AmSurg Corp. Q4 2008 Earnings Call Transcript

Executives

Christopher A. Holden – Chief Executive Officer

Claire M. Gulmi – Chief Financial Officer

Analysts

Brendan Strong – Barclays Capital

Ryan Daniels – William Blair

Kevin Ellich - RBC Capital Markets

Shelley Gnall - Goldman Sachs

Robert Hawkins – Stifel Nicolaus

Whit Mayo – Robert W. Baird

Darren Lehrich - Deutsche Bank

Andreas Dirnagl – Stephens Inc.

David Bachman – Longbow Research

Jeff Englander – Standard & Poor’s

Gary Taylor – Citigroup

AmSurg Corp. (AMSG) Q4 2008 Earnings Call February 19, 2009 5:00 PM ET

Operator

Good day and welcome to the AmSurg Corporation conference call. (Operator Instructions). At this time for opening remarks and introductions, I would like to turn the call over to the President and Chief Executive Officer, Mr. Chris Holden.

Christopher A. Holden

Welcome everyone. Joining us here on the call today with me is Claire Gulmi, Executive Vice President and Chief Financial Officer of AmSurg. We’d also like to welcome not only the folks on the call today but also our participants on the webcast. It’s my responsibility now to read the following disclaimer.

Certain statements in the conference call constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect management expectations and are based upon currently available information. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results, performance or achievements of AmSurg to differ materially from those that are expressed in, or implied by the forward-looking statements.

These factors are discussed in more detail in the company’s reports that are filed with the Securities and Exchange Commission, including without limitation AmSurg’s annual report on Form 10-K for the year ended December 2007 and quarterly report on Form 10-Q for the quarter ended September 30, 2008. Copies of these filings are available from AmSurg on request.

With that, let me begin by saying that we're pleased that we produced solid growth for the fourth quarter of 2008 and met our expectation for EPS for the quarter. After my opening comments, I'll turn the speaker over to Claire for the financial summary for the quarter ending December 31, 2008.

Quickly for an overview of our earnings, for the quarter, net earnings from continuing operations increased 13% over prior year to $12.9 million. EPS increased to $0.40 or 11% over prior year, and performance is consistent with guidance given for 2008. For year ending 2008, net earnings from continuing operations increased 19%. Net earnings per diluted share totaled $1.55, reflecting an increase of 16% over prior year, and those results take into account a $0.05 negative impact per diluted share from the revised Medicare payment system.

Our same-store revenue growth for the quarter was zero or essentially flat reflecting the impact of the CMS cuts and a slowed economy. Volumes for the quarter were choppy over the three months with October being the softest, and like every one, we have concerns about short term unpredictability of the economy on our volumes going forward. We made several significant adjustments and improvements to our corporate cost structure to offset some of these economic headwinds. Most notably, we’ve restructured corporate operations reducing from four divisions to three, and adjusting the corresponding support departments. We’ve converted our GPO to the HealthTrust GPO organization and significantly reduced our equity grants for the year 2009.

Long term, the fundamentals I believe still remain very favorable. The target population is increasing and aging at a rate of somewhere between 2 to 3% on a compound annual growth rate basis. Our target population for colon cancer screening remains underserved and the first generations of screened patients are now beginning to return for their followups. The target population for cataract surgery also remains vastly underserved.

The consumer demand, technology, and market forces are driving more surgery to the freestanding ASC setting, and freestanding ASCs remain by far the lowest priced, highest quality modality of care available to patients and physicians for those services. Our patients enjoy lower out-of-pocket expenses in those settings as well.

I would also add that the creation of new ASC capacity is beginning to wind down, as the demand at the same time continues to increase, and I believe this will lead to a situation where buyers of healthcare will compete more aggressively in the future for access to this most efficient point of service, and lastly, I believe there is some possibility that as we’ve seen in similar economic downturns, a bubble of pent-up demand is likely to be created as patients delay care until the economy stabilizes.

