RadNet, Inc.
Q3 2013 Earnings Call Transcript

Published: 11 Nov 2013

[Operator:]

Good day, everyone, and welcome to the RadNet Inc. third quarter 2013 financial results conference call. Today's conference is being recorded. I would now like to turn the call over to Mark Stolper, Executive Vice President and Chief Financial Officer of RadNet Inc. You may begin.

[Mark D. Stolper:]

Thank you. Good morning, ladies and gentlemen, and thank you for joining us today to discuss RadNet's third quarter 2013 financial results. Before we begin today, we'd like to remind everyone of the Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995. This presentation contains forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995, specifically, statements concerning anticipated future financial and operating performance; RadNet's ability to continue to grow the business by generating patient referrals and contracts with radiology practices, recruiting and retaining technologists, receiving third-party reimbursement for diagnostic imaging services, successfully integrating acquired operations, generating revenue and adjusted EBITDA for the acquired operations as estimated, among others, are forward-looking statements within the meaning of the Safe Harbor. Forward-looking statements are based upon management's current preliminary expectations, and are subject to risks and uncertainties, which may cause RadNet's actual results to differ materially from statements contained herein. These risks and uncertainties, include those risks set forth in RadNet's reports filed with the SEC from time to time, including RadNet's annual report on Form 10-K for the year ended December 31, 2012, and RadNet's quarterly report on Form 10-Q for the 3-month period ended December 30, 2013. Undue reliance should not be placed on forward-looking statements, especially guidance on future financial performance, which speaks only as of the date it is made. RadNet undertakes no obligation to update publicly any forward-looking statements to reflect new information, events or circumstances after the date they were made or to reflect the occurrence of unanticipated events. And with that, I'd like to turn the call over to Dr. Howard Berger, Chairman and Chief Executive Officer of RadNet.

[Howard G. Berger:]

Thank you, Mark. Good morning, everyone, and thank you for joining us today. On today's call, Mark and I plan to provide you with highlights from our third quarter 2013 results, give you more insight into factors which affected this performance and discuss our future strategy. After our prepared remarks, we will open the call to your questions. I'd like to thank all of you for your interest in our company and for dedicating a portion of your day to participate in our conference call this morning. In assessing our third quarter performance, we have to balance the accomplishments we are making as a company to prepare us for future success with the short-term pressures we are facing from lower utilization of healthcare services and from declining reimbursement. All year, we have faced pressured industry volumes and when combined with lower Medicare and private payor pricing, we struggled with our same-center performance. Prior to 2013, for many years, we enjoyed slow and steady same-center growth and as industry expanded. This growth was fueled by a growing and aging population, improvements in technology, which created new application for our tests, wider physician acceptance of the effectiveness of imaging as a diagnostic tool and patients who have become more educated about and aware of imaging as an effective and noninvasive diagnostic measure. These long-term trends have been disrupted, but we believe only temporarily. Why are volumes been light in our industry over the last 12 to 24 months? First, we continue to see a migration to higher deductible health plans, which has caused patients to utilize healthcare less frequently as the burden of cost has shifted to them from their insurance companies. This migration to higher deductible plans has been a trend for consumers who are trying to counteract the rising cost of healthcare premiums and the declining share of those premiums that are being absorbed by their employers. Second, we believe that there may be patients who have been delaying healthcare as they wait to understand and process the changes of the healthcare insurance landscape, particularly with regards to the new healthcare reform and the formation of health insurance exchanges. There is a belief among some patients that they will be able to secure healthcare insurance less expensively in the future because of Healthcare Reform and these patients are delaying all elective healthcare services. The future release of this pent-up demand may benefit us significantly when more certainty and information around healthcare exchanges and the expansion of some of the Medicaid programs becomes more important. We may already be experiencing some of this as our volumes beginning in October have shown a significant increase over the third quarter's per day volumes. Finally, hospitals have become more aggressive in purchasing primary care and specialist physician groups in their communities. When this happens, referrals for ancillary services such as diagnostic imaging often get transferred to the local hospitals with which the physicians are now affiliated. We've seen this strategy by hospitals ebb and flow in the past and we are dubious about the long-term viability and effectiveness of this strategy for hospitals. It wouldn't surprise us if these partnerships unwind in the future like many have done in the past. We're not sitting idly during this pressured period in our industry. Although 2013 has been a transition year for us, we've made important strides in preparing us for the prospects of better performance in 2014 and beyond. What do I mean by this? We've spent much of the year identifying and analyzing opportunities to make our business more cost efficient. With lower industry volumes and lower pricing, we need to be positioned to deliver our services at a lower cost. As such, we've identified and targeted $30 million of cost savings that we believe are executable within the next 12 months. Let me discuss the areas for savings in some more detail. First, we will be adjusting staffing levels at our centers and in the regional operations that support them. This includes adjusting staffing levels of front office, call centers, scheduling, data input, reimbursement operations and other support functions. Second, our continuing information technology initiatives will reduce our costs and increase operating efficiencies. We continue to roll our eRAD risks and PACS products, which brings with it the ability to streamline and automate our operating protocols and allows us to operate our facilities with less manpower. In addition, we continue to integrate our voice recognition transcription system, which is already decreasing our transcription expense and will have a much more pronounced impact in 2014. Third, with a portion of our capital expenditures budget, we will look to opportunistically purchase some equipment, which we currently utilize through operating leases. These will be deleveraging transactions, eliminating a portion of our operating lease expense. Fourth, we are in the process of renegotiations with certain vendors who provide us medical supplies, office supplies and contrast materials. Our scale is paramount for success in these negotiations. For many of our vendors, RadNet represents a large and important book of business, thus, we are able to leverage our book of business with them and to get a better pricing. These vendors recognize that unlike most of the other diagnostic imaging industry players, RadNet is growing in size and likely continue to do so in the future. Our vendors realize that it benefits them to align themselves with us as our account with them is 1 that will increase in size into the future. Many of them are willing to trade off current pricing concessions for long-term loyal relationship. If we are executing a number of corporate cost saving initiatives involving insurance and our commercial banking fees, we are migrating our workers' compensation insurance from a guaranty trust program to a modified self-insurance plan with stop loss reinsurance. Furthermore, we have renewed our property and casualty insurance at a significantly more favorable rate. In addition, as of January 1, 2014, in response to rising healthcare costs, we have modified our health insurance employee benefits, which will bring material savings to our company. Lastly, we are in the process of consolidating all of our commercial banking business under 1 provider, the economies of scale from which will yield a significant banking fee savings. And lastly, we will be benefiting in 2014 from the elimination of facility lease expenses and physician compensation related to the final steps in our consolidation of the CML assets in Maryland. In total, we have estimated these cost savings to approximate $30 million per year and our management team is directing much of its focus on achieving these benefits in this fourth quarter of 2013. I am further encouraged by the acceleration of consolidation and diminishing of capacity I am observing in diagnostic imaging as a direct result of the same industry pressures that have hampered our performance in 2013. Simply put, these utilization and pricing pressures are accelerating the opportunities we are seeing to purchase inexpensive assets or is resulting in competition beginning to exit the business. I'll give one example of this on a very local level of a transaction we completed within the last week to allow you to appreciate what I think will be continuing trends and behavior in our industry from which we can capitalize. For over 5 years, we have competed rigorously in one of our San Fernando Valley markets with a radiology group practice that staffs the local hospital. When this group opened an outpatient facility 5 years ago within blocks of our 2 existing facilities, it deployed a state-of-the-art 64-slice PET/CT scanner and a high-end MRI system. The center never drove enough volume to provide an appropriate return on the group's investment. We had at least 2 discussions with this group in past years regarding acquiring the facility. Each discussion proved to be fruitless because of the unrealistic pricing expectations of the radiology group. Finally, as their center turned profitable and their lease -- and their facility's lease is nearing conclusion, they contacted us in a last ditch effort to purchase them. The result is that we provisioned the 2 pieces of equipment, we'll close their facility with the sellers retaining the financial responsibility for all expense related to vacating the space and their entire book of business will be transferred to the 2 RadNet facilities in walking distance with their facility. Against this revenue, we will have little to no cost except the cost of paying for the radiology interpretation. In order to ensure that the business moves over to RadNet, the radiology group will continue to interpret studies from its referral base and the group's compensation will be tied to the amount of business that is sent to us from the group's referring physician base. The 2 pieces of high-end imaging equipment from the closed center will be redeployed within the RadNet network, thereby lowering our capital expenditure requirements going forward. I took you through this transaction not because of its financial or operating significance to RadNet, but because it represents what is happening in our industry, and what I believe will occur more often in the future. As difficult as the operating environment is for us, it is more difficult for our smaller competitors, who have little ability to drive the cost savings and efficiencies in their business. Like within the example of the radiology groups that I just discussed, our smaller competitors have been resilient in their survival. However, many will eventually succumb to these same industry pressures. As this happens, we expect to see our same-center volumes and revenue return to their more normal long-term history of slow growth. This should greatly improve our profitability. I have more frequently have been asked about Healthcare Reform and what impact it will have on RadNet. While there is much confusion about the formation of the healthcare exchanges and the expansion of state and federally-funded medical programs, one thing on which most experts agree is that it will bring additional insured lives into the healthcare delivery system. Some of the newly-covered individuals were not availing themselves of healthcare services at all in the past. Others may have been utilizing hospital emergency rooms for their needs. I continue to believe that many of these newly-covered individuals will begin utilizing mainstream healthcare outlets, which will include outpatient diagnostic imaging locations like ours. This additional procedure volume would benefit us greatly as it would drive same-center revenue, fill capacity and provide us higher incremental profitability as many of our operating costs remain fixed. So despite some of the pressures that have impacted our performance in 2013, I am very encouraged about the future and the prospects of an improved 2014. At this time, I'd like to turn the call over to Mark to discuss some of the highlights of our third quarter 2013 performance. When he's finished, I will make some closing remarks.

