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SAM A. BROOKS - RENAL CARE GROUP INC (Nasdaq:RCGI)
CEO Interview - published 11/01/1999
SAM A. BROOKS has twenty-eight years of experience with publicly held healthcare services companies which gives him an excellent perspective on the challenges facing providers in the dynamic healthcare marketplace. His career includes previous positions with national providers of healthcare services. Mr. Brooks served as Executive Vice President and Chief Financial Officer of Hospital Corporation of America for seventeen years before leaving in 1986 and establishing MedCare Investments, a healthcare investment company. He is a founding director of three healthcare services companies: Nationwide Health Properties, a New York Stock Exchange real estate investment trust that provides financing for long-term care properties; Quorum Health Group, a NASDAQ listed owner and operator of acute care hospitals; and PhyCor, a NASDAQ listed operator of multi-specialty medical clinics. He is co-founder and Chairman, President and Chief Executive Officer of Renal Care Group. He was with the Dallas office of the public accounting firm of Ernst & Young with principal responsibility for healthcare clients from 1962 to 1969. He is a graduate of Baylor University with a degree in business administration. Mr. Brooks was born in 1939, is married and has three children.
SECTOR: BIOTECHNOLOGY
TWST: Give us a historical perspective of Renal Care Group, Inc.? Then tell us what you see as your business and company today?
Mr. Brooks: I think you would somewhat define the company as being a specialized provider of nephrology services with an emphasis on kidney dialysis. We're headquartered in Nashville Tennessee, and we're located in 22 states. We have a physician driven heritage. We were founded by nephrologists, the specialty that cares for people with end stage renal disease. Additionally, Vanderbilt University Medical School was a co-founder. Our founders challenged us to have an enhanced clinical focus. As a result, our company emphasizes cost-effective quality care. It's one of the ways we've distinguished ourselves from the other, larger, fully product integrated companies in the industry. We have strong university and medical center affiliations. Like I said, Vanderbilt Medical School was one of our co-founders, and we have a partnership with the Cleveland Clinic, and Case University, both based in Cleveland Ohio, and Oregon Health Sciences University in Portland, and the Medical College of Wisconsin in Milwaukee, along with several others. The company had its initial public offering in February of 1996, so it's about three and a half years old as a public company. It now accounts for about 5% of the U.S. ESRD patients, with the other large competitors being Fresenius, a company controlled by German shareholders, that has about 20 to 25% of the market, and Gambro, a Swedish controlled company with about 12 or 13%, and Total Renal Care, a Los Angeles based company that has about 12% or 13%. But even though we're the smallest we're not at any financial disadvantage because, health care services is definitely a local market, and at best it's a regional market. But in most cases, and certainly in this case, it's not a national market. So we're of a financial size to be able to handle almost any opportunity that comes our way. I think the most notable thing financially is that over the past three and a half years the company has increased in size by 7 times. We have built a company with about $1 billion in total value, equity and debt combined. But we've done that using debt sparingly. We only have about $90 million of debt on our balance sheet, and last quarter we paid that down. It didn't go up, it went down. The growth of the company has been pretty substantial. In fact, I've got Fortune Magazine here and in their September 13th issue they listed the 100 fastest growing companies in the U.S., and we were number 90. In order to get on the list you had to grow earnings per share and revenues at least 30% for three consecutive years. There are only about 170 companies in the U.S. that did that and many of them are information technology companies ' it is not easy to get on the same list Dell Computer is on. Our company grew earnings per share at an average annual rate of 44% for that three years, and revenues 67%. Interestingly enough, the common stock increased an average of 22% a year during that period. So most equity analysts think that it's a pretty good buy and that it could be at a good entry point for potential investors.
TWST: When you look at the industry today, what room is there for mergers and acquisitions, either to grow contiguously, to bring in scaleable products and services, or to bring in people. What are those opportunities? What criteria are you using as you look at those opportunities?
Mr. Brooks: One of the favorable attributes of this industry is that it is consolidating. I would say if you went back five or six years ago, no more than about 25% of the sector was consolidated with the large companies. Now it's probably 55%. So there's still about 45% remaining that could be consolidated. And of those, about half are controlled by hospitals, and the other half are principally controlled by nephrologists. So our company has an opportunity to grow not only internally, which it is doing a good job on, but also through acquisitions. We are trying to add about 15% to our base each year through a merger and acquisition program.
TWST: What do you then see as competition? Is that competition following similar strategies? Are the prices for growth going up at this point, or do you feel that those dynamics have points of inflection in which you can take advantage of the opportunities?
