Earnings Transcript for SSY - Q2 Fiscal Year 2012

Operator: Good day and welcome to today's program. [Operator Instructions] Please note this call may be recorded. It is now my pleasure to turn the conference over to Mr. Robert Thornton, CEO of SunLink Health Systems. Please go ahead.

Robert Thornton: Thank you and thank you, all, for joining our second fiscal quarter of 2013 investor call. By way of introduction, I have with me today Mark Stockslager, our CFO; and Ron Turner, our COO, who are on the program a little later.

Before I get into the meat of the presentation, I'd like to read the forward looking statements and cautionary statement and say that I do need to remind you that the discussion today contains forward-looking statements about the company's future financial performance and business prospects. These are subject to risks and uncertainties and speak only as of today. Accounts of these statements are based on the company's current intentions, expectations and projections. They are not guarantees of future performance and a variety of factors could cause actual results to differ materially from what we say that we expect. Forward-looking statements include all statements that we make that don't relate solely to historical or current facts. Some words that we'll put forth like believe, expect, anticipate, estimate, optimistic, intend, plan, aim, will, should and similar expressions are intended to identify forward-looking statements. :

Factors that could cause actual results to differ materially from these forward-looking statements, including particularly the company's financial and other goals, as set forth in our earnings press release, which will be found on 8-K after today, in our 10-Q for the second fiscal quarter, which has already been filed and for our 2011 annual report on 10-K, which is also on file with the SEC and these will also either/or will be available on our website. :

In the earnings release and in today's call, we'll be discussing several non-GAAP financial measures that we believe are helpful in understanding our business and our performance. Please refer to our earnings release for reconciliation of these non-GAAP financial measures to the GAAP results. :

A copy of our earnings release and recent SEC filings are available, as I said, in the Investor Relations section of the company's website at sunlinkhealth.com, at the SEC's website at sec.gov. We encourage you to review that information in conjunction with today's discussion. :

With that, a little bit of background. Our business is seasonal. December is typically a weaker quarter and we did see that this quarter. The March quarter and the June quarters are typically strongest because the winter illness season, if you will. :

As to recent events, we think the macro outlook is still uncertain due to healthcare reform, much of which is developing as usual but market is developing a lot of the issues faster than the government or the regulatory people are, but federal budget activity and state Medicaid stress are still issues that we deal with. So far, we think we're positioning the company correctly for what we see coming down. We think we've made progress in that and I'll talk more about our -- those strategy and some of the strategic changes we've made in response to these things a little later in the presentation. :

First, let me go over the operating results for the quarter. We had a loss from continuing operations of $1,586,000 or $0.17 a share, compared to last year's loss of $2,100,000 or $0.26 per share. Neither of this periods included electronic health records meaningful use funds. We did, during the current quarter, change our method of accounting for electronic health records meaningful use funds. We're accounting for it as suggested by the SEC on the gain contingency method. We had originally accounted for it on the -- what's called a grant method, the SEC guidance indication that the electronic -- I'm sorry, that the gain contingency method is the preferred method for public companies. Those methods are GAAP according to everything we've read, but we are using the gain contingency method as indicated in the SEC guidance. As a result of that, we won't recognize an income anymore electronic health records reimbursement from Medicare until June 2013 and that is after we file our cost reports for the next fiscal year. The next round of payments for our attestation, assuming we make it, which we believe we will, will be in October or November later this year. The change in accounting method has not affected the cash flow either from our historical point of view where we've collected everything for the current year or for the future years. :

As to our health care facility results, statistically, our equivalent admissions were up 5.6% this quarter over last year, but it was due mostly to outpatient activity. We had lower inpatient admissions and we had lower surgeries. And as a result, our revenue was down about 8.5%. Because of the heavy weighing on the outpatient side, our net revenue per equivalent admission was down 14.1%. We didn't really see much change in pricing on a per unit basis. It's just that the outpatient revenue was such a larger amount this quarter. :

Our case mix is also down somewhat this quarter, which indicated lower acuity, something we've seen over the last couple of years. I think that will change, that's somewhat elastic with the economy, I believe. I think we'll see acuity pick up as the economy picks up, but probably not before because acuity is a function to a great many of the surgeries and things like that, which we're not seeing nearly as much of. :

Our revenue by payer mix. Our Medicaid revenues decreased fairly substantially to 17.3% -- about 17.3%. They were overall a 17% of the healthcare facilities revenue in the quarter. Conversely, self-pay revenues increased -- well, consistent with that, self-pay revenues increased 0.7% from last year and were 12.5% of net healthcare facilities revenue. What we see in some of these states, where the Medicaid rolls are being tightened, is that those people just end up as bad debts. So although Medicaid does not pay cost in most cases, it pays nothing, whereas self-pay revenues typically are only yielding us 10% to 12% of charges. Medicaid does pay more than that. :

Commercial revenues decreased slightly, 3%. They're now 31.5% of net healthcare facilities revenues and Medicare decreased as well. It's now about 39% of net healthcare facilities revenues. So we're still seeing very soft volume in our hospitals. :

