Virtual Radiologic Corporation Q1 2009 Earnings Call Transcript

Virtual Radiologic Corporation (VRAD)

Q1 2009 Earnings Call

April 27, 2009 4:30 pm ET

Executives

Rob Kill - President and Chief Operating Officer

Len Purkis - Chief Financial Officer

Mollie O'Brien - Director of Investor Relations and Public Relations

Analysts

Ryan Daniels - William Blair & Company, L.L.C.

Shelley Gnall - Goldman Sachs

Brooks O'Neil - Dougherty & Company

Presentation

Operator

Welcome to the Virtual Radiologic's Q1 2009 Earnings Call. Today’s call is being recorded. At this time for opening remarks and introduction, I would like to turn the conference over to, Ms. Mollie O'Brien. Please go ahead, ma'am.

Mollie O'Brien

Thank you. Before we begin, I'd like to let everyone know that during today's conference call, we'll be making certain forward-looking statements about management's expectations that are not limited to historical facts. These forward-looking statements are based upon current beliefs, assumptions and expectations regarding future events, and involve risks and uncertainties that could cause actual results to differ materially.

For examples of such risks and uncertainties, please see our annual report on Form 10-K as well as our other filings with the Securities and Exchange Commission. Any forward-looking statements speak only of today and we do not intend to update forward-looking statements to reflect facts, assumptions, circumstances or events, which have changed after the statements were made.

We will also be discussing some non-GAAP financial information on today's call, such as adjusted net income and adjusted EBITDA. For a reconciliation of each non-GAAP measure we discuss today to, it's most comparable GAAP measure, please visit the investor relations portion of our website, ir.virtualrad.com, and click on events and presentations.

And with that, I'd like to turn the call over to President and CEO, Rob Kill.

Rob Kill

Good afternoon, everyone and welcome to our first quarter 2009 conference call. Joining me on today's call is Len Purkis, our Chief Financial Officer.

We delivered an outstanding quarter of growth in an extremely challenging economic environment, which speaks to the strength of our business model, as-well-as the focused efforts of our affiliated radiologists and the team members who support them and support our customers.

Revenue grew 23% to $28.6 million, generating adjusted EBITDA of $5.6 million, which represented 40% growth over prior year. We were cash flow positive at end of the quarter with $33 million in cash and investments and we remained debt free.

Volume was up 30% in the quarter with continued momentum in our final's business. Our final's volume grew 53% in the first quarter, coming off with a 46% volume increase in the fourth quarter of 2008. We finished with 212 facilities, sending us final's compared to 137 during the same period last year. Final's represented 27% of our total Read revenue in quarter one.

Year-over-year, same-site volume growth was 2.2%. There has been some conjecture that the weak economy would lead to a significant change of behavior by our radiology group customers as they looked into our studies to save money. However, the fact that the same-site growth rate has been essentially the same over the last nine months, suggest that we are not seeing any accelerated change in behavior.

If you think about it, nighttime volumes still represent a small percentage of any group’s total volume. Virtual Radiologic or vRad was founded because our customers realize that it was a bad economic decision, as-well-as quality of care decision on their part to have a high paid, underutilized radiologist on-sight during these non-peak times. Based on recent discussions with our customers, we believe that this is still the case today, as most groups other than the very large one have come to the conclusion that the economics don’t work, than source through night time volume and that's why the teleradiology business model is so strong.

In considering our same-site volume growth, it's also important you understand, how the rate is calculated. We include only facilities that have been under contract for at least 15 months at the end of the measurement period and who are customers throughout the entire measurement period.

One-third of our facilities served had been live for less than 15 months, which means there is no same-site comparator and therefore they are included in the same-site calculation. Growth in the number of facilities served as well as customer retention rates need to be considered in conjunction with the same-site volume growth rates to get an overall view of the health of our business.

