Prospect Medical Holdings, Inc. Q4 2008 Earnings Call Transcript

Prospect Medical Holdings, Inc. (PZZF)

Q4 2008 Earnings Call

January 8, 2009 2:00 pm ET

Executives

Sam Lee – CEO

Mike Heather – CFO

Devin Sullivan – The Equity Group

Analysts

Sam Rebotsky – SER Asset Management

Michael Potter – Monarch Capital

[Anthony Markie] – Monarch Capital

Presentation

Operator

Good day everyone and welcome to Prospect Medical fourth quarter 2008 financial results conference call. (Operator Instructions) I will now turn the conference over to Devin Sullivan, of The Equity Group.

Devin Sullivan

Good afternoon everyone. Thank you for joining us today for Prospect Medical Holdings’ fourth quarter and fiscal year-end financial results conference call. Our speakers today will be Sam Lee, Chairman and Chief Executive Officer of Prospect Medical, and Mike Heather, Chief Financial Officer.

Before turning things over to Sam, I would like to remind everyone that statements made during today’s call may contain forward-looking statements. Such statements are not historical facts but are forward-looking statements.

Investors are cautioned that forward-looking statements including statements regarding anticipated or expected results involve risks and uncertainties which may affect the company’s business and prospects including those outlined in prospects Form 10-K which was filed on December 29, 2008 as well as risks and uncertainties arising from Prospect’s acquisition of Alta and ProMed, and the debt incurred by Prospect in connection with those acquisitions.

Any forward-looking statements represent Prospect’s estimates only as of the date hereof or as of such earlier dates as are indicated and should not be relied upon as representing estimates as of any subsequent date.

While the company may elect to update forward-looking statements at some point in the future, it specifically disclaims any obligation to do so even if its estimates change.

I would now like to turn the call over to Mr. Sam Lee, Chairman, and Chief Executive Officer of Prospect Medical.

Sam Lee

Thanks Devin, I thank each of your for joining today’s call. I’m very pleased with how we finished fiscal year 2008 especially in light of the many challenges that we had to face and especially when we got started here back in March, April, and I’m especially proud on behalf of the management team to say that we have successfully resolved these challenges.

I am also pleased to report that the fourth quarter of fiscal 2008 was characterized by increased revenues and improved operating efficiencies that were manifested in a significant turnaround in operating profitability.

We achieved just over $40 million in normalized EBITDA for fiscal 2008 ended September. Fourth quarter was about $11.6 million EBITDA and we’ve experienced about $1 million per quarter increase in general quarter over quarter for the year.

And for the year a more then 50% in cash and equivalents to just shy of $34 million and substantial improvements in operating cash flow. We came in at about $12.5 million and if you adjust for about $9 million roughly in extraordinary cash items we would have been just under $20 million.

We also made progress in paying down our bank debt in excess of $9 million by September which included making scheduled quarterly principal payments totaling about $5 million, an additional principal payment of approximately $4.2 million during fiscal 2008.

We also recently in the months of December and January made just under $5 million in principal paydown primarily due to excess cash flow sweep and scheduled a quarterly for year end. Our operations improved, cash increased, our lower debt profile combined to produce a net debt to adjusted EBITDA ratio of 2.75 by September 30, 2008.

Our business units performed well during the fourth quarter and fiscal year. In general key performance metrics have increased, the metrics that underwrite revenues, utilization, operating expenses etc. and these metrics underwrote the improvement in financials as well.

For the first quarter of fiscal 2009 trends for all the operating units are encouraging as well.

In summary we turned the operations for both stabilization of the foundation here with focus, operational discipline, strengthening of management, and a culture of performance and success. And of course we also dramatically and sustainably increased profitability and quality of care for continued organic and same store growth, continuance of our cross [inaudible] model and of course readiness for any external growth.

We have a proven foundation over many years of work, a blueprint for cost effectiveness and quality of care to be, not to be too colloquial here, to be last man standing in a performance-oriented data driven manner to be effective for any future models of what may come whether it be universal healthcare etc.

Now at this point I’d like to turn it over to Mike Heather for him to give you an overview of the fourth quarter and year-end financials.

Mike Heather

Thanks Sam, I’ll take a moment to cover some highlights from our fourth quarter and full year results then be happy to answer any questions you may have during the Q&A portion of the call.

Firstly though which I think will help clarify the discussion that follows, I should highlight that the results for all periods, both current year and prior year, now separate out the Antelope Valley entities as discontinued operations following their August 1, 2008 sale.