Moving on to the development highlights, our development efforts exceeded expectations with the addition of 20 centers in 2008. We completed 13 of those transactions in the fourth quarter, and this is consistent with our history of closing 60% of all transaction in the fourth quarter of any calendar year. For 2008, on the 20 transactions completed, 19 were acquisitions, and one was a new development. We ended the quarter with 5 LOIs and 3 centers under development. The LOIs were all acquisitions, and three of those have subsequently closed in Q1 ’09. One center under development is expected to open in 2009.

Acquisition pricing remained in the 6 to 7 times ranges. Given the constraints of the equity markets, we do hope to see some contraction in multiples going forward; however, in recent experience, the acquisition process does remain competitive, and the pipeline continues to be robust. At year end, we ended with 189 centers, 132 are GI, 36 are ophthalmology, and 21 are multi and ortho. For the year, we added 15 GI centers, 2 ophthalmology centers, and 3 multi/ortho centers for a total of 20. We also divested 6 GI centers and 1 eye center netting an incremental 13 centers in the portfolio.

With that, I will hand it over to Claire to update you on the financial performance for the quarter.

Claire M. Gulmi

As Chris stated, the highlight of the quarter was the acquisition of 13 centers. Almost all of these centers were purchased at the end of the quarter, so they did not contribute meaningfully to the revenue and earnings for the fourth quarter, and the total purchase price for these acquisitions was $76 million, and we used a combination of operating cash flow and debt to fund these purchases. The aggregate purchased product was larger than previously projected due to the inclusion of a large multi-specialty center that was not under LOI at September 30^th but was closed during the quarter.

During the fourth quarter, we completed the repurchase of a little over 500,000 shares of AmSurg stock for $12.4 million. As we previously disclosed, our board has approved a $25 million stock repurchase plan to mitigate the dilutive effects of stock option exercises. Our revolving credit facility has $50 million of availability at year end, and our operating cash flow in the first quarter of 2009 was sufficient to fund the three center acquisitions that we have closed quarter to date.

Our same center revenue growth was flat for the fourth quarter and 3% for the year. In a year in which we experienced reimbursement reductions from Medicare and slower growth in the fourth quarter due to economic factors, we were able to maintain our EBITDA margin at 18.8% versus 18.7% in 2007, and this was the different result of our increased focus on cost controls both at the center and corporate level during the year.

Our tax rate for the quarter was 40.1% and 39.6% for the year. Our operating cash flow was $25.7 million during the quarter. Capital expenditures totaled $81 million, which included the $76 million for acquisitions, $1.3 million for development, and $4 million in maintenance CapEx. Our total long-term debt increased to $265 million at year end.

Today again, we are establishing earnings guidance for 2009 as follows: Revenues of $650 to $680 million, same-center revenue growth is expected to be flat for the full year which includes a negative impact of 1% from the revised Medicare rate. We plan to add 13 to 16 new centers for the year. Net earnings from continuing operations per diluted share in a range of $1.64 to $1.67 including a negative $0.07 impact from the revised Medicare rate. This Medicare reimbursement cut negatively impacts our EPS growth rate by 400 basis points in 2009. Our net earnings from continuing operations per diluted share for the first quarter of 2009 are expected to be in a range of $0.38 to $0.40.

We expect operating cash flow to be $95 to $100 million during the year and to be sufficient to fund the 13 to 16 center acquisitions and all of our maintenance CapEx. We expect our outstanding shares to remain flat for 2009 at approximately 32 million shares.

At this time, operator, I’ll turn it back over to you and open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions). We'll go first to Brendan Strong with Barclays Capital.

Brendan Strong – Barclays Capital

My first question will just be on the revenue guidance for the year. Is it pretty much safe to assume that you might get the revenue you did in 2008 and at the low end of your guidance for 2009. That seems like almost all of that could come from the acquisitions you did at the end of the fourth quarter. Is it the right way to think about it?

Claire Gulmi

That is essentially what is happening because we’re budgeting flat same-center revenue growth.

Brendan Strong – Barclays Capital

Then the high end of the range, it kind of depends on when you close on those other 13 to 16 acquisitions?

