Alliance HealthCare Services' (AIQ) CEO Tom Tomlinson on Q2 2014 Results - Earnings Call Transcript

Aug. 7.14 | About: Alliance Healthcare (AIQ)

Start Time: 17:00

End Time: 17:28

Alliance HealthCare Services, Inc. (NYSE:AIQ)

Q2 2014 Earnings Conference Call

August 07, 2014, 17:00 PM ET

Executives

Tom C. Tomlinson - CEO

Howard K. Aihara - EVP and CFO

Richard W. Johns - EVP, General Counsel and Secretary

Richard W. Johns

Good afternoon, ladies and gentlemen, and welcome to the Alliance HealthCare Services Second Quarter 2014 Earnings Call. My name is Rick Johns, and I am the company's Executive Vice President and General Counsel. This conference is being recorded for rebroadcast and all lines have been placed on mute. As is customary, we will open the conference up for questions and answers after the presentation.

This conference call will contain forward-looking statements, which are based on the company's current expectations, forecasts and assumptions, including statements related to our business strategy, growth opportunities, the impact of the Affordable Care Act, the 2014 Medicare fees schedule, our 2014 guidance, our expected capital expenditures for 2014, expected cost reduction and the company's effective tax rate.

As most of you know, forward-looking statements involve risks and uncertainties, which could cause actual outcomes and results to differ material from the company's expectations, forecasts and assumptions. These risks and uncertainties are described in the 2013 guidance release under the heading Forward-Looking Statements, as well as in the Risk Factors section of the company's annual report on Form 10-K for the year ended, December 31, 2013, as such report may be modified.

The company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Financial and other statistical information presented on this conference call, or information required by the SEC's Regulation G, maybe accessed through the Investor Relations section of the company's website. And please visit our website for replay information of this call.

On today's call, our CEO, Tom Tomlinson, will provide a brief overview of our business, our second quarter 2014 results, the progress of our strategic transformation and growth strategies initiatives and our priorities for 2014 and beyond. Our Chief Financial Officer, Howard Aihara, will follow with the details of the second quarter 2014 results and confirm our 2014 guidance.

With that, I will now turn the conference over to Tom. Tom, please go ahead.

Tom C. Tomlinson

Thank you, Rick, and good afternoon, everyone. Welcome to Alliance's second quarter 2014 earnings call. As always, we appreciate your time and participation. We’re pleased with our second quarter results and the progress we have made in transforming Alliance into the outsource partner of choice for the radiology and radiation oncology service lines.

As we’ve discussed on previously calls, hospitals continue to seek outsourced partners who can bring deep expertise and the powerful value proposition to specific areas of their business. The investments we’re making in Alliance this year, our transformation year, are beginning to yield results.

On our last call, we highlighted an important win for our Alliance Oncology Division with the closing of our agreement with the Medical University of South Carolina or MUSC. This quarter I’d like to highlight a similar partnership win in our Alliance Radiology Division where we have acquired two existing diagnostic radiology clinics and merged them into a newly formed joint venture with the major for-profit operator of hospitals. We expect this single market joint venture to be the model for executing on outsourced radiology operations in additional markets with this customer.

From a revenue perspective, I’m encouraged by the performance of our oncology business which is up 21% over the prior year period. In our radiology business, second quarter revenues rebounded as expected after severe weather in the first quarter impacted volumes for MRI and PET/CT. As Howard will discuss in greater detail, revenue for the second quarter of 111.2 million and adjusted EBITDA of 36.7 million is consistent with the 2014 full year guidance ranges we’ve communicated.

It’s worth noting that overall, Alliance HealthCare revenues increased slightly in the second quarter, up 60 basis points from the same quarter last year after adjusting for the sale of our professional radiology service businesses and the pruning of unprofitable accounts. This is a positive milestone in our story as we move through the three stages of our plan from turnaround to transformation to traction.

Like many in the healthcare sector, we’ve been keenly focused on the rollout of the Affordable Care Act. During the second quarter, there was clear evidence that expanding coverage is lifting utilization in decisionable services like MRI. When we examined same-store results for MRI and Medicaid expansion states versus non-Medicaid expansion states, we’re seeing 100 to 200 basis point differential. While there are always many factors involved, our sample population covers nearly every state in the country and we believe at least a portion of this increase is a result of the Affordable Care Act.

Moreover, we note that many of the large hospitals and health systems have guided towards increased volumes from the ACA in the current calendar year and a number of these hospitals and health systems are our customers. We continue to see evidence that our growth strategy is sound and both divisions are pipelined of opportunities and strategic outsourced services continues to grow and, like the example of our new radiology joint venture, is starting to come to fruition.

