PHC, Inc. (PHC)

F4Q08 Earnings Call

September 25, 2008 4:30 pm ET

Executives

Bruce Shear – Chief Executive Officer, President

Paula Wurts – Chief Financial Officer, Principal Accounting Officer, Treasurer, Controller and Clerk

Analysts

[Alim Talmud] – Boston Partners

Darren Lehrich – Deutsche Bank

Quinton Maynard – Morehead Capital

Presentation

Operator

Thank you for joining us today for the Pioneer Behavioral Health’s fourth quarter and fiscal year 2008 conference call. (Operator Instructions)

Before we begin today’s call I would like to take a moment to read the company’s Safe Harbor Statement. The company’s remarks during this call and answers to your questions may include forward-looking statements that are subject to the Safe Harbor Provision of the Private Litigation Reform Act of 1995. These forward-looking statements include among other things statements regarding future events and future financial performance of PHC that involve risks and uncertainties. We urge your caution that these forward-looking statements are only predictions and may differ materially from actual future events or results.

Listeners are referred to the documents filed by PHC with the SEC, specifically the most recent reports on Form 10-K and Form 10-Q. Each as it may be amended from time to time which identify important risk factors that could cause actual results to differ from those contained in the forward-looking statements. These forward-looking statements represent the company’s judgment as of the date of this conference call.

Joining us today is Bruce Shear, the company President and Chief Executive Officer and Paula Wurts, the company’s Chief Financial Officer. Following their comments we will open the call for questions and answers. I’d like to remind everyone that this call will be available for replay through October 25, 2008 starting this afternoon at 7:00 pm Eastern Time.

Now I would like to turn the call over to the President and CEO of Pioneer, Bruce Shear.

Bruce Shear

I apologize for the rush rush in getting all this out but we had a lot of events happen in the last couple of days with a pivotal transaction, so we needed to make a lot of changes to sort of get ready for this call. Thank you for joining us today to discuss the results for our fourth quarter and our fiscal year ended June 30, 2008. We’re glad to have this opportunity to address you.

I’d like to begin this call with a few comments and then I’ll turn the call over to our Chief Financial Officer, Paula Wurts, who will provide you a detailed overview of our financial results. I’ll then return with some additional comments including our outlook for fiscal 2009 and finally we’ll address any questions that you may have.

Today as you saw at the market close, we issued a press release announcing the results for the fourth quarter and our fiscal year ending June 30, 2008. The 5% improvement in net revenues over the previous quarter helped bring us to another record breaking year in annual revenue, as well as breaking the $50 million annual revenue mark for the first time.

Yesterday we announced our plan to divest the operations of our Pivotal Research Centers, which comprise our Pharmaceutical Studies segment. For some of you I understand this has been a long time coming, but I believe your patience has been rewarded by us finding an ideal buyer, a major research organization with whom we have signed a letter of intent for the purchase of Pivotal. They also represent a great home for the fine people at Pivotal who have made an important contribution into PHC over the last few years.

The terms of the sale involve $3.75 million in cash to be paid to Pioneer at the closing, plus proceeds from receivables estimated at about $1 million. The net cash received from the transaction is expected to total $4.5 million after fees and expenses, and we expect to close this transaction within the next 120 days. The company has reported an impairment loss from this sale prior to tax benefits of approximately $1.771 million.

I should also note that this net cash amount that we expect to receive is exclusive of an estimated tax liability reduction of approximately $600,000. This effectively raises the total cash value of the deal to over $5 million. The sale of Pivotal, which has represented less than 10% of our revenue over the last year, reflects our fiscal 2009 strategic plan to focus more on our faster and more consistently growing core business of delivering behavioral health care.

We intend to use the proceeds from this sale to further the operations we have under development, including key markets like Las Vegas and Detroit as well as take advantage of a number of expansion opportunities we have currently under consideration. While this sale provides us significant working capital to strengthen our core operations, the divestiture of this non-core business also eliminates the inconsistent results traditional generated by research. We can now enjoy better clarity and insight into our future revenue growth and profitability, which I will discuss more later in this call.