On the pharmacy side, the pharmacy company saw revenues for the quarter down 7%. You think that's mostly a timing difference because there are specialty drugs synergies, which is their largest product, had a delayed start to the season this year and we'll know by April if we're going to catch that up but think that there's a good chance that will catch up. We would expect the pharmacy company to do same or slightly better than it did last year :

As to operating cost. The operating cost in the hospitals was mixed. Labor cost was up. It was over 50% of net revenue this quarter versus about 46% last year. It was not due to staffing increases. The staffing control has been recently good in the hospitals. It was due to higher employee medical claims. We've just seen a large number -- we see a large frequency and severity of health claims over the last few quarters in our hospitals. So I say that, that is consistent with economic activity and in some of our rural communities, there had been some economic declines, particularly a couple of hospitals north of Atlanta that were heavy communities based on building and increased construction. So that may have something to do with that but we're taking action to try to deal with their health insurance costs and claims because it is causing the labor cost to be out of line. :

The bad debts, as a percent of hospital net revenue, is actually down this quarter to 11.8% from 12.8% last year. One of the things we've invested a lot of money, time and effort in is improving our business office processes, including IT systems, all of which has kind of been related to the meaningful use work that we got to upgrade our systems and we've seen some benefit of that in our collections. :

Other operating expenses were 15.7% of net revenue this quarter versus 14% last year and that's due primarily to the medical specialty expenses, where we have put hospitalists in most of the hospitals that we think positions us for future growth. It incentivizes the local doctors to refer more to our hospitals, but it does raise our fixed cost so to speak. And we didn't cover that cost with volume this quarter, although we do think that's the right approach and is essential in some of these hospitals that are in competitive markets. :

On the Pharmacy side, cost of sales were down very slightly in the Pharmacy segment, due primarily to the lower and late start to the synergy sales. We also had somewhat improved margins in the pharmacy side from institutional pharmacy products. Salaries, wage and benefits on the Pharmacy side was up from 14.4% of net revenue last year to 16.4% this year. That's due primarily to lower revenues on the Pharmacy side. The pharmacy labor is not as variable. We're not able to flex it quite as strictly as we can flex the hospital labor. But we would expect the Pharmacy business, which is also seasonal, to pick up some in this quarter. :

Our corporate overhead, we've watched that carefully. It decreased around $78,000 this year over last year. That was a decline of 26%. The Hospitals EBITDA for the quarter decreased from last year to $822,000 from $2,680,000 million last year. The Pharmacy EBITDA decreased to 285 from 386 last year. Over the trailing 12 months, our EBITDA, combined, is right at $9 million -- slightly over $9 million. :

Mark Stockslager, our CFO, has come back to comment about the balance sheet and then I'll come back with our growth initiatives, that were put forth in our hospitals and some general thoughts about the industry as a whole. Mark? :

Mark Stockslager: Thank you, Bob. Comments on the balance sheet. We are currently managing our balance sheet. We do have cash of about $519,000 at December 31, that's a decrease from the approximately $7.25 million at June 30. We did use $5.5 million of cash for debt repayment in July.

On our primary credit facility, we have a revolver and term loan, combined, it's outstanding of $26.9 million in December 31 versus $34.4 million at June 30. In July, made an $8 million debt repayment using $5.5 million cash on hand and $2.5 million recent sale of common stock in a private placement. But we are within our covenants on our credit facility and we had approximately $1.5 million available under our revolver for working capital at December 31. :

The hospital days revenue in ER was 36 at December this year versus 37 last year and that's stable due to our emphasis on collections in the business office practices, which Bob talked about in the bad debt numbers for the hospitals. :

Our capital expenditures were approximately $900,000 for the first 6 months. We expect to spend approximately $500,000 for the rest of the fiscal year. That's subject to project approval on the cash availability. :

We do -- it will require financing for some longer-term projects to do upgrades at several facilities. We are seeking to refinance our existing term loan and revolver to reduce costs, and we are considering both the corporate-based financing and facility-based financing. :

Robert Thornton: Thanks, Mark. I would comment that one of the other reasons for refinancing our existing credit facility is to access capital to make some improvements in the hospitals because, as I'll talk about in a minute, I think some of the growth and profitability of these hospitals is dependent on some improvements as these markets change. We do see growth opportunities in the existing hospitals and markets, and we are pursuing them aggressively. Our immediate goals are continued cost emphasis across the board. While we're seeing the lower volumes, I do think a good bit of the lower volumes in December was seasonal. But overall, the volumes are not what they were a couple of years ago or 3 years ago.