We’re focused on building upon the success of these projects through the investments we have made this year in additional sales and business development talent. Of course, a part of this transformation is also operational. Our new growth strategy in radiology called RAD360 in which we provide an enhanced value proposition to our customers enabling us to be a full service radiology outsourced partner for them. Fundamental to this strategy in radiology are operational competencies that drive clinical quality with best-in-class efficiency.

In the last call, we touched on the improvements we have made in patient scheduling and that service is now at a best-in-class level. A few months ago, we announced our seventh year as an avatar award winner in patient care. And all sites across our radiology division and hospital-based radiation oncology sites are joint commission accredited, the same accreditation agency that supports quality in the majority of hospitals. These are just a few of the operational elements that we bring to our hospital customers when we engage with them to improve the performance of their radiology and radiation oncology service lines.

We remain confident that our strategy to transform Alliance into the outsource partner of choice to hospitals and providers remains on track. Our EBITDA results for the quarter included approximately 1.5 million of incremental spending to support growth and build our RAD360 capabilities, including consulting, sales, marketing and strategic development. We also invested about $1 million this quarter in the acquisition of OnPoint Medical Diagnostics within our Radiology Division.

Second quarter revenue results in Alliance Radiology were down slightly from the prior year due largely to the impact of our pruning of unprofitable accounts and challenging dynamics in the PET/CT market. Same-store volumes rebounded from the first quarter’s inclement weather slowdown with sequential improvements of 5.9% for MRI and 1.2% for PET/CT. Yes-over-year MRI same-store volumes were up by 0.3% this quarter but PET/CT was down 4.9% due in large part to payor changes and tighter RBM utilization management.

As a reminder, our dual mandate in radiology is to increase competitive intensity in our core business while also transforming in a comprehensive radiology outsource provider to our 1,000 plus hospital customers. The strength and execution in the first of these imperatives, we continue to focus on several key drivers; improved physician facing sales and marketing to drive volume at existing sites and on behalf of our hospital customers, new leadership in our sales team that’s focused on the hospital segment both retention of existing and acquisition of new customers, targeted investment in our equipment to ensure we are providing high quality competitive technology, and leveraging differential advantages such as the RAD360 diagnostic tool and related consultative services and the OnPoint data analytics technology offering in order to win business in a competitive environment.

The second element of this dual mandate driving to a position as the clear partner of choice for a hospital or provider looking to outsource their radiology service line is progressing well. The recent win noted earlier is exactly the type of outcome we’re looking to create and becoming the long-term strategic partner. Operating an outpatient radiology service line strategy for a hospital, we can make our partners more successful.

As we’re currently doing with many hospital customers, we begin this opportunity through the use of our proprietary RAD360 diagnostic tool accessing key factors and strategies within the market area. Once this market strategy was embraced by all partners, the Alliance team executed the plan which included negotiating an acquisition, finalizing the joint venture and operationally integrating the acquired centers into the care network of both Alliance and our hospital partner.

Going forward we’re focused on delivering results across a number of key success drivers including demand generation and market share capture through sales and marketing, highly efficient operations that also deliver excellence in clinical care, utilizing some of the tools that have made us a seven-time award winner and sustain our [JV] (ph) accreditation, response of patient scheduling and insurance management and the deployment of data analytics through our OnPoint offering to manage quality control and drive efficiency.

We’ve noted our increased investment in a number of key areas to drive growth in our outsourcing solution and I’m encouraged that our pipeline of new opportunities is continuing to grow. As we move into the second half of the year, I expect to see additional RAD360 contracts signed.

In our Alliance Oncology business, second quarter revenues of 23.9 million grew by 21% when compared to the prior year. A combination of strong same-store performance and revenue driven by our new strategic partnership with MUSC were the major factors driving these strong results.

Our Linac centers delivered same-store volume growth of 4.2% and our stereotactic radiosurgery centers generated growth of 4.1%. One element of our radiation oncology outsourced value proposition to prospective hospital customers is our ability to drive exceptional volume results at our sites. Our industry-leading demand capabilities result in average SRS case volumes that are 80% higher than peers.

One of the investments we’ve made this year has been to bring in a senior VP of sales strategy to support physician facing sales and marketing, building upon our strength in direct marketing tactics, our team’s focus on effective engagement with physicians is driving even greater results and further strengthening our outsourced value proposition.

Initiated on March 1 of this year, our partnership with MUSC continues to track ahead of expectations financially and most importantly for our partners we’re hitting our milestones. First, we just installed the first new TrueBeam STx and plan to begin treating patients in mid-August. Second, we’re currently in a process of reloading the radiation source for the Gamma Knife to improve its treatment times.

Finally, we plan to start construction for the installation of a second TrueBeam at the Mount Pleasant location in the fourth quarter. In short, we’re making the necessary technology investments in MUSC now that will further drive growth in the program in 2015 as we’re able to expand our service offerings.

