Description

Elevator Pitch
Assure Holdings provides Intraoperative Neuromonitoring services (monitoring of the nervous system during a surgery to alert a surgeon of emerging nerve issues) in the United States.  A series of temporary issues, accounting nuances, and underappreciated growth initiatives mask the intrinsic value of the business.

Shares are listed on the Canadian TSX Venture exchange (ticker IOM.V) and are also OTC listed (ticker ARHH).  ARHH trades at $0.92 per share with 43.5mm fully diluted shares outstanding ($40mm market capitalization).  Shares effectively trade at a 1x EV/EBIT multiple and a 4x MC/NI multiple despite strong margin expansion and revenue growth initiatives in progress.

Please note:

• This idea is best suited for personal accounts as there is only ~$10k average daily volume on the OTC and ~$11k on the Canadian exchange.
• Financial statements are presented in USD, therefore the figures used in this writeup will also be USD.  Valuation will be compared to the OTC price/market cap/enterprise value for consistency.

Business Overview
Assure Holdings ("ARHH") provides Intraoperative Neuromonitoring ("IONM") services performed during spine and head surgeries.  IONM is the process of monitoring the nervous system during a surgery with the objective of providing real-time feedback on the functional integrity of the nervous system to the surgeon.  IONM will identify if nerves have become compressed or if the brain/spinal cord has experienced reduced vascular flow - this information allows a surgeon to course correct before a neurological incident settles in and becomes permanent.  Surgeries which commonly use IONM include spinal surgery for scoliosis, tumors, aneurysms, vascular surgery, and some ENT surgeries.  ARHH's operations began in March 2016 and the company went public in May 2017 - it is a relatively new business although IONM has been used for ~20 years.  ARHH is the only publicly traded pure-play IONM company. 

The use of IONM in a surgery involves three key players:

• Technologist - A technologist sits in the operating room and is responsible for connecting the patient to the electrophysiological monitoring machine (EEG, EMG).  The technologist is also responsible for communication between the Neurologist and the Surgeon.  The technologists are ARHH employees and ARHH owns the equipment used within the operating room. 
• Neurologist – A remote offsite neurologist reviews IONM readings real-time and communicates to the Surgeon via the Technologist.  Currently, ARHH uses contractors to fulfill the Neurologist role (although this will begin to move in-house in 2020 – refer to the "Growth" section within this write-up for further info).  The remote model is used to achieve economies of scale (monitoring multiple cases at once + reduced travel).
• Surgeon - ARHH's primary stakeholder is the surgeon - ARHH provides value to the surgeon in a few ways:  surgical error reduction as part of the actual service; by providing consistent technologists to allow for continuity in staffing; by handling 100% of the scheduling/billing for the procedure; and importantly by sharing revenue directly with the surgeon (more on this below). 

Revenue is earned as follows:

• Technical Bill
• Revenue associated with the Technologist role
• ARHH earns 100% of the Technical Bill.   This is recorded as "Out of Network Fees Revenue" on the financial statements.
• ARHH bills insurance companies (primary payors) & other groups (hospitals).  The bill is incremental to what the doctors bill.  The bill is pre-approved by payors (insurance co; hospital) in advance of the surgery.

• Professional Bill

• Revenue associated with the Neurologist component of the service.  

• This is an interesting aspect of the business model.  ARHH replaces other IONM vendors and shares a % of the earnings w/ the Surgeons through partnerships structured as Professional Network Entities ("PNE").  Currently, ARHH outsources the Neurologist function using contractors which is a cost center for the entity.  

• For the majority of PNE's, ARHH holds a minority ownership interest in the entity.  In these instances, earnings are recorded in the financials as “Earnings from Equity Method Investments” on the company’s income statement below operating income as these entities are not consolidated.   ARHH earns a % of the net income of the entity (not revenue).

• For the remaining PNE's where ARHH does not hold any ownership interest.  ARHH earns a management fee for managing the operations which is recorded as "Contract Fees Revenue" on the financial statements.  These are structured such that ARHH earns a % of the revenue (not net income).