Claire Gulmi

Exactly.

Brendan Strong – Barclays Capital

In light of the fact that you’re anticipating the flat same store growth, how do you think about margin expansion? Are we in a situation where the best outcome is flat margins because of cost controls? There is probably going to be some cost pressure as well, so how are you thinking about that for the year?

Claire Gulmi

I think we did a really good job in 2008 controlling the margins when we were dealing with just the Medicare reimbursement cuts, but as we look into 2009, when we have flat same center which would lead to negative profit growth for those same center groups, plus the Medicare cuts, I don’t think we’ll be able to fully offset the expenses, so I think you’ll see about a 100 basis point decline in EBITDA margins this year.

Brendan Strong – Barclays Capital

Just thinking about the first quarter guidance, one of the questions I would have is other providers have been talking about making a bigger deal out of copay or particularly deductible resets, and people may be pushing back procedures till later in the year when they’ve gone through their deductible. Do you have any concerns around that?

Claire Gulmi

Well, we’ve got some decent visibility since we’re two weeks into February. January was a little slow, but January is always slow, and the timing of holidays and so on, but February seems to be in the range of where we expect it to be and right on target, so at this point, I think we feel comfortable with that.

Operator

Your next question comes from the line of Kevin Ellich with RBC Capital Markets.

Kevin Ellich - RBC Capital Markets

I was wondering if there was anyway you could break out which specialties or any geographies where you noticed more weakness during the fourth quarter.

Claire Gulmi

We were struggling to identify that. I think we see a little bit in Florida probably. We have a couple of centers in Michigan and a couple in Ohio, and I think those are probably the ones that are feeling it the most.

Kevin Ellich - RBC Capital Markets

Are you seeing any weakness in the GI centers, or is it more of the multi-specialty?

Claire Gulmi

We don’t have enough multi-specialty for us to get a good statistical sampling there. They have been fairly strong throughout the last 4 to 5 months, and it’s really been most in GI and Ophthalmology that we’ve seen a little bit of the reduction.

Kevin Ellich - RBC Capital Markets

Just wondering what the pricing environment is like with the commercial payers. Does it remain challenging or have you guys gotten any decent pricing increases?

Chris Holden

No major changes there, Kevin. It hasn’t been a huge issue with the commercial payers. Most of our attention has just been on a forward-looking basis at where Medicare is headed.

Kevin Ellich - RBC Capital Markets

You talked about the acquisition multiples. Just wondering, is the pipeline as robust as it has been in the past? I mean 13 to 16 centers looks pretty good. Is it as competitive as it has been? How is that coming in?

Chris Holden

I think it’s more robust. Let’s back up and remind the group that this is still a very, mom and pop is not the right word, but it’s not a highly corporatized environment. Most of the centers in the US are single entities or in small groups, and as the regulation increases and the demands for transparency on the quality, the capital constraints, and all of those pressures mount, I think those owners are starting to feel that, and look to organizations like ours to help navigate through those processes and bring some value-add along those lines. I think that’s driving it in part, and then just the overall uncertainty of where reimbursement is headed. I think a lot of physicians have had their personal portfolios affected, and we still have the desire for liquidating events, so there are a lot of positive forces that are driving the pipeline, or negative forces depending on your perspective, and it has been particularly robust in the first quarter of this year. We’ve had quite a few things to look at right out of the gate, far more than at the beginning of last year, so for that reason, Kevin, I’m pretty optimistic, or it’s fair to say I’m not worried about the development opportunities over the next year. We do see that the list of players at the table has probably declined in the competition, but there are still some good ones there. Hospitals have shown up more often, more than ever in the past over the last 6 to 8 months, I think driven by maybe the unintended consequences of the Medicare payment change that puts an automatic 40% price increase on the same book of business for those providers and create a windfall to the hospitals for the acquisition of those centers, and we see that more often. It doesn’t certainly make the system more efficient, but that’s what’s happening. That’s a longwinded answer to your question, but that’s what we see.