To that end, we continue to grow our customer base and ended the quarter with the customer count, 27% higher then the same time last year. We now provide radiology services to 1050 medical facilities. Our customer retention rate was a very strong 96% for the period measured from December 31, 2008 to March 31, 2009.

When you look at the combination of that 96% customer retention rate, the 27% customer growth, the 53% final's growth and the 2% same-site volume growth, you get a much more complete picture, which we believe points to a healthy growing business.

One last piece that helps complete the picture is our technology. We operate a very scalable business model with the industry's best technology platform. Our investments in technology allow us to become more efficient, as we continue to grow which means we can expand our gross margin in the face of pricing pressure.

During the first quarter, our gross margin expanded by 250 basis points from 53.4% to 55.9%, while our average price declined 5.4% compared to a year ago, generally in line with our expectations.

I’m often asked by investors, why do customers choose us over other telerad providers, and I think the best way to explain that would be through the eyes of the customer. We were recently chosen to provide services to a four-hospital health system in Pennsylvania.

The local radiology practice had been using the same teleradiology provider for over four years, but after experiencing some quality efficient care issues as well as technical support issues, they decided it was time to explore the market. They evaluated numerous vendors over a six-month period and for this they chose vRad for three primary reasons.

Number one was our quality assurance process to ensure the quality of patient care; secondly was the strength of our IT infrastructure and technical support; and lastly was the references provided by our other customers.

Our affiliate radiologists and our team members have worked exceptionally hard to earn our undisputed position as the market leader in teleradiology, and this reputation allows us to win new business typically at a premium price and also helps us maintain our exceptionally high customer retention rate.

As one final point of support for our market-leading position, if you look at the small group of clients who left us in 2008 for another provider, approximately 25% of the daily studies from that group have already returned to vRad because of dissatisfaction with the provider they switched to.

We’re currently in active discussions with other former clients, who are also considering returning to us. These customers switched to competitors because of price, and quickly came to realize that along with the lower price came compromises in service and quality of care, and as a result have switched back.

In essence, users of our services, whether they be radiologists, emergency department physicians, or hospital administrators, understand that switching to discounters in the marketplace impacts the quality of patient care.

As discussed earlier, we’ve always viewed technology as an enabler of increased efficiency in our business, and we believe it’s an area where we have significant advantage over our competitors.

We recently received FDA clearance for the largest technology development project in the company’s history, our proprietary vRad PACS. This technology achievement is important for several reasons. First off, it supports our strategy of developing software to precisely fit the very unique distributed teleradiology workflow needs we have here at vRad.

Secondly, it extends the competitive advantage we have in workflow efficiency within our teleradiology technology platform, especially by having software designed by radiologists for radiologists.

And lastly, it allows us to fully control all major components of our platform, so that we can continue to innovate with even greater speed and flexibility for greater business benefit.

Those benefits often enable our radiologists to deliver the highest quality patient care, which in turn extends our competitive advantage even further. We will roll out vRad PACS internally to our radiologists over the next several months, and expect to realize significant cost savings when we fully replace the commercial software we currently utilize.

Turning to the regulatory environment, President Obama’s healthcare reform agenda is pretty straightforward. He wants to expand healthcare coverage, make healthcare more affordable, and improve the quality of healthcare, all of which we feel will drive increased demand for our business.

While there is heightened scrutiny around imaging utilization, much of the reform discussion at this point seems to be targeted at self referral, imaging centers, and the technical component of radiology reimbursement.

We have limited exposure in these areas as the vast majority of our business is hospital based. Furthermore, our revenue is generated from the professional services component, which represents on average appropriately 20% of the total cost of the scan. We have no imbursement exposure to the technical component, which typically represents the remaining 80% of the cost of the scan.

There is also language in President Obama's proposed budget, calling for the use of radiology benefits managers, or RBMs, to reduce imaging cost. The vast majority of our business comes from visits to the emergency room, which is the care setting that will see limited impact from the RBMs.

