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Infusystem ($INFU) released their 2012 10-K on March 28th. This is the first annual report released since the new management team took over in the spring of 2012. Lots of changes have occurred throughout the year, so I was anticipating the release of this report. You can read my initial writeup on INFU to get some background information. A quick summary of the situation is that the old management group did a very poor job at creating shareholder value for a business that generated high gross margins and growing revenues, ~10% per year. An activist shareholder group took control of the board, and the new management team set out to reshape the company to become profitable once again.
The first item of business was to clean up the mess that the previous management team left, which included debt that was coming due in 2013 with a high interest rate. On November 30th 2012 a new credit facility was entered into with Wells Fargo to retire the debt from Bank of America and eliminate the 1% ticking fee that the company was paying due to the change in control. This put the company in much better financial shape, as the high interest payments were eliminated, and a much more manageable payment was put in place. The interest rate equaled 9.25% as of the end of CY 2012. In my original model, I assumed the new debt would be $28.5M, but the actual long-term debt come out to be $27.3M. The increase in the long term debt balance is attributed to fees associated with the extinguished BAC loan and the retirement of a small note from the First Biomedical purchase. I also estimated the interest expense to be $2.6M per year, but actual expense is $2.4M and the current capital lease obligations added another $1.55M. All in all, the new debt has shored up the financing for the future and removed a big red flag for the company. The new management team can now focus on growing the company with plans for long term value creation going forward.
Pros
- New debt facility eliminating a 1% monthly ticking fee which resulted in an additional $1M in payments in 2012. This will not occur in 2013.
- Top line revenue increased 8% yoy to $58.8M mainly attributed to the primary business of pump rental revenue. It is good to see revenue growth during a transition period.
- Gross profit increased 21% yoy to $42.9M resulting in a 73% gross margin! This is back to historical margin levels from 2007-2010.
- Increased Cash balance from $800k to $2.3M
- Cash from Operations was $5.5M
- $19.77M in NOL to utilize in the future
- Q3 and Q4 were profitable quarters after management’s changes started to be reflected in the company results
Cons
- Increased G&A expenses to $23.1M from $18M in 2011. The G&A expenses were inflated because of the costs associated with the Concerned Stockholder Group and payments to the former CEO. In total $4.4M of the G&A expenses are non-recurring and were due to the change in control. Offset to these increased expenses was a savings from the reversal of the previous stock compensation expense of $1.4M. So, $3M of the additional $5.1M in expenses are non-recurring and can be removed to normalize the expenses. I have done this in my valuation calculations.
- Increase in provision for doubtful accounts. The healthcare industry is in constant change, and especially with the new “Obamacare” initiative being put in place. Changes in the way third party payors reimburse INFU have changed, and may continue to change. The result for the year 2012 was an increase in double accounts of $1.2M, of which $1M was written off in the last three months of the year. This needs to be watched going forward. A further explanation of the reason can be found in the 10-K.
- Speaking of changes in the industry; healthcare reimbursements are drastically changing. Much of the details are still unknown by everyone, so it is very hard to accurately predict what will happen, but INFU has provided some information update in the RISKS section of the 10-K. CMS has announced a timetable for their new competitive bidding recompete. Changes will become effective in calendar year 2014, but the changes may impact reimbursements. CMS contributes ~1% of INFU’s revenues. The more worrisome risk has to do with the changes to Medicare reimbursements. Currently revenue attributed to Medicare reimbursements stands at 31%. It appears that the government will reduce Medicare payments by 2% starting on April 1, 2013 due to the sequestration order. Unless the government can get its act together and come to an agreement on the budget, INFU could stand to lose 2% in reimbursements from Medicare. In dollar terms, Medicare represents $18.23M in revenue, of which the 2% reduction would reduce $365K in revenue to INFU. Fortunately, INFU is preparing for the changes, and are working hard to not be impacted too much from the changes.
Valuation Update
I used the 10-K numbers as my baseline, and only removed some expense from G&A that is non-recurring due to the change in control, and removed the $1M in interest expense due to the 1% ticking fee. With these two safe changes in the financials, I calculate the EPV of equity at $2.51 per share. EPV calculates the value of a company/equity without any growth. However, INFU has been growing revenue by ~10% per year and is holding a 73% gross margin. Using a 10X multiple on EBITDA, I calculate a value of $3.51 per share. The stock is currently trading at $1.70 per share.
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