Agiliti Inc
NYSE:AGTI
Earnings Call Analysis
Q3-2023 Analysis
Agiliti Inc
In the third quarter of 2023, the company reported revenue of $292 million, marking an 8% increase from the previous year. Despite the rise in revenue, adjusted EBITDA saw a 7% decline, settling at $62 million, with margins reaching 21%. The dip in EBITDA and its corresponding margins was attributed to revised contract scopes and a decrease in the number of peak need rental placements. Adjusted earnings per share (EPS) took a notable hit, decreasing from $0.19 to $0.09 due to lower net income and a higher effective interest rate on debt, which alone impacted EPS by roughly $0.05.
Revenue across different service lines varied, with Equipment Solutions pulling in $113 million, a 10% increase attributable mostly to recent acquisitions and customer growth, while Clinical Engineering generated $115 million, an increase of 11%. Onsite Managed Services, however, experienced a slight decline of 1%, totaling $64 million in revenue. Gross margin dollars for the quarter were down 5% year-over-year at $97 million, with the margin rate falling to 33% from 37%. Margin pressures were linked to a combination of factors including a lower mix of peak-need rentals, onboarding of new significant customers, and lower pricing in renewed contracts.
The company ended the quarter with net debt of $1.05 billion and a leverage ratio of approximately 3.87x. While the company emphasizes maintaining a longer-term leverage ratio in the low to mid-3x range, there's an immediate focus on enhancing business mix and margins. This includes a temporary halt to M&A activity and share buybacks, redirecting priorities to debt reduction and essential reinvestment in the business for growth support.
No specific guidance for 2024 has been provided, but the company suggests that trends from the completed Q3 in 2023 should be considered as a precursor. The executive team indicates a strategy to make incremental adjustments rather than substantial changes, predicting a gradual return to profit growth over several quarters, with visible progress in gross margin rate.
Returning CEO, Thomas Leonard, stress the importance of small-scale strategic shifts to recover the company’s historical financial performance. The long-term strategy entails leveraging local market infrastructure, which includes teams capable of managing and repairing medical devices, to continue driving profitable growth. Although acquisition and opportunistic expansion appear secondary, organic growth and improved utilization of existing assets and capabilities remain central to the company’s value proposition.
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Good afternoon, and welcome to Agiliti Third Quarter 2023 Earnings Conference Call. Today's call is being recorded and we have allocated 1 hour for prepared remarks and Q&A. At this time, I would like to turn the conference over to Kate Kaiser, Senior Vice President of Corporate Communications and Investor Relations at Agiliti. Thank you. You may begin.
Thank you, and hello, everyone. We appreciate today's call as we provide an overview of Agiliti's results for the quarter ending September 30, 2023. Before we begin, I'll remind you that during today's call, we'll be making statements that are forward looking and consequently are subject to risks and uncertainties. Certain factors may affect us in the future and could cause actual results to differ materially from those expressed in these forward-looking statements. Specific risk factors are detailed in our press release and in our most recent SEC filings, which can be found in the Investors section of our corporate website at agilitihealth.com. We will also be referring to certain measures that are not calculated and presented in accordance with generally accepted accounting principles during this call. You can find a reconciliation of those measures to the most directly comparable GAAP measures on the description of why we use these measures in our press release. To download a copy of the presentation that we will use to facilitate today's discussion, please visit our website at agilitihealth.com, select the Investors section at the top of the screen and in Events and Presentation. Finally, select a presentation titled Agiliti Q3 2023 Earnings Slides. A final note before we begin our prepared remarks. On October 2, 2023, Agiliti announced that Tom Leonard would rejoin the company as its Chief Executive Officer effective immediately. Mr. Leonard previously served as CEO of Agiliti beginning in April of 2015 until announcing his retirement in January of this year. I will now turn the call over to our CEO, Tom Leonard.
Thank you, Kate, and good afternoon. It's great to be back at Agiliti. I'd like to begin today with some brief reflections that we joining the company and our path forward. Over the first few weeks, my focus has been on reconnecting with our teams across the company and doing a deep dive into our solutions and operating systems, seeking a clear understanding of our performance, obstacles and opportunities. What gives me confidence as I reenter the business is that we don't need to look outside for near-term growth opportunities and no part of our business faces a structural hurdle that impacts its long-term potential.