That being said, it would be naïve on our part to think we won't see some trickled down pressure from these government initiatives. But overall, we feel the healthcare reform will be a net positive for a business.

Finally, we believe our ability to increase access to subspecialty expertise, with exceptionally quick turnaround times, in combination with our low cost delivery model will be advantage for our business, especially in rural communities, as the healthcare reform discussions continue to revolve.

Regardless of the outcome, we believe we are well positioned to adapt in an evolving market and remain confident in our ability to leave the industry and gain share during these uncertain times. The problem, there are solutions address, which is the shortage in the number of radiologists to meet the demand for diagnostic imaging services, will only continue to worsen over time, which in turn will create continue demand for our services.

I'd now like to turn the call over our Chief Financial Officer, Len Purkis, who will go through the financials in more detail.

Len Purkis

Thank you, Rob. First quarter revenue was $28.6 million, up 23% over the first quarter of '08, with volumes up 30%. The first quarter of '09 revenue is also higher than the $28.3 million in the fourth quarter of '08, and total volume was up 3.7% over the fourth quarter '08 volume.

First quarter professional services, excluding stock-based compensation and medical malpractice loss reserves, was $12.6 million, representing 44.1% of revenue versus 46.6% in the same quarter last year.

We ended the quarter with a 134 reading radiologists, consistent with last quarter, and expect to increase to approximately 142 reading radiologists by the end of the year. We have successfully addressed the over capacity we experienced in the third quarter of last year, and our continued focus on optimum utilization of our radiologist through technological innovation is key to improving our gross margin in a price pressured environment.

The resulting gross margin percent in the first quarter of '09 is 55.9%, up from 53.4% in the first quarter of '08. First quarter SG&A, excluding stock-based compensation totaled $10.3 million or 36.2% of revenue; the same percent of revenue as in the first quarter of '08.

Included in the first quarter '09 is a charge of $420,000, representing the amount due to of Sean Casey, now that he is no longer Chairman of the Board. Without this charge, SG&A would have represented 34.7% of revenue.

The recorded adjusted EBITDA is $5.6 million for the first quarter of '09. It's up 40% from $4 million in the first quarter of '08, and representing 20% of revenue, which is up from 17% last year. Excluding the one-off charge of $420,000 in SG&A, adjusted EBITDA would have been $6 million, up 51% on last year, and representing 21% of revenue.

Our adjusted EPS at $0.15 for the first quarter of '09 is up from $0.11 last year, and reflects a strong quarter in a price sensitive environment and continuing economic uncertainty. Adjusted EPS would have been $0.17 excluding the one-off charge.

Our balance sheet is strong and debt free. We were $3.8 million cash flow positive for the quarter, and ended the quarter with $33 million in cash and investments, which are held in CDs and money market accounts, and are up from the $29 million at fourth quarter of '08. We spent less than 5% of the 5 million of share buyback program approved just last March.

Now, while the first quarter of '09 was a strong start for the year, it is early in the year and we continue to be appropriately cautious about the uncertain economic environment, and the impact it may have on our customers.

We are maintaining our original guidance with the results of the first quarter of '09 suggesting that we are currently on a track towards the higher end of our guidance, which in summary, was revenue of $113 million to $117 million, adjusted EBITDA of $22 million to $23 million, and adjusted EPS with at $0.58 to $0.61.

And with that I'll open up the call to questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). We’ll go first to Ryan Daniels with William Blair.

Ryan Daniels - William Blair & Company, L.L.C.

Len, maybe a couple of questions really quickly for you. First, could you comment again on the share repurchase? I think in catch what you indicated that you guys completed during the period or maybe you can give me what you have outstanding?

Len Purkis

We have a $5 million program. We completed less than 5% of that. It was about $100,000 in the quarter.

Ryan Daniels - William Blair & Company, L.L.C.

