CareRx Corp

TSX:CRRX

Earnings Call Transcript 2018-Q2

[Operator]

Good morning, everyone. Welcome to Centric Health Second Quarter 2018 Results Conference Call. Please note that today's call is being broadcast live over the Internet and will be archived for reply both by telephone and via the Internet beginning approximately 1 hour following the completion of the call. Details of how to access the replays are available in yesterday’s news release announcing the company's financial results as well as on the company's website at www.centrichealth.ca.Today's call is accompanied by a slide presentation. Those listening via telephone can access the slide presentation from the company's website in the Investors section under Events and Presentations by loading the webcast and choosing the non-streaming audio option.Before we begin, let me remind you that certain matters discussed in today's conference call or answers that may be given to questions asked could constitute forward-looking statements that are subject to risks or uncertainties relating to Centric Health’s future financial and business performance. Actual results could differ materially from those anticipated in these forward-looking statements. The risk factors that may affect results are detailed in Centric Health’s periodical results and registration statements, and you can access these documents in the SEDAR database under www.sedar.com. Centric Health is under no obligation to update any forward-looking statements discussed today, and investors are cautioned not to place undue reliance on these statements.I would now like to turn the call over to David Murphy, President and CEO of Centric Health Corporation. Please go ahead, Mr. Murphy.

[David Murphy, President, CEO & Additional Director]

