CareRx Corp

TSX:CRRX

Earnings Call Transcript 2019-Q2

[Operator]

Good morning, everyone, and welcome to the Centric Health 2019 Second Quarter Earnings Call. Please note that today's call is being broadcast live over the Internet and will be archived for replay, 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 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 the 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 periodic 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 & Director]

Thank you, and good morning, everyone. Welcome to our second quarter earnings call. Joining me on the call today is our Interim Chief Financial Officer, Andrew Mok.The second quarter was a very strong one for our core Specialty Pharmacy business. We delivered our third consecutive quarter of sequential improvement in operating margins and adjusted EBITDA and grew adjusted EBITDA 50.5% compared to the second quarter of 2018. Revenue growth was 6.5%, driven by continued expansion in a number of beds serviced. The higher revenue, combined with the significant improvement to our cost structure after completion of the Business Re-Engineering Plan last year resulted in an adjusted EBITDA margin of 11.8%. These margins are in line with expectations and previous guidance and are also now back to the historical profitability margins in this business prior to the various regulatory changes in 2018.Looking more closely at the growth in our bed count. The average number of beds serviced for the quarter, 31,265, represents an increase of almost 10% compared to the second quarter of 2018 and an increase of 3% from the first quarter of this year. We continue to win new business and increase market share, and we believe that we are currently the fastest-growing company in this sector.On Monday of this week, we announced that we have reached a definitive agreement to sell our Surgical and Medical Centres business to the Kensington Private Equity Fund and its manager, Kensington Capital Advisors. The $35 million all-cash transaction is expected to close at the end of September and is subject to satisfying customary closing conditions, including the receipt of applicable regulatory and other third-party approvals. We are working with Kensington to ensure a smooth transition for our employees, clinicians and patients across the country. We expect to mainly use the net proceeds from the sale to pay down our debt.In the third quarter of 2018, we communicated 2 clear corporate priorities, the reengineering of our Pharmacy business to return it to historical profitability levels and the deleveraging of our balance sheet. With the announcement of the sale of our Surgical and Medical Centres business, I'm pleased to say that both initiatives are on track. Importantly, since the start of 2019, and including the agreement for the sale of our Surgical assets, we have generated gross proceeds of $51.4 million through a combination of the sale of noncore assets and our private placement of convertible preferred shares in March.Our transformation initiatives during the past year were intended to better position us to take advantage of a number of potential growth opportunities. After completion of the Surgical divestiture, we will be a healthier, more efficient and more focused company. Our intention is to transition to a more aggressive growth phase, during which we will establish ourselves as the leading provider of pharmacy and other health care services to Canadian seniors. This growth will include further expansion of beds serviced across the country. The combination of the strength of our team and the quality of our service offering to customers has enabled us to demonstrate clear differentiation from our competitors. We are well positioned to maintain our recent growth trajectory and continue to increase market share. We will also pursue opportunities to provide our best-in-class pharmacy services beyond our traditional core market, with targeted expansion in both institutional and at-home settings. One enabler of the strategy is our relationship with AceAge and our support for the commercialization of their Karie technology. Karie has established solid traction, both domestically and internationally, in recent months, and we expect to see an acceleration of sales through our network in the second half of 2019.We are also pursuing adjacent growth opportunities that leverage our footprint and relationships within seniors housing. This includes medical supplies, a segment in which we believe our customers are currently underserved. It also includes our medical cannabis partnership with Canopy Growth. Deliveries of medical cannabis to our customers continue to increase each week. And starting in the third quarter, we will begin servicing our largest national customer, which we believe will further accelerate medical cannabis growth.Finally, it is our view that consolidation within the seniors pharmacy space is highly likely. Future market leadership in this space will belong to companies who can provide a high-volume, high-quality service offering using operational efficiencies and economies of scale to improve profitability and withstand periodic funding pressures. We intend to explore opportunities to make synergistic acquisitions. And we believe that because of the groundwork we have laid in the last 12 to 15 months, we are well suited to play a leadership role in the period of consolidation that lies ahead.In short, we have strengthened our team, improved our operating performance and increased our financial health and flexibility. And in the process, we have established a stronger foundation for future growth. While we still have work to do, I have tremendous confidence in our strategy, our team and our company, and I am excited to transition to the next phase of the journey.With that, I would like to turn the call over to Andrew for his review of our financial results Andrew?