As I mentioned on our last call, as part of our planned investment strategy we added business development resources to build our pipeline of opportunities and accelerate new contract activity. I’m pleased to say the hard work of our team is paying off and we have a robust pipeline of new opportunities.

In fact we have one transaction in final negotiation of definitive documents and several transactions currently under Letter of Intent and we expect these to move forward into definitive documents in the second half of the year. Now, of course, we’ll share more details of these once they’re fully executed.

We’ve also moved into the construction phase on the Dignity Health facility in San Francisco and we expect it to be operational no later than the first quarter of 2015. These deals and pipeline activities illustrate the success of both our business development and sales investments and overall outsourced partner strategy.

Additionally, we’re also seeing growing interest from new hospital partners and expanding our oncology relationship and service line offering to their other sites and markets. Hospital and health systems value our expertise and are looking to leverage our strengths, including the ability to develop and execute sales and marketing strategies, rapidly deploy cutting-edge clinical equipment, drive efficiencies through operational expertise and leverage a national network of clinicians to rapidly expand treatment into new disease states, all for the purpose of growing and optimizing their oncology service line.

In summary, we’ve made important material progress in our transformation of Alliance during the second quarter. We’ve made incremental investments and we’re driving solid same center volumes across both divisions with the exception of PET/CT. Success in business development activity and a growing pipeline of new opportunities mean we’re well positioned to execute on our plans for the second half of the year. We’re confident the steps we’ve taken to build and expand our offering better positions us to capitalize on growth opportunities and support growth initiatives of our hospital customers.

To illustrate this point, a recent industry survey of hospital CEOs by HealthLeaders Media showed that 72% plan to invest in patient experience improvement, 50% said they would invest in facility expansions or renovations and 42% said investment in service line redesign or realignment would begin or increase over the next three years. As a result of our hospital-centric business model, industry expertise, comprehensive services and disciplined operational execution, we believe we’ll continue to grow and deliver long-term value to our hospital partners and shareholders.

I’ll now hand the call over to Howard to provide the financial details of our second quarter. Howard?

Howard K. Aihara

Thanks, Tom, and good afternoon. Today, I’ll review the highlights of our second quarter 2014 financial performance, discuss the impact of the proposed 2015 CMS reimbursement fee schedule changes which are not significant to Alliance and then affirm our full year 2014 guidance ranges.

On the highlights from Q2, revenue in the second quarter of 2014 totaled $111.2 million compared to $114.4 million last year. After adjusting for the sale of our professional radiology service business line in December of 2013 and to a much lesser degree some pruning in Alliance Radiology totaling $3.8 million in the aggregate, we posted Q2 revenue growth of 60 basis points over last year’s second quarter.

As Tom mentioned, our Alliance Oncology revenue grew robustly in the second quarter with strong same-store volumes across both Linac and SRS and a full quarter contribution of MUSC revenue. Alliance Oncology revenue totaled $23.9 million in the quarter or a 21% increase over Q2 of last year.

Both Linac and SRS same-store volume growth exceeded 4% in the second quarter and our MUSC radiation oncology outsourcing hospital relationship contributed significantly to this quarter’s results. Also, as expected, our second quarter Alliance Radiology revenue bounced back after severe winter storms experienced in many parts of the country during January and February. Sequentially, radiology revenue increased 3% to $87.3 million in Q2 over Q1.

In the second quarter, on a same-store basis, radiology MRI volumes were a positive 5.3% and PET/CT volumes were a negative 4.9%. This positive same-store volume trend for MRI is related to both our increased marketing efforts for the referring physician community as well as a positive impact for patients that are now insured through the ACA. We continue to see pressure in our PET/CT business as payors update policies to require CTs and other less expensive diagnostic tests as well as continued pressure from radiology benefit managers.

Second quarter adjusted EBITDA was $36.7 million and totaled almost $70 million for the first half of 2014. We invested $1.5 million in the second quarter to build our sales, business development and marketing capabilities in our Alliance RAD360 program and have invested $2.5 million in the first half of this year. After adjusting for our RAD360 investments, we have produced stable adjusted EBITDA compared to Q2 of last year.

Another highlight from the same quarter is our bottom line profitability. Pro forma of diluted EPS was a profit of $0.52 in the second quarter of 2014 compared to $0.23 in last year’s second quarter. As reported, diluted EPS for the second quarter was a profit of $0.26 compared to a loss of $1.22 a year ago.

Included in the as reported diluted EPS with a $0.26 charge in the second quarter of 2014 and a $1.45 charge in the second quarter of 2013 due to the following items; restructuring, severance related to costs, legal costs, impairment, extinguishment of debt and differences in the GAAP income tax rate from our historical rate of 42.5%.