Thank you, and good morning to everyone joining us today. Welcome to our conference call to discuss our second quarter 2018 results and other key developments. With me for today's call is our Chief Financial Officer, Leslie Cho.For today's call, I will begin with some opening comments and then provide an update on regulatory changes in Specialty Pharmacy and the impact these have had on our financial results. I will also provide an update on certain key initiatives that are underway as well as the actions I intend to take as CEO to better position the company for profitable growth moving forward. Leslie will then review our financial results for the second quarter in more detail, after which we will take questions.I recently reached my 100th day as CEO of Centric Health. During this time, I've had a chance to visit almost all our sites across the country and meet our talented and committed employees. I came out of these 100 days with even more appreciation of the tremendous growth opportunities that lie in front of us as a company. Particularly, I would note, as it relates to seniors health care services. At the same time, I joined the company at a time in which the entire pharmacy industry is dealing with significant challenges as a result of major regulatory changes. This has impacted both retail and specialty pharmacies across Canada, and we are no exception.In order to overcome these challenges and better position us to take advantage of the growth opportunities that exist in this market, decisive action is required. This includes a more focused strategic direction, the development of new growth platforms, the reengineering of our operations and the deleveraging of our balance sheet. I will touch on each of these initiatives during this call.As we have previously mentioned, our pharmacy business has been challenged by new regulatory changes that came into effect during the second quarter. To recap these, at the end of January, the Canadian Generic Pharmaceutical Association and the pan-Canadian Pharmaceutical Alliance announced the April 1 implementation of a 5-year initiative aimed at reducing the prices of many commonly used generic drugs. As well, this past May, the Government of Alberta implemented a new funding framework with the Alberta Pharmacists' Association, which both reduced dispensing fees and limited the frequency of dispensing.In Q2 2018, the net impact on adjusted EBITDA from these regulatory changes was about $1 million. We expect that these changes will continue to have a negative impact on our results through the rest of 2018. After completion of our business reengineering plan, which I will discuss in further detail, we continue to forecast that the annualized net impact of these regulatory changes will be up to $2 million.Turning now to our financial results. Revenue in the second quarter of 2018 increased by 1.4% to $43.3 million. Driving the growth was a 4% increase in revenue in our Surgical and Medical Centres business as a result of an increase in procedures across the country. Revenue from our Specialty Pharmacy business was flat compared to Q2 2017, as the increase in bed serviced was offset by reduced fees because of regulatory changes and a change in bed mix compared to prior year.Adjusted EBITDA declined in the quarter by 30% to $3.4 million. On one hand, Surgical and Medical Centres performed very strongly in the quarter, delivering a 16% increase in adjusted EBITDA versus prior year and increasing its adjusted EBITDA margin to 18.2% in the quarter compared to 16.3% in the prior year. This was offset by challenges in Specialty Pharmacy, which as mentioned, experienced significant margin pressure as a result of regulatory changes and changes in bed mix. The timing of the regulatory headwinds we have been facing coincided with operational improvements we began to put in place at the beginning of this year to take advantage of the scale we had achieved from our acquisitions and to align best practices throughout all of our pharmacies across the country. We are now accelerating that implementation. As our Specialty Pharmacy business moves from a historically decentralized regional operating model to one which maximizes the efficiencies of a truly national platform, we are optimizing our operation and mitigating most of the impact of the regulatory changes. Our business reengineering plan includes: changes to our operating and service model, centralization of some functions, workforce reductions and increased labor efficiencies and initiatives to digitalize and automate pharmacy operations. This plan will be executed responsibly and without compromising our commitment to quality and service. More than 40% of the reengineering plan has been implemented, and we expect the entire plan to be completed by the end of 2018. Our increasing operational efficiency also gives us further opportunities to leverage our scale by adding more beds under care. Subsequent to quarter end, we signed new contracts with regional multisite home operators located in Ontario and British Columbia, which we expect will add approximately 1,400 beds by the fourth quarter of this year.We continue to pursue other new contract opportunities and additional beds. And we've created a national business development team focused on strengthening our customer relationships and articulating a strong and consistent value proposition to seniors and home operators across the country.We also believe that our competitive positioning will be further strengthened upon completion of our business reengineering plan. Many of our smaller competitors are facing the same regulatory headwinds as us, but don't have the scale or efficiencies to successfully address them.During the quarter, we accelerated our plans to enter the seniors medical cannabis space. Cannabis is increasingly being adopted as a treatment for chronic conditions, many of which are endemic with seniors, and could help reduce the number of daily medications they are taking. Long-term care and retirement homes have been identified by licensed cannabis producers as a growth area for medical cannabis because of the high concentration of complex care patients, who could potentially benefit from this treatment. We believe we are well positioned to play a significant role in enabling greater penetration of medical cannabis in the homes we service, homes which include 46,000 residents, 1,000 prescribing doctors and our team of clinical pharmacists. We are currently finalizing supply agreements and strategic partnerships with licensed producers. We have operational plans in place to facilitate the provision of medical cannabis to seniors upon receipt of a sales-only license from Health Canada. And we're also working with potential partners to ensure that our patients will have access to medical cannabis even prior to the license being granted. We continue to collaborate with AceAge to launch its automated drug delivery device, Karie. The first Karie units are expected to launch later this summer with the first 2,000 units expected to be deployed by the end of the year. Recently, Centric was selected as the Pharmacy Fulfillment Partner for AceAge's upcoming Industry Innovation Partnership Program study in Ontario and Alberta, which is led by the Centre for Aging and Brain Health Innovation.Karie is an exciting innovation that we expect will increase residents' safety and lower costs for retirement homes and help Centric increase our penetration in these homes. Moreover, we regard the Karie device as the centerpiece of our Aging at Home Strategy, which opens up a new market of more than $4 million Canadian seniors living at home.Karie also has the potential -- has potential in the U.S. and other markets throughout the world, and AceAge is finalizing partnerships to commercialize their technology outside of Canada. Centric currently has a 17.5% equity interest in AceAge, with the opportunity to increase that stake to up to 32.5%. Clearly, Centric has many attractive growth opportunities. These include those I just mentioned: organic bed growth in our core business, the cannabis and Karie initiatives and the Aging at Home Strategy. They also including inorganic opportunities as part of what I consider to be a highly likely consolidation of the Specialty Pharmacy sector. Even more broadly, I believe that Centric's footprint and capabilities strongly position us to capitalize on many opportunities and unmet needs that exist in seniors health care services in Canada. The seniors population is the fastest-growing demographic in Canada, and the health care system needs to adapt in order to provide appropriate and sustainable care to seniors. I believe Centric can play a significant role and be a major player in the advancement of seniors health care.In order to capitalize on these opportunities, however, particularly in an environment of regulatory headwinds, we need to reposition the business. First, we need to be clear and focused in our strategic direction. As I announced yesterday, moving forward, our strategic focus will be to establish Centric Health as the leading provider of pharmacy and other health care services to Canadian seniors. Second, we need to further strengthen our balance sheet. The growth opportunities in front of us will require investment in order to execute and scale successfully. Because our operational improvements and business reengineering efforts are, at least in the short term, being offset by regulatory pressures, we need to accelerate efforts to reduce debt. Accordingly, we are commencing a review of existing businesses and assets that may not fit with our new strategic direction, and we may consider divestitures in order to reduce debt and pursue growth opportunities.In closing, we are taking decisive action to deal with the regulatory headwinds we are facing and to reposition the business to better capitalize on the many growth opportunities that exist in our core business and in related adjacencies in the seniors health care services space. With the reengineering work we are undertaking, the growth initiatives we are executing and the strategic plan we have in place, I'm very confident that we are embarking on a new chapter for Centric Health, one that will see us build a leading market position, maximize value for shareholders and have significant positive impact on the lives and health of Canadian seniors.Now I will turn it over to Leslie, to provide a financial overview.