Aside from the one-time items, namely the write-down of intangibles in the prior year and the gain on sales of that business in the current year, those Antelope Valley entities operations were marginally unprofitable in each year and that business as we’ve mentioned before was sold following our determination that they would not be a part of our go forward strategy.

So that’s what represents discontinued operations in these financial statements and in this discussion specifically the Antelope Valley business that we’ve now sold, with everything else we speak about being continuing operations.

With that clarification we’re very pleased with our results for the fourth quarter and full year. Revenues for the fourth quarter and fiscal year ended September 30, 2008 rose 31% and 103% respectively primarily reflecting the full year contributions from ProMed and Alta. Operating income for the fourth quarter was $8.7 million, a $35.8 million improvement from an operating loss of $27.2 million in the prior year.

But that prior year loss including a $27.5 million non-cash pre-tax write-down of intangibles at our legacy IPA operation. The $27.5 million write-down figure represents just the continuing operations portion of that write-down.

We’ve discussed that write-down on prior calls so I won’t expand on it any further at this point but obviously if you’d like to hear more we can cover that in the Q&A. Operating income for the full year was $23.7 million compared to last year’s operating loss of $27.5 million. Focusing on the segments, firstly the IPA management segment, during the fourth quarter revenues were $52.1 million, that was up slightly from $51.4 million in Q4 2007.

During the 2008 quarter ProMed contribution and rate increases were a positive contributor offset by the impact of slightly lower HMO enrollment. Our IPA segment generated operating income of $5.7 million during the quarter as compared to the operating loss of $27.5 million in the prior year and for the year our IPA segment generated operating income of $13.2 million as compared to an operating loss of $24.1 million in the prior year.

Then at the hospital services segment revenues for the 2008 fourth quarter and full year were $35.6 million and $126.7 million respectively. For prior comparative purposes namely the 54 days between Alta’s acquisition date and September 30, 2007 hospital services revenues were $15.6 million.

Given Alta’s mid-quarter acquisition date in 2007 exact period-over-period comparisons are difficult however as Sam as said, our hospital services segment performed well above prior year for almost all key metrics.

Consolidated G&A expense for the fourth quarter was $14.3 million compared to $10.5 million in the fourth quarter of 2007. For the year consolidated G&A expense was $57.4 million or 17.4% of revenues as compared to $31.9 million or 19.6% of revenues last year.

Most of the dollar increase in G&A expense in the current year relates to the increased scale of the company following the ProMed and Alta acquisitions though G&A expense as a percent of revenue was about 2% lower in the current year then in the prior year.

Also as you’ll see in the normalized EBITDA tables we provided with our earnings release there are approximately $9 million in non-recurring costs and expenses in 2008 most of which were G&A type items.

The point being that the greater critical mass of the combined enterprise requires greater G&A expense however keeping those expenses in check is definitely top priority. You’ll also see in this year’s Form 10-K filing that we are now separating out the holding company expenses both to give you a better sense on how we’re managing those holding company costs as well as a clearer picture hopefully of how each of the separate operating segments are doing.

Interest expense was $6.3 million in the 2008 fourth quarter, up from $3.9 million in the fourth quarter of 2007 and full year interest expense was $22.3 million as compared to $5 million in the prior year, with all of that increase attributable to the acquisition-related debt.

We’re certainly able to service this debt, its clearly a lot of debt at very high rates, and a key focus area for us in 2009.

While on the subject of debt, there are two other debt related items that had a significant impact on our P&L this past year. Firstly when the terms of the debt were modified back in April, May of this past year, those modifications were treated for financial reporting purposes as extinguishment of the prior debt and creation of new debt.

So with the extinguishment of the old debt all previously capitalized or deferred financing costs were required to be written off and that resulted in an $8.3 million non-cash loss and debt extinguishment in the 2008 year.

We don’t expect that item to recur. Secondly though related to the debt modification, an item that will recur, is that our interest rate swaps must now be accounted for as derivatives. This accounting treatment means that swings in the market values of those interest rate swaps which are very significant especially in the current financial climate now run through our P&L.

This change in swap market value resulted in $976,000 of expense in the fourth quarter of 2008 and a $3.1 million gain for the full year. Those quarterly fluctuations in the value of our swap arrangements which correlate directly with fluctuations in LIBOR rates will continue to be large and could be either gains or losses and though they are non-cash items as long as we don’t terminate those swap contracts, they do significantly impact our P&L.