Now before we go any further, I’d like to turn the call over to Paula Wurts to drill down on some of the financial results for the quarter and the fiscal year.

Paula Wurts

Let’s turn now to the income statements for the fourth quarter and fiscal year 2008. For the fourth quarter ended June 30, 2008 our net revenue from operations totaled $12.8 million. This was virtually unchanged from the fourth quarter of fiscal 2007.

Our patient care segment revenue increased 2% to $10.4 million for the same year ago quarter, driven by a 6.2% increase in patient days over the same year ago quarter. Our contract support services revenue from the company’s well placed subsidiaries decreased marginally about 1% to $1.1 million.

As Bruce mentioned we announced yesterday the plan to divest the operations of our Pivotal Research Centers which comprised of Pharmaceutical Studies segment. In the fourth quarter the Pharmaceutical Studies segment revenues declined, excluding the impairment for the write down, declined 13% to $1.3 million which is due primarily to the timing of the start to the clinical research activities.

Income from operations for the fourth quarter before the impairment loss of Pivotal totaled

$380,000, a decline of 69% from the $1.2 million reported for the same period a year ago. Income before taxes and the impairment loss decreased 76% to $342,000 from $1.4 million for the same year ago period. This decrease is primarily attributable to an $183,000 or 124% decrease in the income from the operations of the Pharmaceutical Studies business segment and the start up losses that we incurred for the opening of the Seven Hills Hospital.

Net income for the quarter before the impairment loss totaled $206,000 or $0.01 per fully diluted share based on the 20.5 million fully diluted shares. This represented a decline of 75% from net income of $822,000 or $0.04 per fully diluted share based on 20.5 million shares for the fourth quarter fiscal 2007.

Assuming an impairment write down of $1.8 million, this represented the company’s 25th consecutive profitable quarter, which was sustained while incurring substantial start up losses from the company’s new Seven Hills facility that started admitting patients in May of this year. During the fourth quarter we continued to reduce our long term debt and revolving credit note balances. We decreased these amounts from the previous quarter by $291,000 to a now total of

$2.6 million at June 30, 2008.

Now turning to our full year fiscal 2008 results. For the fiscal year ended June 30, 2008 total net revenue from operations increased 12% to a record $50.3 million as compared to $45.1 million in the previous year. This was our sixth consecutive record annual increase, which was primarily attributable to our improved contribution of the company’s Patient Care segment. Revenues from this segment increased 13% over the previous year to a record $40.9 million. This is reflected by a 6.5% increase in patient days over fiscal 2007.

Income from operations for fiscal 2008 before the impairment write down was $2.9 million, a decline of 4% from fiscal 2007. Income before taxes decreased 5% before this impairment write down to $2.7 million as compared to fiscal 2007. This decrease is primarily the result of the start up losses from our Seven Hills Behavioral Institute of approximately $765,000 and an increase in the number of inpatient bed days under our company’s capitated contracts.

Net revenue for 2008 fiscal year, excluding the impairment loss, was $1.6 million or $0.08 per fully diluted share based on 20.5 million fully diluted shares. This was a decrease of 11% as compared to net income of $1.7 million or $0.09 per fully diluted shares based on 19.7 million in fiscal 2007.

Now turning to the balance sheets, the company’s cash and cash equivalents totaled $3.3 million at June 30, 2008 which decreased marginally from $3.4 million at the end of the previous fiscal year. Total net receivables from patient care was $6.4 million at year end, which decreased 1% from $6.5 million at the previous year end. The balance sheet current ratio was 2:1 at June 30, 2008.

Stockholders equity increased marginally to $18.7 million at June 30, 2008 from $18.3 million at the end of the previous year. This increase was negatively affected by the $1.8 million asset impairment write down. Our balance sheet continued to strengthen with total liabilities reduced by $1.3 million since the end of our last fiscal year.

This completes our financial presentation. I look forward to reporting back to you at the end of the first quarter with our continued progress. I would like now to turn the call back over to Bruce.

Bruce Shear

Now while our strong results for the 2008 reflect solid growth in patient care, it also means we’ve seen an increase in the utilization under our cap stated contracts, particularly in Las Vegas. While this has impacted our income over the short term, specifically the last quarter, it has triggered a process of renegotiating these agreements in future periods, meaning the potential for increased revenue and improved margins for this large segment of the business.