In terms of CapEx, we continue to invest in solid capital projects and efficient upgrade of our assets. For the second quarter of 2014, our CapEx spend totaled $7.5 million compared to $4.8 million a year ago. Our first half of 2014 CapEx totaled $13.3 million. We expect to spend a greater amount of our CapEx in the second half of this year as our MUSC radiation oncology project will incur approximately $11 million of CapEx in Q3.

We also expect to incur capital expenditures of approximately $6 million for the two radiology centers we acquired in partnership with a large for-profit health system in Q2 and an additional multimodality center we opened in July, all of which are part of our RAD360 growth initiative.

We also continue to generate strong free cash flow. We define free cash flow as a change in net debt before investments and acquisitions and debt financing fees. We generate free cash flow by focusing on organic growth and adjusted EBITDA, efficient CapEx spending and effective pricing of our debt structure. This focus has resulted in Alliance generating $10.4 million of free cash flow in the second quarter of 2014.

In the LTM period ended this June, we generated $44.4 million of free cash flow or $4.08 per share. This strong free cash flow generation continues to strengthen our balance sheet. As of the end of June, total leverage is 3.6 times and net leverage is 3.3 times. At the end of the quarter, Alliance had cash balances of $31 million, long-term debt totaled $508 million and net debt was $477 million.

Now I’ll make a few comments on CMS’ proposed 2015 fee schedules. Alliance is largely shielded from proposed reductions in the Medicare physician fee schedule through the vast majority of our revenue as generated from hospital relationships. Only 6% of our total revenue is directly reimbursed by Medicare.

The proposed 2015 Medicare reimbursement changes make the assumption that Congress waives implementation of the 21% proposed reduction related to the SGR formula which is not waived would be affected beginning in April of 2015. The 2015 proposed Medicare physician fee schedule reimbursement changes would decrease our MRI revenue by $300,000 or 11%.

The 2015 proposed Medicare physician fee schedule does not address PET/CT services. PET/CT reimbursement is proposed to be governed by the individual Medicare intermediaries and no impact is expected.

Additionally, Medicare physician fee schedule reimbursement related to our Linear Accelerator revenue is proposed to be reduced by 5%. This proposed reduction in reimbursement is expected to impact us by $600,000, rebuild our stereotactic radiosurgery business under an arrangement with our hospital joint venture partners or under a traditional wholesale arrangement. Under CMS’ proposal, our analysis indicate that there is a 0.5% increase under the HOPPS reschedule which would translate into a $250,000 increase in reimbursement.

In the aggregate, the proposed 2015 CMS fee schedule changes will reduce Alliance’s Medicare reimbursement by a total of $700,000 or 0.5% of our 2014 adjusted EBITDA guidance range. These proposed changes, if enacted, are manageable.

Now I’ll reaffirm our 2014 guidance ranges which remain unchanged. For full year 2014, Alliance expects revenue to range from $437 million to $462 million. As Tom mentioned, 2014 is a foundational year for the transformation phase of Alliance. We believe that 2014 will be a pivotal year in terms of growing our capabilities in a meaningful and significant way as we look into 2015 and beyond.

Our 2014 revenue guidance range also assumed a negative impact of $15 million, almost all of which is related to the sale of our professional radiology services business in December 2013. Our 2014 adjusted EBITDA guidance range is $140 million to $160 million, which includes incremental investments on our sales business development and marketing teams of $5 million to grow Alliance into the premier hospital partner for radiology and radiation oncology services. We’ll continue to remain cost disciplined throughout the organization.

Our 2014 capital expenditure guidance is $52 million to $62 million. Approximately $30 million is expected for maintenance CapEx while the remaining $22 million to $32 million is for growth projects, including Alliance Oncology MUSC project and our radiology RAD360 projects. We’ll continue to allocate sufficient resources through targeted investments designed to support long-term growth.

Our free cash flow guidance range is a range from $27 million to $37 million. Impacting our 2014 free cash flow guidance range, our cash income tax payments for full year 2014 are $14 million to $17 million, which increased from $2 million of cash income taxes paid in 2013.

At year end 2013, we had $22 million of federal NOLs and $12 million of state NOLs, all of which are expected be used during 2014, as Alliance transitions into becoming a regular cash taxpayer during 2014. We expect to pay $24 million to $25 million of cash interest payments in full year 2014.

Thank you for your interest in Alliance. We look forward to answering your questions. I'll now turn it back over to the operator to begin the Q&A session. Operator, we’re ready to begin the Q&A session.

Question-and-Answer Session

Operator

Yes, sir. (Operator Instructions). There are no questions at this time, sir.

Tom C. Tomlinson

Okay. Thank you. Thank you everyone for listening in today and look forward to talking to you again at the end of our next quarter. Thank you.

Operator

This concludes today’s conference call. You may now disconnect your lines.

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