Income from continuing operations for the fourth quarter was $1.1 million or $0.01 a share as compared to a loss from continuing operations of $24.7 million or $2.44 a share in the prior year period. And for the full year the loss from continuing operations was $2 million or $0.68 a share as compared to a loss of continuing operations of $23.5 million or $2.90 per share last year.

The sale of the Antelope Valley entities generated a large gain for both the fourth quarter and full year of 2008 resulting in income from discontinued operations of $6.3 million and $6.2 million for the quarter and year respectively largely as a result of this gain on sale, net income for the fourth quarter of 2008 was $6.5 million or $0.32 a share as compared to a net loss of $34.4 million or $3.25 a share in the same period a year ago.

The net loss for all of 2008 was $2.6 million or $0.20 a share as compared to a net loss of $34.6 million or $4.08 a share last year.

And lastly on our P&L the fourth quarter of fiscal 2008 was the last quarter in which we recorded dividends on the preferred stock issued in connection with the Alta transaction. At our Shareholders Meeting in August, the conversion of those shares into shares of common stock was approved and as a result the accrued dividends amounting to about $6.8 million in fiscal 2008 were cancelled and the liability reclassed to equity.

There will be no further preferred stock dividends recorded in our P&L going forward. Now given the very significant level of unusual items this past year such as write-downs of intangibles, debt modification charges, gain on sale of non-core operations, interest rate swaps, preferred stock dividends, and various other non-recurring and unusual items, we recognize that our P&L isn’t that easy to follow.

So in our earnings release we provided a table reflecting normalized EBITDA for the past four quarters which is identical to what we use internally to track our progress. Normalized EBITDA as Sam mentioned was $40.1 million from fiscal 2008 and on a quarterly basis was $8.4 million, $9.9 million, $10.2 million, and $11.6 million for each of the last four quarters.

Then if you look at our cash flow statement you’ll see that for the 12 months ended September 30, 2008 we generated $12.3 million of operating cash flow, that’s up from $6.8 million for the prior year.

Turning to the balance sheet we had cash and equivalents of $33.6 million at September 30, 2008, an increase of $11.5 million for the year after all debt service and the various one-time items we’ve mentioned. Our [inaudible] debt at September 30, 2008 was approximately $144 million, down from $149 million at June 30, 2008 and as Sam mentioned the reduction reflects the additional $4.2 million paydown from proceeds of Antelope Valley sale as well as the regular quarterly principal payment.

We’ve met all of our principal and interest obligations on time and without exception and continue to do so. Obviously debt service is our single biggest expenditure outside of caring for our patients and we continue to focus on ways to chip away at that cost.

Net debt at September 30, 2008 was $110.4 million, net debt being long-term debt less cash on hand and our net debt to normalized EBITDA ratio was 2.75. That’s still higher then we’d like it to be but since September 30, we’ve made one more quarterly principal payment of $1.25 million and supplemental principal payments of another $3.9 million.

That concludes my prepared comments but I’d be happy to answer any questions you may have during the Q&A session.

With that I’ll turn the conversation back to Sam.

Sam Lee

Thanks Mike, in summary we had an interesting 2008 to be sure. But it is time now to focus on 2009 as we have already and look forward. I think you’ll see us being very focused and purposeful with a very efficient care delivery model as a cornerstone of our strategy.

We’ve been doing this for a long time and I feel supremely confident in our team and our blueprint and we are battle tested. We’re optimistic about the future.

Thanks for your attention and at this point let’s open up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Sam Rebotsky – SER Asset Management

Sam Rebotsky – SER Asset Management

As far as the derivatives situation, if an increase of 1% in LIBOR, what impact will that have on your P&L.

Mike Heather

I can’t give you a definitive answer. I don’t know mathematically what that translates to but it’s a lot. I’ll give you an example that LIBOR, when we think rounded the turn at 9/30/08 it was just over 3%. Its just over a percent I think right about now and that’s effected us in the P&L to the tune of about $8 million. So it’s a big number, it has a big impact. Its non-cash, it’s a nominal item. We define nominal as just a mathematical item for now and obviously as the duration of those swaps lessens which it will over time and as the size of those swaps lessen as they will over time because they correspond to our debt amortization, those swings will get less and less wild.

But for the quarter that we closed out in December I think our number is going to be an $8 or $9 million negative swing on those swaps. Like I said its non-cash and it can’t go much further and over time those swings are going to net to zero. But they’re big numbers. So I don’t have a specific answer to your question other then maybe you can glean from those numbers of the magnitude of how it impacts us.

Sam Rebotsky – SER Asset Management

So to the extent that the December quarter is impacted, going forward it would be positive, it would have to go the other way, it can’t go any more.

