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Andrea Clegg - VP, Finance

Dave Engert - President and CEO

Dave Sankaran - CFO


Brooks O'Neil - Dougherty & Company

Sean Wieland - Piper Jaffray

NightHawk Radiology Holdings, Inc. (NHWK) Q2 2010 Earnings Call August 5, 2010 4:30 PM ET


Welcome to the NightHawk Radiology Holdings Second Quarter 2010 Conference Call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions) This conference is being recorded today, Thursday, August 5, 2010.

At this time, I would like to turn the conference over to Ms. Andrea Clegg, Vice President of Finance. Please go ahead, ma'am.

Andrea Clegg

Good afternoon, everyone, and thank you for joining us. I would like to welcome you to the NightHawk Radiology conference call to discuss the company's results for the second quarter of 2010. By now, you should have received a copy of the press release, which was sent out a short while ago. If anyone still needs a copy, you can access it on the Investor Relations section of our website at

On the call this afternoon, we have Dave Engert, our President and Chief Executive Officer and Dave Sankaran, our Chief Financial Officer. After management completes their prepared remarks, we will open the lines for your questions.

Please note this afternoon's conference call is being recorded and will be available for three weeks on our website. I want to remind you that management will be making certain forward-looking statements in their remarks. All statements other than statements of historical fact that address activities, events or developments that the company believes, anticipates, intends, expects, estimates or projects and similar expressions are forward-looking statements. These forward-looking statements are based on assumptions and assessments made by the company's management based on factors they believe to be appropriate in light of their experience.

However, these forward-looking statements are subject to risks and uncertainties that could cause actual results and business decisions to differ materially from those contemplated by these statements. We describe these uncertainties and risks in the Risk Factors section of our periodic reports filed with the US Securities and Exchange Commission. The company undertakes no duty to update or revise any forward-looking statements made during this call, whether as a result of new information, future events or otherwise.

Finally, we will be presenting certain financial measures on this call that will be considered non-GAAP under SEC Regulation G. For reconciliation of each non-GAAP financial measure to the most directly comparable GAAP financial measure, please refer to the information included in our press release and in our SEC filings.

At this point, I will turn the call over to Dave Engert, NightHawk's Chief Executive Officer.

Dave Engert

I am particularly encouraged by several recent events that I would like to share with you. First, we are pleased with our overall results for the quarter, as they were better than anticipated.

We exceeded expectations on our guidance with $38.8 million in revenue and $0.10 adjusted earnings per share of which $0.07 are from our continuing core business and $0.03 from our St. Paul Radiology relationship.

Second, as I have been mentioning since Q1, we have continued to take the appropriate steps to protect the quality of our earnings by cutting more than $4 million in annualized overhead cost during the quarter. This brings our year-to-date annualized overhead cost reductions to more than $6 million per year, and another $2 million in planned expenses we have chosen not to incur.

Finally, we reached settlement with St. Paul Radiology on June 30th on the terms we expected and as previously shared with you. Results from St. Paul will obviously no longer be included in our go forward results and Dave Sankaran will discuss more specifics about this deal in his update.

I will, however, say that the $26 million settlement resulted in what we believe to be the most favorable outcome available for the company, and for our shareholders. Commensurate with the settlement we also lowered our outstanding debt by the full $26 million down to $51.8 million at quarter end and made a commitment to pay another $10 million in the near term.

Looking at our ongoing business, our volume year-over-year was essentially flat at about 1% growth, but the continued effect of price declines resulted in our quarterly revenues declining 9% from last year.

An encouraging sign, however, was that our final's volume continue to grow 37% year-over-year, which represents our most significant growth opportunity. We clearly still have some challenges to address in our core business and our priorities continue to be focused on high quality service level for our customers combined with achieving more cost effective operations.

Our earnings from continued operations and related expenses are not yet, where we want them to be. At this point, we have taken step this year to cut a significant amount of operating cost out of the business and starting in the first quarter, we begin to right size the company and flatten management by eliminating several senior level positions.

We continued in second quarter with additional reductions of 35 employees and closed several offices. We ended the second quarter with approximately 330 employees down from over 500 that we ended 2009 with. This reduction totals 55 employees in our NightHawk operations and 125 associated with St. Paul settlement.

We continue to evaluate other operational efficiencies and we are working to further optimize our workflow solution. We are lowering our professional services expense by contracting with additional positions and more competitive market rates in order to support our growing finals business.