• There are key changes occurring to the structure of Professional Revenue which will expand Professional Revenue margins - ARHH is in the process of renegotiating legacy contracts at higher ownership interests & is also moving towards bringing the Neurologist function in-house in 2020.  Please refer to the "Professional Revenue - Margin Expansion" within the 'Growth' section of this write-up for further info.

Please see the attached fancy illustration I stole from the company investor deck which summarizes the above:

Growth
Attractive M&A
ARHH competes in a highly fragmented industry with hundreds of small regional players.  The majority of these competitors are undercapitalized due to the same working capital dynamics impacting ARHH where the balance sheet is funding a lag in out-of-network billing (see Accounts Receivable section separately within this writeup).  Management believes that they can buy these companies, in some cases, for ~1x EBIT.  Although it is fair to look at the ~1x EBIT target with skepticism, the two most recent acquisitions provide some credence to management's strategy:

• In May 2019, ARHH purchased the net assets (primarily Accounts Receivable similar to ARHH's balance sheet) of Littleton Professional Reading for $700,000 in cash. 
• Littleton managed approximately 375 spine and neurosurgery cases in 2018.
• By the Q2 earnings call (August 2019) ARHH had already collected 60% of what they paid for the business.  And as disclosed in Q3- through November 15, 2019, the Company collected approximately $660k of cash from the accounts receivable acquired in the acquisition (94% of the purchase price 6 months later!)
•  In Feb 2020, ARHH acquired Neuro-Pro for $7.7mm.  This is funded by cash and convertible debt issued during 1H2020 at 9% interest w/ $2 USD strike.  
• Neuro-Pro performed 2.5k procedures in 2019 which is a 39% increase to ARHH’s 2019 base

• Neuro-Pro is already cash-flow positive.  In 2019 Neuro-pro earned $6mm in revenue (cash basis) and $3mm in net income (cash basis).  A 2.5x FCF multiple.  This incremental amount of FCF worth $12mm in value if capitalized at a 4x earnings multiple consistent with the current market multiple (~30% of the current market cap).

• Additionally, management believes it can increase prices (which is reasonable given Neuro-Pro revenue per case was $2.4k in 2019 versus ARHH revenue per case of $5.5k TTM).

• Historically, approximately 80% of Neuro-Pro’s procedures were commercial insurance payers while roughly 50% of Assure’s procedures are commercial payers. From a financial perspective, commercial insurance payers are more profitable procedures to Assure than procedures covered for patients with government insurance

Professional Revenue - Margin Expansion
There are key changes occurring to the structure of Professional Revenue which will expand Professional Revenue margins.

• Ownership Share - ARHH is in the process of renegotiating its PNE contracts to a higher % of the ownership interests.  (As described above, in most instances ARHH owns a minority equity ownership in its PNE's with the Surgeons)
• When the business started, ARHH gave 90% share to the Surgeons.  As of the last quarter, every new deal the company gives 60%.  On the recent 2020Q1 Neuro-Pro acquisition, the acquired business has 50% interests.
• Founder 2019Q1 CC:  "Back when I started Assure, the concept to partner with doctors was a new one and one that I was experimenting with. At that time, I was just trying to establish and grow the business. So I was happy to take a lower percentage of the professional bill than I knew was warranted. Fast-forward to today, where we are a well established and proven entity, we can now go to doctors and show them improved value of services we can provide. This now gives us a road map to what we can and now do command for a split of the revenue of the professional bill.  Our services are such that the old days of only getting 15% of the professional bill are now gone. Our customers splits with our partners today are now 2x to 3x that. The amount of services we provide and value it brings to our partners definitely warrants these splits.  Garnering a higher percentage of the professional bill, something we set out to do in 2019, I'm happy to say we are now doing that. This will have a significant impact in the go-forward of our financials"
• ARHH will also be moving towards bringing the Neurologist function in-house in 2020.
  • Under the current (i.e. legacy) structure where the Neurologist is outsourced, this function is a cost center which effectively reduces ARHH's portion of earnings in the PNE's.  By bringing the Neurologist in-house, the Neurologist function will become a profit center as this revenue will be captured by ARHH.   This is expected to occur in 2020.