In other words Agiliti has far more room to execute than it has been apparent in recent quarters. The key to unlocking our potential begins with the rebalancing of mix. We've already begun to be focused and retrain our selling teams to once again deliver a healthy balanced business mix for the company. For Agiliti, mix is not simply the relative proportion of individual solutions we sell. As an important point that bears repeating. For Agiliti a healthy mix of business is not just about the relative proportion of our individual solutions. It also includes balancing larger multiyear customer contract wins with a steady flow of more transactional, high contribution margin business, including rental and supplemental clinical engineering, it means regaining the discipline of building local market density to ensure we best utilize our existing local market capabilities, a key driver to improving our overall margin profile. It's about refocusing on share of wallet capture opportunities within our existing customers, that our combined solutions drive meaningful synergies for customers and we benefit from the efficiencies of shared teams, tools and infrastructure, and it includes targeting our selling efforts in local markets where we have pre-existing capabilities to reduce our growing short-term alliance on margin sapping third-party service partners. Importantly, these actions are not meant to represent the comprehensive list. Rather, they're among the many levers the company has long used to deliver a best-in-class margin profile but that have been missed is the company over-indexed on generating top line growth. Also key to achieving both near- and longer-term growth goals will be unlocking the potential of our entire business. In recent quarters, much of management's discussion with investors has revolved around a post-COVID rebaseline for our peak need rental solution as well as the financial impact of delays and upfront implementation costs, as the company onboarded more and larger contracts than ever before in its history. This remains an accurate description of the variance in reported results from management's expectations in those prior periods. But variance expectations is not the same as unrealized potential. Let me illustrate that point with a couple of examples, beginning within our Equipment Solutions service line. Peak need rental has emerged as a significant drive in Agiliti's financial performance over the prior 3 years. First as the company benefited from outsized demand for medical equipment during the pandemic. And again, as we moved toward a lowered utilization baseline post COVID as a result of our customers excess medical device purchases during that period. But keep in mind, peak need rental represents just 6% of total company revenue this year. So while it will always be critical for us to continuously refill the bucket with this type of transactional high contribution margin volume, forward financial impact of P&R on our overall results should be more muted at this current level. Today, as it was prior to the pandemic, the more strategic offerings within our equipment solutions and service line and more importance to our longer growth plans include our specialty beds and clinical surfaces solution or SCS as well as our surgical services offering. SCS includes product manufacturing capabilities and clinically differentiated support services acquired through the Sizewise acquisition in 2021. This solution has been a consistent growth driver and represents a long runway for margin improvements as well as opportunities for future strategic investment. Shortly after our acquisition 2 years ago, we began to invest in R&D, systems infrastructure, manufacturing automation. Starting in 2024, we'll begin to see clear benefits as a result of those investments. One example, we currently make and support more than 100 variations of therapeutic support services in a variety of sizes, materials and levels of performance capability. We will soon launch a streamlined best in class range of therapeutic support services under the Agiliti brand that will simplify the decision process for our customers and provide Agiliti line of sight to gross margin improvements as we simplify our supply chain and achieve benefits from our increased manufacturing scale. We're excited about our first significant new product family launch within a solution we see is key to our long-term growth goals. Our surgical services offering is primarily focused on urology procedures where Agiliti surgical lasers, and certified laser technicians provide access to a range of modalities in a pay per case model. We enjoy the #1 competitive position by revenue in this segment and have access to a broad range of technologies, including several on an exclusive basis through our strong manufacturer relationships. Having completed the integration of the -- contracts teams and modalities that came with the late 2022 acquisition of HealthTronics, we're well positioned with gross and margin expansion initiatives as we prepare to enter a new year. Staying on the topic of unlocking the potential of our entire business, I'll share just 1 more example, this time from our clinical engineering service line. You recall that we acquired Mobile Instruments in early 2020 and Northfield Medical in 2021. These acquisitions of the prior numbers 2 and 3 players by revenue in surgical equipment repair, launched Agiliti into a fast-growing segment of the market. As an independent service provider, we offer our customers a strong financial value proposition, a 1 vendor solution for their repair needs, along with the confidence of working with the business that is ISO 1345 certified and backed by a full medical device quality management system. Both Mobile Instrument and Northfield were acquired during the pandemic. When surgical case values around the country were below normal levels. So we took the opportunity at that time to focus on integrating our operations and harmonizing our commercial strategies. Today, we hold a strong competitive position. We enjoy a positive momentum in the market and are executing on our road map for growth and accelerating margin expansion. In summary, as we rebalance our selling mix and focus on better execution across all of our solutions, we believe our core financial engine will once again deliver highly profitable and predictable growth. Our ability to execute on these and other opportunities within our portfolio remains well within our control. I'd like to conclude with my prepared remarks today, I want to acknowledge the recent analyst and investor feedback we've received. We appreciate the importance of management rebuilding the trust and confidence of the market. We believe the recent performance of our equity significantly undervalues the strength of our financial engine. Our competitive position in the markets we serve and the sustainable advantages of our unique operating model. We understand the overhangs that currently lay on our valuation and we're committed to working through them. I'll return to Agiliti to lead this company as I deeply believe in our team. And the critical role Agiliti plays in our national medical device infrastructure and in our ability to rebuild a bright future for this company while delivering strong returns for our shareholders.