Kevin Ellich - RBC Capital Markets

Has your appetite for doing larger deals or chain deals changed, or what’s your opinion now?

Chris Holden

We’re still prospecting along those lines, and the rationale being that we can be very choosy and look for those value buys in this market. John Ransom is on the phone. He made the point the other day that some of those players have to do mark to market and reconcile their valuations with our valuation, and that’s going to create opportunities, so we’re just keeping our ear close to the ground for that and not ruling it out. I would add that a key driving force is our credit facility and maintaining the integrity of that for the duration of the term on that.

Kevin Ellich - RBC Capital Markets

In the past, we’ve talked about ancillary businesses or segments that you guys are looking at. Are you still considering anything, and could you talk about that now, or has that changed given the environment we’re in?

Chris Holden

One of the other trends that we continue to see is the super-grouping, we call it, of physicians particularly GI physicians across the country to make larger groups, so that they can take advantage of building ancillary lines of business and create the scale needed to do that, and we’ve reorganized internally to create some expertise to facilitate that with the physicians and through that process looking for opportunities to perhaps work with them as we expand our services to include perhaps more than just a surgery center to some of the ancillary lines of business.

Operator

Your next question comes from the line of Shelley Gnall with Goldman Sachs.

Shelley Gnall – Goldman Sachs

One followup on the same-site revenue growth. It looks like for the first three quarters of the year we saw the implied procedure growth was somewhere around 4% to 5%. Am I correct in thinking that the flat same-site topline guidance implies procedure growth of somewhere around 1% to 2% for next year?

Claire Gulmi

That’s correct.

Shelley Gnall – Goldman Sachs

In the fourth quarter, the lower salary and benefit expense, Chris, I’m assuming that that reflects the reductions in corporate overhead, the changes that you made in operating divisions. Was there anything that either benefited the quarter or maybe put pressure on the quarter? Where there any severance payments included in the fourth quarter or is this a run rate we can expect going into 2009?

Claire Gulmi

There was an unusual item that slipped some of the expense out of salary and benefits down to other operating. You can see that as a little bit higher, and what that was is the investment loss that we incurred which was obviously worse in the fourth quarter than in any other quarter during the year on our deferred compensation plan. It is a reduction of salary expense, but an increase in other operating. It has a zero effect on the bottomline, but it moves about 50 basis points of expense out of salary and benefits down into other operating, so I think the average for the year is more appropriate than what it was for the quarter, and again as I said, for 2009, we’re expecting about a 100-basis point drop in our margin, and the largest part of that will come in salary and benefits just because of the lower revenue.

Shelley Gnall – Goldman Sachs

I was just wondering if we could talk a little bit about Medicare. Looks like CMS is proposing not to cover virtual colonoscopy. Can you remind us how that could impact your strategies and the long-term implications for AmSurg?

Chris Holden

I don’t know that it would have that much of an impact on us. In speaking with our partners, the theory is that it might increase the penetration of screening for those people who balk because they don’t want to go through the scoping procedure, and it would have yielded more procedures when they had positive detection. We were really never that concerned about it as a threat, but that said, we certainly don’t have any risk now in the short term of that cannibalizing some of the business.

Operator

Your next question comes from the line of Whit Mayo with Robert W. Baird.

Whit Mayo – Robert W. Baird

Chris, can you talk a little bit more about the corporate cost structure realignments you mentioned in your prepared remarks? Just any sense for what you guys may be thinking about in terms of annual cost savings for the year?

Christopher A. Holden

Whit, if you added it altogether and be careful not declare it as savings because it’s really just changing our trajectory going forward. Some of it is savings. We did reorganize the operations function and some of the support staff underneath, and the biggest element of that was we consolidated from four divisions down to three. The rationale for that change was one division focuses specifically on the multi/ortho and ophthalmology centers. The other two are strictly GI, so we’ve got now sort of an east and a west for GI and then one division that functions specifically for the other two lines of business. That roughly was probably $500,000 to $600,000 just in the labor component. The related adjustments are about $1 million in total, and then we changed our equity. We no longer distribute equity as far down in the organization or as much, and that should net about an additional $1 million or $1.2 million in savings over our historical run rate, and that should be compounding going forward, and then we changed our GPO which should have an additional $1 dollars of advantage to us going forward.

