麥卡遜 (MCK) 2004 Q2 法說會逐字稿

(OPERATOR INSTRUCTIONS). Today's call is being recorded; if you have any objections, please disconnect at this time. Your host for today's call is Phil Pead.

Thank you, operator. Good morning and thank you for joining us on this call to discuss our second quarter 2004 earnings. I have with me today Chris Perkins, our Chief Financial Officer.

Before we begin, I would like to read the following Safe Harbor Statement. Please be aware that certain statements made in this call will be forward-looking in nature within the meaning of the Private Securities Litigation Reform Act of 1995. These statements will include expectations with respect to future results and the assumptions on which such expectations are based. As with all things, actual results may differ materially from those projected in the forward-looking statements. Additional information concerning factors that could cause actual results to differ from those in the forward-looking statements is found in our press release issued this morning and in our SEC filings, including the Form 10-Q for the quarter ended March 31, 2004, and the form 10-K for the year ended December 31, 2003.

Also, in accordance with Regulation G., please refer to our press release issued this afternoon for discussion and reconciliation of non-GAAP financial measures discussed in this call to their most directly comparable GAAP financial measure.

During the second quarter we increased our income from continuing operations, excluding the costs associated with the additional procedures and the convertible debt transaction, by more than 40 percent as compared to the second quarter of 2003.

In our release this morning we reiterated our 2004 guidance of 7 percent to 9 percent consolidated revenue growth, and tightened our fully diluted earnings per share range to 88 cents to 95 cents, an increase of 26 to 36 percent over our 2003 performance. We also reiterated our cash flow from operations guidance for 2004 of 48 to 51 million.

I would like to spend a few minutes talking about the operations of our divisions, and Chris will then provide you with more detailed financial information later in the call.

In our Physician Services division we achieved net new business sold during the second quarter of approximately $2 million. Net new business sold is new business sold, less client terminations in the quarter. During the second quarter, our sales were negatively impacted due to the distraction related to the additional procedures work and the delay in filing our Form 10-K. This period of uncertainty for our prospects and customers, which was amplified by our inability to provide definitive information regarding the scope or duration of the additional procedures, led some prospects to choose other alternatives.

We were, however, very pleased that a large number of physician groups agreed to move forward, and on a cumulative basis we achieved a record net new business sold of $15 million in the first half of 2004. As a result, we expect to meet the low-end of our revenue guidance for the full year. We continued to experience good client retention for the quarter, which was in line with our expectations.

Turning to our Hospital Services division, we achieved new business sold of $15 million in the second quarter compared to $7 million in the second quarter of last year. Second-quarter new sales include a significant five-year contract we signed during the quarter to provide print and mail services for a new customer. The contract is for hospital and physician patient statements as well as paper claims. As part of the deal, we agreed to purchase the customer's current production assets, which were classified as a $1.1 million acquisition during the quarter.

We are still experiencing some challenges in marketing our revenue cycle products during this HIPAA conversion period, but expect positive market demand for the latest version of our ClaimTrack electronic claims management system which we introduced in June.

ClaimTrack Version 8 integrates denial management functionality with our workflow-driven claims management system. Hospital central billing office staff are provided with specific denial codes so that they can analyze the denials, correct and resubmit the claims for payment. When our hospital clients better understand the root of the denial, they can proactively alter their billing process to avoid duplicating the error in the future, thereby substantially increasing the speed of their reimbursement. In addition, the newest version of ClaimTrack also provides for real-time claim status, which allows a hospital to track a claim as it is accepted by the payor, adjudicated and paid.

I'd now like to turn it over to Chris to discuss our financial results for the second quarter.

Thanks, Phil. First, reviewing our consolidated results, revenue was 88.1 million as compared to 85.5 million in the second quarter of 2003. During the second quarter, we incurred approximately 2.5 million in costs associated with the additional procedures requested by our external auditor as part of their year-end audit. We also incurred approximately 5.9 million in costs associated with our convertible debentures issuance at the end of June and the concurrent retirement of our Term Loan B debt. These costs are excluded from the financial measures I will now review.

Operating income was 8.8 million, or 10 percent of revenue, as compared to 9.5 million, or 11.1 percent of revenue in the prior year period. Income from continuing operations for the second quarter was $7 million, or 21 cents per share on a fully diluted basis, compared to 5 million, or 16 cents per share on a fully diluted basis for the second quarter of last year.

In the Physician Services division, revenue was 66.1 million in the quarter as compared to 64.1 million in the second quarter of last year. Operating income for the division was $7.1 million, or 10.8 percent of revenue for the quarter, compared to $7.8 million, or 12.1 percent of revenue in the prior year quarter.