[Mark D. Stolper:]

Thank you, Howard. I'm now going to briefly review our third quarter 2013 performance and attempt to highlight what I believe to be some material items. I will also give some further explanation of certain items in our financial statements, as well as provide some insights into some of the metrics that drove our third quarter performance. In my discussion, I will use the term adjusted EBITDA, which is a non-GAAP financial measure. The company defines adjusted EBITDA as earnings before interest, taxes, depreciation and amortization each from continuing operations, and excludes losses or gains on the sale of equipment, other income or loss, loss on debt extinguishments, bargain purchase gains and noncash equity compensation. Adjusted EBITDA includes equity earnings and unconsolidated operations and subtracts allocations of earnings to noncontrolling interests and subsidiaries and is adjusted for noncash or extraordinary and onetime events that have taken place during the period. A full quantitative reconciliation of adjusted EBITDA to net income or loss attributable to RadNet Inc. common shareholders is included in our earnings release. As many of you may have seen on Friday, we made an 8-K filing, which discussed an error in our 10-K as of December 31, 2012, related to a onetime income tax benefit, which we will be amending in a restated 10-K likely to be released tomorrow. The error was noncash in nature and by correcting the 10-K, there will be no further adjustments in current or future accounting periods. In the fourth quarter of 2012, we recorded a benefit from income taxes of approximately $60.4 million, primarily relating to releasing a valuation allowance against our deferred tax assets. Last week, during our review of our workpapers supporting our deferred tax assets, we discovered an error in the historical tax treatment of certain mark-to-market adjustments recorded in relation to our interest rate swaps. This error caused the company's deferred tax assets to be overstated by approximately $4.3 million and unrecognized tax benefit liability to be understated by approximately $400,000 at December 31, 2012. Periods prior to the fourth quarter of 2012 were not significantly impacted by the overstatement as we had a valuation allowance established against the overstated deferred tax assets. The results of the restatement will reduce the noncash income tax benefit we recognized in last year's fourth quarter by $4.7 million from $59.9 million to $55.2 million, and the corresponding deferred tax asset we recognized on our balance sheet was reduced by $4.3 million from $60.4 million to $56.1 million. In response to this error, we will be implementing new controls by year end designed to create further oversight over our tax work and minimize the chances of further errors related to our accounting for income taxes. With that said, I'd like now to review our third quarter 2013 results. For the 3 months ended September 30, 2013, RadNet reported revenue and adjusted EBITDA of $175.9 million and $25.4 million, respectively. Revenue increased $14.7 million or 9.2% over the prior year same quarter and adjusted EBITDA decreased $3.2 million or 11.3% over the prior year same quarter. Adjusted EBITDA and profitability were impacted by our same-center performance, which outweighed the positive contribution from the acquired facilities of Lenox Hill Radiology. Same-center revenue declined by 3.6%, which was primarily the result of lower year-over-year pricing as same-center procedure volumes remained flat. For the third quarter of 2013, as compared to the prior year's third quarter, aggregate MRI volume increased 12.7%, CT volume increased 3.7% and PET/CT volume decreased 0.3%. Overall volume, taking into account routine imaging, inclusive of x-ray, ultrasound, mammography and all other exams increased 12% over the prior year's third quarter. In the third quarter of 2013, we performed 1,132,135 total procedures. The procedures were consistent with our multi-modality approach whereby 77.6% of all the work we did by volume was from routine imaging. Our procedures in the third quarter of 2013 were as follows