Yesterday it was in the news that the Senate finally passed their version of the parody bill again. Now they are working out the final language for the House for the measure to reach the President’s desk soon. The bill when signed, and we’re hopeful that it will be very quickly within the next couple of weeks, will further improve reimbursement to us as well as make behavioral health services accessible to the many that currently cannot afford them due to the high co-pays.

Now looking to the future, given the performance of Seven Hills now approaching breakeven, the divestiture of Pivotal and its [lumpy] result and no new major construction start-ups in the immediate future, we can now enjoy much better clarity into the future growth of our business beginning in January of 2009 and going forward. We feel we can expect the growth of our Patient Care segment revenue to continue to accelerate and exceed greater than 20% in fiscal 2009, which compares to 13% growth this last fiscal year.

Along with this core segment growth, we see an achievable goal of net income before taxes of 8% to 10% of net revenue as we approach 2010, and a higher percentage as we begin our fiscal year of 2011. We expect the great majority of this growth and profitability to come during the second half of 2009 as I’ve mentioned in the past, as our newest projects particularly Capstone Academy in Detroit come up to speed. We’re anticipating opening that, by the way, sometime late September.

Our overall vision for the remainder of fiscal 2009 will be to continue to drive growth and shareholder value. And I assure you, my fellow shareholders, as one of the company’s largest ones I am with you and this is and shall always be my number one priority. I’m proud to say that 2008 represented some great strides and some great struggles in our efforts to build this value and position our company to meet the great opportunities in our market.

As we continue through fiscal 2009, we’re excited about the potentials ahead as we are in an ideal position to reap the great rewards from our investment that we’ve made in 2008. I am particularly grateful to the dedicated efforts of our colleagues in our hospitals and our treatment centers across the country that have truly made this possible.

I want to significantly note here that you know we did this venture at Seven Hills was our largest venture to company to date. And even with the significant start-up losses, we still had a reasonable profit for this fiscal year. And I do believe that is significant.

Now at this time I’d like to open the call up to address your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from [Alim Talmud] – Boston Partners.

Alim Talmud – Boston Partners

First of all, you’ve got Detroit and Seven Hills and Seven Hills should incrementally add over $12 million , $12 millionish. Then Detroit should add something, and when you line it all up that puts us nicely above 20%. Am I missing anything by chance?

Bruce Shear

Just the timing of opening Capstone which we’re already going to be starting Q2. And there’s still phase in and we’re not quite full at Seven Hills yet, running at the annual revenue rate of north of $10 million. So we’re still sort of ramping that up. Capstone we’re anticipating an annualized revenue of about $5 million once that gets fully occupied. And we have had experience – I mean our track record on the adjudicated beds is that they do fill pretty quickly.

But again I think on an annualized revenue base, you’re right. Compared to last year it’s

$10, $15 million plus on an annualized revenue rate. Yes.

Alim Talmud – Boston Partners

You had mentioned this capitated business. Can you explain the dynamics so you – I’m just a little confused.

Bruce Shear

We have some large contracts in Las Vegas where we get a fixed rate, no matter what the utilization is. If the utilization is low, then our profit margins are higher. If the utilization is high, then our profit margins aren’t as high. There’s been a national trend and it’s been reported by all of the healthcare companies, not only behavioral health companies but medical companies, that they’ve seen significantly increase in utilization over the last six months.

We’ve experienced that, too, in Las Vegas. Now we’re able to moderate that to some degree because we are able to treat those patients in our own hospital. So we’re not going to see such a huge impact as some of our other peers might. But again it has had an impact. And as a result of that, we’re going back to our customers and they’ve acknowledged the fact that there’s been an unusual increase in utilization to renegotiate our contracts to take some of that into account.

Alim Talmud – Boston Partners

We naturally had some guaranteed escalators built into those contracts, right?

Bruce Shear

That’s correct.

Alim Talmud – Boston Partners

And so hopefully we’ll be able to go back and increase another amount and then also get some better margin on those contracts?

