CareRx Corp

TSX:CRRX

Earnings Call Transcript 2022-Q2

[Operator]

Good morning, everyone, and welcome to CareRx's Second Quarter 2022 Financial Results Conference Call. [Operator Instructions] Certain matters discussed in today's call or answers that may be given to questions asked could constitute forward-looking statements that are subject to risks or uncertainties relating to CareRx'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 CareRx's periodical results and registration statements, and you can access these documents in the SEDAR database, under www.sedar.com. CareRx is under no obligation to update any forward-looking statements discussed today, and investors are cautioned not to place any undue reliance on these statements.

I would now like to turn the call over to David Murphy, President and CEO of CareRx Corporation. Please go ahead, Mr. Murphy.

[David Murphy, executive]

Thank you, and good morning, everyone. Welcome to our second quarter 2022 earnings call. With me this morning is our Chief Financial Officer, Andrew Mok. Once again, during the second quarter, we delivered strong year-over-year growth in revenue and adjusted EBITDA. The 3 acquisitions we made in 2021 were a significant driver of that growth with each of these acquisitions continuing to contribute revenue and adjusted EBITDA in line with expectations.

Our year-over-year performance was also driven by organic growth and in particular, the 5,000 beds we added during the second half of 2021 from new customer contracts. On May 30, we closed our fifth acquisition in the past 2 years, the purchase of Hogan Long-Term Care Pharmacy. During the second quarter, we also commenced operations at our new state-of-the-art high-volume fulfillment center in Oakville.

Turning to some of the specific financial highlights. Revenue for the second quarter grew 95% to just under $97 million, with growth driven primarily by an 82% year-over-year increase in the average number of beds serviced to 96,746. Our bed count at the end of the quarter was 97,760, an increase of 2,000 beds from the end of the first quarter. As I mentioned, the year-over-year increase was mainly driven by our acquisitions, but also included organic growth from new contracts onboarded over the last 12 months.

Adjusted EBITDA for the first quarter increased 103% year-over-year to $8.8 million. This growth was driven primarily by the organic and acquisitive growth I just described.

With another quarter of strong year-over-year growth in Q2, our business continues to deliver an outstanding growth trajectory. Over a 3-year period, we have more than tripled our bed count and revenue, and we have increased quarterly adjusted EBITDA just under 3x to $8.8 million, which represents a compound annual growth rate of 36%.

Turning to the integration of our Medical Pharmacies acquisition. During the second quarter, we completed an additional 3 pharmacy site consolidations. All site consolidations related to the integration are now complete, with the exception of the previously disclosed decision to defer one of the planned consolidations to the first half of 2023.

Our second quarter results reflect an annualized run rate of approximately $2.8 million in cost savings synergies from the transaction, and we continue to expect total annual cost saving synergies of approximately $5 million to be realized upon the completion of the integration. With the exception of the one deferred site consolidation, we expect all integration activities to be completed by the end of 2022.

In May of this year, we completed our previously announced acquisition of a long-term care pharmacy business of Hogan Pharmacy Partners. This acquisition adds 800 beds and is expected to contribute run rate annualized revenue and adjusted EBITDA of approximately $4 million and $600,000, respectively.

On closing, we signed a new 7-year contract with Hogan's largest customer. And over the course of the next 4 years, we expect Hogan's customers to increase their bed service by over 1,200 to approximately 2,000 beds. To date, this acquisition is contributing in line with our expectations.

As previously disclosed, during the first half of 2022, we secured long-term contract extensions with 3 of our 4 largest customers, including our 2 largest customers, representing approximately 18,000 beds serviced in total. Importantly, these beds will be under contract for an average of 5.5 years from the end of 2021. We regard these long-term extensions as further validation of the strength of our service offering and the uniqueness of our value proposition as the only national pharmacy services provider that is focused solely on congregate care communities.