So as we complete and prepared report on the full year and set expectations for 2024 we are committed to providing the right level of transparency and color on the business to strengthen your review of our progress. For now, I'll pass the call to Jim to provide detail on our Q3 results before returning to take your questions.
I'll start with an overview of our Q3 2023 financials and later offer some comments on our outlook for the year. For the third quarter, total company revenue was $292 million, representing an 8% increase over the prior year. Adjusted EBITDA totaled $62 million a 7% decline compared to Q3 last year. And adjusted EBITDA margins totaled 21%. Adjusted EBITDA margins were affected by the revised scope of the new HHS contract renewal as well as a lower number of peak need rental placements. In addition, adjusted EBITDA margins were negatively impacted by mix within equipment solutions with lower peak need rental revenue, partly offset by strong revenue growth for both SES and surgical services, including the contribution of the prior year acquisition. Adjusted earnings per share of $0.09 in the quarter compared to $0.19 in the prior year, driven by a decline in adjusted net income, the impact of the increase in the effective interest rate on our debt amounted to approximately $0.05 per share in the quarter. Taking a closer look at the third quarter across each of our service lines. Equipment Solutions revenue totaled $113 million, up 10% year-over-year. The increase was primarily attributable to onboarding new surgical rental business primarily driven by the December 2022 acquisition as well as new customer growth within SES. Growth within equipment solutions was partially offset by lower peak need rental revenue in the quarter versus the prior year. Moving to Clinical Engineering. Q3 revenue was $115 million, representing a year-over-year increase of 11% for the quarter. New customer growth was the primary driver of the increase versus the prior year as we continue to win and onboard new business including within our surgical equipment repair service line. Finally, Onsite Managed Services revenue totaled $64 million, representing a year-over-year decrease of 1% for the quarter. Continuing down the P&L. Gross margin dollars for Q3 totaled $97 million, a decrease of 5% year-over-year. Our gross margin rate was 33% compared to 37% in the prior year. The decline in margin rate was primarily due to a lower mix of peak-need rental placements, the onboarding of new large customers within our clinical engineering solution and the lower renewal pricing of the HHS agreement. We will anniversary the HHS renewal pricing in Q1 of 2024. SG&A costs for Q3 totaled $87 million, an increase of $1.3 million point year-over-year. The increase was primarily due to severance costs related to a reduction in staffing in the quarter as well as costs associated with the CEO transition. These costs were partially offset by favorable incentive expense associated with a lower projected management incentive payout. Moving to the balance sheet. We closed Q3 with net debt of $1.05 billion. Our cash flow from operations for the first 9 months of the year was $148 million and our leverage ratio at the end of Q3 was approximately 3.87x. As we proceed through this year and into 2024, our capital allocation strategy will focus primarily on reducing our debt and continuing ordinary course reinvestment in our business to support our operations and growth initiatives. In the short term, we are internally focused on improving our business mix and margins. And we have paused on actively pursuing M&A opportunities, although we continue to maintain a healthy pipeline. Additionally, we do not anticipate further share buybacks under our current authorization in the foreseeable future. We continue to target maintaining our longer-term leverage ratio in the low to mid-3x range. Agiliti maintained a solid liquidity position as of September 2023 with $323 million available comprised of $30 million of cash on hand and $293 million available under our revolving credit facility. As a reminder, in April 2023, we expanded our revolving credit agreement by $50 million and extended the term to Q2 of 2028. Further, in early May, we completed a modification and extension of our term loan, which transitioned our key underlying benchmark rate from LIBOR to SOFR and extended the maturity to Q2 2030. Finally, of our $1.05 billion in debt, we maintain an interest rate swap agreement on $500 million with swaps floating rate terms for fixed rate terms. This swap has the effect of fixing our SOFR base rate of 4.07%, and the agreement expires at the end of Q2 2025. Turning now to our outlook for the remainder of 2023. We are reaffirming our full year guidance for each of our metrics. Specifically, revenue in the range of $1.16 billion to $1.19 billion, adjusted EBITDA in the range of $260 million to $270 million and adjusted earnings per share of $0.54 per share to $0.59 per share. And finally, our capital expenditures at $80 million. That concludes our prepared remarks. And I'll now turn the call over to our operator, to provide instructions for Q&A.