We are also in discussions with our legacy radiologist to adjust their compensation to a more market competitive structure. While the outcome of these discussions is dependent upon reaching agreement with our physicians, we have recognized the importance and necessity of adjusting this key component of our cost structure in light of pricing decline.

We believe that these additional efforts will continue to improve our financials in Q3 and Q4 of this year and a full year impact will be realized in 2011. We have also lowered our ongoing interest expense as we paid down our debt. While we continue to focus on optimizing our cost structure, we are excited about our newly developed growth strategy to participate with our customers in the broader finals market.

We have introduced this new strategy with selective customers and have received an encouraging level of interest and support. As discussed, it is a collaborative approach to servicing the full spectrum of finals business with and through our customer. Together we will strengthen their local practice and the relationship they have with their customers.

Again it is important to me to reiterate that the strategy will be in concert with our customers and will not be competitive or predatory. Together we believe we can deliver a cost effective fully sub-specialized capability with industry-leading quality and turnaround times and capitalize on our mutual assets and delivery models. We see this new strategy as a clear win-win for all constituents, NightHawk, our customers and their customers and ultimately patients.

In addition, there are two other markets we are actively pursing that I would like to talk briefly about. Last year, together with our physicians we developed what we believe to be the most advanced QA program ever to be introduced into radiology.

We will now be launching this QA program as a service to our customers and non-customers alike. This program will provide a best-of-breed third-party solution to address the sensitive and complicated internal peer review process that Rad groups perform internally in reviewing the quality of their radiologist.

We believe that this QA program will be transformative to the industry and change the way that quality will be measured in the future. Second, we are actively pursuing the multibillion dollar clinical trials market and we have uncovered some very promising opportunities

With our breadth of high quality and some specialized physicians and further improvements in our operations, we are poised to benefit in our existing core business as well as in these new emerging market opportunities.

With that, I will turn the call over to Dave Sankaran, our Chief Financial Officer.

Dave Sankaran

Before I review our results, I want to spend a minute and describe how our presentation has changed. As you are aware on June 30, we completed the settlement with St. Paul Radiology or SPR. As part of that settlement, we sold our MPS and ERS operations to a third-party. Accordingly, these operations are now classified as discontinued operations in the company's financial statements.

This presentation, as required under GAAP, reports the revenue and expenses of the discontinued operations net in one line item on our P&L called income or loss from discontinued operation. This presentation also calls for results from continuing operation to be presented allowing historical results to be better compared with our results going forward.

Of course we didn't know when the settlement would close, when we held our last conference call. Thus the financial guidance that we gave for Q2 at that time was for the combined operation. So, in order to ensure comparability in both our press release and here in my remarks, we will discuss both combined and continuing operating results, where appropriate.

With that said, our second quarter total revenue of $38.8 million was above consensus estimate and above our guidance range of $37.5 million to $38.5 million. Our combined adjusted diluted EPS was $0.10, well above our guidance range of $0.06 to $0.07.

Revenue from continuing operations came in at $33.6 million, down 9% from the prior year. Volume of 800,000 scans was up 1% from the prior year, and was up 8% sequentially. Driving the volume increase from the prior year was new site volume growth of 10%, along with same site volume growth of 1%, offset by the impact of lost volumes from costumer attrition of 10%.

With regard to customer retention, we reported 96% volume retention this quarter, within our 96% to 98% historical range. We continue to see strong growth in the finals business. Finals volumes increased 37% in the quarter.

Finals revenue grew 10% year-over-year to $5.2 million and now represents 16% of our total revenue, up from 13% last year. Our prelim volumes declined 3% from the prior year, at same site growth of 2% and new customer volumes of 6%, were more than offset by the impact of customer attrition of 11%.

Total price declines were 10% from the year ago quarter. Preliminary price is declined by 8.5%. Finals pricing fell 20%, largely due to mix shift, as well as some market pricing pressure. Obviously we continue to see price declines in the core business.

That said, the rate of decline in preliminary pricing has lessened somewhat in recent months, and also with regard to the impact of changing mix on finals pricing, we expect that impact to lessen in coming quarters as our mixed is expected to stabilize.

With regard to volume trend, we have experienced slower same site growth in recent months. This is consistent with what we are hearing and seeing in hospital and insurance company utilization commentary.

We also believe some of the slowdown is due to our customers feeling reimbursement pressure, and as a consequence, for some customers we are beginning to see them extend their hours of coverage.

