some more regional operations folks that allow us to have best-in-class providers, best-in-class operations team and that proximity of geography helps.

[Richard Close:]

Okay, great. I will jump back into the queue. Thanks.

[Operator:]

The next question comes from Noel Atkinson with Clarus Securities.

[Noel Atkinson:]

Hi, good morning. Thanks for taking my questions. In terms of the new MAC practice that you are developing in North Carolina, can you give us a sense of this potential size of revenue or procedures relative to the first one that you developed in Seattle?

[Jay Kreger:]

It’s, Jay. So, I think we disclosed that they have 6 rooms. Generally speaking, the size of these practices is really more based on rooms rather than the number of centers. The practice is existing and you are probably talking additional 15,000 cases, patient cases, so you could look at it that way. We look at it ramping up pretty quickly probably by the end of the first quarter, but we won’t exercise our option and consolidate for at least 12 months, right.

[Noel Atkinson:]

Okay, great. And then secondly maybe this is a question for Edward, where do you see the company today in terms of annual free cash flow potential of the existing business after we subtract scheduled debt repayments and distributions to minority interests.

[Richard Bear:]

I will take that. I mean, so year-to-date, I think it’s close to $18 million in free cash flow, which we define as cash flow from operations less interest payments, less NCIB, which I think is what you just described. That will ebb and flow a little bit, just as it relates to working capital changes and other things, but we would expect that obviously to be north of $20 million by the end of – for the year and then growing as we do more deals into the next year.

[Noel Atkinson:]

Okay. I think in the past, there has been some discussion of that the business was at sort of $6.5 million a quarter of available cash flow for acquisitions or other activities. And I just wondered if now that there is more scale to the business, the business seems to be performing relatively well after the impact at the start of the year just whether that’s ticked up meaningfully from sort of that old number.

[Richard Bear:]

Yes, that old number, Noel, as you recall was based on pre-CMS cuts. So we are pretty much at that similar pace right now. And I think we will end the year at that pace and continue to grow from there into 2019.

[Noel Atkinson:]

Okay. And then finally, are there any geographic segments that did particularly well or particularly weak for the anesthesia business in Q3?

[Edward Wright:]

No, Noel. I think geography doesn’t play that bigger part in it. So there is really no material difference from a geography standpoint.

[Richard Bear:]

Yes. Maybe you are referring to some of the weather patterns and there is none of the weather – none of the hurricanes or other storms impacted us during the quarter.

[Noel Atkinson:]

Okay, great.

[Richard Bear:]

Thank you.

[Operator:]

The next question comes from David Martin with Bloom Burton.

[Antonia Borovina:]

Good morning. This is Antonia on the line for Dave. My question is as you look to your business, which is no longer in the startup phase, do you see any new levers you can pull or issues you can leverage to further enhance your performance. So for example, with your current scale and the CMS cuts behind you, do you feel you can buy significantly larger target businesses maybe expand into other areas or cut costs because of synergies in your network?

[Edward Wright:]

Antonia, this is Edward. I think the things that to address your questions, one of the major advantages that we have today is really in terms of the number of customers that we have. Having now completed 19 acquisitions, we have quite a large role of decks of people that we can utilize or reference to anyone that we are speaking to and because the GI community is a relatively small community and people know one another well. That’s probably our single greatest well, the two single greatest references we have today, obviously, the O’Regan customers that have been longstanding within the CRH community. And then secondly, the more deals we do, the more doctors that they know that we are asking them to reach out to and then Jay and his team are visiting many of those practices and educating them about our offering. Now just to remind everyone, what we are doing is, we have sort of come out with something that was relative, which was new to the marketplace that we introduced in 2014 and then in 2015 we did our first JV. So and it’s that JV model that resonates with most people.

[Antonia Borovina:]

Okay. And then in a somewhat related question, in an environment of rising interest rates, are you adjusting down the price you are willing to pay for acquisitions and do you see any softening or hardening of potential target ask valuations?

[Edward Wright:]

We don’t see valuations change. We haven’t seen valuations change significantly. And to answer your first question, we look at – we value these in a number of different ways, one of them is under discounted cash flow basis. So the hurdle rates adjust with our internal interest rates.