[Howard G. Berger:]

Thank you, Mark. Imaging will continue to be an indispensable part of the healthcare delivery system. Non-hospital outpatient imaging will always be delivered more cost effectively and conveniently than the offerings of hospitals, who lack the domain expertise, management breadth and operating culture necessary for outpatient success. Our strategy is to execute on the principal business tenets that will ensure our future success. The first is scale. In our highly-fragmented industry, which is suffering immense pressure of lower reimbursement, decreasing utilization and lower availability of capital, size matters. Our cost structure, leverage with suppliers and payors and industry relationships with powerful joint venture partners set RadNet apart from other industry players. We will continue to make strategic acquisitions in our regions, particularly tuck-in transactions of single centers and small groups. We will also continue to leverage our scale and expertise to partner with powerful local healthcare systems and hospitals. Consolidation and the shrinking of capacity will be long-term things in our industry in years to come. We intend to position ourselves to capitalize on these trends. We are also focused on efficiency and cost containment. As discussed earlier on the call, we have key initiatives that we expect will help to mitigate current and future reimbursement and utilization pressures. We will continue to identify other avenues to save costs and achieve efficiencies within our business in the future. And finally, we'd look to continue to diversify our product offering. This has included our entry into radiology software, teleradiology, professional services and staffing and medical oncology, which are imaging-dependent. We are leveraging these capabilities to provide a continuum of services to joint venture partners, who seek an imaging partner who can provide solutions to all their diagnostic needs. Furthermore, each product offering represents a unique growth opportunity in and of itself and these offerings are far less capital intensive than our core business. We are working on new initiatives to diversify and look forward to being in a position soon to discuss them publicly. Operator, we are now ready for the question-and-answer portion of the call.

[Operator:]

[Operator Instructions] And first, we'll go to Brian Tanquilut with Jefferies.

[Brian Tanquilut:]

Howard, you talked about physician acquisitions by hospitals. So we're hearing a lot about that obviously, in talking to some of these hospitals, you're talking about imaging as an area of potential profitability where they want to go into, just because it's better margin than their current businesses. So as we think about that, how do you position your company and compete when the hospitals are buying doctors or putting up imaging facilities on their own? And just to couch this -- I believe, I share your thoughts in the long term. But how do you deal with the near term where the volumes are getting sucked away from freestanding facilities?

[Howard G. Berger:]

Good question. And I think we're very much reflective of, I believe, our opportunities here for the future. First of all, most of these hospitals have limited capability of absorbing physician groups. And while there is an immediate impact on this, you also have to realize that 2 things happen as a consequence of it. #1, they alienate effectively other people on the hospital staffs who are now looking at the hospital as a competitor in the delivery of professional services. So many of the doctors who are not part of that roll-up[ph] process, in fact, now look to perhaps direct their business elsewhere as they don't feel they want have their patients captured in a health system that might ultimately be competitive with them and vie for that same patient's primary care services. The second thing is and what we're beginning to see quite a bit of and perhaps we'll be able to discuss in more detail in future earnings calls is that they then, meaning the hospitals, layer on their reimbursement, which is substantially higher than the outpatient freestanding imaging centers. Perhaps by a factor of 2, 3 or even sometimes 4x higher and the payors are beginning to see the crush of that kind of strategy and tools, with which the hospitals are leveraging themselves into better reimbursement. As a consequence, many of the payors are beginning reach out to freestanding multi-modality centers like us and starting to speak more specifically about redirecting some of their business. And more importantly, coming up with plan design of these health insurance products that incentivizes their enrollees to direct them into the lower cost freestanding facilities. So while I see the effectiveness of this strategy, I can only tell you that the scope of it will be limited because of the enormous number of other physicians out there who will not be part of those roll-up opportunities. And that the pricing will continue to deflect the willingness of the payors to support the hospitals because of the higher pricing that they are experiencing. That along with as the capacity dries up because some of the smaller operators, as we mentioned, are finding it difficult and are either being absorbed by hospitals or going out of business or perhaps being acquired by us. The strategy of RadNet is continuing to be enhanced where we want in all the markets that we participate in to be the major, if not only, serious alternative to the hospital systems for outpatient imaging. And we think in every one of the markets that we are in, we can have that ultimate long-term position that will get us ultimately better reimbursement and more patients.

[Brian Tanquilut:]

And then Howard, second question for you. In terms of volume visibility, clearly, reimbursements have been pulling your performance down for the last 4 or 5 years. But volumes have been weak as well. Where do you sit today, how do you gain comfort or confidence in your ability to continue driving volume growth going forward?

[Howard G. Berger:]

I think that was partially answered in the question that you raised before this, Brian. First of all, as some of the smaller operators either go out of business or are acquired, that business will be redistributed to existing and surviving outpatient imaging centers such as RadNet. Secondly, I believe that there will be an increasing participation and coordination with the payors to direct business away from hospitals as the increasing cost to the payors by the substantially higher cost of imaging in the hospital systems causes the payors to create healthcare plans. And thirdly, as we mentioned, I believe and I think it's echoed in many other reports that we read, that the healthcare reform, Accountable Care Act, ObamaCare, however you want to describe it and health insurance exchanges, which began kicking off October 1, will bring more people into the system who have either not availed themselves of imaging services or who have been getting them in other places that the new insurance exchanges will direct them to a lower cost providers. So actually see many ways that, that will inure to the benefit of RadNet. And I am very cautiously optimistic that we may be starting to see that trend already here in the fourth quarter, where our volumes in October and through November here have been some of the largest that we've enjoyed all year.