ARHH recorded $1.1mm "Earnings from equity method investments" during the Trailing 12 months (line item specific to minority interests in PNEs).   Assuming a current 15% margin expanding to 50% margin as a result of the two changes above would increase this figure to $3.6mm.  The incremental amount is worth $8mm in value if capitalized at a 3x pretax multiple consistent with the current market multiple (~20% of the current market cap).  

Organic Growth

• Regional Expansion
• Over the past two years the Company has expanded operations from one (Colorado) to seven states.  Many of these states are in the process of maturing and will continue to experience growth and fixed cost margin expansion.  Colorado was responsible for 82% of revenue in Q1 2018, 44% in Q1 2019, and 23% in Q3 2019.  
• Importantly, the process of achieving approval to operate in additional states is also a forward-looking indicator of future growth.  Similarly, expenses have been incurred in the current and previous quarters in establishing presence in each of these states prior to any revenues being recorded - this is a driver of margin expansion going forward once these states mature.   ("And there is a cost to go into every new market that we open up, there is legal, there is setup costs. And there is hiring of techs and other support people that all happen in advance of revenue" - Q3 2019 CC)
• Q1 2019- achieved approval in Nevada, Georgia, Oklahoma, Arizona, Michigan
• Q3 2019- achieved approval in South Carolina
• Biggest source of growth to date (>75% of revenue growth) has come from surgeon referrals
• Customer retention is strong.  ARHH has only lost 2 surgeons (they are currently working with 98 surgeons today) in the past 2.5 years, one to retirement and another because they moved to another state not serviced by Assure.
• Overall IONM industry is growing at 6.5% per year.  Additionally, hospitals and surgical care facilities increasingly outsourcing IONM (where ARHH operates) in order to improve quality and reduce training, staffing, and equipment costs.   The outsourcing market is growing 10.3% a year.  This growth is prior to the gains in market share that ARHH's is achieving through accretive M&A. 

Temporary issues create opportunity
There are several key variables that should be directly addressed related to negative aspects of this company.

Accounts Receivable
One of the key variables and ick-factors with this business is its Revenue and Accounts Receivable dynamic.  Because ARHH has historically earned revenue through out-of-network insurance billing relationships, there is a significant lag between the earning of revenue versus the collection of revenue.  Between the time that ARHH submits its bill to the insurance company and the time it actually gets paid can be as long as 2 years and could even drag on, in some cases, for 3 years as negotiations with the insurance companies are drawn out.  This does not mean that the business does not have value.  This issue was exacerbated by the company’s legacy model of outsourcing its billings/claims operations.  

Previous revenue restatements have caused the market to remain skeptical of the current A/R balance, meanwhile recent strategic decisions made by management will reduce the overall impact of this dynamic on the business. 

• Historical Write-off Overhang
• As part of the filing of the Q4 2018 financials, the company revisited its Revenue and A/R accounting policy resulting in restatements of prior financials and a stricter revenue booking and allowance reserve policy going forward. This restatement occurred subsequent to the onboarding of the new CFO in Sept 2018 (discussed separately in this writeup).  The restatement was a result of the company performing a cash collection analysis for its historical out-of-network billings to private insurance companies.  This analysis showed that the estimated realizable value of revenues and the related accounts receivable generated from out-of-network revenue was approximately $10 million less than the amount originally recorded by the Company for 2017 and 2018. 

• It’s important to note that the prior CFO essentially didn’t book an allowance reserve.  In the 2017 financials, the company disclosed Gross A/R of $16.7mm and an Allowance for Doubtful Accounts of $117k.  

• Going forward, every 6 months the company will re-evaluate its revenue bookings against historic A/R collections to ensure recorded revenues are in line with cash collection experience.   This was performed for 6/30/2019 and did not result in a material adjustment to A/R or revenue.