Bruce Shear

That’s the goal is to be above the nationally built in escalators.

Alim Talmud – Boston Partners

And now what’s the risk that they say no? I mean, what do they – what could happen?

Bruce Shear

You know I think just nationally companies are seeing a syncopation. I think it’s different in every market. Las Vegas has its own unique reasons, whether its related to the economy or folks not seeking out treatment in the past. In this business, we’ve been lucky over the years. We’re always able to have pretty good control. But we’ve had a bad run for six months, and as a result of that we’re going back to our customers. And we have close, long term partnershiping relationships, and saying to them, we’re seeing this. What are you seeing in your other markets?

What are you seeing on your medical side? And as a result bringing to them viable information that shows that we need to sort of reconsider sort of our rate structure. And we’re again I don’t want to comment too much about the process, other than the fact that we’ve identified it, they’ve identified it and we’re hopeful that that plus even maybe a little lower utilization to boot, will move us back to even a stronger position.

Alim Talmud – Boston Partners

Net cash should be getting pretty high now?

Bruce Shear

Yes net cash is good. We’re paying cash for everything. We’re going to be dropping

$4.5 million net in the bank from the Pivotal sale. If you look at our balance sheet, when you read our K you’ll see our receivables balance continues to come down. We have to borrow on our line just to meet our minimum balance requirement so we don’t pay a penalty in fees.

So the company is clearly strong, cash flow positive and is basically paid for everything in cash, without having to tap our line. As a matter of fact we’ve generated enough free cash flow to do that plus pay down debt at the same time.

Alim Talmud – Boston Partners

So what should we be seeing within the next year? I mean, should we see a $0.40ish net cash position? Or if you don’t use it on other things, including Pivotal? Or around what would you anticipate with what you just guided to, and the Pivotal business, where would we – and the fact that you’re doing a good job managing your receivables? What kind of net cash should we be able to see just roughly?

Bruce Shear

We’re on the acquisition hunt, too, Alim.

Alim Talmud – Boston Partners

But I mean excluding that, because I don’t know what you’re going to do there.

Bruce Shear

I think the even it numbers certainly are going to be well north of 10%, and our run rate you’ve identified as on an annualized basis by the time calendar ’09 starts is going to be close to

$70 million without another deal. So if we don’t buy anything or use that to pay cash for our next project, then we’re going to be in an even stronger cash position. I mean, the good news is we don’t have to borrow money right now, I mean, in this market I think it puts us in the small minority of companies that really don’t have to worry about going to the credit market.

Alim Talmud – Boston Partners

The start up loss, that is pretty much non-recurring, right? I mean, if you take that out, I don’t know, you would probably have earned over $0.03 for the quarter excluding that? Or am I reading wrong?

Bruce Shear

The fiscal year without the start up loss would have been slightly ahead of last fiscal year by not a great number but something north of $3 million compared to $2.8 million or something, I don’t remember the numbers. But it was slightly ahead of last year taking that out. And if we factored in the Pivotal loss for the current quarter and net loss, I think the number would have been a little bit north of $0.03.

Operator

Your next question comes from Darren Lehrich – Deutsche Bank.

Darren Lehrich – Deutsche Bank

I just wanted to start with the Pivotal transaction itself. Can you just confirm for us that the accounting treatment for this will continue to be in continuing operations until you have a definitive agreement? I guess I just wanted to clarify what we’ll be seeing in your financial statements until the transaction either closes or does it need to move to a definitive agreement before you move it out to discontinued ops?

Paula Wurts

Well, we are close to a definitive agreement. So the expectation is that it will move to discontinued ops very soon.

Darren Lehrich – Deutsche Bank

The write off that you took, the loss that you took, this $1.8 million number was that triggered by your devaluation of the deal in the LOI or is that triggered by your review of Pivotal and its value in a normal year-end review?

Paula Wurts

Well it was a part of a normal year-end review, but certainly we had a letter of intent in our hands. And that letter of intent is the driver of course to a certain extent. So the write down basically brought the asset to where we anticipate a purchase and sale agreement would bring it to. In other words, we don’t anticipate additional loss to be booked on a purchase and sale agreement.