Whit Mayo – Robert W. Baird

Most of these initiatives are put into effect at least at some point in the fourth quarter, right?

Christopher A. Holden

Yes.

Whit Mayo – Robert W. Baird & Co., Inc

Claire, how many centers are going to be in the same store count for 2009?

Claire M. Gulmi

There will be 173.

Whit Mayo – Robert W. Baird

Any sense for stock comp expense for the year? What’s the number going to be for your stock comp?

Claire M. Gulmi

For 2009, it’s about $5 milllion.

Operator

Your next question comes from the line of Robert Hawkins with Stifel Nicolaus.

Robert Hawkins – Stifel Nicolaus

Could you guys expand a little bit on the commercial rates? You said it’s about the same. What have you guys been getting? You’re going to get about somewhere between a 1% to 2% drop on Medicare, which is I guess the biggest payer, but where are commercial rates heading right now as they see Medicare dropping?

Chris Holden

We’ve seen historically at zero to 2% increase, and we haven’t had a lot of push back on it because we still are by far the lowest-priced alternative in the marketplace, and it really hasn’t been a major consideration I don’t think for them to amend that at all.

Robert Hawkins – Stifel Nicolaus

Do you guys do that center by center or do you guys have a centralized function for that?

Chris Holden

We have a centralized contracting function that we implemented last year.

Claire Gulmi

But each contract is at the central level.

Chris Holden

Yes. We don’t do corporate contracts.

Robert Hawkins – Stifel Nicolaus

I guess a lot of the margin drag is coming out of the pricing, but are you guys expecting some of the margin drag from purchase centers? If you said that, I missed it.

Claire Gulmi

No, not really because you have flat revenue growth or revenue growth and obviously some increased cost at the center level, whether its in salaries, and that would be the major place. That’s really the issue—Medicare and the flat revenue growth.

Operator

Your next question comes from the line of Darren Lehrich with Deutsche Bank

Sudeep Singh - Deutsche Bank

It’s Sudeep calling for Darren. Going back to your guidance, my understand is that it implies roughly 1% to 2% volume growth for next year, but in the event, and of course none of us are hoping for this, but in the event that volume comes in less than 1% to 2%, are there other areas within your business where you think you could try to preserve margin or squeeze out additional cost savings, if you will?

Chris Holden

Well, we’ve made some adjustments in anticipation of a conservative case, so I think we’ve pushed on as if it’s a little bit of a worst case scenario. You can always go deeper. That goes without saying, but I think the most important thing to tell you is that I think we’ve anticipated that and made the adjustments that we needed to make in anticipation of potentially a little more aggressive downturn in the economy.

Sudeep Singh - Deutsche Bank

I was curious as to in terms of your affiliated practices, how extensively are you guys using physician assistants, and is that a strategy that you guys can see as a way to kind of maximize the time of your GI doc?

Chris Holden

It’s funny. I just had that conversation with the leadership of the ASGE Medical Society. It is not widespread, and the primary barrier is that there are very few properly trained assistants, and there is no well-recognized training program right now. I think that over time that is likely to be a solution. We do have some centers that have implemented it, but right now, the short answer is it’s a market to market decision, physician group to physician group decision. Most have not adopted it.

Sudeep Singh - Deutsche Bank

Claire, just one housekeeping question. Could you maybe give us the procedure and revenue mix?

Claire Gulmi

Procedure volumes: GI 80%, ophthalmology 13%, and multi at 8%. On the revenue side, GI at 68%, ophthalmology at 19%, and multi at 13%.

Operator

Your next question comes from the line of Andreas Dirnagl with Stephens Inc.

Andreas Dirnagl – Stephens Inc.