As I discussed last quarter, one of our existing large customers awarded a request for proposal to another pharmacy services provider. This contract loss will result in us offboarding approximately 5,800 beds, which is now scheduled to occur throughout the second half of the year. The impact to adjusted EBITDA from the off-boarding is expected to be up to $0.5 million in the third quarter of 2022, up to $1.5 million for the fourth quarter of 2022 and in the range of $6 million to $6.5 million on an annualized basis following the completion of the off-boarding.

Although we are disappointed by this outcome, we are proud of our consistent track record of retaining a very high percentage of our existing customers, and we are confident that we will continue to deliver new organic contract wins as we did in 2021 that will allow us to continue to deliver a strong long-term growth trajectory.

I would now like to turn the call over to Andrew to discuss our second quarter results in more detail. Andrew?

[Andrew Mok, executive]

Thank you, David, and Good morning, everyone. Before I begin, a reminder that our financial statements and MD&A for the second quarter have been filed with SEDAR and are also available on our website. Revenue for the second quarter of 2022 increased $47.2 million or 95% to $96.9 million from $49.7 million for the second quarter of 2021. Growth was driven primarily by the Rexall and Medical Pharmacies acquisitions completed during the second and third quarters of last year, respectively, as well as approximately 1 month of contribution from the acquisition of the Hogan Long-Term Care pharmacy business that we completed at the end of May. To date, as David mentioned, the Hogan acquisition is contributing in line with expectations. The increase was also driven by organic growth resulting from beds from new contracts onboarded over the last 12 months.

Adjusted EBITDA for Q2 increased $4.5 million or 103% to $8.6 million from $4.3 million for the second quarter of last year. As was the case for revenue, adjusted EBITDA growth was driven primarily by the contributions of the acquisitions completed during last year, a partial quarter's contribution from the Hogan acquisition completed in May as well as organic growth.

Adjusted EBITDA for Q2 of this year was dampened by approximately $600,000 of costs related to overtime, contract labor and recruitment, resulting from a higher-than-average number of open pharmacy staff positions due to the current challenges in the labor market. These incremental costs are expected to persist for the remainder of the year.

Our net loss in the quarter increased to $25.1 million from $8.5 million last year, primarily due to noncash adjustments, including impairment losses related to goodwill and intangible assets totaling $24.3 million. The goodwill impairment loss was primarily attributable to the loss of the large customer contract and increases in the input costs of the business. These adjustments were partially offset by the contribution of the prior year acquisitions and other noncash adjustments.

Turning to our balance sheet. Cash at June 30 was $15.2 million, down $13.3 million from $28.5 million at the end of the first quarter. This reduction was primarily due to the cash used in operations during the second quarter, which was driven by working capital movements with the most significant impact being from a pay down of accounts payable related to inventory purchases. The effect of this pay down on working capital reversed in July, resulting in a significant increase in our cash balance post quarter end.

Net debt at June 30 was $79.4 million, an increase of $14.8 million in the quarter, which related to the cash movement that I just discussed. Net debt to annualized run rate adjusted EBITDA was 2.3x at the end of the quarter.

And with that, I will now turn the call back over to David for some concluding comments. David?

[David Murphy, executive]

Thank you, Andrew. With the successful execution of our growth strategy, we have expanded our current bed count to just under 98,000. Our growth strategy has been incredibly successful during the past few years and has truly transformed the company. At the same time, with more than 3/4 of the Canadian market still serviced by other pharmacy service providers, our growth potential remains very significant.

Although short-term profitability is expected to be impacted over the next few quarters by the customer loss I discussed earlier and by the challenges and cost pressures created by the current labor market, we remain highly confident in our ability to deliver an outstanding long-term growth trajectory as we have done consistently over the past 3 years.

We are seeing accelerated expansion in the number of long-term care beds across the country. We are benefiting from the expansion and acquisition activity of our current customers. We are competing aggressively to win new customer contracts, and we are actively exploring opportunities to expand our business to provinces that we do not currently operate in.