Bruce Shear

It’s significant to note that Pivotal is profitable now, too.

Paula Wurts

Right. I mean they also are moving in the right direction in terms of the studies that we had started now, but it is an inconsistent revenue stream.

Darren Lehrich – Deutsche Bank

Are you in a position at this point to disclose who the buyer is just so that we can get some assurances from you, Bruce, that the buyer is capable of closing?

Bruce Shear

I can’t disclose the name, but I can assure you that this is a buyer of significant substance on a national and international basis. And the cash purchase price is not a very important aspect of their overall operation. So I’m not concerned that they don’t have the way without a close. It’s not a local company or a smaller group that we have any risk in that regard.

Darren Lehrich – Deutsche Bank

And then just going back to the first questioner’s questions about the capitation, it sounds like you’re going to be reopening some arrangements that you have some contracts that you have. I’m assuming that you’ll be reopening that with Sierra. Can you just confirm that and given the terms and the length of that contract, can you just help us think about what we should expect coming out of this? That was viewed as a long term arrangement so might it now be different in length? What should we expect from this situation here?

Bruce Shear

We have a long term partnership that we don’t anticipate changing at all. We’re a significant provider in their puzzle. I’m not going to address the specific customer, but I will say that we’re looking at all of them. There’s been a utilization increase in the Las Vegas market and it’s not isolated to one customer. So we will take this opportunity to re-visit every contract that we have with the hopes that either we’ll have better control, better partnershiping relationships or a combination of all that plus increased capitated rates.

This is not an isolated contract. We’re going to look at all of them. We are looking at all of them. And I think we’ll have some more guidance in that regard by the end of the next quarter.

Darren Lehrich – Deutsche Bank

And then just as far as Seven Hills goes, can you just comment for us on where the census is roughly right now? And where it’s been averaging in recent weeks? And have you settled on a leadership team at Seven Hills?

Bruce Shear

Yes. I can comment on the census. We’ve been hitting high numbers. Actually we had 40 patients one day last week, which was certainly a company high. We opened our second inpatient unit. You recall seeing the Hospital about three weeks ago and we consistently need that unit. Our census has been running anywhere between the I would say at the lowest now, the low 20s and generally high 20s to low 30s. So in terms of our inpatient days, it’s probably above projections for inpatient days.

And we’ve hired a couple months ago a very, very seasoned executive, someone that worked for a large company with over 20 years experience, who brings a lot of strength to the leadership team. We’ve brought in a new Director of Nursing and so I think our strong leadership team is coming together out there. And we’re waiting – and as you know, understanding our business a lot, we’re still waiting for – the joint commission needs to come in and survey. And we have a date from them now which is exciting.

They’ll be in October 15, so we’ll then be able to add another tier of patients that their insurance companies did require [Jayco] approval. And on the first survey, you get a conditional approval and we’re ready for that. So we’re hopeful that that will help. The application for CMS and Medicare certification is also in process. We don’t have a commitment date for that yet, but that also is in process. So these are all components of the census that we have not been able to see yet and they’re in process. And I think we’re moving in the right direction there.

Darren Lehrich – Deutsche Bank

Could you comment on your same store patient day growth, I guess just excluding Seven Hills, what that was and what the same store revenue growth was on the facility side?

Paula Wurts

Well I don’t have a whole lot of detail with me right now, but with Seven Hills it didn’t open until the middle of May and of course it does service some of our cap patients, which means no revenue but a bed in service. So we have some of the patient days relative to that are included in our occupancy rate, but not included in our revenue per patient day calculations.

Our revenue for patient day did go down slightly from prior quarters and that’s largely because of the number of adjudicated beds that we had. It’s just adjudicated beds are as you know a lower paying group – a lower paying bed day so the revenue per patient day goes down significantly as those patient days go up.

Bruce Shear

But you’ll be able to get Darren that schedule once we get –

Paula Wurts

Oh yes I’ll get you that schedule certainly.