Margins in the division were negatively impacted in the current year quarter by costs associated with the implementation of the record level of net new business sold during the first quarter of 2004. Included in this implemented business was the University of Texas Health Science Center at Houston, which outsourced the revenue cycle management for its entire faculty practice plan to Per-Se in January of 2004. Although this business is being implemented at higher than normal transition costs, we expect normal margin levels to resume for the full year 2005.

In our Hospital Services division, revenue for the second quarter was $25.4 million as compared to $24.8 million in the prior year period. Operating income in the division was $6.4 million, or 25 percent of revenue for the quarter, compared to $5.9 million, or 23.9 percent of revenue in the second quarter of 2003.

As discussed in the first quarter, revenue during the second quarter was positively impacted by previously unbilled maintenance for certain software customers that is being recognized upon receipt of payment. Systems conversions in prior years have resulted in the maintenance not being billed in a timely manner. We determined that revenue related to the previously unbilled maintenance should be recognized when payment was received. Essentially all of this revenue has now been collected.

Our cash position at June 30, 2004 is approximately $10 million, compared to total cash at June 30, 2003 of $25 million. Cash balances are lower year-over-year due to the approximately 26 million in cash on hand that we used in addition to the convertible debenture proceeds to retire our Term B debt and to fund a $25 million share repurchase completed concurrently with the convertible transaction. For Accounts Receivable, our days sales outstanding by division at the end of the second quarter were 49 days outstanding for Physician Services and 64 days outstanding for Hospital Services.

Cash flow from continuing operations for the first six months of 2004 was $10.4 million, which essentially in line with our prior year performance. Current year cash flow included $6 million in cash spent associated with the additional procedures.

As we discussed last quarter, during June, we received $4.3 million in cash related to finalizing the closing balance sheet for the Patient1 sale. We recognized an additional gain on the sale during the second quarter of $3.8 million.

During the second quarter, we issued 125 million of 20-year subordinated convertible debt with a coupon rate of 3.25 percent. We used the proceeds of the convertible debt, together with cash on hand, to permanently retire our $119 million Term Loan B debt, as well as repurchase $25 million, or approximately 2 million shares of our common stock concurrently with the transaction.

As part of the transaction we incurred a $5.9 million loss on extinguishment of the debt which related to the write-off of unamortized debt issuance costs associated with the Term Loan B's original issuance, the call premium for the Term Loan B, and other costs.

The convertible debt has a conversion stock price of $17.85, which was a 42 percent premium over the stock's closing price on the date the offering was priced. While the convertible debt can convert to equity at a stock price of $17.85, the debenture holders cannot convert the debt until the stock reaches a price of $23.20 per share. This type of offering is referred to as a contingent convertible.

As you may have read, the Financial Accounting Standards Board is considering a proposal to change the accounting for contingent convertible debt. Under the current accounting rules, the if-converted method of accounting would not be used until our stock price reaches a conversion trigger value of $23.20. Under the proposal being considered by the FASB, the if-converted method of accounting would be used immediately.

When applying the if-converted method, interest expense related to the debentures is added back to net income and the shares related to the debentures are added to the weighted average shares outstanding for calculating fully diluted earnings per share. Even if the if-converted method is applied immediately, our offering will be slightly accretive in future quarters. The transaction had no impact on earnings per share in the second quarter as it was closed on June 30.

As discussed in the release this morning, on July 30 we relocated our corporate offices to a new location in Atlanta. This move will result in a cash flow savings for the Company of more than $5 million over the life of the 10-year lease, compared to our previous office lease. As part of the new lease arrangement, the new landlord is funding the remaining 7-month lease obligation on our previous corporate facility. While this arrangement is neutral in the current year from a cash flow standpoint, we will record a onetime noncash expense of approximately $1 million during the third quarter.

Thank you, Chris. We have had a solid operational performance so far this year, and I am confident in our ability to deliver on our targeted revenue and profitability targets for 2004.

That completes my comments. Operator, I would like to open it up now for questions.

(OPERATOR INSTRUCTIONS). Sean Jackson, Avondale Partners.

I think, Chris, you mentioned that the operating income -- I'm sorry -- the margins for the U.T. Health deal would resume to normal levels in '05?

That's correct.

What exactly are normal levels here?

The normal levels on that business are above 25 percent operating income margin level.

Okay. So for the back half of '04, will the deal be actually profitable in the third quarter?

Yes. It is profitable now and the profitability will be improving on that each quarter in Q3 and Q4.

Also on your guidance, you, I guess, raised the lower end of it a little bit. However, there's the accretiveness of the convert offering. I guess the question I have is what is sort of the difference, and what prevented you from raising the top-end of the guidance as well?