• Additionally, the company writes off all receivables after 2 years regardless of cash collection experience.  Specifically, the company establishes a reserve for all A/R aged > 24 months and subsequently writes off the Gross A/R and Allowance after 36 months.   This is conservative as the company reported in its recent IR deck that in March 2020 the company collected $900k from 2016 and 2017 receivables that had previously been reserved and written-off (2.5% of the market cap).  

• Off Balance Sheet A/R

• Given the nature of the unconsolidated minority interests ARHH holds in its PNEs (PNEs are described in detail separately in this write-up), the company is entitled to Accounts Receivable which is entirely off-balance sheet.  This is only disclosed in the recent IR deck which states that "another ~$25mm of receivables are off balance sheet but collection should further drive cash flow to Assure".  The company does not distinguish whether this is the portion attributable to the entire PNE or to ARHH, but it likely the former.  Given historic PNE ARHH ownership share (~10%), a conservative assumption is that $2.5mm of these receivables are due to ARHH (~6% of the market cap)

• Strategic shift to in-house billings and claims

• Prior to Q1 2019, ARHH outsourced its billings and collections to one company. In April 2019, ARHH onboarded a separate company (Clever Claims) to manage incremental billings and effectively compete with the original billing company.

• With the success of the Clever Claims relationship, in September 2019 management terminated the legacy billings/collection company and entered into a joint venture agreement with Clever Claims.  ARHH owns 65% of the JV (which is called Velocity Revenue Cycle).  Through this process, management has completely overhauled the revenue cycle management process, resulting in more timely and accurate claims being filed.  As an example of low-hanging fruit identified as part of this process, ARHH identified that one of the issues w/ the legacy billing company was that they were not issuing bills for 3-6 months in many cases. 

• The joint venture provides greater control and transparency over the billing and collection process - a key milestone as given the nature of this business, billings and collections is a core competency which ARHH has to own.  

• Strategic shift to in-network insurance relationships

• Until Q2 2019, all of ARHH business was billed out-of-network w/ insurance companies.   Although insurers pre-approved prior to surgery, the collections process was generally 9-14 months of negotiations on average.

• In 2019, management announced that it will begin to contract w/ insurance companies directly (in-network) where it is economically attractive to do so.  ARHH hired a VP of Strategy who has experience bringing $1B+ of revenue in-network to achieve this objective. 

• By going in-network, revenues can drop 25% relative to out-of-network - however that revenue becomes much more valuable because of the certainty of being paid and the certainty of being paid in a timely manner (typically 30 to 45 days). 

• The strategy is to use in-network relationships as an additional vector of growth where economically attractive but there will continue to be out-of-network business for the foreseeable future.   Overall, this will help smooth cash flow by reducing the volatility in cash collections and bring further predictability to the business.

• Management is patient and economical - "We've been offered in-network rates by a number of groups, but they just don't fit our economics. The challenge for Paul [VP Strategy] next year [2020] is to accelerate the in-network process, at the same time, being opportunistic. We're not going to take an in-network deal if our margin evaporates. We'll wait, we'll be patient. We were very happy with the deal that Paul struck in Michigan. And I think part of our challenge will be wanting to go in-network, but yet being patient enough to say no and only take the deals that work for us" - CEO Q3 2019 CC.

• In Q3 2019, management completed its first in-network contract with Aetna in Michigan.

• Management stated that they will take "slightly" lower rates, but will be paid in 45 days.

• Contract including contracted rates, prompt payment requirements, medical necessity conditions, and dispute resolution steps.

• As of the Q3 2019 cc transcript, ARHH is also in contact with 5 additional payors regarding in-network contracts.

Legacy improper expense restatements/trading halt not relevant to the core earnings power of the business
Beginning March 2018, a series of announcements including the resignation of the prior auditor as a result of issues related to the treatment of founder/director expenses and other fees. 

