Robert Horrar - CEO & President Tyler Murphy - CFO James Rolfe - Chief Development Officer

Ling Han - TD Securities Neil Linsdell - Industrial Alliance Securities Endri Leno - National Bank Financial Douglas Miehm - RBC Capital Markets Neil Maruoka - Canaccord Genuity Prakash Gowd - CIBC Capital Markets

Good morning, everyone. Welcome to the Medical Facilities Corporation 2017 Third Quarter Results Conference Call. Before turning the call over to management, listeners are cautioned that today's presentation and the responses to questions may contain forward-looking statements within the meaning of the safe harbor provisions of Canadian provincial securities laws. Forward-looking statements involve risks and uncertainties, and undue reliance should not be placed on such statements. Certain material factors or assumptions are applied in making forward-looking statements, and actual results may differ materially from those expressed or implied in such statements. For additional information about factors that may cause actual results to differ materially from expectations and about material factors or assumptions applied in making forward-looking statements, please consult the MD&A for this quarter, the Risk Factors section of the annual information form and Medical Facilities' other filings with Canadian Securities Regulators. Medical Facilities does not undertake to update any forward-looking statements. Such statements speak only as of the date made. Listeners are also reminded that today's call is being recorded, for the benefit of individual shareholders, the media and other interested parties, who may want to review the call at a later time. I would now like to turn the meeting over to Mr. Robert Horrar, President and CEO of Medical Facilities. Please go ahead, Mr. Horrar.

Thank you, Sharon, and good morning, everyone. Joining me today is Tyler Murphy, our Chief Financial Officer; and Jim Rolfe, our Chief development Officer. As you know I've been with the company since May as Chief Operating Officer. In that time, I have met with and worked with all of our hospitals and centers, and met with many of you in the investment community. I'm very pleased to be taking on the role of President and CEO, where I'll be able to continue to work with our teams, driving growth and operational excellence. I would also like to thank Jeffrey Lozon, for stepping in as an interim CEO for the past several months. His guidance and leadership are valuable and I look forward to continuing to work with him and the entire MFC board. Now on to the results of the third quarter. Prior to market opening today, we released our 2017 third quarter financial results. Our news release, financial statements and MD&A may be accessed through our corporate website at www.medicalfacilitiescorp.ca and are also filed on SEDAR today. For today's call, I will start by discussing the results for the past quarter. Tyler will then review the financial performance and then, I will wrap up with some comments on our outlook, which we will open to call with questions. In the third quarter of 2017, we continued our consistent trend of year-over-year growth in surgery volume and revenue. This is a reflection of our nationally recognized quality and patient satisfaction scores and continuing success with organic growth initiatives. Overall, surgical cases increased by 5.2%, largely driven by additions from Unity Hospital and Prairie States Surgery Center. We also had strong growth of 12.6% in Urgent Care center cases. Offsetting this was a decrease in pain cases at our Oklahoma Hospital and unfavorable on case mix changes in Black Hills and Unity Hospital. In the quarter, we also continued to work with our local teams on organic growth initiatives. The new physicians added recently at Unity continue to ramp up and the new G.I. physicians joined our team at surgery center at Newport, California. We also signed an agreement with Ambulatory Innovation Associates to establish an urgent care center at Arkansas Surgical Hospital. Urgent care centers have been a successful strategy for us at Black Hills Surgical Hospital, as a source of revenue and for expanding our access points in the community. We expect to have similar success with the center at Arkansas, which is on track to open by the end of the year. And hence the indications inception in the quarter, we continue to deliver reliable returns to our shareholders. In October, MFC shareholders received their 163rd consecutive dividend. In the quarter, we also achieved a low payout ratio of 70.7%, ensuring continued reliability. Over the past 4 quarters, we've maintained an average payout ratio of 66.2%. Now Tyler will provide more details and insight into our financial performance for the third quarter of 2017. Tyler?