[Leslie Cho, Chief Financial Officer]

Thank you, David, and good morning, everyone. Our complete results for the quarter are available in our financial statement and MD&A, which have been filed with SEDAR and are also available on our website.As David mentioned, consolidated revenue for the second quarter grew to $43.3 million from $42.7 million for the same quarter of the prior year, a 1.4% increase.Adjusted EBITDA from continuing operations declined 30% to $3.4 million from $4.9 million in Q2 2017. And adjusted EBITDA margin for Q2 2018 was 7.9% compared to 11.5% in the prior year.I'll now walk through the quarterly results for each of our business segments separately. Beginning with our Specialty Pharmacy segment, revenue was relatively flat at $31.2 million in Q2 of 2018 compared to $31 million in Q2 2017. Adjusted EBITDA decreased by 39.5% to $2.7 million from $4.4 million, and adjusted EBITDA margin declined to 8.5% from 14.1%. Both revenue and adjusted EBITDA were negatively impacted by the regulatory changes David mentioned earlier as well as changes in the bed mix.Funding models vary by province as well as type of bed, such as long-term care and retirement beds. While we serviced more beds in Q2 2018 compared to the previous year, a larger proportion of the beds in the current year generated lower margins.Moving to our Surgical and Medical Centres segment. Revenue for the second quarter of 2018 increased by 3.8% to $12.1 million from $11.7 million in the same period of the prior year. Adjusted EBITDA for Surgical and Medical Centres grew by 15.8% to $2.2 million from $1.9 million, and margin expanded to 18.2% from 16.3% in Q2 last year. Growth in revenues was driven by an increase in surgical procedures at all centers, with adjusted EBITDA also increasing as a result of more higher-margin procedures combined with improved operational efficiencies. Corporate costs for the second quarter of 2018 were $1.4 million, relatively flat compared to the prior year. As we discussed earlier, the company has initiated an expansive business reengineering plan to improve the operational efficiency of the business and mitigate the impact of recent regulatory changes. In addition to the execution of this business reengineering plan, the new customer wins that we announced and other strategic initiatives, such as medical cannabis and our investment in Karie, will be able to offset the regulatory challenges that we are facing and reestablish a growth trajectory for the business.While we believe that the annualized net impact of the regulatory changes will ultimately be up to $2 million, there'll be timing difference in the offsetting impact from these initiatives as they are implemented throughout the remainder of 2018. This will continue to put downward pressure on short-term financial results, particularly in the third quarter of 2018, with an expected return to steady-state results by the first quarter of 2019.Turning to our balance sheet. Total debt outstanding remained relatively flat at $81.5 million, while total debt-to-adjusted EBITDA increased slightly due to the lower adjusted EBITDA to 5.5x. Throughout 2018 and as we execute on our strategic direction, we will continue to improve our leverage as we're targeting a ratio of 3.5x in the medium term.David and I will now be happy to take any questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Doug Cooper with Beacon Securities.