And then speaking of your guidance, I guess I applaud it being conservative given the macro environment. But if we look back, over the last several years, Q1 was always one of the weaker quarters, and I'm curious, if it is a just a conservatism, worrying about unemployment maybe spiking up and fewer people having insurance coverage or if there's anything unique that you're looking at or modeling internally that would take us off this $6 million or so adjusted EBITDA run rate for the year, which would obviously get you well north of where your guidance currently is?

Len Purkis

Right. Like if I said, we are very pleased with the results for the first quarter, but we really need another quarter under our belt before we can reasonably take a view on the rest of the year. We feel the business model is working well. We continue to have profitable growth with a strong balance sheet. We've got positive cash flow generation that enables us to continue to grow. We've got management performing both its tasks on strategic goals, but it really is just prudency that’s letting us continue to be cautious for the near term until we see this economic environment and see how it plays out for the rest of the year.

Ryan Daniels - William Blair & Company, L.L.C.

I think that's very fair. You mentioned in your prepared comments that you anticipate having a 142 radiologists by the end of the year. I think before it was 147. Is that just improvements on your system that are going to drive more efficiency and allow you to add or maybe even above the high-end of revenue with fewer radiologists?

Len Purkis

If you go back to where we were at the third quarter, we had 134 reading radiologists, and we had the overcapacity situation. We have the same number of reading radiologists at the end of the fourth quarter and at the end of the first quarter. We've been very pleased with how we've accomplished the gross margin improvement in the first quarter. And if you sort of break down that gross margin improvement, there's about $3.8 million of dollar improvement from the volume. And the 5.4% pricing equates to about a $1.6 million in price, which means we’ve been able to majoritively offset that price segregation in the first quarter by improvements in the utilization of our radiologists.

So we think the technology has enabled us to make big strides in improving that utilization and we feel that we’ve 142 rads -- getting close to maybe 142 rads by the end of the year. We put the right level of rads with the technology improvements we have made, and that we can handle the summer surge with that number.

Ryan Daniels - William Blair & Company, L.L.C.

Okay, great. And then a couple of maybe bigger ones, Rob you talked a lot about the vRad PACS system that you guys are rolling out. I was hoping you could talk a little bit about how long you anticipate that might switch, and then what level of savings? I assume there’s going to be some redundancy up from while you go through the conversion just to make sure that you have the uptime. But what might we think about in regards to annual savings after this is totally transitioned?

Rob Kill

Ryan, in terms of the timing of the rollout, it will take several months to roll it out through all of our affiliate radiologists, and we’re going to take our time to do it right. Secondly, in terms of how much we can save, I think the answer is, due to the confidentiality agreements we have with our vendors, we don’t comment on the specifics. But that being said, the savings are reflected in our guidance moving forward.

Ryan Daniels - William Blair & Company, L.L.C.

Okay, great. And then last question; you hinted on this I think Rob in your prepared comments. Just talking about the potential to gain some share in this environment, and I’m wondering if you could just talk a little bit about what you’re seeing in the market with what’s going on in the macro environment. There’s probably some smaller competitors with difficulty obtaining funding and I’m curious if that drives them to be more pricing disciplined, if it drives them to be more, almost irrational just to try to get contracts to survive? Any color you have there from the field would be very helpful? Thanks.

Rob Kill

You are right. We’re seeing competitors who don’t provide the same level of service or the level of quality of patient care, dropping prices in their attempts to win business. That’s out there. But I think what’s our advantage is we have the ability to exercise some pricing discipline and in many cases we’re still receiving a premium price versus our competition for our services because of that reputation of service excellence and quality of care.

And I as we’ve talked about in the past, competitive conversions have become and more a significant part of our business. Of the studies we brought live in the first quarter, the facilities we brought live in the first quarter, 40% of those were from competitive conversions. And we typically don’t win that business because of price. We win the business the customer is dissatisfied which the quality or service from their prior provider and when we touched on it, 25% of the smaller group of clients throughout this last year of the studies have already returned to us. So the bottom line is even with the pricing pressure we’re continuing to take share and at the same time we’re expanding our margins because of the investments in technology.

