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Sunlink Health Systems, Inc. (NYSEMKT:SSY)

F1Q09 (Qtr End 09/30/08) Earnings Call Transcript

November 12, 2008, 11:00 am ET

Executives

Robert Thornton – Chairman and CEO

Mark Stockslager – CFO

Harry Alvis – COO

Analysts

Ross Haberman [ph]

Michael Obrien [ph]

Operator

Good day ladies and gentlemen and welcome to the SunLink Health Systems, Inc. announces its first quarter earnings conference call. This company will share its prepared presentation, followed by a question-and-answer session. At this time, we would like to turn the call over to Robert Thornton, Chief Executive Officer. Mr. Thornton, you make begin.

Robert Thornton

Thank you and welcome to SunLink’s first fiscal quarter 2009 conference call. By way of introduction, I have with me today, our CFO, Mark Stockslager and our COO, Harry Alvis, who will speak momentarily.

Before I start, I would like to read the forward-looking statement which can also be found be in risk factors in 10-K. This call will contain disclosures, which are forward-looking statements within the meaning of the Safe Harbor contained in the Private Securities Litigation Reform Act of 1995. Forward-looking statements include all statements we make which don’t relate solely to historical or current facts. These forward-looking statements are based on current plans and expectations and are subject to many risks. Also, they are subject to uncertainties and other factors that could significantly affect our current plans and expectations and the future financial conditions and results of SunLink. These factors may differ materially from those that we anticipate as we operate the Company. They are set forth as updated in our 10-K for fiscal 2008, which was filed September 25, 2008.

With that let me say that our business is somewhat seasonal. September is typically the weaker quarter. December likewise is usually a somewhat weak and volatile quarter because of the holiday. Stronger quarters are March and June. This quarter we had the Specialty Pharmacy segment included for its first full quarter since we acquired it on April 22, 2008.

As far as operating results, we had a loss for the quarter from continuing operations of $488,000 or $0.06 a share that was apparent from earnings of $443,000 or $0.06 a share last year.

After discontinued operations, the net loss for the quarter was $549,000 or $0.07 a share versus earnings of $393,000 or $0.05 a share last year. Both obviously disappointing results. We will talk a little bit about the reasons as we got through it. As far as revenues in the Healthcare Facilities, our net revenue in the Healthcare Facilities was $37, 67000 in the first quarter and that was actually down 3.1% from last year, which is the first quarter in my experience to have seen a decline in net revenues from hospitals on a same-store basis. We really were affected by that thing by some trends out there.

Our inpatient admissions were down 3.5% but our equivalent admissions were down 8.2% and surgeries were down 14.1%. Equivalent – the decline in equivalent admissions in surgery is a reflection of outpatient – primarily outpatient work which declined. A lot of that is elective, a lot of that is the sort of thing that people can’t defer if they can’t pay the deductibles in co-insurance or if they don’t have insurance and we think that is what is happening.

We did have a little bit of pricing. Net revenue per equivalent admission was up 5.6%. Our patient mix was actually somewhat better this quarter. Commercial revenue was up to 33.6% while net revenue (inaudible) was down by about 4.5% to 12.6% and Medicaid was down 2.7% to 14%. Medicare was also up. So, commercial revenue and Medicare revenue up, Medicaid and self-pay were down.

Those are good trends in the normal context but we saw too much decline in volume overall. The benefit to the extent there is any of the declines in the Medicaid and the self-pay is that our bad debts moderated this quarter and moderated pretty substantially. I doubt probably that is a trend, what tends to happen is when people lose Medicaid coverage and they will go without treatment for a while and then they will show up as self-pay patients in our emergency room. That is probably what is going to happen over the winter.

The revenue from the Specialty Pharmacy division SunLink Scripts was $9,671,000 for the quarter and they are tracking pretty much on target with what we expected from them and did reasonably well at the margin level too, which I will comment on in a minute.