Thanks, Jim. We will now be conducting a question-and-answer session. [Operator Instructions] The first question is from Jason Cassorla of Citi.
Great. I know more on 2024 is coming next quarter, but was hoping if you could give us a sense of the major swing factors, headwinds and tailwinds to consider for next year. And if at a high level, there's potential for margin expansion in '24, just outside of any major upswing in P&R demand? And then if there's any reason why we shouldn't leverage the longer-term targets you have out there for the 3 businesses, just as proxies to think about revenue growth for next year at this point?
So I'll start.
I'll follow.
We're both eager to jump in. So let me start and say our ability to expand our margins is not simply a function of peak need rental performance. It's actually about driving the right mix, as I described in my prepared remarks across our business with really the most important driver being a focus on building local market density in certain of those areas in and around our local infrastructure of teams and medical devices of our vehicle fleet, driving business near in and around those local facilities. It's when we leverage that as a core part of our service delivery that, that business generates its best incremental margin on that next dollar of revenue. Jim, do you want to touch on mix?
Yes, I think you've hit it to see -- Jason, we haven't provided the guidance yet in 2024. What I ask you to look at though is just that our trend for 2023, as we completed Q3 and use that as a starting point for 2024 but more to come there, Jason, as we round the bend.
Okay. Got it. And maybe just a follow-up on that plan around the transactional, I guess as we think about the growth levers there, the SES and the Surgical Services and outside of the P&L, how should we think about the EBITDA flow-through of those solutions against the P&R just trying to think of the magnitude as you focus there? And then it sounds like the shift is a top priority, but just curious what the lead times look like for the implementation of the shift if we should think about this is like a day 1 turnaround or it would take a few quarters to kind of see more of a material mix shift? Just trying to get a sense of timing around this too.
So first with regard to individual solutions and their contribution merging as the next dollar of revenue that we onboard it is less about -- if it is peak need rental? Or is it supplemental clinical engineering. It's really a lot more for this business and the margin profile around the place that we source the operating capabilities to deliver against that next dollar of revenue. So what I mean about that is more simplified. I can sell the same piece of business, for example, supplemental clinical engineering who may go in and help a customer who's fallen behind and he has a couple of dozen infusion pumps that they haven't been able to get parts for as an example. If that is a customer who's down the street from 1 of my local -- my local service centers, we may be able to do that work transporting that equipment in our existing vehicles to an existing facility with existing full-time employees that have already been bought and paid for by other parts of our business that would flow through at very high contribution margin. Conversely, if that same need was done in a place that's not a place where I have local market capabilities or I don't have capacity and I have flex over time or if I have to put somebody on an airplane to go to that facility that can actually not very profitable less than our corporate average contribution to service that revenue. So what's -- it is not necessarily exactly which solutions d which proportion we sell them. It's really about how we drive our business in ways that we can maximize that leverage of these local market capabilities that we enjoy. And in terms of the sort of the speed of the turnaround or the change here's what have you think about it. In terms of us getting off course as we have at this point, I think about it like ship crossing the ocean, if it steering compass is just 1% off, a couple of degrees off, in the first day or so, might not be noticeable, maybe a few hundred yards off course. So by the time you reach the other side of the ocean, you might miss your intended port by a couple of hundred miles. And while a business is a perpetuity it doesn't have a destination, the same thing is true by being a little bit off in a number of these areas, but always off for the wrong side, we've gotten off course and you can see that clearly in our margin profile. Getting back on course is about making small course adjustments in a variety of places within our business. It's not big changes. It's not blowing up anything that we do today. We don't need entirely new sales force. We don't need anything that we don't already have within our portfolio. It's about the small adjustments, some of which we've already started to make that will increasingly be seen in our financial results. So it doesn't happen in a day or a week, but it will happen consistently, I would say, give us a few quarters to start to see some of the impact. We'll point to some of the impacts as it happens as a living indicator will give you a report card as we proceed. But you should expect a slow but steady progression back in the right direction, which will be most clearly seen over time in gross margin rate of this business.