[Brian Tanquilut:]

And then Howard, 1 more question for you. So thank you, for laying out the cost cutting initiatives that you're doing and exactly what the moving parts are there. But how do you balance between potentially cutting to the bone and still investing in your business to drive growth going forward? I mean, it's a big number, $30 million now.

[Howard G. Berger:]

Yes, you have to remember and perhaps we'll lay out more detail in our next call at the end of the year. Of the $30 million, less than 1/3 of that is related to cost cutting measures for employees. All the others are basically relatively inconsequential to the staffing levels that we currently have. In addition, a lot of the staffing reductions are a continued process that we began early this year for consolidation of various centers. For example, in Maryland, where we consolidated a lot of our centers as a result of the CML ARS transaction, which have just taken us longer to effectively integrate into our system. So I don't believe we're anywhere close to cutting to the bone and I don't believe that, that would be long-term beneficial to the company. So what we've detailed so far are not what I consider to be draconian measures by any stretch of imagination. And in fact, are mostly things that will be done at the corporate level as part of the initiatives that we've been working on really over the last couple of quarters.

[Operator:]

And next we'll go to Miles Highsmith with RBC.

[Miles L. Highsmith:]

I'm just looking at the volumes, flattish, and the revenue was down on a same-store basis 3%, 4%. Can we assume a lot of that is Medicare? Actually kind of revisit the commercial pricing dynamics and get a sense as to whether you're seeing rate reductions or any things that are noteworthy on the commercial side?

[Mark D. Stolper:]

Sure. Yes, we have a significant impact in 2013 in general from Medicare. We also -- you just have to also understand that each quarter, there is a fluctuation in pricing based upon that quarter's business mix in terms of modalities, as well as that quarter's mix with respect to payor class. So it's not all -- you can't call it pricing 100%, but the -- so the impact of payor class mix and modality mix does affect the average pricing for that particular quarter. But we have seen some erosion in private insurance over the last 12 to 18 months. And it's generally been in the range of 1 to 2 points over the last 18 months. And part of it is that some of the -- there are some plans, although it's a very small part of our business that are tied to Medicare such as some of the Medicare Advantage plans. And then we've had some declines in reimbursements by a couple of the California payors. It's also been -- we also have had some increases in reimbursement from private payors in the state of Maryland, where we have significant concentration of outpatient imaging centers. We think that we're going to be fairly protected going forward in New Jersey with our newer relationship with Barnabas and our book of business related to capitation, generally speaking have price increases year-over-year through escalation clauses in those contracts. So we do have the largest book of business, which is our commercial insurance business. We have felt some pricing pressure over the last couple of years, but it's somewhat been mitigated by the other books of business that I mentioned where we have gotten some increases.

[Miles L. Highsmith:]

So just to confirm, you've mentioned some erosion in the commercial pay rate and I'm focused just on rates not mix. I think you mentioned 1% to 2%. I guess it was my kind of historical understanding, Howard had talked about not accepting a rate decrease and I'm just wondering if that had a change more recently? Or is that -- was 1% to 2% kind of a deceleration in the increase that you were receiving?

[Mark D. Stolper:]

No, I mean, I think it's market-by-market, Miles. I think there are certain markets where we've got significant leverage with the payors such as the 2 I mentioned earlier, Maryland and New Jersey. And then other markets where we have felt some pricing pressure. And at this point, we're still growing scale to a point where we'll be able to push back effectively. But we also don't -- in those markets where we don't have the leverage, we don't want to cut off our nose to spite our face, meaning that we're not going to get rid of a big book of business at this point just to prove a point. We've got to get to a place where we've got enough assets that a threat is a real threat and I think we're doing that in a number of our markets.

[Miles L. Highsmith:]

Okay, great. Just a couple of others. In terms of M&A, would it be more fair to say that if you guys have historically seen multiples, let's call it 4x, would it be fair to say that you're seeing more at 4x now or that maybe you're seeing opportunities at lower multiples?

[Howard G. Berger:]

I think it's a combination of both. We've pretty -- been pretty rigid in our acquisition criteria. And I think what we're really seeing is that the sweet spot for the company are multiples in that 4x range for good assets. But what we're also seeing are certain operators who have no serious EBITDA to do the leverage off of and we're looking at more like asset purchases, much like the example that I gave in my opening remarks, that wind up being much more attractive for the company not because the EBITDA has value to the seller, but it has -- the revenue has value to RadNet by virtue of consolidation within these markets and the ability to eliminate other capacity. So we're seeing, to answer your question, I think a bifurcation in the marketplace of what I will just term asset sales for distressed assets and other operators who have good businesses, but who are looking perhaps for some kind of consolidation opportunity. And we're staying very firm in our 4x multiple valuation of those assets.

[Miles L. Highsmith:]

Okay, great. And then just finally, I guess I'll be curious to hear when we would get 2014 guidance. Will that be at the next earnings call? And my last substantive question is in terms of the $30 million, kind of a follow-on to an earlier question. You mentioned 1/3 of this would be potentially related to staff, the bulk would not. Can you talk about that 1/3 a little bit? I just would like to hear a little more about any areas that might be sensitive to things that provide value to the referring physicians or otherwise that you might have any expectation or concern that it could impact your top line?

[Howard G. Berger:]

Yes, we have no concern that it will impact our top line. As I mentioned on one of the prior questions, a lot of this is the ability for us to do consolidation in certain markets, of staffing reductions that have been a little bit slower in coming than we anticipated as a result of other acquisitions that we have done. So we have done nothing that we think will interfere with or decrease the attractiveness of our referring physicians sending their patients to our centers. And in fact, some of the other very significant IT initiatives that we're doing, for example, with scheduling, reporting turnaround time as a result of the eRAD rollout, will actually create some opportunities, I think, to further distance ourselves from the competitors by providing an even higher level of service, but using it with technology tools rather than manual efforts.

[Miles L. Highsmith:]

Great. And will we expect 2014 guidance at the time of the Q4 call?

[Mark D. Stolper:]

Yes. That's when we regularly give guidance for the following year.

[Operator:]

Moving on to Darren Lehrich with Deutsche Bank.

[Darren P. Lehrich:]

So I just -- I wanted to put the $30 million cut into -- or savings rather, into a little bit more perspective. First of all, can you just maybe frame for us how much visibility you think you have at this juncture into that number? I know you said you'll be working some things through this quarter and maybe some of it spills over into early next year. But I guess based on your comments, Howard, it sounded like there are still some vendor discussions that you were looking to finalize. So I'm just curious to know how much you think you've got visibility into at this point?