Bruce Shear

We’ve had to do a lot of quick moving around. This Pivotal deal came on very, very quickly and so as you can imagine we needed to have everything ready. And that coupled with the end of our fiscal year and our K being due it sort of –

Paula Wurts

But even in that last quarter with just the half of May and all of June, we had 502 bed days that were attributable to our cap contracts that we would’ve had to pay a significant amount of money to put them in someone else’s facility. So already its beginning to do what we need it to do, to relieve our expense piece of that cap contract.

Darren Lehrich – Deutsche Bank

When you do report the segments, are you basically saying that the revenue won’t be captured in the capitation? In other words I was expecting it to be eliminated through inter-company.

Paula Wurts

That’s correct. It’s eliminated through inter-company. That’s why when you look at our financial statement, all of the eliminations have taken place so that the revenue, the net revenue per patient, per patient days is net of that capitated money.

Darren Lehrich – Deutsche Bank

But in your segment reporting in the K, you’re saying the segments won’t be on a – I can follow up offline but the segments won’t be on a pre-elimination basis?

Paula Wurts

No, the segments will be after elimination. Absolutely after elimination.

Operator

Your next question comes from Quinton Maynard – Morehead Capital.

Quinton Maynard – Morehead Capital

You mentioned in ’09 looking at a net income margin, is that after taxing you’re saying 8% to 10%?

Bruce Shear

That’s pre-tax.

Quinton Maynard – Morehead Capital

As far as the bill that is going through Congress right now, do you know when that is likely to be voted on?

Bruce Shear

Well, you know they’re somewhat sidetracked this week. But our association is saying any day and we get daily bulletins from them. And pending another world crisis, which we’re certainly in one right now that they haven’t quite figured out, I mean, I’m very hopeful that really in the next 30 days we’re going to have a signed bill by the President.

Quinton Maynard – Morehead Capital

Would that actually have direct impact for you?

Bruce Shear

There’s really a three-fold impact for us and for our industry. Number one, more recognition of mental health illness in America and the significant need and the government’s commitment and support of providing care and mandating the care is at a reasonable rate. That’s number one.

Number two, the co-pays will be reduced. Now they’re going to be reduced as it stands right now over a four or five year period. So reduction in co-pays has sort of the answer on number two and number three – I mean, the second point is the reduction in co-pays reduces the potential of bad debt.

And the third point that I wanted to make was that by having a lower co-pay, it will provide easily more accessibility to the patients to come in for treatment. And that’s something that we have not and our industry actually hasn’t been able to quantify yet. But if someone has to pay $50 to see their psychiatrist and they’re now going to have to pay $10, I think we can come to a conclusion that more people will seek help.

Quinton Maynard – Morehead Capital

Makes sense to me.

Bruce Shear

So those are the three points.

Quinton Maynard – Morehead Capital

In Detroit have you budgeted for operating costs – opening costs?

Bruce Shear

We’ve budgeted for opening costs in the September and December quarters and anticipation of profitability in the March quarter.

Quinton Maynard – Morehead Capital

And roughly the number of the dollar amount of those opening costs that you’re expecting?

Bruce Shear

I don’t have that number in front of us. We don’t have the budget sheet in front of us.

Quinton Maynard – Morehead Capital

Should it be roughly the same size as in Las Vegas or?

Bruce Shear

No I think it will be a lot less than that. And like I said we have not projected – we’ve talked about the traction from all of these projects being in the quarter, in our third fiscal quarter so we really don’t want anyone to be under the impression that now that Seven Hills is open and Capstone’s going to open next week that all the pre-opening losses are behind us.

Operator, do we have any other questions?

Operator

There are no further questions in queue and this concludes our Question-Answer Session.

Bruce Shear

Well I think having answered all the questions we certainly have a lot of information to talk about and there have been a lot of things happening in our company of recent times. And as I’ve said before the building blocks are certainly coming together and we’re excited for the next half of this fiscal year and certainly even more excited about where we see 2010 going.

And we do have many potential acquisition opportunities out there. Our acquisition guy is identifying a lot of deals for us. So we’re very optimistic. And we appreciate your patience, your confidence in our company, and we appreciate your being a shareholder and welcome you anytime to call. I look forward to talking to you all offline. Thank you very much.

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