The next question we have is from Brian Tanquilut of Jefferies.
This is Nur Robleh in for Brian. Tom, now that you are back at the helm, I guess I just want to first get a high-level forward view of what your strategic priorities are moving forward as we go into Q4 and into 2024?
The wide-open question. What I'm really excited about spending my time doing right now is getting back deep into the heart of the business and working with the teams to understand exactly where we are, which things are going well and what adjustments we need to make to make this business that extraordinary financial engine that used to be able to set your watch too, it's something that gives me great joy and it's one of the things I'm most excited about as I return to the business. This is an amazing business. It is under achieving, I think, by a wide degree, what its true potential is.
So getting there quickly again, is the biggest near-term priority that I have. Longer term, what makes agility unique is this is in a bet on a single technology. It's not a bet on a short-term trend. What we enjoy, what powers this financial engine is a local market infrastructure of teams and capabilities when it comes to managing, maintaining, repairing, mobilizing medical devices. The longer-term opportunity for this business is to continue to drive profitable volume, not just of the solutions that we enjoy today, but the others that we might build or acquire and a business really has untapped potential in terms of the future for it. So near term, it's getting back to a healthy margin profile. Longer term, it's really about driving growth organically and inorganically by driving meaningful volume through our local market infrastructure, where we can do it more profitably and without peer better than anyone.
Great. And then for Jim, I guess, I'm curious to know some of your capital allocation priorities. You noted that you paused M&A and aren't doing any share buybacks. But given that half of the overall debt of the company is at a variable rate, how are you thinking about paying down the debt versus investing in the business?
Yes. Look, I think we'll be very thoughtful about it. Obviously, we know our cost of debt has gone up. So I think we'll be pretty well balanced with both paying down debt as well as reinvesting in our business for all the reasons that Tom pointed out in his script. That's the way to think about it.
[Operator Instructions] The next question we have is from Kevin Fischbeck of Bank of America.
This is Nabil on for Kevin. Recently, hospitals have been talking about cost pressure from labor and professional fees. Is that having impact on your conversations with clients on where they can save money elsewhere? Or is it preventing them from having conversations with you at all because they're distracted by it.
What we have long prided ourselves on as a company is being on the right side of health care. What that means for us is we have the opportunity every time we go into one of our customers' facilities to take on some of the work that they try to do for themselves and do it in a fundamentally different way. We don't have a badge flip model where we trade their employees for our outsourced employees, which really runs the risk of just adding cost for them. Rather, we can help them when it comes to the medical devices they own.
Free up the excess capital tied up and owning too many medical devices and the costs -- the attending costs that come with supporting those devices, we can reduce their reliance on rental by driving the utilization of the equipment that they own. We can reduce their costs of repairing and maintaining their medical devices because we focus our solutions on delivering a hard dollar financial return for our customers, it's precisely when they're in this place when they feel that financial pressure. I think that our conversations are most powerful with our customers.
There are no further questions at this time. I would like to turn the floor back over to Tom Leonard for closing comments.
So first, I want to thank everyone for the opportunity to speak with you today. I'm 6 weeks now back in the business. I'm very excited to have the opportunity to be here. This truly is a business with a bright future. And our near-term challenges are both obvious and I think very manageable. So we're going to look forward to providing an update on our progress as we complete 2023. And as we share our goals as we turn the corner into a new year. And with that, I'll go ahead and conclude today's call.
This concludes today's conference. Thank you for joining us. You may now disconnect your lines.