[Antonia Borovina:]

Okay, thank you.

[Operator:]

[Operator Instructions] Our next question comes from Richard Close with Canaccord Genuity.

[Richard Close:]

Great. I was wondering if you could talk a little bit about volumes. I know you don’t give same-store but MEDNAX which does some anesthesia, they reported today and they talked about some volume weakness. Now they have different business lines, but just curious your thoughts on the volume trends that you are seeing?

[Richard Bear:]

Yes. I will start with that one, Richard. So we have historically stated organic growth in case volume of around 1% to 3%, again depending on the market and the maturity of the business. We continue to see that. We have some under-performing, we have some over-performing, but on average is 1% to 3%. These are – remember we are servicing GIs in the ASCs. These GIs are – these ASCs are GI-specific, GIs are in private practice and they worked hard to drive volume into these centers. So, I am not – I haven’t seen MEDNAX’s results, but ours are consistent with previously stated expectations. Jay, anything to add?

[Jay Kreger:]

Okay. The only thing I would add to that, Richard is that to Richard’s point about the GIs and this is their business. The only time we usually see any kind of movement is when there is succession issues within a practice and usually it’s temporary, because they will be replaced with newer younger doctors as for instance in a retirement situation.

[Richard Close:]

Okay. And I guess my second question or follow-up here would be DSOs, I think you talked a little bit about that picking up if I am not mistaken and cited maybe the CMS reimbursement change. What are your thoughts there? Is that just a couple of quarter blip or any details?

[Richard Bear:]

Yes, good question, Richard. We spend a lot of time up – we obviously spend a lot of time on – obviously we spend a lot of time on the accrued revenue side of our business, because we haven’t collected all the revenue in Q3 and we are still collecting revenue in Q2. I would say Q1 is at this point is fully collected. So we do deep dives at the payer level, the market level to make sure that our accruals are correct. And then kind of look at what that means in terms of days outstanding by payer, by market. And there has been a – the impact of the new codes started impacting us in Q1, but just kind of slowed the whole process that we are seeing Q2, Q3 as well. I think what we are going to see is we are going to see a slight tick up in the days outstanding in Q4, just because of the bullets of revenue that typically comes in Q4, but by Q1 and going forward will be normalized again.

[Richard Close:]

Okay. Final question, are you guys seeing any changes in terms of the – maybe receptiveness of deep sedation, obviously there has been a big push or growth over the last 5 years to 10 years, in terms of this becoming the standard of care, but I have seen some articles, maybe some pushback by commercial payers, are you seeing or hearing about anything along those lines?

[Jay Kreger:]

So Richard, it’s Jay. There has not been a lot of specific data, so it’s really anecdotal and it’s very regional in nature, just like you said, you have heard out there. I think at the same time that areas of the country are accepting deep sedation is the standard more and more. You do have some neural networks that are considering it, but it’s always been pushed back from the other side. So overall, we are still very optimistic that approximately 60% of the endoscopic procedures are accepting deep sedation. That’s across the nation, excuse me.

[Edward Wright:]

At the centers we serve, we are not seeing any material pushback.

[Richard Close:]

Great. Thanks.

[Operator:]

The next question comes from Endri Leno with National Bank Financial.

[Endri Leno:]

Hi, good morning and thanks for taking my questions. Just a couple for me, first one is on the debt side, I mean it has been ticking up almost every quarter for the last few, so I was just wondering like what kind of debt level which – are you comfortable with and where do you see it stabilizing?

[Richard Bear:]

Currently, we are – currently, I think we are about again on the calculation of our defined covenants were about 2.2 – debt to EBITDA is around 2.2 in our financials. I think we clearly stated that our max is 2.5. And so under our current debt facility we are comfortable staying below 2.5.

[Endri Leno:]

Okay. And do you see it stabilizing under 2.5 or would it…

[Richard Bear:]

Yes. I think it will stabilize. It’s again depends on the calculation. I mean if you just did a straight up calculation, it would probably be less than what I just stated. But the covenant calculation that we use is a rolling four quarter calculation that takes into account a number of different things. But yes, I believe it will stabilize, but it will also – it will increase and decrease just by the pace of acquisitions.