What we did is in our guidance we listed the accounting proposal being reviewed by the FASB. Our guidance assumes that we will be required to use the if-converted method of accounting immediately for that. So our guidance includes the more conservative approach which is being reviewed by the FASB. And it is slightly accretive, about a penny per share in each quarter in the third and fourth quarter, and going forward. That would be more accretive if we were going to use the current accounting method that is being used for contingent convertible structures, which would not imply that the if-converted method would be used until the stock price reached $23.20.

Lastly, on this new print and mail customer. Can you kind of go in details? What are the margins on that business, and approximately how large was it?

Well, we don't specifically talk about individual contracts, Sean. I can tell you that it was a substantial part of our growth year-on-year for new business for the division. The margins for that business, again, are something that we don't actually break out in the Hospital Services division. Chris, I don't know if you can add anymore?

Yes -- we typically, on that type of transaction business, we typically have lower profit margins on that type of business than we have for some of our software products, but it is contributing positively each quarter as we go forward.

What it does for us, Sean, is it, again, adds additional contracts for us in the hospitals market, where we can sell more of our revenue cycle management products as well. So it was a good contract for us.

Sandy Draper, Draper Investment Research.

A couple of quick questions. First of all, I guess I would ask on the revenue guidance, you're looking for pretty good acceleration the back half of the year. What -- is it really just the new business you signed in the first half of the year that gives you the confidence you're going to continue to see the revenue growth pick up for both divisions?

That's pretty much it, Sean -- I mean, Sandy. We've got -- we had a good first half of the year in both divisions, and that new business going into backlog will drive our revenue growth in the second half of this year.

And then on the hospital margins in the quarter being up compared to the first quarter, even though the revenue was a little bit below where I was estimating. Is that just the pickup from those old contracts, or is there anything that's driving the sequential improvement margins? And then, to get to your guidance you would look at that going down. So is that reflecting, again, that new print and mail impacting the margins?

In the second quarter there was nothing significant that improved the margins from Q1. We had -- we met our expectations on the revenue side and we just had good control of costs, etc. As we look to the back half of the year, as we talked prior to coming in to 2004, we do have some development initiatives that we are working towards this year. And some of those development initiatives are ramping up and being incurred more in the second half of the year, so that as we talked about the beginning of the year, that will have a negative impact on our margins in the second half. But I would expect that we would get to continue to see those improve after those development initiatives are completed.

That's not related to that print and mail customer.

Two more quick questions. On the Lloyd's side in relation to the 21 cents in the press release, that's not more factoring out the incremental 900,000 of Lloyd's expenses; is that correct?

That's correct. That's included in our 21 cents.

Okay. Is there any more in the third quarter? It sounds like there may been a little more expense there due to the adjustment, or do we see finally the fully clean quarter without any Lloyd's expenses in the third quarter? Is that delayed to the fourth?

That's correct. We will have no expenses related to Lloyd's in the third quarter going forward. We will -- our guidance for the year excludes the gain on Lloyd's that we expect -- that we will book in the third quarter of about $1.5 million.

But you would expect to see some SG&A cost drop-down just because you finally unwound all those expenses?

That's correct.

Just a final question, just to make sure I understand. Where did you actually end the quarter in terms of actual shares? Do you know that number?

Yes. On a fully diluted basis, it's about 33.5 million in the second quarter. And that's essentially no impact from the convertibles transaction, because it was closed on June 30, and calculating the weighted average shares outstanding.

So the 33.5 is a fully diluted, as if you had made money, then?

That would be correct.

So a basic share count is probably more in the 31.5 type range?

Just under 32.

Great.

On a going-forward basis, Sandy -- and again, it depends on the FASB's final determination on the accounting for the convertible debt -- on -- if it's on the existing accounting method, our going forward weighted average shares would be about 32.5 million shares. If the if-converted accounting is changed by the FASB, it will be about 39 million shares.

Okay, perfect. That's what -- you're factoring into your guidance the 39 million shares and then adding back the interest expense?

Yes. About $1 million of interest expense add back in each quarter.

Eugene Mannheimer, Roth Capital Partners.

Most of my questions have been answered, but on Hospital Services, particularly the scheduling products, what -- could you characterize the level of R&D investment that is currently going into that, into those solutions?

As far as the types of initiatives?

Can you quantify it, like say as a percent of revenues?

We have not quantified that as far as the percent of revenue. We had implied that the negative cost impact on our P&L related to those development initiatives is going to be about between 1 million and $1.5 million for the full year.

David Francis, Jefferies & Co.