In the context of cost, the healthcare facilities cost, labor was up to 47.0% of net revenues for the quarter versus 44.6% last year. That increase was due almost solely through the cost of employed physicians. We have a downturn in employed physician model in a couple of the hospitals. We think that is the right way to position a couple of the hospitals but the labor cost element of that will distort the statistic somewhat. I would also say that because some of these – most of the physicians are relatively new to the practice in these hospitals, they are not fully producing revenue yet. Maybe that is another reason somewhat for the revenue drag we have seen.

As I said, bad debts moderated pretty substantially this quarter. They were 14.4% of net revenue versus 17.3% same quarter last year. We had lower self-pay patients. We had fewer individual patients as well. Internally, we have done a lot of things to promote that. We worked hard on improving our case management medical evaluation procedures, particularly in the emergency room setting. We have increased our efforts for upfront collections and we have tried to streamline and improve our registration procedures for people coming in on an outpatient basis and we are seeing that pay off.

Again, there is no underlying narrow economic factor that is causing bad debts to moderate and I think it is pretty hospital and country specific at his point. But we are hopeful with some of the proposals out there and a little better consumer confidence at some point we will improve that.

We also had increase in purchase service expense this quarter. Some of our specialty services such as anesthesia and radiology include minimum usage guarantee charges and in a couple of places we didn’t meet the minimum usage because the volume was down. So, that caused them to be higher as a percent of net revenue.

Overhead this quarter was up to $1,405 from $1,155 in the same quarter last year and that was due almost exclusively to SunLink Scripts and the Specialty Pharmacy company where we added a couple of people – in connection with the acquisition and we had some costs relating to getting that acquisition integrated. It is hard to tell how much of that is nonrecurring but some of it is certainly is.

At the adjusted EBITDA level for the hospitals, they were down last year – this year from $2,566 from $3,455 last year, again due to lower volume and high labor cost. On the other hand SunLink Scripts contributed $807,000 in EBITDA for the quarter. So, the combined total of the two was adjusted EBITDA excluding overhead remained $273 for the quarter versus $3,445 for the same quarter last year.

On a trailing 12- month basis, our adjusted EBITDA excluding overhead was $15,670,000. So, we have got some work to do in the hospitals. SunLink Scripts and the pharmacy company are tracking along as we expected. Harry is going to talk about some of the things we are doing in the hospitals in the cost area and we are also promoting heavily on these doctors in an effort to increase revenue.

And with that Mark will make a few comments on the balance sheet.

Mark Stockslager

Thank you Bob. Our balance sheet remained stable. We had cash of $1,825,000 at September 30th, up slightly from $1,716,000 at June 30, 2008.

Hospital days revenue and accounts receivable is at 38 compared to 39 at June 30, 2008. It decreased due to our continued emphasis on upfront collections and business office practices at the hospitals will remain effective.

Capital spending grew to $382,000 in the quarter and we expect an approximately $1.7 million for the rest of the fiscal year. This is substantially less than the $8.3 million we spent last year as we completed expansion, renovation, and upgrades in selected hospitals. The revolver and term loan outstanding at September 30th was $40.1 million compared to $38.8 million at June 30.

We had $34.4 million outstanding on the term loan and $5.7 million drawn down on our $12 million revolver.

We think our balance sheet will improve further if our capital expenditures need continued to decline during this fiscal year.

Robert Thornton

I would comment also that our CapEx expenditures this year unlike the past couple of years is almost exclusively maintenance CapEx. We have everything in place we think we need in most of these hospitals and don’t have the CapEx plan at this point. I would also note that under the revolver in the term loan we had paid down debt, the term loan is sound [ph] since we took it out in April and made compliance with all the covenants on that loan as well. And with that Harry will make some comments about operations and physician recruiting.

Harry Alvis

Thanks Bob. Physician recruiting for the quarter had a zero net. We brought on 3 new specialists but will also be primary care physicians. The added doctors will take a while to get settled (inaudible) and develop their practice. But we should see the results of these recruiting efforts over the next few months and then next few quarters. As Bob mentioned earlier we have somewhat changed our recruiting models at selected hospitals to more broad positions. We didn’t give any guarantee to recruiting physicians. This allowed us more (inaudible) of clinical activity and (inaudible).