[Howard G. Berger:]

I would say at this point, Darren, the vast majority of it, probably 80% to 90%, is already developed in terms of the implementation of it to the point where we're confident that they will be fully in place by January 1. So none of this is really speculative. It's all based on detailed backup and discussions internally and with other vendors that have already taken place. So our confidence on the line is extremely high.

[Darren P. Lehrich:]

Okay. That's helpful. And then just to put the savings into perspective, I know that there is a fairly sizable Medicare reduction on the table again for 2014. I'm assuming that's probably going to consume about half of the savings that you're looking for. Can you confirm that? And then when we think about the other half or however much left there is you're trying to offset, is it really a function of just the managed care pricing environment having gotten more challenging relative to what you thought, and so that's basically what you're looking to offset? Or is there a view of -- for growth when you think about this $30 million number?

[Mark D. Stolper:]

Sure. Just to go back to your statement. Your statement is correct. Up to half of this savings is going to be consumed by -- if you believe Medicare's proposal back in June for 2014 Medicare reimbursement, half of this would be consumed by those Medicare cuts in 2014. So the other half would be -- of these savings would be essentially incremental EBITDA to the company. And the final rule -- the most recent that I've read is that the final rule is supposed to come out by the end of this month. I think the CMS said November 27. So there's no guarantee that what they proposed will ultimately be seen in the final rule. In the last few years, they have rolled back some of the proposed cuts that came out earlier in the year with respect to the final rule, but we don't know if that's going to occur today, especially in light of what's going on in government, as well as them trying to figure out how to fund some of the newly -- the new aspects of healthcare reform, particularly these healthcare exchanges. So we'll see. But we are assuming, back to your question, that up to half of this would be absorbed by the cuts that we'll see in 2014.

[Darren P. Lehrich:]

And then the -- just the managed care side of the question, I mean, is there something that's changed more distinctly as this year has progressed so that when we think about actual run rate of your managed care book of business, it's just turning out to be lower and different than what we all thought? So I guess that the other half, if you will, is not necessarily totally incremental because you've got more managed care pressure in the environment.

[Mark D. Stolper:]

Yes, we have not seen recently any additional managed care pressure. We saw some towards the end of last year, the beginning of this year. We had to absorb some cuts in certain markets. But we have not seen any acceleration to that or any continuing cuts from the managed care providers. So at this point, going forward, we think what we have in terms of pricing will be 2014 pricing.

[Darren P. Lehrich:]

Okay. That's helpful. And then just the last thing I want to ask is just a clarification in the press release. You've been giving us some window into your payor class breakdowns and just noticed this quarter, the capitation percent had been at 9.6%. Looked a lot different than the 13% or so that we've seen over the last, call it, 6 quarters. Can you just help us understand that? And is there anything that's changed either in how you're reflecting that number or just in how your capitation is flowing through?

[Mark D. Stolper:]

Yes, it's a presentation change. We had some comments from the SEC with respect to new revenue guidance as to how they'd like us to show our revenue on our GAAP statements. And we're now breaking out our capitation revenue based upon the checks that we receive on a cash basis. And so that's what you see on our GAAP income statement. What we've done from a payor class perspective is that we're calculating payor class based upon that cash received. And what it does do is it excludes all the copays and patient portion responsibility of those -- with respect to those same capitation payments and then put that revenue up in fee-for-service revenue as opposed to capitation revenues. So it essentially lowers the way we calculate the percentage. So I footnoted that, and it's a difficult footnote because it's a difficult calculation. But I did change the footnote in the earnings press release to reflect how it's now being calculated. So nothing has changed with respect to our capitation business. In fact, you can see from year-over-year revenue, it has increased. We've picked up a couple of new contracts. We're getting some new increasing pricing in many of these contracts, and we're working on a number of new contracts going forward. I would say that over time, in the absence of healthcare reform, in the absence of ACOs creating more capitation opportunities, a lot of our growth has been outside of California, and therefore, our capitation percentage has been diluted somewhat. But if the formation of these exchanges and the ACOs, if they create more opportunities for risk taking and risk sharing with providers, which we think that it will, then our cap percentage might go up in the future.

[Darren P. Lehrich:]

Okay. That's helpful. Maybe just one last thing about capitation. Howard, we're obviously hearing a lot about MA cuts. And you're sub capitated sort of downstream from some of the providers that take full risk. So I guess, just as it relates to MA and given some of the cuts that are on the table there, should we expect rate increases in your capitation business? Or is that something you'd expect to be under pressure as well next year?

[Howard G. Berger:]

We don't see a lot of Medicare Advantage in our capitation products, particularly here on the West Coast. And as a rule, all of our capitation contracts have actually been getting slight increases regardless of the type of lives that we're covering, whether it be commercial, Medicare, Medicare Advantage. So we don't really see that being very impactful from the standpoint of capitation one way or the other. Most of these capitation contracts are more in the commercial lives or Medicare senior lives rather than Medicare Advantage.

[Mark D. Stolper:]

Yes. Just to give you a perspective. Of our capitated lives, approximately 15% or so are senior lives and then they're mixed between Medicare fee-for-service types of patients as well as Medicare Advantage. We don't -- even if Medicare Advantage rates were to go down slightly, I don't think it's going to really affect our cap rates with our medical groups.

[Operator:]

Moving on to Duncan Brown with Wells Fargo.

[Duncan Brown:]

Maybe going back to the $30 million, one point of clarification. In the past, you've talked about $10 million to $15 million of savings from voice recognition patch and things like that. Is that $10 million to $15 million incorporated in that $30 million? Or is there a portion of the $10 million to $15 million that's already been realized?

[Howard G. Berger:]

No, some -- we have realized a small amount of those savings, but the preponderance of the savings we expect from that is built into the $30 million that we talked about and will be available to us fully in 2014. But -- and any savings that we've already recognized is not -- I'm not double dipping, so to speak. I'm not counting it again as part of the $30 million savings. All of that related to IT is new savings that we expect from the fourth quarter of this year and moving forward.

[Duncan Brown:]

Got you. And then as we head -- looking forward into Q4, can you remind us the -- maybe the EBITDA impact from Sandy in the prior year quarter -- Q4? And then also I think you've mentioned that October volumes so far have been very strong in the current quarter. Is that relative to what was -- relatively easy Q4 comp due to Sandy, or is that just on a stand-alone basis?