I’m trying to put together the various aspects of the components of the flat revenue growth for next year. If we’re talking about 1% to 2% overall volume growth, we’re talking about a negative 1% impact from Medicare, doesn’t that imply that commercial pricing assumption has to be flat to slightly negative to get to flat revenue growth for the overall business?

Claire Gulmi

I’m sorry. Say that again, Andreas. I’m not following you.

Andreas Dirnagl – Stephens Inc.

We know that your assumption is about 1% to 2% overall volume growth. We know that Medicare is a little bit of a negative hit on a pricing perspective. Does that not imply therefore to get to flat revenue growth overall that you’re assuming sort of flat pricing on the commercial side and maybe even slightly negative?

Claire Gulmi

No, we’re not. I’m trying to think through your question. I probably need to do that offline, but we do have some price increases from commercial in our budget in 2009, so we’re not considering that the commercial payers will cut their rates, so I’ll need to think about that Andreas and answer that question later.

Andreas Dirnagl – Stephens Inc.

The overall development growth has been really good, but it’s been almost entirely acquisition oriented. There is hardly any de novo development. You’re only going to have one that’s going to come online in 2009. Is it as simple as the doctor finding it harder to get credit at this point in order to do those programs, or is there something else that’s driving that?

Chris Holden

That’s a great question, and it kind of goes hand in hand with your managed care question as well, but I think the short answer is, Andreas, we’ve reached the pinnacle of the growth curve or passed it really. Up till ’05, we were growing centers at about 10% to 11% per year and creating new capacity, and then in ’06 and ’07, it dropped to the 4% range, and no one knows yet for ’08, but if it’s 1% to 2%, I’ll be shocked, and for ’09, I’m guessing it might be negative. I think with the credit crunch and the compression on margins, I’ve had this discussion with the rule makers, and the perception is that AmSurg is the proxy for the space, and everybody is healthy, and the truth is that that’s not the case. The dynamics across the board probably more closely resemble hospitals where a third don’t do very well, a third are cash flowing, and then a third do well, and most of our transactions or almost all of them are with the top third, so we represent the tip of the iceberg, and that’s part of my earlier comment. I think that we’re now in a mode where consolidation is probably more prevalent than new development. We still get new development. Our source tends to be with our existing centers in markets where we do well and have an expansion story. We average 1 to 2 a year doing it that way, and we don’t see that really stopping as we go forward, but you’re now at a time where there are roughly 110,000 eligible physicians. If you do the math, that’s about 20 physicians per center in the US, so there’s not a lot of excess uncommitted physician capacity out there to do a lot of new deals. You do find them from time to time, and we found one this last year. It was a new market that was good, but that’s a tough proposition going forward, and I think if ’09 proves to be negative, which I think it will, and then flat going forward, I think there’s going to be a real competition to purchase the capacity in the surgery enter environment because of our pricing advantage, and we’re already hearing physicians say they’re rethinking their strategic planning around targeting more commercial business and getting more focused in that area. So it’s been a wakeup call for them, and it has prompted some good thought process along those lines, and I think it will lead to continued strong pricing or about the same as where we are and more competition for commercial buyers of healthcare to take that capacity. That’s a long answer for you, but that’s what I see happening.

Andreas Dirnagl – Stephens Inc.

That’s great, and I just want to clarify. I guess the assumption there is what you’re talking about is capacity in your existing specialties of GI, ophthalmology, and there really is no specialty on the horizon that looks like it’s suddenly going to start moving to single specialty outpatient centers in the near future.

Chris Holden

No. I’m speaking to the entire universe of freestanding outpatient capacity.

Andreas Dirnagl – Stephens Inc.

Claire, you gave some great color in terms of maybe seeing a little bit of a differential impact from a couple of geographies. Was there any differential impact between the specialties?

Claire Gulmi

Not really. As I said, we don’t have a large sampling of multi-specialty. I’m not sure that one center that has a new physician can distort the whole percentage, but they really did better. GI and ophthalmology were similar.

Operator

Your next question comes from the line of Ryan Daniels with William Blair.