[Endri Leno:]

Okay, great. Thank you. And next question is more, I mean you have alluded and you have in your financial statement that you are switching to GAAP accounting next year, so I was wondering if you have any early guidance on what it could mean for all your disclosures and in terms of how you present financial statements in general?

[Richard Bear:]

Yes. So good question, so yes, because more than 50% of our shares are now owned in the U.S., we have lost our foreign private issuer status and exemption. So effective 01/01, we became a full – we become a full SEC filer. So our 12/31/2018 financials instead of being presented in the format that you have all been used to, they will be presented on Form 10-K. And as a result the MD&A financial statements, annual information form will all be kind of combined into a single document. There will be some enhanced disclosures as a result of that. There will be some disclosures that are not required as a result of that as we harmonize IFRS in U.S. GAAP. But we don’t expect there will be any material changes in the presentation of the numbers themselves.

[Endri Leno:]

Okay, great. Thanks. That’s all the questions for me.

[Operator:]

The next question comes from Tania Gonsalves with Cormark Securities.

[Tania Gonsalves:]

Good morning and congratulations again on the announcement of your second MAC program deal. My question follows along the line of questioning from Richard actually and I am trying to figure out what kind – like how big the slice of market you can capture, that is the roughly 50% of GI ASCs in the U.S. that haven’t yet converted to monitored anesthesia care, practically speaking, what kind of a piece do you think you could ultimately convert, I imagine there are barriers to entry such as reimbursement, operation size, etcetera, it’s not just the education treating aspect?

[Edward Wright:]

Thank you for the question. You are right. There are qualifiers that we try to use. We use that – we look at the broader market, which is approximately 1,000 GI centric ASCs. And a certain percentage of those are of a size that we would go after. We believe that size is ample and will be a product for us to transact with for years to come.

[Tania Gonsalves:]

Okay. And then specifically looking at the earn out, which caused a bit of – to revalue the fair value of it, other than the actual volume performance, is there anything else that ties to that fair value, so how does that fluctuate?

[Richard Bear:]

The fair value – so the earn out is based on cumulative EBITDA from the date of acquisition, which is 12/01/2014 and so it’s volume rate and expense driven. So it’s basically everything that affects earnings from that asset. So as we see different changes in cases, changes in rates, positive, negative, changes in cost, positive, negative, it caused us to revalue and look at the earn out. So in this quarter, we increased the earn out, which means that asset, the GI asset is performing better than it was last quarter. That’s the positive news. But as we increase that liability for those who love accounting, that’s a credit, the debit has to go somewhere and that goes to finance expense, which impacts net and comprehensive income.

[Tania Gonsalves:]

Okay. And then lastly, I know you mentioned that you haven’t really seen any changes to valuations and you are looking for acquisitions, I did notice the last couple ones for Lake Washington and Lake Erie, they were kind of lower than normal on a revenue basis, so appraised revenue basis, does that has to do with the cuts or was that specifically just circumstantial?

[Richard Bear:]

You should be looking, when you – you should be looking – when you look at our multiples, we always talk about effective multiples based on income not revenue because margin profiles will differ from practice to practice based on payer mix. So our Lake Washington was really right in that sweet spot of around 45 which we guided to. Lake Erie is still – we used fairly because we only had one month of operations to Lake Erie. We had no collections data just because of where we are at. So we used a pretty conservative number. So I wouldn’t look at that one until fourth quarter.

[Tania Gonsalves:]

Okay. And the EBITDA margins for the Lake Erie Sedation Associates, it’s kind of standard for what you have seen in the past?

[Richard Bear:]

Yes. The EBITDA margins, yes are consistent with what we have seen in the past. Yes.

[Tania Gonsalves:]

Okay, perfect. That’s all for me. Thanks.

[Operator:]

This concludes time allocated for the question-and-answer session. I would like to turn the conference back over to Mr. Edward Wright for any closing remarks.

[Edward Wright:]

I would just like to thank everyone for joining us. And we look forward to speaking with you again. Thank you.

[Richard Bear:]

Thank you.

[Operator:]

This concludes today’s conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.