Mr. Brooks: There is something of an inflection point that occurred this year in that all of the other companies in the sector were following the same merger and acquisition strategy, but Fresenius, which had assembled probably 20 to 25% of the patients in the U.S. was on a very aggressive acquisition strategy, paying all cash, and looking to have significant presence in major U.S. markets like Chicago, for example. They achieved their goals and retracted from the acquisition market, probably a year ago. Gambro, another big provider, is very controlled and cautious in their merger and acquisition growth demands. Even though Gambro is three times our size, their growth objectives, in terms of absolute units, is about the same as ours. They're also a very disciplined buyer. They're very price conscious, very conscious of return on invested capital. So the bottom line is they don't overpay. However, there was a very aggressive acquirer, Total Renal Care, but they ran into some problems that were publicly disclosed in the first quarter of this year. Those problems were principally internal, and had to do with growing so fast they weren't able to satisfactorily integrate those acquisitions, either through systems or building a company culture and getting the people working together well. So they missed earnings and announced some write offs. They grew through the use of debt so they're a little overleveraged at this time. Their current approach is to retract from the M&A field and get their house in order before they reconstitute that effort. My guess is that it's going to take them a year or more to do that. So that leaves the acquisition market less competitive than it has been in the past two or three years.
TWST: At this point, are there limitations on cash or capital as you look at not only these opportunities, but your own operations?
Mr. Brooks: There are of course limitations, but we believe these limitations won't keep us from meeting what most analysts have projected as our expected growth, in terms of earnings per share. We're looking for about 10% growth in EPS from merger and acquisition efforts, and maybe as much as 15%. But we aren't constrained in so far as our cash flow and debt levels are concerned because our debt level is only 25% of our capital. I think we could take it up to 50% and still be a conservatively financed health care services company. In addition, our cash flow is very strong. This year it should be about $125 million, and analysts think it will be about $160 million next year. Of course our priority on the use of that cash is what you would expect. First, it's to provide working capital because the company's top line is growing 40% to 50% a year. So working capital is the first use of our cash flow, and the second is keeping our property plant and equipment modern and up to date. And that's principally dialysis machines, and water treatment facilities in our dialysis units. Then third, it would be directed towards de novo units, and expanding in regions we're already in. Finally merger and acquisition efforts. A significant positive for our company is that our dialysis machines and our water treatment plants are first class. Having a physician-oriented culture, we committed initially to have a high priority on maintaining that plant and equipment at a very high quality level. So we have first class plant and equipment. Deferred maintenance costs just don't exist in this company. So the bottom line is there's quite a bit of our cash flow available for growth.
TWST: From your experience, what has been the time line when you look to grow the business from the planning and review of a potential acquisition or growth opportunity through the results to the shareholder, results to the bottom line?
Mr. Brooks: On every acquisition we've made, we've been able to improve both the financial operating parameters expressed principally in our company as EBITDA margin. In addition, we've improved the medical outcomes. We do that principally by just focusing on it, and making it a target, and part of our culture. We usually get those results within six months. This is a company that is very disciplined in its budgeting and planning efforts. We're currently in that effort, and by the end of October we will have completed our year 2000 profit plan that comes from the bottom up and involves many hours of work. As to the second part of your question, we're disciplined in our merger and acquisition effort. We have all seen merger and acquisition people that get carried away and very enthusiastic with the ability to spend to this money. But in our company the projections of future earnings of an entity to be acquired becomes the operating people's budget. So the operating people have a role in com ing over and looking at the projection that the M&A department has made. That projection has to be approved and accepted by them. I can add this, every acquisition we've made, we have met or exceeded the projections that were made when we did the acquisition.
TWST: Give me a quick assessment of top management today. As you look at that team, what are the primary skill sets you're relying on. Do you have bench strength as you look ahead. Are there areas that you are looking at for change or addition?
Mr. Brooks: I'm very proud of the way this management team has performed. There has been pretty heady growth here. Whenever you look at the growth from an operating standpoint, you need to look at the top line growth. The company grew the top line 58% in 1997, 73% in 1998, and this year it should be 45 to 50%. They not only met or exceed analysts expectations for earnings per share every quarter since we've been public, but they've also done so in a disciplined manner. This is, for example, reflected in the number of days in accounts receivable. We have a little over two months in our accounts receivable, which is among the lowest in the industry. It can be tempting to overreach for earnings per share when you have a strong stock market like we've had in the past four or five years. But our company has resisted doing that. Almost all of our management team has a health care background, but fewer have a background in kidney dialysis. The reason for that is that this field is one that many would call a mom and pop industry, principally controlled and owned by groups of nephrologists, or it was a small, rather insignificant section of a large hospital. So there weren't many corporate executives, with public company experience in dialysis units. So the people I have in top management are from managed care and hospital backgrounds or financial experience with health care companies. That's one of the reasons the company is located here in Nashville. Nashville is a hotbed of health care services companies. There is an abundance of executives with those types of skills. We function in a decentralized management style, with nine geographical regions. Now in those regions we have some executives that are very skilled and have a long background, in most instances, in the dialysis business. What we did, as corporate managers, who were more experienced working with large companies, was to put in the discipline of a three year profit plan, a detailed annual budget, a capital expenditure budget, and a three year capital expenditure plan. We asked them to make their regions grow by expanding geographically in their region, expanding the outward bounds of it. On top of that we did something a little unusual for health care services. We put in a medical outcomes measurement system that would measure medical outcomes. These people really responded to that. They were challenged, they learned quickly and were proud of what they were doing. And they've done a tremendous job. As to depth of management, anytime you've got a company growing as fast as ours has it's difficulty to have a great deal of depth. It's adequate, but we're always looking for good, top quality people. I won't get into the details, but it's a challenge in the United States right now in health care, to find committed, top quality people. With business as good as it is, and employment as high as it is, you've got to have an excellent company with a lot more to offer than just a salary and a job to attract top people.