Before I discuss expenses, I want to remind investors that similar to other companies, we will be discussing pro forma or adjusted amount. Our pro forma amount excludes certain non-cash and non-recurring charges. In addition to items excluded in prior quarters, this quarter we also excluded approximately $1.1 million in pre-tax restructuring cost. A detailed reconciliation debt to GAAP can be found on our press release and in our 10-Q.

Turning to professional services expense, please note the reported GAAP professional service expense include a favorable reduction in our IBNR medical malpractice insurance reserve of approximately $1 million.

For adjusted reporting purposes, we don't include this favorable non-cash adjustment, which was driven by actuarial calculation. Thus adjusted professional services expense was $17 million for the quarter, the same as the prior year.

Adjusted SG&A expense of $12 million was also flat with the prior year. As Dave discussed, we have taken several actions to reduce our cost going forward, including the elimination of our 50 physicians in our continuing operation and closure of offices in San Francisco, Austin and portion of our facility Coeur d'Alene. When combined with the management streamlining and other actions we took in the first quarter, we expect annual cost savings of more than $6 million.

I also want to spend a minute on taxes for the quarter. Typically we expect to report an effective tax rate of around 38% to 40%. For example, we estimate our blended statutory rate for combined federal and state taxes to be about 40%, and that's the rate we use for our adjusted earnings.

On the other hand, from time-to-time there are specific transitions or adjustment that have different rate depending upon the timing and deductibility of that particular item.

Examples include stock compensation expense and goodwill and intangible asset write-offs. When these occur, we assign a unique tax rate to those items. This quarter our GAAP tax provision contained a few such item, notably for stock compensation and for allowance against certain state deferred tax asset plus our GAAP result show a tax provision despite a pre-tax loss.

Again we do adjust each of those items individually as part of the reconciliation of GAAP to adjusted earnings contained in the press release and in our upcoming 10-Q. Our GAAP interest expenses have been volatile due to the accounting impact of changes in the value of our interest rates swap contracts.

As you will recall, we hedge the interest on our debt by fixing the rate through the execution of interest rate swap contracts. As fully described in our 10-K and 10-Q these swaps essentially fix our interest rate at 5%, rather than the floating rate based on LIBOR in the debt agreement. Recently interest rates are fallen and thus the value of our hedges has fallen to a loss position of $2.8 million at June 30th.

This mark-to-market adjustment in the value of the hedges is recorded in interest expense. Also because we paid down $26 million in debt during the quarter, we had to accelerate the amortization of a portion of our remaining deferred loan fees in the amount of $1.1 million. This adjustment is also included in interest expense.

Consistent with prior periods, we have excluded the non-cash items from our calculation of adjusted earning. Speaking of earnings, second quarter adjusted earnings for the combined operations were $2.5 million, or $0.10 per diluted share, above both consensus estimate and our guidance range of $0.06 to $0.07.

Continuing operations reported adjusted earnings of $1.6 million, or $0.07 per share. Discontinued operations reported adjusted net income of 900,000, or $0.03 per share, which was above where expected and consistent with prior year in the first quarter.

Thus the above guidance performance was all in our continuing operations, where we saw slightly higher than expected volumes, price declines were bit less than expected and expenses were a little lower than expected due to the impact of our cost savings initiatives. Added all up in our results were $0.03 to $0.04 better than guidance.

Turning to cash flow, our operating cash for the quarter was $8 million. Q2 operating cash flow includes $2.5 million in collection of outstanding accounts receivable as part of the settlement with SPR.

Speaking of the previously announced our SPR settlement, we received total cash of $12 million at closing on June 30. Of the $12 million as mentioned, $2.5 million was for accounts receivable. Another $7.5 million was for a termination fee and finally $2 million was for the sale of MPS and ERS. We also received a note receivable from SPR in the amount of $14 million which will be paid in 48 monthly payments of $250,000 and a one-time payment of $2 million no later than March of 2011.

In addition to the $12 million in cash and the $14 million net receivable, we also expect a settlement result in tax refund for approximately $10 million plus the total expected value of the settlement including the expected tax refund is approximately $36 million. The note receivable is included on the balance sheet on a computed interest and the expected tax refund is included in current assets as income tax receivable.

During the quarter we repaid $26 million on a term loan reducing the outstanding balance to $51.8 million. This payment was part of a consent agreement with our lenders related to the SPR settlement and we also agreed to pay an additional $10 million no later than June 30 of 2011. Our total cash position at the end of the quarter remained strong with $24.3 million in cash and investment and our accounts receivable DSO is at a low 44 days.