[Andrew Mok, Interim Chief Financial Officer]

Thank you, David, and good morning, everyone. I'll walk through our second quarter financial results, which are available in our financial statements and MD&A, which have been filed with SEDAR and are also available on our website.Revenues for the quarter for the Specialty Pharmacy business was $31.5 million, which was an increase of 6.5% compared to the $29.6 million generated in the second quarter of last year. The revenue increase for the quarter was due to growth in the average number of beds serviced and revenue initiatives implemented as part of our Business Re-Engineering Plan that was executed during the third and fourth quarters of 2018. Together, these 2 contributors more than offset the impact of the regulatory changes that came into effect in the second quarter of last year.For the quarter, adjusted EBITDA in Specialty Pharmacy improved to $3.7 million from $2.5 million in Q2 of last year. The 50.5% increase was due to the higher revenue, cost savings achieved through the Business Re-Engineering Plan and operational efficiencies resulting from increased scale from the higher average number of beds serviced. It should also be noted that this was our third consecutive quarter of sequential growth in adjusted EBITDA following the execution of the Business Re-Engineering Plan. In addition, as David mentioned, our adjusted EBITDA margin returned to double digits for the quarter. Adjusted EBITDA margins in Specialty Pharmacy was 11.8% for Q2 or 10.4% if normalized for the impact of IFRS 16, which resulted in an increased to adjusted EBITDA from Specialty Pharmacy of $0.4 million for the quarter. These adjusted EBITDA margins are in line with those that were achieved in the Specialty Pharmacy business in the periods prior to the 2018 regulatory changes, as we have achieved our goal of returning the business to its historical profitability.And that concludes the key highlights for our second quarter financial results. With that, we would like to now open the line for questions. Operator?

[Operator]

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

[Doug Cooper, Managing Director and Head of Research]

Congratulations on the success of turning the business around to date. The 31,265 average bed count in the quarter, can you let us know what the exit number was?

[David Murphy, President, CEO & Director]

What the -- like the end-of-quarter number was?

[Doug Cooper, Managing Director and Head of Research]

Yes. End of quarter, yes.

[David Murphy, President, CEO & Director]

31 -- just over 31,400.

[Doug Cooper, Managing Director and Head of Research]

Okay, okay. What about RFPs in process, where do you envisioning the bed count ending the year just from organic? Is there a number of RFPs out there that you think you can secure before the end of the year?

[David Murphy, President, CEO & Director]

Yes, good question, Doug. I think in terms of bed count in the second half of the year, I think you probably can expect Q3, with the summer, to be relatively stable versus Q2. But to answer your question, yes, we have already one business that will onboard in the fourth quarter. And we are still in the final stages of some RFP opportunities for additional wins. So I don't know that we're going to guide to a specific number, but we're -- if you look at the trajectory of the last 4 quarters in terms of what we've been able to grow bed count by, I think you can safely say that our internal target for the end of Q4 is consistent with that trajectory.

[Doug Cooper, Managing Director and Head of Research]

Okay. And the annualized revenue per bed, just over $4,000 in the quarter, is that -- how do you see that trending? Does that -- do you see that pretty stable?

[David Murphy, President, CEO & Director]

On the revenue side, yes. I think, the obviously, profitability is somewhat impacted by what types of beds they are and regulatory issues. But on the revenue side, yes, that's a good model.

[Doug Cooper, Managing Director and Head of Research]

Okay. The proceeds from the sale of the Surgical side, you indicated, for the most part to be used to pay down debt. Can give us an idea where sort of pro forma bank debt would be? And what sort of covenant relief, if any, you have once that is paid down? And where -- sort of maybe just give us some color around how the banks are thinking about your business.

[David Murphy, President, CEO & Director]

Yes. So I think just to answer the question for some of the pro forma debt. At the final closing, we estimate, based on our working capital needs between now and then and the net proceeds, we'll probably be in the high 40s in terms of bank debt. In terms of covenant relief, that's still to be discussed with the lenders, but they've been very supportive with us so far, and we've been working together on this. And so in advance of closing the deal, our expectation is that we'll have another set of covenants or amendments in place before that.

[Doug Cooper, Managing Director and Head of Research]

Okay. Strategic initiatives going forward now that you have some maneuverability, you indicated some of the growth opportunities. Can you talk about more specifically on the acquisition side what, in fact, are you looking at in the beds? You mentioned some, I guess, supplies -- medical supply business, companies maybe that have some beds for sale. What -- maybe give us a bit more color on what you're seeing on the acquisition front.

[David Murphy, President, CEO & Director]

Yes. So I think high level in terms of the strategy, Doug, I think what we said in this presentation is we're looking at, from an organic perspective, 2 different things. One is just leveraging our footprint of relationships in seniors housing to offer more diversified health care services. That's where the medical supplies piece comes in. That's where the medical cannabis strategy comes in. Similarly, we're looking at taking our pharmacy footprint and pharmacy offering and offering it in sort of nontraditional areas. That's where the Karie strategic initiative comes in.And then on the acquisition front, yes, I'll probably won't comment on specifics, except to say, as I said before, I've been in health care for almost 15 years. I would say that relative to other spaces in the health care sector, the seniors pharmacy space, I don't think it's followed yet the expected curve as it relates to the evolution and consolidation in the industry. I think for various reasons, that is not only likely, but I think welcome. And a huge part of what we've been trying to do in the last year as we executed in the delevering strategy is prepare for that phase 2 and identify what sorts of acquisition opportunities we would like to go after. I would say most of them will be consolidation plays within our core business of seniors housing pharmacy as opposed to anything else.