Thanks, Rob. As on our previous calls, I would like to note that all of the dollar amounts expressed in today's call are in US dollars unless otherwise stated. In Q3 2017, MFC had revenue of $89 million, a 12.9% increase over $78.8 million in Q3 of 2016. The increase was driven by contributions from new acquisitions as well as the new urgent care and ENT Clinics at Black Hills, and case growth at our existing facilities. This is now the 9th consecutive year-over-year increase in quarterly revenue. With the 9 months ended September 30, revenue was $274.1 million in 2017, an 18.4% increase over $231.5 million in 2016. As a result of higher caseload, operating expenses increased to $76.5 million in Q3 2017, from $64.6 million in Q3 2016. Acuity and case mix shift had a significant impact at Unity, which incurred to operating loss of $1.6 million as a result of lower reimbursement rates. As of Q3, a new finance executive is in place at Unity, who is focused on executing our operating expense and growth initiatives. EBITDA in Q3 2017 was $19.3 million, a slight decline of 1.4% from $19.6 million in Q3 2016. The decline is the result of the lower operating income at Unity. On the same hospital basis, eliminating the results from Unity and Prairie States, EBITDA increased by 4.3% to $20.3 million from $19.5 million in Q3 2016. With the 9 months ended September 30th, EBITDA was $62.6 million in 2017, a 7.1% increase over $58.4 million in 2016. EBITDA margins for the past quarter was 21.7% compared to 24.9% a year earlier. On a same hospital basis, EBITDA margin was 25.5% compared to 25% in Q3 of 2016. Cash available for distribution in the quarter was CAD 12.3 million, a 17.2% increase from CAD 10.5 million a year earlier. On a per share basis, our cash available for distribution was $0.40 in Q3 2017 compared to $0.34 in Q3 2016. As Rob mentioned, the resulting payout ratio was 70.7% for the quarter compared to 83.1% in Q3 of 2016. With cash and short-term investments of $63.1 million and about $32 million available on our credit facility at September 30, we believe we are well resourced to execute on our growth strategy. For additional detail on specific results for each facility, please refer to our MD&A. Now Rob will provide some comments on outlook, and then we will take your questions. Rob?

Thanks, Tyler. Overall, we are pleased with the third quarter results and the progress that we're making at executing growth and operational improvements. Looking to the rest of the year and beyond, we will continue to focus on growth. In terms of organic growth, this means adding complimentary facilities to our hospitals, as we did when we added Prairie States, Ambulatory Surgery Center at Sioux Falls, as well as opening new urgent care centers, adding and enhancing service lines and recruiting new physicians. Managing supply cost initiatives remain a priority, and we continue to make progress. We are still highly engaged in making acquisitions, and in fact, are currently evaluating several accretive opportunities. In keeping with our communicated strategic plan, our investment criteria for acquisitions of position alignment, accretive earnings and growth opportunity remains constant, and as such, we've walked away from several potential transactions that did not meet this criteria. We also continue to navigate the changes in the U.S. Healthcare System, as government and other pairs endeavor to reduced cost through changing reimbursement rates at lower-cost settings. An example of this is the recent announcement from the centers for Medicare and Medicaid Services or CMS, to remove total knee replacements from the inpatient only procedure list and to allow certain of them to be carried out in an outpatient surgery basis. Whether to carry out the procedure on an inpatient or an outpatient basis, is a medical decision, not a financial one and is at the judgment of the physician. There is also a 2-year period before these procedures really [indiscernible] by CMS. This is a very recent development, and we are still considering the impact. However, we see both challenges and opportunities in this change. An important consideration is that a total knee replacement procedure on an outpatient surgery basis would not be recommended for all patients. Both patients that are elderly or complications may still require an inpatient stay, so their recovery can be observed and managed. A significant proportion of Medicare patients will require inpatient stays. We are confident that we'll continue to successfully navigate the changes in the U.S. Healthcare System to the benefit of our shareholders. With that, we would now like to open the line for questions. Operator?

[Operator Instructions]. Your first question comes from Ling Han from TD Securities.

My first question is related to the CMS decision you just mention about total knee replacement. So I'm just wondering, can you tell us about the orthopedic outpatient capacity that currently exists in Sioux Falls and Black Hills? And your perspectives for increased outpatient capacity in those markets?

I will take that on. So we know very well that the demand for knee replacements and hip replacements especially due to osteoarthritis, is increasing at a rapid rate, is particularly among the Medicare population. So to your point, this is a growing service line so total knee replacements are growing, and we do have capacity. We have capacity, as we have mentioned, our acquisition of Prairie States Surgery Center gave us additional capacity in Sioux Falls. So we do have capacity to add surgeries in these locations.

And my second question is related to a more macro hoardings. So several of your hospital in ASC payers have recently reported hoardings related to the high deductible insurance plans and related to deteriorating payer mix. So I'm just wondering, can you tell us about facts vulnerability to these trends, and if there is not much -- if that has been followed or why not?