[Mark D. Stolper:]

Yes, a little of both. We did have a huge impact with Sandy last year, and I'm going by memory, but I think it was in the $4 million to $5 million EBITDA impact from Hurricane Sandy. And so we had a very weak fourth quarter 2014 of EBITDA under $25 million. So it should be at comp that we're fairly comfortable with in this fourth quarter. One, given that weak last year's fourth quarter; and two, based upon what we're currently seeing with our October and early November volumes being very strong.

[Howard G. Berger:]

But I think more specifically, the volumes that we're experiencing in October and here early into November of increase is quarter-over-quarter, meaning what we're seeing in the third quarter of this year and comparing it with the performance in October and November for the fourth quarter of this year. So we're not comparing the volumes from last year. We will do that, of course, on the fourth quarter and year-end close call. But right now, the volumes that we're seeing are being compared to third quarter volumes and year-to-date volumes for 2013.

[Duncan Brown:]

Yes, that makes sense. And then lastly for me, you talked about part of the $30 million is, I think, buying some of the equipment that you currently lease. Can you help us talk about purchase -- think about purchase multiples there and then sort of the size of the opportunity here? How many machines potentially you think you could repurchase?

[Howard G. Berger:]

The repurchase of these -- we're using because many of our vendors that we have these operating leases from are looking for some year-end benefits, if you will, so we are accelerating these buyouts. We normally buy out all of our operating leases at the end of their term. But in many of these, we have what we call early buyouts that we can exercise usually a year earlier than the original term. And given that, several of the financing institutions are interested in doing it before the end of the year and therefore making it a little bit less expensive for us. The magnitude of this is probably about $6 million of the $30 million savings that we're talking about.

[Duncan Brown:]

So sort of $6 million of annual decrease in operating expenses from that?

[Howard G. Berger:]

Yes.

[Duncan Brown:]

Operating leases?

[Howard G. Berger:]

Yes.

[Duncan Brown:]

And what would the purchase multiple on that be? I mean, what would you pay to buy that back?

[Howard G. Berger:]

Usually in around 3x or less level.

[Operator:]

We'll go to Jack Wallace of Sidoti.

[Jack Wallace:]

I just got -- want to get a little better clarification on the shift in mix from both a payor standpoint and a procedure standpoint. It looks like revenues -- net service revenue down slightly quarter-over-quarter, both cost and operation is up a little bit more than maybe expected. Can you just talk me about the impacts of those mix shifts and if there's anything else there from a quarter-to-quarter standpoint that'll explain lower gross margin?

[Mark D. Stolper:]

Sure. I mean, the phenomenon of our aggregate revenue being up and our aggregate EBITDA going down isn't so much a function of mixed shift or payor class mix. It's a function of revenue that was acquired at a normalized EBITDA level in our industry, which, if we're acquiring a good operation, they may have 10% to 20% EBITDA margins versus same-center revenue declines, which come with it an 80-plus percent EBITDA margin. So the phenomenon here is that even though our revenue has increased due to some of the acquired operations such as Lenox Hill, which was significant, our profitability has gone down because some of -- we've been averaging 3% to 5% same-store sales declines over the last few quarters, which come with it a large portion of that is a decline in EBITDA as well. So it's not so much a function of business shift or payor class shift, but more a function of the shift in increased revenue at a normalized EBITDA rate versus declines in same-center volumes. On a quarter-by-quarter basis, our same-store sales revenue is fairly sensitive to payor class mix and modality mix, but it's -- over the long term, that's a trend that seems to be evening out. There isn't a long-term trend of shifting away from MRIs towards routine imaging exams or vice versa or as you could see from our payor class mix with the exception of how we're treating capitation. Our payor class mix has been very constant really over the last 5 years.

[Jack Wallace:]

Okay. That's helpful. And then can you maybe talk a little bit about any impacts you're going to see in the fourth quarter from the government shutdown?

[Howard G. Berger:]

I don't think we noticed any significant impact that we can break out right now. As I mentioned a couple of times, our volumes in October and here into early November have been significantly better than they were in the third quarter. So I don't really think we saw much of an impact from that.

[Mark D. Stolper:]

The only impact we saw was when the government shut down, they delayed Medicare payments, so we had some cash delay. But that -- we've collected that money. So there really wasn't an impact to volumes or pricing or anything that would affect us.

[Jack Wallace:]

Yes, that's what I was trying to get at, the timing of payments. But that's been caught up, that's excellent. And then lastly, thinking out through '14 and '15, particularly with the decline in rates expected to come through I guess at the end of the month for '14 and beyond, can you make any estimations as to what your thoughts are for same-store volumes, say, 2 years out in light of, let's call it, flat reimbursement from the government?

[Howard G. Berger:]

I think that we're optimistic that our same-store sales will level off or perhaps even increase a little bit. We talked a little bit about various reasons why that might be the case, some of which are new people coming into the healthcare system as a result of healthcare reform. Some of it, I believe, as further consolidation in the marketplace drives out capacity. Some of it will be new plan design that I believe the payors will be far more aggressive about directing some of the patients away from hospitals and into freestanding centers. I think there's a number of reasons, but mostly, imaging isn't going anywhere. I think while there had been some utilization pressures, the public and referring physicians see the enormous benefit that imaging provides by being able to diagnose earlier and get better outcomes as a result of that. And that's right up the mainstream of where healthcare in general needs to go in order to rein in overall cost. So we see no slowdown at all in what we believe will be the continued need for these procedures. Remember, again, we still have an aging population that needs more of this testing as they become -- as they get into the senior years. So I'm optimistic that our trends will be continuing, not necessarily because more and more of this work will be done because that may not be the case, but certainly because there will be less capacity and more opportunity for this work to be done, where it should be done and that is in the outpatient arenas.

[Jack Wallace:]

That's helpful. But I guess, how are we going to go ahead and be able to, I guess, see that coming? I guess, what has to happen for the private payors to go ahead and say, "All right, we're getting hurt by the hospitals here?" But so far it doesn't look like we've done a whole lot to address that from -- the patients being referred to hospitals. When are they going to get -- when are you going to see, I guess, that shift back towards the stand-alone facilities like RadNet? Because right now, I mean, your same-store sales, you're still getting hurt, but so far the private payors don't look like they've come to that realization yet, which it sounds like they should, but again, it hasn't happened.