Mike Heather

That’s correct unless if LIBOR falls below one, then it will keep heading in that same direction on our P&L but if LIBOR starts rising again then the P&L impact would be a pick up to the P&L, but that’s exactly right.

Sam Rebotsky – SER Asset Management

To the extent the number of patients you’re seeing, has there been based on the economy, has there been any reductions or people willing to do medical procedures or stuff that would impact you, how do you relate your business, what’s beyond your control and what’s under your control.

Mike Heather

From a seasonality point of view, we’ve got a cross over, we do better in the hospitals during the colder winter months. They have a seasonality there where there’s greater utilization. On the IPA business seasonality is that we do better in the summer months when there’s lower utilization and we’re getting the same premium for it.

And by the same token I think what you’ll see is that on the IPA side of the business HMO enrollment you continue to see some migration to PPO. Fortunately that is not as noticeable at the senior member lever with the Medicare advantage members and that’s where we make all our money frankly but we continue to see pressure on our HMO membership both from the PPO migration and from the economy.

On the hospital side, the hospital census has been running very high and a good kind of census, case mix index.

Sam Lee

There’s a, obviously generic or macro type question, but for us in our environment here, there’s a saying, healthcare services is a local business not a national business and the dynamics are much more underwritten by the local dynamics in Southern California we are, there are lack of beds.

Moreover many hospitals are struggling, the ones that run inefficiently. So by virtue of that and the favorable curve which is the population growth versus the number of beds ratio has given us the opportunity to really have some wind at our backs on the volume side. So as long as, again we keep focused methodical and cost efficient and deliver good quality care we should be in pretty good shape.

Sam Rebotsky – SER Asset Management

Do you expect your operating margins to improve going forward and what are you going to do that’s in your control to reduce interest expenses other then the swaps, your expensive cost of money, what’s your expectations, are there certain abilities if you perform well to replace expensive debt with cheaper debt.

Sam Lee

We expect our margin to improve and I guess really the qualifying question on it is have our margins improved quarter over quarter, generally yes. Do I think that the business has matured in the way of efficiencies, absolutely no. At what point will we mature, and that’s a function of a number of things, but all things being equal it won’t be for awhile as far as I’m concerned.

And as far as improving our capital structure vis-a-vie our debt structure, what’s within our control is to continue performing which improves our debt profile, our credit profile and at some point sooner then later hopefully we’ll have better terms.

Operator

Your next question comes from the line of Michael Potter – Monarch Capital

Michael Potter – Monarch Capital

Can you give us kind of a 30,000-foot view of where you see Medical, what’s going on in Southern California market and any of the issues with regards to the California budget which could effect reimbursement rates.

Sam Lee

As far as the pressures on the California budget and how it extends to Medical we’ve been dealing with the state of California budgets pretty much every year. Is this going to be an extraordinary year, we are prepared that its an extraordinary year but we’re prepared that its going to be an extraordinary year every year.

And part of what I speak to about being battle tested is really being, is our preparedness and part of the reason why we obviously find some relief in having some additional cash on our balance sheet versus last year.

But I don’t want to chase ghosts. We can’t control what we can’t control and I think that because of our cost efficient model, quality model, we will be the best performer in my opinion. As far as how it relates to Medical really the same response. But for us on the hospital side, our rates are contracted and locked in for multi years so it won’t be an immediate impact and so as far as the current budget issue it should not apply there.

As a correlation to this would be what are the dynamics and what are we preparing for, what are we thinking through vis-a-vie this recessionary period and this is one in which again there’s so many different variables here, I think that from an operating perspective as I’m sure many investors and many operators experienced, it’s a humbling period for the world in which maybe some of the stronger operators are benefiting because we are a stable place to work and the various vendors that supply to us, it is a humbling period and we are again a stable place to be selling goods to.

I think that there will be some nuances in the arena of bad debt but I think because of our [peer] mix we shouldn’t be too effected. And again part of this will exacerbate either weaker or less efficient operators whether it be IPAs or hospitals, to struggle which hopefully it will be a benefit to us in some level of correlation.

And so those are the general thoughts that go through our mind as we peck through our P&L relative to the outside world right now which of course we can’t control.

Michael Potter – Monarch Capital

When you describe the Alta business in the presentation you mentioned that some of the key metrics were up across the board, utilization rate, patient revenue per admission and per day, can you quantify those for us.