[Doug Cooper, MD & Head of Research]

Let me just start with the specialty pharma. What was the number of beds outstanding in -- at the end of the quarter?

[Leslie Cho, Chief Financial Officer]

The number of beds serviced you mean?

[Doug Cooper, MD & Head of Research]

Yes.

[Leslie Cho, Chief Financial Officer]

28,700, just over it.

[Doug Cooper, MD & Head of Research]

Okay. And so is Chartwell fully rolled out now? Or when I take a look at pro forma beds, would it be the 28,700 plus the 1,400 that David mentioned?

[Leslie Cho, Chief Financial Officer]

That's correct, yes.

[Doug Cooper, MD & Head of Research]

Okay. So that's close to approximately 30,000 pro forma.

[Leslie Cho, Chief Financial Officer]

Yes.

[Doug Cooper, MD & Head of Research]

Okay. Revenue per bed, you talked about changes in mix between long-term care and retirement homes. What would be a sort of good modeling number of annualized rev per bed then given your mix?

[Leslie Cho, Chief Financial Officer]

Yes, so I think the range of the revenue per bed by type is really between around 3,500 to 4,500. I think, historically, you would have used somewhere between the 4,000 to 4,500. It's been reduced a bit now given the regulatory changes.

[Doug Cooper, MD & Head of Research]

Okay. So maybe just slightly under 4,000 kind of thing is a half-decent modeling.

[Leslie Cho, Chief Financial Officer]

I think that's fair, yes.

[Doug Cooper, MD & Head of Research]

Okay. The segment margin, 8.5%, is there some slack in there? It used to be upwards of -- as it was last year, 14%, 15%. Like is this a sort of 12% segment business going forward once the -- you've implemented all your changes? Or what do you think there?

[Leslie Cho, Chief Financial Officer]

Yes. I mean, I think for the remainder of the year, we can probably expect single-digit margins. But our intentions are to get the business back into the double-digit margin range.

[Doug Cooper, MD & Head of Research]

Okay. And is there any further RFPs outstanding in a [ directed term ] on in addition to the 30,000 beds pro forma between that -- over the next 12 to 18 months?

[David Murphy, President, CEO & Additional Director]

Yes, Doug, I -- and even within the next 6 months, there's a couple of specific opportunities and RFPs we're chasing on top of -- you'll know that bed growth can come via 2 ways: one, in new RFPs wins; but also just increasing the bed -- the penetration of beds within retirement homes that we already service. So yes, even within the 2018 calendar time frame, we have a couple of specific targets that we are pretty confident of. And then 12 to 18 months is obviously quite a bit more in terms of open contracts.

[Doug Cooper, MD & Head of Research]

All right. Okay. Any further regulatory changes that you're hearing whispers of? Or we think we're done with those now.

[David Murphy, President, CEO & Additional Director]

Yes. I think in this space, you never say we're done. But I -- there's nothing significant or imminent that there's even whispers about at this stage.

[Doug Cooper, MD & Head of Research]

Okay. Moving on to surgical. That was a record quarter, looks to me. Is that -- was there anything one-off in that quarter? Or is that sort of run rate staying over capacity utilization in the quarter?