Finally, our acquisition pipeline remains robust and active, and we expect to continue our track record of making disciplined and accretive acquisitions as part of our growth strategy. And just as importantly, we continue to build and strengthen our team, a team which I believe to be the very best in the industry. The team is committed to execution of our growth strategy, continued strengthening of our capabilities and service offering and becoming a truly world-class institutional pharmacy partner for our customers and their residents.

With that, I would now like to open the call to questions. Operator?

[Operator]

Your first question comes from Tania Armstrong-Whitworth of Canaccord.

[Tania Gonsalves, analyst]

Firstly, I'm hoping you can talk about organic contract wins. I know we've discussed this in the past. With the cadence of new RFPs coming up for tender, what do you see on the horizon for H2 '22?

[David Murphy, executive]

We certainly are seeing a lot of activity. I think really, as the Omicron wave subsided late Q1, really since then seen a lot of activity. It is, I think, fair to say that based on our previous comments that the large contracts in the sector are generally settled, but below those sort of top 5, top 6, we're seeing a lot of activity and certainly bullish on our ability to get more than our fair share in the second half of 2022 and beyond.

[Tania Gonsalves, analyst]

And then in terms of the changes to generic drug pricing, did that have any impact in Q2? Or is that expected to be more of a Q3, Q4 impact?

[David Murphy, executive]

I think there was a partial quarter's contribution in Q2. Andrew, maybe you could help with the exact number for Q2.

[Andrew Mok, executive]

So we said the annualized impact, Tania, would be about $750,000 or $500,000 for this year. There's only 1 month of that in Q2, and it would be steady throughout the year.

[Operator]

Your next question comes from Gary Ho of Desjardins Capital Markets.

[Gary Ho, analyst]

My first question, just going back to the kind of labor cost issues. Kind of what gives you confidence that this will normalize by year-end? Are there certain initiatives that you're working on internally?

[David Murphy, executive]

I think given what's going on in the world, I think we're probably living a quarter or 2 at a time. I think we don't think what we're dealing with will disappear before year-end. And there's certainly certain macro factors that are outside of our control in terms of when things do subside. But I think we are responding to the challenge. We have significantly increased our recruiting output and the resources devoted to filling open positions and training and onboarding new staff. I won't get into too much detail. We're also exploring other things in terms of how we can use technology to have certain work done remotely in order to get work done without driving things like incremental overtime costs.

So we're certainly acting on what we can act on, but some of this does depend on a normalization of the overall labor market and the labor market for health care workers, in particular.

[Gary Ho, analyst]

Okay. And then maybe as a related question, I know some of your contracts could be longer dated, but can you give us some details whether you have any ways to kind of pass through some of those cost increases to your customers, anything in the contract that allows you to perhaps put those through?

[David Murphy, executive]

Generally speaking, because of the extent to which our revenue is regulated and government paid, there's minimal opportunity to pass through cost pressures to our customers.

[Gary Ho, analyst]

Okay. And then maybe just last one, David, yes, thanks for providing the details on the impact. I think that's on the revenue side in your prepared remarks. I'm not sure if you can help us quantify or triangulate kind of the EBITDA impact of those lost contracts. So maybe looking at it on a margin basis, looking out?

[David Murphy, executive]

I mean just one contract. But to clarify, the amount disclosed is an EBITDA impact. So that's our estimated projection on the impact to EBITDA in Q4 -- excuse me, Q3, Q4 and then on an annualized basis once the offboarding is completed.

[Operator]

Your next question comes from Justin Wood (sic) [ Keywood ] of Stifel.

[Justin Keywood, analyst]

So just to follow the question on the lost contracts, it seems to have an outsized impact on EBITDA versus the revenue, calculating at around 5% or 6% of sales or beds under management, but having a far larger impact on EBITDA. My question is, why is that impact so much more than the sales or beds under management?