TWST: At this point, how could the investment community improve its perceptions? As you speak with your own shareholders, with potential investors, with industry analysts, what are the misperceptions? What are the assumptions with which you could disagree?
Mr. Brooks: I cannot say that there are many misconceptions. Our company, and this sector of health care services, is well-analyzed. The near-term threats to our profitability have been identified by analysts as modest, and analysts feel we have a relatively secure outlook. We've got 15 sellside analysts that follow our company and publish reports. Of those 15, seven of them have strong buy to outperform ratings, and eight of them have buy recommendations. This isn't a sector of health care services that has had difficulty. So far as the sector is concerned, one company has internal problems, but the other companies have done well. I think most equity analysts and equity buyers have told me that one of the reasons for the relative weakness of stocks in this sector, and of our stock in particular, is due to the health care services sector performing so poorly. That includes hospitals, nursing homes and HMOs, for example. They've missed earnings. They've had problems with reimbursement. So the entire health care services area has had some difficulty attracting investors. A lot of people have lost money there. So when you have a small sector like ours that is doing well, but investors have been burned in most parts of the health care services area, then I'm told that the entire area has to start doing well before investors are going to return and p/e valuations expand.
TWST: What then would be the summary statement, or the essential message for an investor, your short list of highlights and strengths that would convince an investor today to buy in?
Mr. Brooks: The fundamentals are strong here. The internal growth rate is good. The number of patients in the U.S. that have end stage renal disease is growing at a rate of 7 to 8%. It has done that over the past 15 to 16 years, and it's expected to do that in the future. There has been a relatively stable reimbursement rate. We feel the outlook for reimbursement, especially from Medicare, which accounts for about 60% of our revenues, is positive. There are two bills now in Congress to increase the Medicare reimbursement to dialysis providers by 2.9%, so there's a chance that an increase could occur. There's also the consolidation trends I mentioned earlier, the value that large companies like RCG bring to the freestanding independent providers is not only financial, but also our focus on superior patient outcomes. Finally, I think investors can be a little misled if they only look at the two U.S. based companies, Total Renal Care, and Renal Care Group. Total Renal's problems have been company-specific, rather than industry-specific. So if investors will go a little further and look at the two non-U.S. based companies, they'll see 25% earnings per share growth at Fresenius last quarter and expanding EBITDA margins at Gambro, just as they see with Renal Care Group.
TWST: Give us a little insight into your own personal management philosophy. As you go about setting goals and standards for this organization, is there a simple or a distilled Brooks' ABCs of business?
Mr. Brooks: I think that when you're consolidating an industry, and in that M&A process, you work to acquire good people that are committed to health care. The people have never worked in a public company before, so you can really make their professional life a lot of fun by giving them a chance to have some meaningful work, and health care services is that, and also give them a chance to share in the financial rewards. You have to do both. We have two ways they can share in the financial rewards. One is through a stock option program that's pretty wide spread. It probably covers 10% of our employees. It goes well down into the operating regions where the real work is done.Then we have a bonus plan, incidentally is equally weighted for financial goals and patient outcome goals. That holds true for me too, the President of the company. The amount of my bonus is equally weighted for achieving the financial goals, including earnings per share, and the patient outcome goals. I think the other thing I try to do is build the culture of the company. It's important for that message to be simple, and for it to be widespread, easily understood, and integral to our whole operating philosophy, because since we're decentralized a lot of decisions are being made on the local level. With us, it's integral to our culture that we set goals and meet our goals. Furthermore, it is well known in our company that the provision of superior care is in the best interest, not only of our patients, but of our shareholders as well. I think that's a pretty basic tenet of American business and it is based on the fact that having the highest quality product at the lowest possible price is what you're looking for. That's what we're focused on too. We label that optimal care. Our objective is to be the low cost, high quality company with a significant market presence in every region we are in.
TWST: Thank you.
SAM A. BROOKS
Chairman, President & CEO
Renal Care Group, Inc.
2100 West End Avenue, Suite 800
Nashville, TN 37203
(615) 345-5500
(615) 345-5506 - FAX
Each Executive who is the featured subject of a TWST Interview is offered the opportunity to include an Investors Brief or other highlight material to be provided and sponsored by and for the company. This interview with Sam A. Brooks, Chairman, President & CEO, Renal Care Group, Inc., is accompanied by an Investors Brief containing corporate information.
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