[Leslie Cho, Chief Financial Officer]

Yes. So it was a record quarter. From a run rate number, I'd remind everyone that Q2 is generally our seasonally high quarter in the surgical segment. I think we're operating at around 41% utilization. And we do want to highlight the fact that some of the other services, like diagnostics, executive health, family practice, that doesn't fall into our utilization number. And those had a positive impact to the results.

[Doug Cooper, MD & Head of Research]

Okay. I'm assuming when you talk about review of assets, this is the one you're talking about. How -- if this is -- if this segment is deemed to be nonstrategic and look to be sold, how long a process are we talking here? Is it 6 months between when something is deemed to be nonstrategic, sold and get some money in? What -- maybe you can just give us a time line.

[David Murphy, President, CEO & Additional Director]

Yes, it's a good question. I think probably premature to quote too far in the answer to that question as, I think, the announcement we made yesterday for us -- from our perspective is more about where we are going to focus as opposed to what we're going to do with the nonfocus areas. And so we want to declare where we want to spend our time and our money, and that's in the seniors health care space. And so we will -- we've commenced a review. I think we're going to try to move as expeditiously as possible in determining: a, what we think is noncore; and b, what opportunities might exist in the marketplace to get value for them. But I'd probably wouldn't go much further than that in terms of either identifying specific asset and/or giving a time frame.

[Doug Cooper, MD & Head of Research]

Okay. Moving on to Karie. 2,000 units by the end of the year, I think that's consistent with what you had said in the past. What do you anticipate the rollout to be in distribution? And is all that sort of set in place? And how would need to execute?

[David Murphy, President, CEO & Additional Director]

Yes, I think customer demand and sort of preorder interest has never been the issue. There's a lot of people that want their hands on these devices, so our main focus has been -- AceAge's main focus with us as a partner has been getting the hardware in place where it's functioning, where the workflow with pharmacy and with our business is in place and the units are commercially available. So I -- we've got to that important juncture, I think, in the rollout of this. And so yes, I -- we feel pretty good about the ability to relatively quickly place the 2,000 units as they come across the -- as they come off the manufacturing line.

[Doug Cooper, MD & Head of Research]

Okay. And I know it's obviously early days, but what kind of, I guess, installed base you would be thinking about at the end of 2019? And what's the sort of -- based on -- if you guys are the pharmacy who's supplying the drugs, rev per unit would be somewhere in the sort of $2,000 to $3,000 range. Or what are you thinking there in terms of the drugs side?

[David Murphy, President, CEO & Additional Director]

I mean, on the first question, and I understand the question. We're all trying to model this the best we can. I would just say, based on having spent a fair number of years in medical devices, I don't want to jump past the current moment. I mean, the most important phase in the successful commercialization of technology like this is getting to the point where you have a functioning piece of equipment that has -- it's commercially available for sale. And so we're at an important juncture. The -- what the rollout looks like past the first 2,000 units is a bit difficult to predict. Then more specifically, in your second question though, I think you're probably safe to look at this as, every Karie device that gets installed somewhere in a bed that we're not currently serviced would almost look like a bed. And so the model, I mean, even Leslie talked about it a few minutes ago in terms revenue per bed. I think if a Karie device gets placed a in -- whether in a retirement home or in a seniors living at home, that should be looked at it from a modeling perspective as the equivalent of a new bed.

[Doug Cooper, MD & Head of Research]

Got it. Two more quick ones. Moving over to the cannabis side. You talked about finalizing potentially a supply agreement with a Canadian LP. When would something like that be finalized? And when do you think the rollout would be of the actual product? And what would the product look like? It would be sort of pill form or what?