Obtaining [ph] cost for physician guarantees was $188,000 this quarter versus $147,000 for the same quarter last year. As Mark said our continued focus on the (inaudible) we did improve our collections for the quarter as evidenced by the (inaudible). Although collection challenges in non insurance patients are an industry wide issue, our hospitals have made good progress to stand on that curve.

(inaudible) is to continue our cost emphasis across the board due to lower volumes at our facilities and due to legal economic conditions. All facilities have implemented plans to lower costs that appeared at lower volumes.

Robert Thornton

Thanks Harry and that period of lower volume we were anticipating will last through December. The next seasonal increase we would expect would be in January. So, it will be interesting to see how the volume develops in January. As far as the physicians, I would also add that our primary objective this year, although we have a number of net physicians we intend to add is mostly back drilling [ph] and tweaking in the hospitals rather than having to replace groups of physicians in any of the hospitals. We are pretty well positioned we think on physicians at this point.

As far as the macroeconomic environment acquisitions as we said a couple of times we are focused on internal operations in cost control. It is uncertain I think with macro reimbursement environment is right now although the announced increases in the Medicaid rates, Medicare rates for next year are better than we expected and the Medicaid programs although they are under pressure in each of the states, it is expected to change at any time or not as bad given the economic conditions as they could have been and we think we have live with those.

In the Specialty Pharmacy area, we are seeing pretty stable demand. That business is seasonal as well like our hospital business is and the seasonality in that business starts in fall. So, we are beginning to see a tick up with some of the drugs that are used to treat winter type [ph] respiratory illnesses, clearly that sort of thing.

We also are seeing a number of smaller complimentary Specialty Pharmacy acquisitions which we are pursuing. We have a little (inaudible) in our revolver that we can make smaller pharmacy acquisitions. Smaller in the grand scheme of things, but actually pretty substantial in actually the total of the pharmacy businesses as they exist today and we are pursuing those. So, we think our challenges are good cost control and developing our physicians in the hospital segment and continuing to grow and develop in the pharmacy segment.

And with that I will be glad to take questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first quarter or comment comes from the line of Ross Haberman [ph]. Mr. Haberman your line is open.

Ross Haberman

Good morning, Bob. How are you?

Robert Thornton

Good. How are you?

Ross Haberman

Could you tell me on the revenue side, how much softness you are – you would attribute to lack of optional or discretionary procedure. I know you were concerned about that issue. Is this coming forward is soft as you thought it might and were there any one-time expenses in the quarterly results?

Robert Thornton

They were no one-time expenses in the quarterly results. Actually there is a $300,000 interest expense charge for the collar around the shares given in the Carmichael’s acquisition. So, interest expense includes $300,000 of what would essentially be derivates costs because we put a collar around that and if he sells before a certain date he is entitled to some reimbursement for that.

Ross Haberman

Okay.

Robert Thornton

One of the hospitals had about $150,000 of unanticipated repairs on one of the digital imaging machines. That doesn’t happen every quarter but I would tell that a one-time thing because it happens periodically. Things (inaudible). So, I wouldn’t say that there is anything terribly one-time in the operating results in the hospital. As far as the demand for the services in the hospitals, it is a little – it is softer than we expected and it is in the discretionary stuff and I don’t have statistics to show exactly how much the discretionary is down but it would be reasonably substantial. Some of that will be because there is doctor turnover here and there in the hospitals and that usually occurs in the summer and the fall, rather than in the busier seasons of the winter and spring, but we have seen a decline in demand.

Ross Haberman

And do you think you will continue to see it and have you broken, again have you broken that out as a percentage of total revenue, annual or quarterly revenue?