Well, I think, it's just helpful to understand that our model, typically, is that on -- of elective surgery basis. So patients did come to our centers, it's not an emergency situation, but rather an elective situation. So they are preauthorize, precertified. And those insurance questions have been addressed up front. So I'm not saying that we don't have some sensitivity. Clearly, all providers are better with more covered individuals. But from a exposure standpoint, we would be less so, just because of that elective nature. And again, we are also looking forward to -- we typically see the fourth quarter is one of our higher seasonal times of the year, as patients have met a lot of these deductibles.

Our next question comes from Neil Linsdell from Industrial Alliance.

I was wondering with the Unity Hospital. So you had the increased expenses. Can you give us a little bit more color about what's going on there? If you expected it to be more expensive or take more time to get things going? And what kind of initiatives are you putting in place to get that in line with the other pieces of your business?

Yes, well, I will take that as well. Overall, we have seen our volumes actually grow here third quarter over third quarter. The issue at Unity is one of a payer mix and acuity. So the volumes that we've seen aren't of the same acute nature and under different payers that shifted. So we have made some progress there. Since acquisition, we've added a number of physicians, I believe, 4 physicians, that continue to ramp up. And clearly, we've said in previous calls, this is a growth platform. We have a lot of opportunity to add a significantly increased number of physicians to this platform. So we think that we're in a good position to do that and to execute that growth strategy. So most of it is on the revenue side and the growth, and we think we'll make good progress here.

So is there any timeline?

So we have several large opportunities in this market. And those take time to develop. So I wouldn't give you a specific timeline, but I'll tell you, our timeline is as soon as possible.

So are there any specific initiatives you can tell us about? Or is it more just ongoing, it will come as it comes?

Well, like I said to add physician participation to the center. It has got a good platform to grow and expand and there is a lot of opportunity to attract partners to this center. So that's our primary driver. As Tyler mentioned in this call, we hired a new Chief Financial Officer in this area, and we continue to manage expenses. Our supply initiatives are in place. We continue to see the benefits of that, and also managing productivity in our labor, our salaries wages and benefits. So we're focused on all fronts, but clearly, the most significant opportunity in this market is to grow. And we have a number of those initiatives in place.

Yes, I would just add to that, Rob. There's a large number of unaffiliated physician groups in that market. So those are the groups that's why we feel so good about that market. We think, we can get some of those aligned with our hospital.

Okay. So within that context as well then, if I look at the broader -- so all your facilities -- all your geographies. Can you talk about how the acquisition pipeline might be developing the number of acquisitions, how long have you been talking to a lot of these guys? And if things are moving quicker or slower, and with management getting solidified at the MFC?

I would let Jim Rolfe talk about that.

Yes, we have been very busy since the first of the year. And as Rob talked about, our two major charges coming onto the MFC were to grow our current portfolio and of course to grow through acquisition, right? So we have had a pretty robust and very active pipeline from -- since January. So we've looked at a lot of deals. We've actually had advance discussions with several, and as Rob said, we walked away -- we've got 5 hospitals and 1 ASC. So we have to be very selective in making sure that the assets that we look at are high quality, good margins, make sure they have good management and a good growth potential. And if they don't have those, then we're small -- then we have to walk away. So we actually walked away from a couple. We are in advanced discussions with several of these opportunities that meet our adjacent core business of the high quality and accretive and good growth opportunities. And so we're still very, very optimistic on these discussions that we're having now. So yes, it has been active since January, and it remains active, right now, currently.

[Operator Instructions]. Our next question comes from Endri Leno from National Bank.

Just have a quick question. If you can talk a little bit to the Urgent Care Center in Old Rock Arkansas. How is that going? And you said it, that you'll track to the end of the year, what kind of traction did you expect on it? And yes, just talk a little bit about the development.

Sure. We'll be happy to. As we've mentioned earlier -- the urgent care center strategy for us is very positive, it expands our outreach. There are arrangement with American innovations is a platform deal for us. This is going very well, and we do anticipate being open at the end of the year and with opportunity to do more. Not only in and about the Little Rock area, but throughout our company. So we think, it's a good strategy. It's been positive for us and particularly in Black Hills, and we see this is a platform to continue to add complementary facilities organically.

And if you had to prioritize between these types of organic developments and acquisitions, which one would you preferably go for?

Well, we wouldn't necessarily exclude one or the other. I think, both are important. Our stated strategic plan is organic growth and external growth. So we are focused on both.

Your next question comes from Doug Miehm from RBC Capital Markets.

Couple of questions. Maybe the first one for Tyler. I'm just trying to reconcile how on the U.S. dollar basis, anyway, distributed cash could have risen 23% when EBITDA was down year-over-year?