[David Murphy, President, CEO & Additional Director]

Yes, good question. I mean, first, in terms of our approach here, I want to make clear that we've decided not to do what some companies in other spaces have done and just go out and sign a bunch of supply agreements and announce them all. And we believe that the right way to do this is to do strategic partnerships with a much smaller number of licensed producers in order to really set ourselves up to maximize the impact in the continuing care space. So that's what we're focused on. In terms of when, I -- my past experience tells me that there's only 2 kinds of deals: The ones that are done, and ones that aren't. So I would -- don't know that I would be specific in our expectations. I'd just tell you, we're -- we feel really optimistic about what we have in front of us right now, and we feel like we can get a good deal done. In terms of the question around what it looks like. I think the predominant expectation is that capsules are going to be the predominant vehicle on how this is delivered in continuing care.

[Doug Cooper, MD & Head of Research]

And then what -- it's going to be predominantly for pain.

[David Murphy, President, CEO & Additional Director]

Yes, I think pain, sleep. There's a number of, I think, working theories on what symptoms and what meds this cannabis product could offset or alleviate.

[Doug Cooper, MD & Head of Research]

Okay. And then just on the financials. Leslie, can you just give us an update on the bank and where they stand in terms of covenants and things like that?

[Leslie Cho, Chief Financial Officer]

Yes. So as of the second quarter, we're in compliance with our covenants. I think, as we continue to see some downward pressure on our results, we'll probably have some pressure on our covenants going forward. But we continue to maintain good relationships with the banks and have been transparent with them. So we will continue to work with them as we go forward and so...

[Doug Cooper, MD & Head of Research]

Okay. Is the bank encouraging you to sell assets to delever?

[David Murphy, President, CEO & Additional Director]

I wouldn't say that, Doug, at all. I think the bank's just -- in the few months I've been here, we have -- as Leslie said, we have quality lenders and quality relationships. And I think they just want to make sure that we're clear with them on what we're dealing with, and how we're dealing with it, and that we have a clear plan in place. So the strategy we developed is our strategy. It's not necessarily based on any pressure from anyone. And it's -- and I would say -- I would go further and say, it's not necessarily primarily motivated by covenant compliance. My recommendations here, specifically as it relates to the balance sheet, are about what the -- what the leverage situation we need to have as a company in order to capitalize on growth opportunities and do what I want to do with this business. And so our strategy is motivated by creating a balance sheet that we need to have that sets up for growth. And also creating a balance sheet that's going to make us attractive to investors and help existing shareholders grow their investment. The covenant piece is not the driver of this. But to your question, I think what the banks want is a clear plan, and I feel very confident that we have a clear plan.

[Doug Cooper, MD & Head of Research]

Okay. And then final one for me. When you talked about the Q3 sort of -- the soft sort of guidance, would -- do you think that'll be the low quarter? And would that -- from the side that you're talking about lower EBITDA than you just reported, what sort of quantum should we be thinking about?

[David Murphy, President, CEO & Additional Director]

I don't know that we guide on a quantum. But yes, that's fair. I think Q3 will be the low point and likely will be a further reduction from this quarter. Although Q3 is, I think, seasonally -- is always lower than Q2. And really, that's just -- we're doing a lot of things to offset the regulatory hit that's reengineering, that's onboarding these beds, which won't happen until predominantly in the fourth quarter, and these other growth initiatives. So I think the combination of a full quarter of the regulatory hit and the offset just not being fully in place will absolutely make Q3 the low watermark.

[Doug Cooper, MD & Head of Research]

Okay. And that includes -- do you think -- should we be expecting charges coming through in Q3 or Q4 related to some of the rightsizing of the business or reengineering or…

[David Murphy, President, CEO & Additional Director]

Yes, I think you'll see the transaction costs sort of ongoing. You saw some in the second quarter as we made the first wave of changes. And I -- you -- I don't know that, that will ramp up in Q3. But you'll see additional ones, yes.

[Operator]

There are no further questions at this time. I'll turn the call back over to you.

[David Murphy, President, CEO & Additional Director]

Thank you very much, and thank you to all the participants and those who are listening via the webcast. We look forward to speaking to you on our next call. Thank you.

[Operator]

This concludes today's conference call. You may now disconnect.