• A subsequent forensic audit was performed and it was ultimately identified that a Director spent <$1mm & the Founder (CEO at the time) spent ~$2mm (including interest etc) on personal expenses using company funds (just my quick read from skimming the press releases - I am not making any assertions - please read the press releases to form any conclusions).
• Trading on the TSX was halted for 5 months (resumed trading in August 2018).  Eventually issued FY2017 financials in August 2018 w/ restated FY2016 figures - nothing substantial to note.
• Importantly, these issues are largely behind the company.  All debt resulting from these issues have been settled (the Founder paid all auditing and legal expenses involved in the investigation as well).  The director has resigned and is no longer involved in the company.  The Founder resigned as CEO and was demoted to a Sales management position, but likely given his significant ownership in the business (38% FDSO) he continues in a management and director position.  (Interestingly, the Founder played in the NFL for 6 seasons). 

Going forward

• Given the Founders substantial ownership in the business (and prior employment…) I simply don't believe this impacts the core earnings power of the business.  The Founder has also agreed to give away a substantial portion of his 5mm shares due in the "Provision for performance share issuance" (discussed separately in this writeup) to other employees which he does not have to do.  
• New CEO was appointed in March 2018 - John Farlinger.  Was promoted from Interim to permanent CEO in August 2019 and overall has done a decent job with the business strategy and revamping the Revenue/Accounts Receivable booking model.
• Prior CFO resigned in Aug 2018.  Hired new CFO (who is still with the company) in Sept 2018.   The restatement of Revenue and A/R are a result of the new CFO and unrelated to the matters discussed above - see 'Accounts Receivable' section of this write-up for further info.  
• Interestingly, shares traded in the mid $2 CAD range for an extended period following the resumption of trading in 2018 (relative to $1.21 CAD today - despite the various progress made over the last year in the actual business).
• Also note that management compensation and board fees appear reasonable, although management ownership is low with the exception of the founder who continues to own ~17mm shares (38% FDSO).

COVID
ARHH is undoubtedly impacted by COVID due to its exposure to elective surgeries. In a recent press release, ARHH stated that “Although Assure has seen over a 50% decline in the number of procedures performed in March and April due to a downturn in elective procedures driven by the COVID-19 pandemic, we have been encouraged by the healthy volume of cases already scheduled for May. In addition, we anticipate that the majority of the procedures that were postponed in March and April will be rescheduled for another time in 2020."

Further, the company delayed the issuance of its FY2019 financial statements due to COVID - citing the Blanket Relief provided by the SEC.  The market is clearly hypersensitive to this topic specifically for ARHH due to its history but it is likely that ARHH simply experienced reasonable delay.  The financials will only be delayed by one month as they are set to be issued by end of May (originally end of April). 

This is definitionally a short-term issue and does not influence the inflow of cash from its existing Accounts Receivable balance.  In the longer term, this may benefit ARHH's accretive M&A strategy (discussed in the Growth section of this writeup).  Further, Q2 is a seasonally slow quarter for ARHH so it happened during the best quarter possible, for what it’s worth.

With it's continued inflows from the existing A/R balance, ~$4.3mm raised in 1H2020 in convertible debt (note-  not included in the market cap/EV b/c subsequent event and balance sheet neutral for now), and $1.2mm SBA loan received, ARHH would be able to sustain ~1 years worth of operating expense with no incremental revenue before assuming any cost cuts (the company has already announced 20% reduction in corporate spending).

Valuation
There are a few ways to think about valuation – but first there is a key adjustment to the financials which needs to made:

• Provision for performance share issuance (Liability) - A one-time performance stock agreement was executed in 2016.  The structure was such that the company would issue 6mm common shares to executives contingent on achieving certain EBITDA thresholds.  This was recorded as a $16mm liability on the financial statements when the agreement was initiated in 2016.  Importantly, this $16mm balance sheet liability value does not fluctuate as a result of mark-to-market changes in the stock price.  As such, it remains a $16mm liability on the financials despite the 6mm shares being worth only ~$6mm at today's prices (the difference being 25% of the  current market cap).   These shares will be issued by end of Q2 2020 and the liability will be removed from the balance sheet.   The dilution of these 6mm have been captured in the fully diluted shares outstanding count referenced throughout this writeup.  