Robert Thornton

Not broken that out as a percentage of revenue. We don’t have a statistic precisely like that and it is also subject to some clear definitions. I don’t really have anything like that. As far as whether we expect it to continue, we have seen blips in volume over the last month, subsequent to September 30th. But in none of the incidents sustained here, blip up for a week or two and take the hospital because of flu and (inaudible) what you see in the fall. So, what we are seeing is not abnormal. It is just at a lower level than I think we expect it. I think the real measure of what demand can look like will come in the winter. We will certainly get the normal Medicare pickup because the winter months are harder on the elderly and they will come to the hospital and they have to come to the hospital. The question is when the self – when the commercially insured patients become more comfortable in coming and doing more discretionary things, not just deferring treatment. Most of the treatment we are not doing, I suspect is being deferred. It’s going to show up one of these days. Our challenge at that point would be to treat them in an efficient way because they’re likely to be more sick or sicker, when they show up after having deferred treatment for a while.

Ross Haberman

Thank you.

Robert Thornton

Yes sir.

Operator

Our next question or comment comes from the line of Mr. Michael Obrien [ph]. Mr. Obrien your line is open.

Michael Obrien

Hello Bob.

Robert Thornton

Hi.

Michael Obrien

One thing that seems to be noticeably absent on this call, although it probably does not matter, is the fact that is the board still looking as strategic alternatives with the stock now presently at $1.45 and where do we stand in that. We have heard nothing for nine months and I assume that anybody that ever had any interest in this company is long departed.

Robert Thornton

The proposal from resurgence is no longer on the table as I understand it and I think we addressed that in the 10-K in the section strategic alternatives, but in preparation to deal with strategic alternatives in a broader sense than just the resurgence proposal. The board set up a strategic planning committee, which is active in looking at all strategic alternatives on an ongoing basis, not just when we get one of these (inaudible) letters, we have to react to it. But yes it is an ongoing thing, but no, resurgence is not a factor.

Michael Obrien

Thank You.

Robert Thornton

Yes sir.

Operator

(Operator instructions) The next question or comment is a follow up from Mr. Ross Haberman. Mr. Haberman, your line is open.

Ross Haberman

Bob could you give us the short-term debt number if you can.

Robert Thornton

Yes just a second.

Ross Haberman

And Rob while you’re looking for that, responding to the prior gentleman – would you consider buying back shares at some price there as opposed to looking for other hospitals to buy.

Robert Thornton

The board hasn’t ruled out any alternatives and we would say – (inaudible) I think would say that the price is pretty appealing.

Ross Haberman

I think it’s actually cheaper than all of your options are priced now.

Robert Thornton

You’re right. (inaudible) without paying tax for a change. Cheap option. So, yes, I think they have not ruled out any alternatives. We don’t have any specific plans right now to buy back any shares, but I certainly agree what you’re saying. The debt – the short term debt we have a revolver and it’s a $12 million revolver, of which $5,700,000 is outstanding and current maturities on the term loan are $1.844 million at September 30, 2008.

Ross Haberman

So, I am sorry, so the 5.7 was included in your 41.9, you show on the press release or –

Robert Thornton

Yes it is.

Ross Haberman

So only the 1.8 you’re saying is the short-term?

Robert Thornton

No, 5.7 is short-term and 1.844 is short-term.

Ross Haberman

Okay.

Robert Thornton

5.7 is revolver.

Ross Haberman

And how much is long term in total.

Robert Thornton

Long term in total is $32,723 under the credit facility and then there is a subordinated debt from the purchase of Carmichael's of $2,850 million.

Ross Haberman

And final – and just two final questions. Did you get anywhere in your examination of the Carmichael receivable issue.

Robert Thornton

It’s underway and we don’t think it will be completed before the 1st of the year.

Ross Haberman

Okay. And the other specialty pharma businesses, this is which you’re looking for would they be basically rolled into the Carmichael business if you found an appropriate acquisition.

Robert Thornton

Yes if geographically and product ramp complimentary to Carmichael's.

Ross Haberman

Okay thanks. It helped a lot.

Robert Thornton

Thank you.

Operator

(Operator instructions). Mr. Thornton, there are no additional questions or comments in the queue at this time, sir.

Robert Thornton

Okay thanks very much for your interest. Our second fiscal quarter conference call will be mid February. We will put an announcement towards the end of January or 1st of February as to the exact time and date and we look forward to talking to you then. Thank you very much.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This concludes the program. You may now disconnect. Everyone have a wonderful day.

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