[David Murphy, executive]

I think in terms of quantifying the impact, I would start with -- I think we've generally used the rough number of about $800 a bed usually in the context of -- if we were to add additional beds, what the incremental contribution less the direct costs associated with servicing the beds would be. So I think the starting point is that $800 number, which I think would cover about 75% of the impact that we're estimating. I think what's left really is a function of when you delete beds or when you remove beds from the network, unfortunately, very few of the costs associated with servicing those beds disappear naturally. They have to be shed. And in the context of offboarding 5,800 beds. And remember, this isn't a national contract, so it's concentrated in Ontario. And I would say it's particularly concentrated in a handful of sites in Ontario. There just is not the ability to shed the full proportional costs associated with servicing that volume. That, in a nutshell, is why the number is higher than $800 per bed.

[Justin Keywood, analyst]

And if I interpret this correctly, there's not an opportunity to redeploy the staffing resources that we're servicing that contract for perhaps the labor challenges you're experiencing elsewhere?

[David Murphy, executive]

I think that general assumption would hold in terms of if we have open positions there could be some movement between the 2. But I think we've tried to keep those 2 things distinct. And really, what we've said is, if you think about a facility that perhaps might be losing 25% or 30% of their volume, there just isn't an opportunity that reduce costs by that same percentage even with the number of open positions we might have.

[Justin Keywood, analyst]

Understood. And then in your opening remarks, you mentioned a new fulfillment center, that's state of the art. When would we start to see the impact of this -- the new center and perhaps some efficiency there show up in the financials?

[David Murphy, executive]

I think it's still premature. I mean the facility just opened. Remember, we only purchased 2 machines, high-speed machines as an opportunity to sort of prove the concept. And so I think we'll have, I think, good learnings from that, hopefully, as early as by the end of the year. But I think in terms of actually reflecting in something that will be noticeable in the financial statements, I don't think that's a 2022 thing.

[Operator]

Our next question comes from Paul Stewardson of iA Capital Markets.

[Paul Stewardson, analyst]

Just coming in for Chelsea. My question here is it looks like prescriptions over the last year have grown significantly more than beds. Am I getting that right? And if so, is that a change in LTC versus retirement mix? Or is that a trend you're seeing generally that each patient is getting more prescriptions. Can you talk about that?

[David Murphy, executive]

I think high level, you're probably best to look at that primarily as a bed mix issue. And in particular, Paul, Medical Pharmacies was much more skewed to long-term care than to retirement. And so I think some of this really is the impact of acquisitions in changing our bed mix. I don't think we're seeing anything at this point that we would characterize as any actual underlying change in prescription volume. I think it's primarily or maybe almost entirely bed mix.

[Paul Stewardson, analyst]

Okay. And then the only other one for me is just in terms of acquisition pipeline. Is there anything sort of in the more what you'd call near-term outlook for targets in the pipeline?

[David Murphy, executive]

There's definitely a lot of activity. We're always hesitant to be too specific about expected timing because these deals all have lives of their own. But I can say we're doing as much work as we've done in the last few years and confident that deals will happen. When exactly is probably difficult to predict.

[Operator]

[Operator Instructions] Your next question comes from Stefan Quenneville of Echelon Capital Markets.

[Stefan Quenneville, analyst]

Just a couple of questions. First, can you give me kind of maybe a general sense of how many beds are up for contracts in the second half of this year that you're looking at bidding on just to give me a sense of that? And second of all, could you also give me a little more color on the sort of M&A target environment, given the challenges you're seeing on inflation and filling positions. Obviously, a lot of the smaller non-scaled players are probably feeling those pressures even more acutely. So I'm wondering if that's changing the dynamics in your discussions with them? And then finally, I just wanted to ask about your long-term bed targets. You didn't seem to mention it in the press release today, anything like that. Have you made any changes to those long-term targets?

[David Murphy, executive]

So on the first question, I don't think we've ever quantified pipeline, but I think it continues to be the case that in a market certainly below the top 5 or 6 largest home operators, generally, contract lengths are 3 years or so. So a large percentage of the market is potentially available at any given time. So we believe that number is large. And I think really for the first time now in probably 9 quarters of a pandemic, we do feel like activity is normalized and the sales efforts are there to be made as it relates to convincing customers to convert. So pretty bullish on the pipeline.