Turning to guidance for Q3. The company expects to see flat to slightly higher volume sequentially. Typically, third quarter volumes are seasonally stronger than Q2 but given the lower same side growth experienced recently, we are prudently guiding for flat to perhaps slightly up. Revenue will be impacted by price declines and thus we expect revenue to be in the range of $32 million to $33 million. Adjusted EPS will also be impacted by the price decline but we will be positively impacted by the savings from our cost reduction initiatives. Thus we expect EPS from continuing operations to be in the range of $0.06 to $0.08.

With that, we will be happy to take your questions. Operator?

Question-and-Answer Session


(Operator Instructions) Our first question comes from the line of Brooks O'Neil with Dougherty & Company.

Brooks O'Neil - Dougherty & Company

Well, good afternoon guys and congratulations on all you have accomplished in the recent past. I have a couple of questions. The first one I would like to ask you is, I am very impressed with the cost savings initiatives that you've taken so far. Can you comment on whether you think you maximized on your cost savings opportunities or whether you think there are additional items you might be able to identify going forward?

Dave Engert

Hi, Brooks, this is Dave. Engert, good question. Yes. I don't think we are through yet. I think the heavy lifting on taking expense out of the company that was associated with flatting the management and streamlining some operations and closing offices, that's been done. Ongoing, we still have opportunities ahead on improving with automation capabilities some of our work flow and resource utilization.

That's been a key focus and that's going to continue and as I have mentioned, we are in discussions with our existing and legacy radiologists as we refer to them, the ones that have been with us a long time, and we are looking at ways to have a more commensurate market rate in regards to our physician reimbursements to them. Based on how that goes, I wish we hope and encourage in seeing some more cost savings coming throughout the rest of this year.

Another big thing too is, as I have mentioned, we are bringing on newer physicians that are really focused on the growing burgeoning finals business we have and the market rates we've brought them on and contracted with them are very market appropriate. So that blended with our existing radiologists we should begin to see our cost per read begin to reduce through the end of the year.

Brooks O'Neil - Dougherty & Company

Sure. Is you are feeling that process of re-contracting with some of your existing radiologists are trying to figure out where they are at with regard to their desire to continue reading with NightHawk. Are you third of the way down, a quarter, or half? How would you estimate where you are to them?

Dave Engert

It's tough question to answer because until it's done percentages of completion don't really matter. It's an ongoing process. I think our radiologists are sensitive to the market realities that we are dealing with today. They are really tremendous. I mean they have got…


…the way we are. So we have tons of respect from and the quality of their service is pretty much unparalleled. We are very appreciative of everything that they have done and continue to do but lot of the thing we are facing from price declines to some utilization slowdowns in the market and newer mixes that we are taking on that are lower cost mix such as plain films. They have come to realization along with us and lots of discussion we've had that it's market reality we have got to get to and so for I am very pleased to say they understand it and we look forward to having something completed in the near future.

Brooks O'Neil - Dougherty & Company

Sure. That's great, and then I know you have been there now for a good period of time and you've accomplished lot. I am curious if you've had any success in trying to identify what you might be able to do about the price declines in the prelim market mitigate that or?

Dave Engert

Well, I wish I could say I have a formula for slowing up price declines in the prelim market. We do see it start beginning to slow up a little bit but the reality is where we see the real market is not in the prelim market anymore. Its really, the future is in the finals market.

We are experiencing significant growth there and one of the things that we are very focused on and I am very much personally involved in is this new strategy we are rolling out to not just to do final emergent business but final routine business and to do it in concert with our customers.

So far we are very encouraged as I said, by the response and the feedback because the reality is the radiology groups customers that we have, they are experiencing challenges in the market too and so the model that has been terrific for rad groups for the last 10 plus years is really undergoing a lot of market stress and pressures just like we are.

A lot of the pressures we get are result of the pressures they get and so we are looking at the next stage of NightHawk's evolution as to be able to figure out not just how to supply a really convenient reading solution in the middle of the night but to try to provide a solution that helps them cope with these challenges and address some of the difficulties they are dealing with on utilization slowdowns on governance problems within their group and so on.

We have a tremendous set of assets and our model is terrific in what we do. They have a tremendous set of assets and relationships with hospitals and their customers and they are undergoing challenges with their model that we believe together in a combined offering, both of us have a better solution than either one of us have individually.