Our response to that is additional physician recruiting and adding selected services at the hospitals to meet the needs of the local communities, where those services can be provided on an economic, profitable, if you will, basis. And we believe those things that we're doing are going to result in increased revenues and better performance at these hospitals, things like the hospitalists and recruiting physicians. :

In the area of recruiting of physicians, we reported in the 10-Q a net recruited physicians of 0 for the quarter and 1 for the year. That obscures the fact that the model has somewhat changed on how we're doing physicians. We are employing physicians and will probably continue to do that. But we're also more affiliating with physicians at tertiary hospitals around us. They also were seeing volume declines and so they're reaching out more to us to provide physicians in our hospitals, who then refer the more complex patients to them and do the diagnostics and the more basic services in the hospital. And where we can find hospitals that work in a non-predatory, symbiotic kind of way, we think that's a good model and we've had success on that at a couple of hospitals but that's an internal operating strategy that is still developing. :

On the acquisition side, we're not really in a position right now. We think our best opportunities right now are to refinance our debt and improve our existing hospitals, but we do continue to monitor acquisitions and we see more of them available. We think there will be more available. We think we're beginning to understand what the attractive acquisition opportunities for the future given the way the markets are changing looks like and so we're monitoring those, but don't expect any acquisitions in the current year. :

In the macro-environment, we see some contingent risk in the credit markets for small companies like us that have limited ability to access financing. That's why Mark said we're looking at financing options both for the company as a whole now and facility-specific basis. :

We also see continuing pressure in the uninsured and market, which keeps the bad debt levels high, although it changed and it improved slightly this quarter, it's still at a level that is too high to be sustainable in the long run. So our response to that is to maintain a lean cost structure and we are emphasizing cash flow to respond to these economic conditions. :

All in all, we'd be remiss if we didn't say we're terribly disappointed in the quarter but we are using this low-volume period to lean up the company as much as we can and focus on the things that are going to make these hospitals successful as the economic activity turns up. :

With that, I'll be glad to answer questions. :

Operator: [Operator Instructions] I'm showing no questions in queue at this time. [Operator Instructions] We'll take our first question from the side of Rob Stiedlitz [ph.]

Unknown Analyst: This is Rob Stiedlitz [ph]. I have a question for you regarding the Specialty Pharma business. You talked in the past, I believe, about -- well, let me just ask, what are your strategic plans for the Specialty Pharma business going forward?

Robert Thornton: Our strategic direction on the Pharmacy business right now is to improve its results by expanding its product offerings, improving their systems. That was a privately held company when we bought it and we've improved the systems. A lot of that costs, I say a lot, given the costs that's inherent in that business is keeping the margins depressed right now is because of systems improvements and staffing. That can be improved as we put in better systems there. So our objective is to improve that Pharmacy business. We think it can do a much better margin than what it's doing now.

Unknown Analyst: I have of couple of other questions on the corporate side. You mentioned the refinancing, that seems to me to be very important. Can you talk about timing? I know the bank expiration is January 13. So, what do you expect to see?

Robert Thornton: The maturity of the existing credit agreement is January 1, 2013. We're well aware of the deadline. We are looking at a number of different financing alternatives. The specifics of them and the timing are not predictable or anything that probably we should talk about now. I would refer you back to what we did last summer. We had excess cash on hand last summer. The business tends to be seasonal in terms of developing cash on hand, plus we had large electronic health of records collections last year and so we devoted part of that together with the private placement to reduce the term loan under that credit facility and extend the maturity. I'm not saying that's what we're going to do this time, but we're looking at alternatives to get it paid off by January 1, 2013.

Unknown Analyst: Just a couple more quick questions. You're now about 2/3 through your fiscal third quarter. Can you talk generally about what you're seeing?

Robert Thornton: It's -- seasonally, we're seeing some change seasonally, as we always do. Beyond that, I think I would not like to predict what the quarter is going to look like, but what I would say a couple of things. We haven't seen a flu season as such this year and that's kind of not unusual given what we've seen in the last few years. I haven't seen much of flu season as such last few years. We have seen it sporadically in some of the hospitals and this is sort of based on my experience, the changeable weather we have, particularly the southeast, has tended -- does tend to result in more respiratory illness. We've had an extremely mild winter down here, but at the same time, it's been very changeable. It will be cool and clear and then it will be wet and cold and that tends to drive people to the hospitals some. But it's too early to predict the quarter and we are not prepared to do that.

Unknown Analyst: You mentioned that you'd like to put in some more capital improvements in existing hospitals. Could you just generally talk about how much CapEx you'd like to see on an ongoing basis if you had the cash available?

Robert Thornton: Our CapEx -- our maintenance CapEx runs about $2 million a year. And we're a little behind that this year. In addition, the kind of improvements in service projects that we look at are modest. To add a service in our hospitals tends to be a modest capital improvement like several hundred thousand and not several million. Over a longer period of time, we have hospitals that need to be upgraded, improved, have and always built, just like any other hospital portfolio. So those are things that we're looking at longer term, but I don't see any of that happening during this calendar year for obvious reasons of need to get credit agreement taken care of and then put something in place that is more amenable to the hospital-level growth we think is the opportunity out there.

Operator: [Operator Instructions] I'm showing no further questions in queue at this time.

Robert Thornton: Okay. Thank you, and thank you for joining us for our investor call this quarter. Our next call will be the middle of May to report the third quarter and the 9-month year-to-date. We certainly hope to have better news to report to you then. But in any case, we will look forward to talking to you in about 3 months. Thanks very much.

Operator: This concludes today's conference. You may disconnect at this time.