Yes, it's because you have to factor in, taxes and other things go into that calculation. So it's not just a straight EBITDA calculation.

No, I understand that. So I'm just trying to understand, maybe some of the timing issues that are associated with this, because if we were too simply take the lower EBITDA, and we can use over a year, all things else being equal. If we look at the accruals, the taxes and working capital, I'm just thinking that, is it correct to assume or are you getting some benefit on working capital somehow that in a specific year if EBITDA is down, distributable cash should be down?

Not necessarily, again, because of the other factors, as I just talked about. About income taxes, there is times where we get recoveries. There aren't really necessarily period specific and other working capital things like that. So I can run you through it, our calculation off line.

Yes, yes. Okay. I think it was mentioned earlier in some of the prepared comments, just about, when you were talking about total knees and the potential for, a greater proportion of patients to be on Medicare that would need to stay as inpatient that makes sense. But does that mean that going forward, a greater proportion of the patients that you are doing work on, in terms of total knees are going to be at lower reimbursement levels because there are Medicare patients?

Well, that's a little bit -- it's a more complicated response than that. So for the total knee final rule, basically just removes total knee replacement from the inpatient only list. And it, also, I'll just make a note, does not approve them for the Ambulatory Surgery Center list. So if there is a Medicare patient that can qualify, the physician feels and if the service is available, and the patient can meet the criteria, and it's -- you have the care patterns established in your facility and can be done on an outpatient basis, then the reimbursement is less. But that's a very large filter to go through. So as I said earlier, we see the demand for the service continuing to grow, and for the most part, there are very, very few outpatient total knees done today, they are zero for Medicare today and single-digit on the commercial side.

Okay, perfect. Fair enough, that makes sense. And then, I just wanted to go back a little bit to Unity. I know that you may not have this on your books for very long, but it appears to be the business, it appears to be quite variable. So if we were to -- forget about Q1, because we had one of the key doctors gone, but if we look at Q2 versus Q3 and that dramatic variable between those 2 quarters, I think, you indicated that this was largely due to, I think, it was payer mix and acuity. How come we be confident that things are going to stabilize, like the swing of several million dollars in EBITDA potentially at this facility is a little, just concerning?

Right. Well, I'll tell you that, all of our attention it on this facility, and we are equally concerned about the shift. However, as I've said, there's a whole lot of very good underlying supportive strategies that have been implemented and have taken hold. We've mentioned that organic growth with physicians that we brought to the center and continue to do that. We mentioned that we are implementing our supply cost and we are seeing traction on that. I mean those are right now going to take some time to germinate those larger opportunities that Tyler and Jim mentioned in this area with large and affiliated groups. We have a lot of room that we can grow this center. And we are focused, right now, our new -- particularly, our new CFO on operating what we have. I think, the future is -- will be good for this facility with all these..

That's good. You mentioned the unaffiliated doctor groups that could join with you. Would there be any cost? Do you have to buy them? Or would they just be working with you?

They could be investors in our facility. Or just working with us. Either one.

Yes, Jim here. It a lot of times when we look at a large groups to invest in a hospital, a lot of times we will do in-client transfer. For example, if they have an ASC that we are interested in acquiring as well, possibly trading that acquisition for acquisition into shares into our hospital. Just kind of a combination of both, if its singles, yes, they will buy into our hospital, if it's a large group, then we look at doing some trading , if you will.

If Tyler could follow up with me, that would be great on the distributable cash.

I will there.

Your next question comes from Neil Maruoka from Canaccord Genuity.

I apologize I missed the first part of your conference comment. Just on Black Hills and the margin that we're seeing there. Can you talk about what kind of pressures you might be seeing in that environment? And what might have contributed to the weaker performance for Black Hills on the quarter?

Yes. So again, nothing that is not unusual in this market. I think, we did have a neurosurgeon that left town. It's the very end of the second quarter that was part of it. We had just some payer -- again, some payer mix and acuity shifts in this market. I think, that this is, again, on a year-to-date basis, Black Hills has performed fairly well. And I don't see that is inherent of any competitive threat or issues or weaknesses there.

Okay. Nothing that you can address on going forward?

Right. That's correct.

And you had mentioned, in the ASC acquisition strategy. Can you talk a little bit more, what you're seeing out there on the ASC front? And how you are looking at potential acquisitions of ASCs or group of ASCs? Just any commentary on the M&A side.