So this new strategy is an approach that we have to work with and through our customers to try to better engage in the markets and which will result in more finals and routine final business growth for us.

Brooks O'Neil - Dougherty & Company

That's great. I am a big believer in that as well. I have two more just quick questions. I hope. One is, I saw an article recently indicating that CMS was thinking about changing the credentialing rules. Have you heard much about that and if so, could you comment on what you think might come out of that?

Dave Sankaran

Hey Brooks, it's Dave Sankaran. I don't know the timing of the article you are referring to, but certainly there was a set of changes that CMS was fumigating that culminated this summer, that we've been speaking to and adjusting to for the last year or more. Turned out to be sort of the silent tree falling in the forest at the end of the day with very little impact on how we do business and how we credential and privilege doctors at the hospital site. So it's really had no impact on the business but that's actually reasonably completed more or less that was effective in July as I recall.

Dave Engert

But we were ready for it to go into effect in July which was the original deadline CMS gave for it. So we prepared for it and made all our adjustments internally and went back with our customers and so on. We were fully prepared to be ready for that enactment in July and then maybe a month and a half ago, two months ago, CMS decided to defer that until March of next year. So it's really a non issue at this point.

Brooks O'Neil - Dougherty & Company

Okay, that's helpful. Then, lastly, I am just curious, obviously in your press release about the St. Paul settlement you mentioned selling the assets to a third party in that St.Paul Radiology, and I am just curious if you could tell us a little bit about who that was that bought those assets?

Dave Engert

Yeah, it's a group of people that have experience in the radiology industry in particular and some of those administrative services and back office functions that were introduced to us through St.Pauls. So it was a bit of a three way transaction in the end between a company called FutureRad and us, and on the other hand there was some transactions with St.Paul that resulted in I think, Dave characterized that accurately as a good outcome for this as we could have hoped and that transaction was closed on June 30.

Brooks O'Neil - Dougherty & Company

Yea, that is great. Thank you very much and keep up the good work.


And our next question comes from the line of Sean Wieland with Piper Jaffray.

Sean Wieland - Piper Jaffray

Can you comment at all on the competitive landscape especially since (inaudible) is no longer an independent entity and specific to that the trend that you are seeing of some of your competitors contracting directly with hospitals.

Dave Engert

Okay, well in regards to (inaudible), we don't see any real market change in how they are operating in the market. They are a really viable competitor to us. We haven't seen any significant changeover with the fact that they are now privately owned. So as far as, beyond that we are, its business as usual.

We are competitors. We are good competitors and I don't foresee that changing. I do think the fact that we are now probably the only real publicly traded entity in teleradiology that we alone are going to be held to a far more public and accountable standard particularly when it comes to the second point you mentioned which is our action in the market and so on.

I strongly believe that the original mission and premise that was put in place with this company is right. I don't believe we want to ever position ourselves to really be competitive with radiology groups through our customers and that's why we have gone to an extensive way to create and develop this new approach that allows us to get to the ultimate goal of which every teleradiology company want to get is to broaden its services and solution into the bigger yet untapped market place of the daytime business.

We are trying to do it different than I think everybody else we see so far in the market and that is to do with in collaboration with and through our customers. Hopefully, next quarter we will have some more evidence of how that's are developing and turning into business. As far as those organizations that have openly and blandly decided to become predatory, I think that's a mistaken strategy. I think there maybe short term gains that ultimately will not pan out to be long term successful but time will tell.

All I can talk about is the strategy we are engaged in and that's one that we are try to focus on a win-win for everybody versus one that develop losers like some of our competitors are doing?

Sean Wieland - Piper Jaffray

A question on the radiologist's compensation. Can you give us a sense of what kind of, in percentage terms, how much that has to come down?

Dave Engert

I would love to. That's part of course to developing conversation so commenting on that would prematurely not be smart. So let me get to the conclusion on that and hopefully we will have some specifics we can talk about.


Thank you, and I am show there is no further questions in the queue. I will turn the call back over to Mr. Dave Engert, CEO for closing comments.

Dave Engert

Okay, well thank you very much. I appreciate the interest and patronage and we appreciate your support as we continue to work through the challenges and the changes and the things that we have to do in the company to get us back on a really successful growth track which I am confident we will get to and again thanks for your help and support. Take care everyone.


Thank you, sir, and ladies and gentlemen, and that concludes today's NightHawk Radiology Holdings second quarter 2010 earnings conference call. Thank you for your participation. You may now disconnect.

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