Sam Lee

Let us get back to you but in broad strokes our admissions are up year-over-year probably in [inaudible] of 10%, our length of stay which is certainly a key indicator of stable and my opinion optimal especially as it correlates to good quality of care, our [denial] rates stable or even lower, our primary cost indicators are down meaning staffing, pharmacy, supplies, etc. by a few percentage points.

And that’s on the hospital side of course. As it relates to the IPA side of the business and I really focus on, because ProMed one of the IPA arms, is a nice performance and on the legacy IPA side of the business some of the key indicators is that from a year-over-year comparison its kind of a mixed bag however if you look at the last quarter compared to the whole year we’ve had probably a good point improvement in our medical loss ratio. Our G&A has gone down about 3%, these are driving items obviously.

Let’s say our claims expense PMPM, is down probably a solid 10% in that area again in general and again staffing and other things we drive on efficiencies. Our holding company expenses have gone down on a monthly level of about anywhere from $200 to $300,000 a month which is now sustainable and holding and obviously I leave you with the fact that we’re not satisfied in any area and we keep grinding.

Michael Potter – Monarch Capital

On that the legacy IPA business is now profitable or EBITDA positive.

Sam Lee

Yes.

Michael Potter – Monarch Capital

So you’ve been able to return it back to profitability over the past year?

Sam Lee

Yes.

Michael Potter – Monarch Capital

One thing, the sequential growth in EBITDA has been terrific. I guess we’re running at about 13.2% for Q4, and we’ve been up again every quarter over the past year, you mentioned in the third quarter call that your target was for 15% that you thought was reachable in the fairly near term, do you think we’ll be running at that rate for 2009. We’re close, that’s for sure.

Sam Lee

Yes, thanks for reminding me of that because directionally we’re getting closer right. We’d like to achieve it. It won’t be a lack of work. So that’s our initial target and again we’d like to get there as soon as possible.

Operator

Your next question comes from the line of [Anthony Markie] – Monarch Capital

[Anthony Markie] – Monarch Capital

Now that things seem to be on track, what are your plans for investor relations, the stock really does not trade all that much and yet sort of masks, in my opinion, the progress that the company has made.

Sam Lee

As you are aware and many of you have been frustrated by my mantra over the last year which is less is more and performance not talk, what I really wanted to accomplish when I say I, meaning collectively as a team, is let’s perform first which, and its not just financial performance, its other things like compliance and I think we as a team have done a, I’m pretty proud of the team in what we’ve executed categorically, a lot of the housekeeping, a lot of the compliance, the filings, etc.

We feel pretty confident in our abilities at this point in that area and in certainly financially we wanted to through that vehicle show our performance which we have through September. I wanted to clip off another quarter here which its ended calendar wise and then report and then get out and start talking about what we’ve accomplished and to see the market understand through real performance and metrics and data versus talk so I think the window is right around the corner in which we file our next quarter and have really four quarters of solid performance in which every quarter we start dropping off what would be Q1 and Q2 fiscal of having paid for some past extraordinary items so there’s nothing really to explain except your performance and not have to keep constantly explaining the $9 million roughly of extraordinary one-time expenses from that past.

And that I believe will cliff off by end of Q3 or end of June quarter but again every quarter, some of it drops off and so to answer your question directly that’s top of mind for us and obviously doesn’t effect operations but for our investors so that they have a recognition of how the company is doing, the company that they have confidence in that they’re investing in so its reflected and again I think the best way to do it is after we’ve shown some performance which I think we are one of the three steps there in the way of reporting.

So again the K’s done, get Q1 done, have that surface more and then Q2 that surface more and then Q3 again into June is when all of the past stuff, extraordinary items are gone and during this window we’ll be out and talking to a targeted audience.

[Anthony Markie] – Monarch Capital

When you say this window, are you saying post June or between now and June, I’m not sure what you mean.

Sam Lee

Yes between now and June.

[Anthony Markie] – Monarch Capital

It would seem to me that a higher stock price does a lot for you. Obviously one of the ways to deleverage is if the stock were to truly reflect your value, you can certainly use the stock as a tool to deleverage so obviously its in everybody’s best interest to have a stock which more fully reflects your prospects.

Sam Lee

I definitely appreciate your sentiments there and it helps in several ways and so this is now the window that’s opening for us to start not necessarily talking about it but allowing, getting the focus of some targeted audiences on it.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Sam Lee

Thanks for the questions. Again thanks for your participation everyone and thanks for your, many of you who I’ve spoken to throughout the year, have shown your support and confidence and I do appreciate that and I hope that you feel that management has reciprocated through its efforts, so again thanks for your investment in Prospect Medical and have a good day.

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