Assuming management's new policies on A/R have established a revenue booking model which is an accurate proxy for expected cash collections, the business appears to be trading for $12mm EV simply by accounting for the A/R balances and netting out ALL liabilities.  The business did $12mm in TTM GAAP EBIT.  $12mm TTM EBIT does not give any credit for the following discussed separately throughout this writeup:

• Earnings from its equity-method investments ($1.1mm TTM)
• Additional EBIT growth from the recent Neuro-pro acquisition ($3mm FCF)
• Increases in cash-flow certainty and timeliness
• PNE Margin Expansion
• Organic Growth

As a thought exercise, please note that if the $3.5mm of assets which were excluded from the above for conservatism (Prepaids, Other Receivables, Net PPEs) were to be included AND also assume that the $4.3mm Deferred Tax Liability included in all liabilities above for conservatism was instead not included, the business would have an EV of $4mm.

TTM Cash Collections from Accounts Receivable was $10.5mm which will naturally increase as:
a) prior A/R acceleration is backlog for future cash collection growth and A/R has increased 68% since Q4 2018 and
b) further revenue continues going forward which it is poised to do.  In March 2020 alone, ARHH had cash inflows of $1.8mm which included the collection of nearly $900k from 2016 and 2017 receivables that had previously been reserved and written-off. 

It is difficult to forecast A/R collections along with opex on a cash basis, but the business reported being cash-flow positive in March and April 2020 (recent I/R deck) which is not surprising given the Neuro-Pro deal and increased cash collections (and maybe due to lower than usual expenses due to COVID).  As of today, the business is probably near ~breakeven steady state which is a key milestone given upcoming revenue growth and margin expansion initiatives.

And for what it’s worth, the business trades at headline 4x GAAP earnings using the above FDSO count.  

A note on margins - the business does 75-80% normalized gross margins and has attractive normalized operating margins (prior to the consideration of A/R lag).  The takeaway being that if some aspects of the "Growth" section in this writeup continue to play out, we should see some continued margin expansion.   (Note the Q4 overhang due to the expense and A/R restatement issues). 

While there will always be a lag between revenue cash collections and operating expenses, and the market certainly does not like this, you don’t need a significant amount to go right to do well here at a $12mm EV.  

Why does this opportunity exist?

• Illiquid – ~$10k average daily volume on the OTC and ~$11k on the Canadian exchange
• Small and ignored – 15 followers on seekingalpha; 40mm market cap; no analyst coverage; listed in Canada but entirely a US healthcare company
• Overhang of temporary issues described within the "Temporary issues create opportunity" section of this writeup

 Risks

• Underperformance in A/R collections relative to current allowance accruals.  The A/R lag relative to OPEX is a consistent cash drag.  Although the business trades at or near liquidation value, future scale will be difficult without continued growth.
• Revenue pressure (revenue per case) as the company transitions to in-network billings or if the overall industry becomes more cost-sensitive.
• The company came public through a reverse takeover, its history includes less than optimal ethical decisions as well as F/S restatements (see writeup), and the integrity of revenue and related collectability of accounts receivable is critical to the thesis.  For these reasons, position sizing is crucial and this business may be best suited in a basket along with similar illiquid and ignored cheap value.

Catalyst

• Removal of the $16mm non-cash liability (Provision for performance share issuance) on the balance sheet which has a current mark-to-market economic cost of $6mm

• Transition from out-of-network payor to in-network payor revenue model substantially increasing Days Sales Outstanding and removing A/R overhang from the story

• Transition to in-house billings collections resulting in a decrease in DSO and increase in economic value of A/R

• Renegotiation of existing Professional Network Entity agreements at higher margins

• Transition to in-house neurologists resulting in a greater portion of PNE revenue captured by ARHH

• Continued organic growth via expansion into new states and overall market growth

• Accretive M&A roll-up of the fragmented and undercapitalized industry at extremely cheap prices (accelerated by COVID)

• Removal of COVID overhang on elective surgeries and issuance of FY2019 financials

• Recently hired head of investor relations in October 2019

• Management has been working with bankers with the objective of uplisting to a US exchange in 2020