On the M&A side, certainly, what your comment is right that I think everyone is dealing with the same labor market issues that we are, and I think that's putting pressure on everyone. I wouldn't observe a material change in what that means in terms of acquisition pipelines or valuations or anything, but it's definitely a factor that the whole industry is dealing with.

And then lastly, on the 130,000 bed target, which is I think what your question was, yes, we have not backed away from that at all. We are -- when we set previous growth targets, and we've got a pretty good track record at being able to both make and hit long-term bed growth targets. We still feel like there's a path to being 130,000 beds by the end of 2024. It's always been a target that required a mix of organic and nonorganic. But we're certainly very bullish on continuing to get there by the end of 2024.

[Operator]

Your next question comes from Sepehr Manochehry of 8 Capital.

[Sepehr Manochehry, analyst]

I just wanted to ask about the new jurisdictions. When you guys had this Hogan pharmacy acquisition, you touched on the model being slightly different. Does that go hand-in-hand with you entering new jurisdictions? Will you be essentially deploying this new model? And can you kind of touch on the kind of areas of focus there?

[David Murphy, executive]

So probably a 2-part answer. I think the Hogan model, which entirely is focused on Ontario right now, we do think it has applicability outside the country, including in markets that we currently operate in Western Canada. So I put that separate from the question of entering new province. And that's something that, as I've mentioned on past calls, we've done an increasing amount of work on in recent months. And I wouldn't say anything definitive at this stage, but I think you can expect to hear from us before the end of the year in terms of our plans to expand to other provinces.

[Sepehr Manochehry, analyst]

And I guess in terms of when you talk about labor challenges, is that particularly at the sites? Or is that more at your distribution centers? And if it's at the latter, does that kind of propel you towards more of these BD Rowa implementations, which in the past you'd mentioned requires staff oversight? Does that go hand in hand?

[David Murphy, executive]

I think that the time lines are different. I think you're certainly right, the BD Rowa, if we approve the concept and use more of those in our facilities over the next few years, that would drive a level of automation that may reduce labor needs. But I think that the current labor issues are more near term and they need to be managed, I think, by filling the positions. And although I think the labor market challenges are broad, the ones we would highlight are certainly related to our frontline folks in the pharmacies themselves.

[Sepehr Manochehry, analyst]

And just lastly, on the 130,000 target. From my assumption, I assume there's some of that will be new institutional care settings, if I understand correctly. So can you kind of touch on any initial prospecting or RFPs you're looking at? Or whether there's a time line to kind of framing the opportunity in the maybe jurisdictions of focus for whether it's penitentiaries, group homes or other settings that you're looking to get into?

[David Murphy, executive]

So growth target includes expansion. It includes most significantly organic growth -- and it does include, as you mentioned, increasing penetration in communities other than seniors living. And so we already do business in those spaces and things like group homes and corrections facilities, but we consider our penetration to be minimal relative to the overall opportunity. And so there have been RFPs and other opportunities that we bid on in the last few months. So yes, certainly, that other congregate care communities is part of the growth strategy.

[Sepehr Manochehry, analyst]

So you bid on some RFPs, I guess, in that setting? Or like what's the time line to maybe breaking out where you are in the core business of senior care and then what proportion of the beds is outside of senior care. Do you see doing that?

[David Murphy, executive]

It's a good question. We'd have to think about that. I think it's still -- it's not immaterial now. It's a few thousand beds, I think. But I think about whether that be we should break out with more specificity. Remembering that the senior living business is still [Technical Difficulty] beds will be. And I don't think that will change through the 3-year period we're talking about.

[Operator]

There are no other questions from the phone lines. I will turn the conference back to Mr. Murphy for closing remarks.

[David Murphy, executive]

Thank you, and thank you, everyone, for participating in today's call and for your continued interest in CareRx. We look forward to reporting on our continued progress next quarter. Thank you.

[Operator]

Ladies and gentlemen, this concludes your conference call for this morning. We would like to thank you all for participating and ask you to please disconnect your lines.