Operator

We’ll go next to Shelley Gnall with Goldman Sachs.

Shelley Gnall - Goldman Sachs

Hi, great, thanks for taking my questions. First of all, Len, could you provide a little bit more granularity on the volume growth? Can you give us the organic volume growth excluding Diagna for the first quarter?

Len Purkis

Yeah, it would have been 17%.

Shelley Gnall - Goldman Sachs

17%, okay, and is there anything, anything new that was..

Len Purkis

I’m sorry, that was on revenue. On the volumes it would have been 25%.

Shelley Gnall - Goldman Sachs

Okay. And any reason to think of that kind of a growth rate is not sustainable through the year for the organic business? Or I mean were there something specific that you want during the first quarter or any particular weakness in the first quarter that wouldn't be sustainable?

Len Purkis

I think we are just being prudent until we gave another quarter under our belt to really see how the rest of the year is going to play out. I think we've had a great quarter, you can see that from the results. We are just cautious. There is still a lot of uncertainty, and I think that the half way mark through the year will have a better view of what the rest of the year holds for us.

Shelley Gnall - Goldman Sachs

Okay. And I apologize if I miss this, but I think the pricing was down 5.4% in the quarter. Can you break out the next impact versus the just pricing pressure?

Rob Kill

Sure. The mix, Shelley, was immaterial in this quarter.

Shelley Gnall - Goldman Sachs

So you actually saw more pricing pressure in the quarter, you had mentioned at the start of the call that there was a pretty challenging operating environmental that primarily what you were referring too?

Rob Kill

No. I mean, price is just once more component. I think the challenging operating environment is, we are in the worst economic environment at least in our generation and it has an impact on consumer. There is an impact on our customers, etcetera. So, I think it's a much broader statement than just on pricing.

Shelley Gnall - Goldman Sachs

Okay. So, let just follow up on that, so I noticed, I think, your final mix as a percentage of revenues remain flat sequentially at about 27%, if I am getting that right. Is it the case that your outsourcing business have made the prelim business has held that pretty well but maybe the new business went in, final's have been more challenging?

Rob Kill

No, I don't think I'll make that assumption. I mean, our final's growth was up 53% over prior year. We are growing our business on all facets and that just on focused execution, it's by retain our customers, it's by the customer growth of 27% and same-site volume growth that we talked about.

Shelley Gnall - Goldman Sachs

Okay. Then on the board's decision not to renew Sean Casey's term as Chairman. Can I confirm that the full $420,000 came out of SG&A in this quarter and it wasn't phased through the next three quarters?

Len Purkis

No, it's in the first quarter.

Shelley Gnall - Goldman Sachs

The full charge. Okay.

Len Purkis

Full charge.

Shelley Gnall - Goldman Sachs

Can you share any color behind the decision there?

Rob Kill

Sure, I mean, I think, it's very clear. We all have a tremendous amount of respect for Sean and we are thankful for what he did to help build this company. The decision simply was a function of the annual meeting process and the board's deliberation on nominees up for election this year.

And although the board initially envisioned Sean's continued service as Chairman and as a Director following the CEO transition earlier in the year for reasons of board size, board relationships and functionality and desired to have the CEO me, served on the board. The board subsequently decided it was better for the company to continue its relationship with Sean in his capacity as the significant stockholder.

Shelley Gnall - Goldman Sachs

Then just finally a little bit of higher level question. You had mentioned, we heard that vRad is willing to be a little bit more flexible and adapt to a changing environment. Any change in your view here, your willingness to contract directly with hospitals rather than contracting generally with radiology practice group?

Rob Kill

No. I mean our view is we are supplement to local radiology groups. We work in partnership with them. I think the way the teleradiology needs to be viewed as is in a couple ways. One is, it's got a very bright future, as evidenced by our great results in an extremely challenging economic environment.