[Howard G. Berger:]

Well, I think it has happened and is beginning to happen and without me getting into too much conversation at this point in time. I think we have been seeing a surprisingly higher amount of incoming calls from payors or people with, let's say, the responsibility of paying for outpatient imaging that are being more diligent now about where that work is going and how it can best be controlled within a more cost-effective environment. So I believe while there may not be a lot of public awareness of this, I believe that it is and has been heating up now for the past quarter or 2. But these processes are slow. Payors are very deliberate in their planning for these changes, some of which require more than just them saying we need to direct that work elsewhere, but also designing plan changes that will help incentivize people. But I think you will begin to see early in 2014 more and more of these payors that have the responsibility for paying for these services, reaching out to outpatient providers and looking to find some kind of strategic alliance to help offset what is going to be a tidal wave of increasing costs as the hospitals continue to attempt to implement or affect their pricing on to the outpatient marketplace.

[Operator:]

Henry Reukauf with Deutsche Bank has the next question.

[Henry Reukauf:]

Just on the cost savings earlier question asked. The $10 million to $15 million that was to come from the systems integration was in addition to the -- or the $30 million is an addition to $10 million to $15 million you originally cited. I think you said yes, so I guess the total -- just to make sure, the total here of cost savings that you think you can get are the $30 million, plus the $15 million that you already announced. Is that -- so basically $45 million kind of this year?

[Howard G. Berger:]

No, Henry. No. What I think I said was that incorporated in the $30 million is additional savings that we have not yet realized from the IT implementation. And that will be part of what we will incorporate into the $30 million, not on top of that. We've already realized a small amount of that savings, but the preponderance of it will be forthcoming and is part of the $30 million savings.

[Mark D. Stolper:]

Yes, you should think of the IT savings as a subset of the $30 million.

[Henry Reukauf:]

Okay. And most of that is basically after the third quarter. I know it's been delayed a little bit. Correct?

[Howard G. Berger:]

Yes.

[Henry Reukauf:]

Okay. Just on the revenue and EBITDA, the mix. I had a question about that, how revenue was being maintained and EBITDA was down. You explained it was the less profitable acquisitions that have come in. So my understanding was that you'd be able to bring those acquisitions up to kind of the RadNet profit level with time. So are we -- is that still the case? And so will we benefit? Will we see a benefit in, say, gross margin in the next 6 months as the acquisitions are fully integrated? Or is it just becoming more difficult to realize that profitability at the old level that RadNet had?

[Howard G. Berger:]

Well, no. I think your point's well taken. We expect that some of that profitability will be realized in the next couple of quarters. These integrations, particularly the larger ones, like we did in New York with Lenox Hill, just take a long time to fully realize the benefit because we don't want to do it so quickly that we jeopardize the revenue stream. So we've been very deliberate and very thoughtful in going through that process. And that's one of the reasons why I believe our third quarter was not exactly what we expected. And some of that will be part of what we realize going forward here in the fourth quarter and certainly into 2014.

[Henry Reukauf:]

Is that -- so is that -- is there a dollar amount in kind of normalization of those acquisitions that you realize? And is it part of the $30 million, or is it in addition to?

[Howard G. Berger:]

I think some of it is part of the $30 million and represent some of the cost savings and salaries and consolidation. There may be some small amount on top of that, but we've tried to build that into the $30 million of cost reductions that we're talking about from this point going forward.

[Henry Reukauf:]

Okay. And then I wasn't quite sure I got it, but the availability on the revolver, I think, it was pretty much unutilized. Is that right, Mark?

[Mark D. Stolper:]

Yes, we're drawing down, I think, at the end of the quarter about $3.4 million on our $101 million revolver.

[Henry Reukauf:]

Okay. Do you -- so I guess the question is do you -- a lot of opportunity out there with all the changes and people suffering with the reduction volume and price, is that $100 million basically of availability enough for you guys to kind of meet 2014 expectations in terms of what you may or may not acquire? Or do you need to raise more?

[Howard G. Berger:]

Yes.

[Mark D. Stolper:]

No. I think at this point, we're comfortable with our liquidity and think that the utilization of that $100 million will take us through 2014. And if to the extent that something of scale comes our way in terms of acquisitions, then we might have to go back to our existing credit facility and do an add-on there or with the bonds and do the same. So I think we're comfortable that we have enough liquidity to do what we need to do here with respect to acquisitions. And we've never let good transactions fall away because of inability to finance them. And I think we've -- up to this point, we have very strong relationships with our creditors, our lenders on the term loan side, as well as our bondholders. So I think we're comfortable right now with our liquidity.

[Operator:]

Omar Vaishnavi with Blue Mountain Capital.

[Omar Vaishnavi:]

I have a couple of questions. So to give you guys an example, if you buy something for $20 million and you pay a 4x multiple, you're essentially acquiring $5 million of EBITDA. Is it safe for us to assume that this is a clean cash number that you are acquiring day 1? Or is that $5 million what you hope to be acquiring once you bring it to the margins that RadNet's at? Because what I'm getting concerned about is you guys are including integration benefits from acquisitions that have been made previously in your $30 million number. And I want to confirm that anything that's being included there is numbers that will get you to under 4x, not just the 4x that you guys are promising the market to begin with.

[Mark D. Stolper:]

Sure, yes. Omar, I don't think we're double counting here. The additional cost savings that's included in the $30 million are above and beyond the -- that which we needed to achieve to get the type of multiple that we've been acquiring these facilities in the past. So if we were buying something in the past, that did $20 million of revenue and a 20% EBITDA margin, that would get us to $5 million. Even if that included cost savings to get us to $5 million, this $30 million does not include those same cost savings that would get us up to $5 million. It would include additional cost savings that would get us beyond $5 million.

[Omar Vaishnavi:]

Got it. And in terms of the timing, I mean, you guys mentioned the words CML, eRAD, things that I believe you first discussed in mid to late 2011. How do we know for sure in 2014 that these things are going to take place? I believe in 2012 and in 2013, these types of things were mentioned before, and now it seems like there's a more comprehensive cost savings plan. And I think people want to understand why would it take place in 2014 when it didn't take place in 2013?