I wanted to shift focus to the new business front in Physician Services, understanding that given the sideshow you were dealing with in the first half that new business signings may have been negatively impacted. Can you characterize for us kind of what does the pipeline look like right now from both a regular business -- for lack of a better term -- perspective, and other jumbo type deals such as the U.T. deal that was signed first part of the year? And if any business actually fell out of bed as a result of what you were dealing with in the first half?

Thanks, Dave. Clearly, Q2 was a major distraction for our sales organization. It did lengthen some sales cycles for some of the deals we were working, and we did lose some. Because clearly there were some clients that needed to make a decision, and they were concerned about really the lack of information that we could give them, which I think all of you suffered from as well. However, I can say, Dave, that we're still comfortable that we will meet our new business sold objective for the year. And that is going to be above $28 million for '04. And the reason I can say that is because our Q3 right now is looking better than I have seen quarters as early as we stand today, and so that gives me good visibility for Q3. It's a little early for Q4 yet. But I am confident -- I've been with the sales organization last week in a number of meetings, and the opportunities we are working are across the board. We have got some large deals that we're looking at that I'm not sure will come through this year, but again, that's not factored into our objectives for this year. General business, Dave, is very solid. I think the sales organization is doing a great job in putting all the distractions behind them, and it doesn't come up again. So that's the good news. We're really focused on our value proposition, and I'm pleased with the pipeline.

Steve Halpern, Thomas Weisel Partners.

This is George Shultz sitting in for Steve. Just a quick question, I guess it's a housekeeping question. You're saying that your outlook is regarding using the as-converted method with the convert. But what you guys will actually be reporting under the term FASB is you will be putting up 325 or 2.25 million a year, roughly a little more, as the interest expense on the convert, divided by 4, over the current share count, the 33.5?

It's just over $4 million; it's 125 million at the (indiscernible) percent.

All of my other questions are answered. Thank you.

Chris Sasuni (ph), Eagle Asset Management.

I had some questions that I'm trying to reconcile in the press release. I guess I don't quite understand how these numbers all work out. You're saying here that the Physician Services business had net new business of 2 million; year-to-date it's 15; and then, that there was a net backlog of 3. And I was wondering if you could -- and then, new business in the Hospital Services division was 15. So am I to basically add those two to get to roughly $18 million or $17 million of net new business sold during the quarter?

Yes.

And your goal for the year is 28?

The 28 that Phil referred to was related specifically to the Physician Services division.

Okay. So you're --

We're at 15 on a year-to-date basis.

How do you reconcile the statement that you made that you are still experiencing struggles with HIPAA, and yet you still believe that you can hit all of your business goals and that business is strong? It almost seems like a dichotomy to me; either something is starting to finally change with HIPAA adoption that is allowing new business to roll your way, or there's some dynamic that I don't totally understand.

The comment that I was making about the challenges that we face in the HIPAA conversion period, it relates to the claims processing solutions that we have been marketing. The reason why I say business is good is I was talking about Physician Services specifically, which is not related to -- or not impacted by these HIPAA conversions. It's really the Hospital Services side that is seeing the impact on the claims processing-related solutions. Now outside that, we actually had a good quarter in Q2 on non-claims processing solutions. And that is why we're seeing, I think, in the second half of this year will start to see a pickup in those solutions, particularly we think in our ClaimTrack 8 product that we just released in the denial management area.

So in light of all this, how do you get the acceleration in the back half of the year? It's that you're seeing that much net new business that's non-claims-related -- it's more revenue cycle management or it's other stuff?

It's revenue cycle management that we sold in the first two quarters of this year for hospitals that's going to drive our back-end revenue growth. And similarly for Physician Services, we have had a good first half of the year. New business sold in the third and fourth quarter in Physicians has a minor impact on our revenue growth for this year given the ramp-up of business. So we've got pretty good visibility now as to what our expected revenue growth is going to be in the division for Physicians, and similarly for Hospitals.

Finally, if you just look at your operating margins in aggregate, which are in, I guess, the 10 or 10.5 percent range right now -- do you still believe that given all of the efficiencies that you can gain on a going forward basis, that over the next three to five years that you could see that operating margin get into the high teens?

I think we've got real opportunities to continue to improve on that year-over-year in a meaningful way, really driven by, again, further efficiency opportunities and the opportunity for leverage we have on incremental revenue, that we feel confident and strongly that we can continue to produce.

Ray Lewis (ph), (indiscernible).

Chris, just back to another one on the share count question; I'm sorry. You were at 33.5 for the average for the second quarter million shares outstanding; that does not reflect the shares that were purchased in the open market at the time of the convertible?

That's correct. They're really done at the very end of the quarter.