[Doug Cooper, Managing Director and Head of Research]

The top 4 or 5 players in the space, I guess, historically, have maybe, what, 40 or 30 -- 30% to 40% market share, meaning like, I guess, a lot of them are sort of smaller maybe family-run businesses. Are they feeling financial pressure from the regulatory changes? And does that make them -- are these guys looking for an exit strategy? Or what is prompting maybe some of these guys to sell or interested in selling?

[David Murphy, President, CEO & Director]

Yes. I'm hesitant to sort of get too commercially sensitive or talk about our competitors, but your math is right. I think you have, if anything, actually, the top 3 may even be a smaller percentage of the overall market. So I would just say, look, if large-scale providers like ourselves have had to reengineer our business in order to adapt to a new regulatory environment, if we had to sell off other assets, you can probably imagine what a smaller operator might have had to deal with and likely had less levers to pull in order to offset. So at the end of the day, these sorts of regulatory interventions tend to make assets in the marketplace cheaper, and we believe that's the case here.

[Doug Cooper, Managing Director and Head of Research]

Okay. Then just on the regulatory. Is there any pending changes that you see in the environment that should -- could cause any flex in the business going forward?

[David Murphy, President, CEO & Director]

The only change that is possible, and I think it's in our MD&A, the Ontario provincial government did indicate in their budget in the spring a desire to change the funding model as it relates to long-term care pharmacies. There's nothing definitive there. They've been, to their credit, quite consultative with industry in terms of engaging us with the dialogue and what the funding regime could look like. Particularly national players like us, we have a real breadth of perspective based on doing business in multiple provinces. So a standby there. But I would just say we were cautiously optimistic that we'll get to a good place that won't be a significant sort of change for the business.

[Doug Cooper, Managing Director and Head of Research]

Okay. And my final question, just on Karie, you indicated they've seen traction internationally and domestically. Maybe just an update there in terms of the manufacturing from their perspective. Is it all set, things are running smoothly, and now they're running sort of other full sale mode? Is that fair?

[David Murphy, President, CEO & Director]

Yes, that's right. I mean, they've been manufacturing pretty steadily this year, but they ramped up volumes, and, as you would have seen, a fairly sizable purchase order in Europe starting -- delivery starting later this year. So yes, they're certainly -- their horizon's now have ramped up well beyond the initial 2,000 units that we originally discussed. So it's less of an operational scale issue now and just more of a commercialization issue. And we're happy for them on the European order, but, obviously, we also want to make sure we can create -- working with them create sufficient domestic demand to launch some of those devices in Canada.

[Operator]

[Operator Instructions] Your next question comes from the line of Doug Loe from Echelon Wealth Partners.

[Douglas W. Loe, Analyst of Healthcare and Biotech]

Just to follow up on Doug's themes. It's been a while since you've actually mentioned McKesson and your alliance that you consummated with them a few years ago. And they're not overtly mentioned in your MD&A, but I was just wondering if that was an important alliance for you to have announced when it was announced, including infusion of capital into the business. Just wondered if you wanted to comment about that relationship to whatever extent you feel comfortable, and whether or not there's still perhaps some additional torque that could be developed in your business through that relationship. And I'll leave it there.

[David Murphy, President, CEO & Director]

Sure, Doug. Look, it is one of if not our most important stakeholder relationships. I think we did a long-term drug supply deal with them a few years ago. I think it's -- I think my sense of -- from talking to them on a regular basis, I think both sides are very happy with the relationship. I think it's certainly simplified our business in terms of being able to do a -- not sole-source, but largely sole-source business in terms of formulary and getting our medications to procure and delivered. So it's a healthy relationship. I think some of the questions in the past have been around other aspects of the McKesson organization. They do have a sort of separate business that, as you know, operates both retail and specialty pharmacy. One of those unique relationships where they're our partner and a supplier in one part of their company, but a competitor in the other, and I think that's just sort of how it is. And our goal is to have a collaborative relationship with them as it relates to drug distribution, but also beat them competitively in the commercial space. And that's probably how it's going to be for the foreseeable future.

[Douglas W. Loe, Analyst of Healthcare and Biotech]

Well, just as a supplement, is there any potential for them to be relevant in whatever strategy you have evolving in the medical cannabis space? I mean, could they be relevant to dispensation or developing distribution channels or developing new relationships for you there?

[David Murphy, President, CEO & Director]

I think [indiscernible] McKesson probably has their own perspective on the cannabis space. And so I wouldn't presume to speak for them.

[Operator]

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

[David Murphy, President, CEO & Director]

So thank you for participating on today's call and for your continued interest in Centric Health. We look forward to reporting on our progress again next quarter.

[Operator]

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