[Howard G. Berger:]

The fact of the matter is that this is an enormous undertaking by the company and involves multiple systems and centers. And it's not just something that you can put in, plug and play. We have 250 centers, and, basically, both radiologists and non-radiologist staff have to be trained on this. So some of this is a matter of resources. Some of it is the testing that we've been doing exhaustively to make certain that when we do implement it, it doesn't interfere with or cause any problems with the center performance. And so we've been deliberately slower than we anticipated just to be certain that we are on the safe side. But we now have basically the systems worked out. We have the rollout plan and are extremely comfortable that we will be able to realize the benefits that we've been talking about in 2014.

[Omar Vaishnavi:]

And is this as simple as taking the $30 million number, divide it by 4, and saying in the first quarter of next year we would expect a $7.5 million uplift assuming the same volumes and pricings from this year?

[Howard G. Berger:]

That's our anticipation at this point in time, yes.

[Omar Vaishnavi:]

Got it. And then one thing that I think we want to understand in terms of -- whether some of these issues are more macro related versus micro. Can you guys give us an example of some other companies, either in -- publicly traded ones, ideally, in imaging or in other sectors that are undergoing the same types of trends that you guys are seeing? Because I think a lot of what you're saying is that these trends are relating to changes in deductibles for plans, changes in patient behavior with respect to the Affordable Care Act. Who else are you guys seeing with these sort of similar trends that can kind of confirm the macro piece this year?

[Howard G. Berger:]

Well, it's hard to find other public companies because as you're probably aware, the only other public company in our space is Alliance Imaging -- or Alliance Health, I'm sorry. And they really are mostly a mobile operator and have a lot of radiation therapy. Very -- relatively small part of their revenue, although not inconsequential, is outpatient imaging freestanding centers. So it's -- hardly use them as a benchmark. We are aware of other nonpublic companies -- Insight that used to be a public company and was merged with CDI. We do have some conversations with them and recognize that they are experiencing similar issues. But more importantly, I think, is hospitals, for example, like the Barnabas Health System and other people that we talk to in allied ancillary services like radiation therapy, all seem to have experienced a rather difficult third quarter. And while we don't look at their specific results, we certainly get that kind of anecdotal information from them that indicates that, that third quarter was a challenge to everybody. So if you couple that along with the fact that we are seeing increasing numbers of people call us that are looking to do some kind of a merger, acquisition, sale, we certainly have the impression that the impact on the industry is widespread and not certainly anything unique to RadNet. When we do look at these acquisitions and get their current volume numbers, we are seeing very similar kinds of patterns in those acquisitions as we are seeing in RadNet. So I think we're a good barometer of what's happening in the industry as a whole and certainly not experiencing anything unique.

[Mark D. Stolper:]

Omar, we used to track the IMS Health data in terms of physician office visits. And what we have noted over the last 12 to 18 months is that they have shown declines in patient visits to both primary care physicians and specialists, which is consistent with what we're hearing from our regional operations, which is that when we go out to a physician and say, "hey, you sent us -- you've been sending us 20, 22 patients a month, and this month, you sent us 16. What's going on?" Consistently, we're hearing that it's not that they're sending their business elsewhere, it's just that they're seeing fewer patients.

[Omar Vaishnavi:]

Got it. Last question, when you guys -- I just want to confirm because I know we've talked about it offline a lot. But when you think about acquisitions on an LTM basis paying 4x, do you guys still continue to think that, that makes sense on a forward basis? Because to use some of your examples for numbers and contacts, if you bought something for $20 million in revenue and then the next year, it declined by 5%, which is that 3% to 5% same-store results you're talking about, and you have 80% flow-through on that $1 million decline in sales, you're talking about $800,000 on your 20% margins, which would imply 20% to 25% EBITDA decline year-over-year. So instead of paying 4x for a business, you guys would be paying upwards of 5x just 1 year forward or potentially 6, 7x several years forward. So how are you guys thinking about future volume increases, decreases and pricing changes on acquisitions that you're making today?

[Howard G. Berger:]

When we go through the acquisitions, we look at what the impact of the -- using this period as an example, what the 2014 impact to the revenue is likely to be as a result of the announced changes. So we're not doing this in a vacuum. And when we say we're buying, let's say, $5 million of EBITDA, just using your example, that would include impacts that we see coming down the pipe for 2014. So we really don't use an LTM. First of all, we only look at the calendar year 2013 year-to-date numbers, try to annualize that and then put the impact of reimbursement changes that we've seen, that are predictable at this point in time. I think it's a slippery slope to look at LTM numbers because as you look at those, it incorporates, let's say, 2012 at this point in time when we know 2013 already had significant reimbursement impacts. So our methodology adjusts, if you will, to the kind of changes that the industry has provided us guidance to, to make certain that we are in fact adjusting that EBITDA to reflect that kind of performance.

[Omar Vaishnavi:]

Well, I hope that's the case. The issue is, if you look at the acquired volumes that you guys got this quarter, which is about $120,000, using a flat same-store figure that you gave at $160,000 of revenue per scan, which is roughly where you're at on a blended basis, and you apply any sort of reasonable incremental margins on that, the EBITDA decline that you had is even worse on a same-store basis than what you guys are reporting on the total basis, given you should have had some positive EBITDA uplift from your acquired centers in your last quarter's mix, which would imply your existing business is falling in the $20 million to $30 million range on an EBITDA same-store basis.

[Howard G. Berger:]

Well, I think there's a lot of factors that go involved in that, some of which is, it was just weak volumes in the third quarter no matter how we try to put a spin on it, but we expect that to change. And just like when you have reimbursement declines, a lot of that goes right down to the bottom line. It's the same impact with volume declines. We expect that trend to reverse itself here in the fourth quarter and for next year, along with other consolidation costs, as well as unrealized benefits that we had hoped to achieve in that third quarter. So I'm more comforted by the fact that we do have increasing revenue because we know that there are opportunities for cost savings. If we didn't have the increase in revenue, it would be a whole different set of problems for us to try to adjust to.

[Operator:]

And we have no further questions.

[Howard G. Berger:]

All right. Thank you. And I would like to take the opportunity to thank all of our shareholders for their continued support and the employees of RadNet for their dedication and hard work. Management will continue to endeavor to be a market leader that provides great services with an appropriate return on investment for all stakeholders. Thank you for your time today, and I look forward to our next call. Good day, everybody.

[Operator:]

Once again, this does conclude today's conference. We do thank you, all, for your participation.