How many shares were repurchased?

2 million shares.

Okay. Just cash flow questions -- can you just review your capital expenditure objectives, both in terms of property, plant and equipment and then capitalized software for the remainder of the year?

Sure. I will just give you the full year expectations that we have targeted. We said we expected to incur about 15 to $16 million in the combined capital expenditures and capitalized development. I think that is going to be pretty -- a slight bit higher than we had last year in the capitalized development expenditures, as we have our development initiatives that we've got in place for this year that we talked about. I think capital expenditures will be, again, pretty well on line to there -- just slightly above the last-year level.

I'm just trying to reconcile, because if you're moving it over into the -- basically into the capitalized side of the shop, then I would have thought that there would have been a positive effect on the P&L because you effectively were reducing the R&D expense.

No, it's not that we're reducing -- we're actually putting more efforts on development in 2004.

Even as things are reaching a commercially viable threshold?

Yes. Once they're out there in the marketplace we would end the development of capitalization of those development costs. But we are actually going to be incurring more in capitalized costs, and we're actually going to be incurring more expense, non capitalized development expense, in the year 2004.

Sandy Draper, Draper Investment Research.

Just a quick follow-up. I want to make sure I understand. This sort of follows up to Dave's question. Phil, did I understand you correctly that some of the business that was impacted by the 10-K issue -- it didn't slide, it was actually lost -- correct?

That's correct, Sandy.

But even with that, you still feel like you're seeing a better start to the third quarter than you have seen in a long time, and you're still comfortable with where the business is going?

Absolutely. Even with the loss that we experienced -- losses we experienced in Q2, we still expect to meet or exceed our objective for new sales in '04.

Do you think that that really related to the improved marketing method you have? Is it related to industry trends, where you're seeing people who were doing stuff in-house are outsourcing more? I guess what I'm trying to get at -- is it more of a company-specific, that you guys are just starting to sell better, or do you think it's really more of an industry event where you're starting to see the in-house folks starting to understand the returns on outsourcing? You're starting to see more of an industry trend?

I think we're seeing both, Sandy. We're seeing the improved productivity of our sales organization. As you know, we added a significant number of salespeople over the last couple of years, and we're beginning to see the positive effects of there being here for more than six months. So I'm seeing a much more productive sales organization that can articulate our value proposition well. We're seeing a much broader lead generation, because we have been particularly effective in getting our message out to the market. And that allows our sales folks to start working those sales cycles. If I look at the analysis that we've done on where the prospects are coming from, we are finding a larger percentage of new business coming from physicians that are willing to outsourcing than taking business from other competitors. It is slightly higher in the outsourced area than we've seen in '03, which leads me to believe that there are more physicians out there willing to move that billing from being in-house to outsourcing, which I think is positive. So, yes -- it's a combination of better productivity of our sales organization, and the market dynamics where physicians are willing to outsource.

Sean Jackson, Avondale Partners.

A quick follow-up on the tax rate. What is the assumption of the tax rate for the rest of this year, and is that going to change at all in '05?

It will be about in the 5 percent range for the rest of this year, the third and fourth quarter. From a cash paying perspective, I don't expect that to change substantially -- maybe get up into the 7 percent range as we get into 2005.

So from the expense side as well, (inaudible) the same; correct?

What we will be evaluating, as we are required to do regularly as we go into '05, we will be evaluating our valuation allowance that we have on our deferred tax asset. And we will be discussing it and reviewing that with the investment community as we're giving 2005 guidance. But from a cash paying, tax paying perspective, it won't be much change.

Eugene Mannheimer, Roth Capital Partners.

A quick follow-up. Speaking of '05 guidance, are you in a position to comment today in general terms? And then secondly, any change to the competitive landscape, or does your main competition continue to be in-house billing?

Let me do the billing part, Gene, and then Chris will tell you about guidance for '05. We're not seeing any real changes out there in the marketplace. We still think that the opportunity for us is to convince physicians not to do it themselves. That's still the majority of the market today. So the fact that we're seeing a higher number of prospects in the in-house category, I think, speaks to the fact that there is a market change here. It's a combination for us. We still see the local regional billing companies out there that we compete with everyday, but I think we're seeing a greater number of prospects moving from in-house to outsourcing.

As far as '05, we won't be giving any guidance or view on that until we get towards the end of the third quarter, as we have historically done. But I think we feel good about our business outlook on an overall basis, driven by our expectations to have good new business performance in the back half of the year, that will be a strong driver for ongoing performance for '05.

At this time there are no further questions.

Thank you, operator. We appreciate everybody's participation, and look forward to talking to you next time. Thank you.

Thank you. This concludes today's conference call.