But, I think traditionally folks think of teleradiology in a very narrow way, meaning the start of is just providing remote leads in the op hours and our belief is that's not the right definition. We think teleradiology is become a really important tool for local groups and hospitals to really enhance and optimize the manner in which they provide care to their patients.

And if you look at our growth in final's over prior year, and the fact that it represents 27% of our total business, we just don't fit and haven't fit that very narrow definition, and we believe teleradiology will play a more important role in the future and we think we can do that with relations with local radiology groups.

Operator

(Operator Instructions). We'll go next to Brooks O'Neil with Dougherty & Company.

Brooks O'Neil - Dougherty & Company

I have a couple of questions. Number one, I was curious if you could provide any additional color on why the professional services amount as a percentage of revenue fell?

Len Purkis

It's a question of where we have the overcapacity in the third quarter last year. We have addressed that. If you look at compared to last year in the first quarter, we have 116 reading rads, which grew to 134. The full time equivalent of those reading rads last year was 90, and it is now at 104. So, that's a 16% increase with the read volume up 30% in the same period, and that equates to reads for fulltime equivalent rad of 5,300 last year, and that's grown 13% to 5,900 in the first quarter. So, reads were 600,000 in the third quarter. They stayed flat going into the fourth, and they are up 4% in the first quarter to 613,000 reads, basically with the same number of rads.

So, therefore, we corrected that supply-demand imbalance we had in the third quarter, and it's reflected in the first quarter '09 results.

Brooks O'Neil - Dougherty & Company

And you think that's sustainable Len?

Len Purkis

I think if you look at the breakdown of our gross margin in the first quarter, we managed to offset the 5.4% price decline by efficiencies, and my goal is to make sure we continue to focus on the efficiencies to make sure we can counteract the pricing decline, and continue to grow the volume, which is basically where we grew the gross margin in dollars. It was up $3.5 million on first quarter last year, and volume accounted for $3.8 million of that increase, so you pretty much offset price with efficiencies in the first quarter.

Brooks O'Neil - Dougherty & Company

Can you just give us any feel for the sale's pipeline? Obviously, at least, some of the strength in reads and volume this quarter relates to the tremendous success you had last year. So any help you can give us on more current what you're seeing in the market place would be great?

Rob Kill

Brooks, its Rob. We don't comment on specific sales pipeline for competitive reasons, but what we can tell you is, we continue to have confidence on our ability to grow this business in a challenging economic environment, and we're essentially on track versus where we were last year at this time.

Brooks O'Neil - Dougherty & Company

I'm just trying to understand exactly what you're telling me. When you say on track, do you mean your pipeline is roughly flat with where it was at this time last year?

Rob Kill

Brooks, let me make sure its clear. One, we don't comment on our pipeline. Two is, we feel confident in our ability to achieve our forecast for growth in this market place, and we are performing at an equivalent level to last year at this same time.

Brooks O'Neil - Dougherty & Company

Okay. I think I understand all of that. That's great. I know we talked a lot about the revenue line. I'm just curious if you can give us a couple more numbers, specifically the total revenue from reads Len; so we get a sense for whether there was some revenue from other sources, for example software?

Len Purkis

No. It was predominantly revenue from reads.

Brooks O'Neil - Dougherty & Company

Can you give us numbers in terms of total final reads volume or preliminary reads volume? Sorry to be so detailed here, but it is encouraging me to ask these questions for them?

Len Purkis

We had 613,000 reads in the first quarter; 450,000 of those were prelims, so 163,000 were final's.

Operator

At this time, I'd like to turn the conference back over to Mr. Rob Kill for any additional or closing comment. Thank you.

Rob Kill

Yes. Thank you. We appreciate your time, and we look forward to talking to you in the next quarter.

Operator

That does conclude today's conference call. Thank you for your participation.

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