Yes Neil, Jim here. We are looking -- yes, that's part of our core business. As mentioned throughout the year, we're looking at an ASC strategy, but also a surgical hospitals strategy. So again, as a lot of commentary and a lot of things are moving to the, or not moving, are addressed in a low-cost providing area like an ASC, we are -- that's part of our charge and my charge is to go find either a platform ASC or to find individually ASCs around our current centers. And so yes, we are full steam on that, for sure, from the ASC side.

Okay. And just finally on -- maybe, just shifting back to Black Hills and some of the other markets we are seeing increasing competition out there. Can you describe how that's shaping up and what you're doing to preemptively deal with additional hospitals that are being built in some of those -- some of your markets?

Sure. So nothing is open yet. This is, again, I'll reiterate in both cases. I think, we've talked about this in previous calls. Not a new competitor, it's a new building with an existing competitor. That's not open yet. So we continue to stay focused on all of our opportunities. Our organic growth strategies, we are going through our strategic planning process now and identifying areas where we can continue to capture more market share. We've seen these markets are attractive, all growth -- service line growth opportunities are there, organically. And we continue to execute those strategies and we are well in advance of that. We're going to stay focused and eye on the ball.

[Operator Instructions]. Your next question comes from Prakash Gowd from CIBC.

First question is, what are the factors that influence case acuity mix? And are you actively either advertising, promoting or patient targeting to make that more favorable?

Clearly, we do. I mean, what the fix acuity is case mix. It's the type of -- intensity of service. A spine case will be more intense than a knee replacement, which will be more intense than, say, an ENT procedure. So we're looking at total case counts. If you look at acuity, you look at case mix, in the terms of what drive that? And then, beyond that as well, it's the acuity under which payer mix, which payer contracts. We've talked about payer, governmental payers pay typically less than commercial. So those types of dynamics are not controllable. And yes, we do have a very good marketing strategy in all of our markets, and they do a very good job. And we continue to evaluate ways to improve that.

Okay. If you look on a year-over-year basis, what changes have you seen in the private payer reimbursement for orthopedics procedures?

Tyler, you want to take a shot on that?

Yes, I don't think, there has been significant changes in the reimbursement. I think, goes back to what Rob just said, it's more of the acuity of what type of patients, there have been. Obviously, implant costs continue to go up, that something weird, on all of our facilities, trying to get the best deals we can from an implant cost perspective at our different centers. So that's the important part, is more kind of the expense, then there has been a wholesale change on the reimbursement side.

Right. I'll just add to that. We continue to negotiate with our commercial insurers, under contract to get our 3% to 5% rate increases that we think is very doable for us. Medicare just announces a part of final rule, that announced -- that brought to us the total knee. And I think, its 1.9% increase on outpatient perspective payment. So overall, the reimbursement rates are trending up. That's helpful.

Okay, so just so, I understand you mentioned that the changes are not significant, I guess, what is the minimum reduction in the reimbursement that you would consider to be significant? That you may need to actually disclose?

I'm not sure that there will be minimum. To Rob's point, we negotiates these contracts may come up and continue to try to get some type of 3% or 5% increase of reimbursement rates. To kind of, keep up with the cost of living and things like that. So I don't -- we're not seeing wholesale cuts in our rates anywhere.

So you're saying that the average revenue per ortho case has actually increased year-over-year?

Well, if you're talking about reimbursement rates, reimbursement rates have increased slightly. But when you're looking at revenues, I mean, again, that's impacted, as I said by, payer mix and acuity. So if you're looking at an overall service line per case, the answer would -- is acuity dependent. That I think, we have highlighted some issues with acuity in the third quarter that have caused some of that to be less on the orthopedic side.

And is the change in acuity simply meaning that the higher acuity cases are not coming to you anymore, and they are going somewhere else?

Not necessarily. It just means that for whatever reason, the level of service that was done was not as intense as it had been historically, doesn't mean it's not going to return. And again, there might be some elements of seasonality to that. We typically, along with our other healthcare operators, see the fourth quarter as a higher seasonal time for us due to the meeting of deductibles and coinsurance copays.

Okay. Last question is, if you look through the course of 2017, how many physicians have actually left your system or retired?

Well, I'm not sure we published that. But I will tell you, that we do track our physicians that we've added on a quarter-by-quarter basis. And we've added around 19 physicians for the company overall year-to-date.

So for the beginning of the year, you have 19 more physicians than you did?

That's correct.

At this time, I will turn the call over to the presenters.

Okay, thank you very much. Thank you for participating on today's call, and for your continued interest in MFC. We look forward to reporting on our progress next quarter. Thank you.

This concludes today's conference call. You may now disconnect.