麥卡遜 (MCK) 2004 Q3 法說會逐字稿

Hello, and welcome to the PSTI conference call. All lines will remain in a listen-only mode until the question-and-answer session. (OPERATOR INSTRUCTIONS). At the request of the Company, today's conference call is being recorded for replay purposes. I would now like to turn the conference over to Mr. Phil Pead, Chairman, President and CEO. Sir, you may begin.

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

Before we begin, I'd 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 June 30, 2004 and the Form 10-K for the year ended December 31st, 2003. Also in accordance with Regulation G, please refer to our press release issued this morning and our website for discussion and reconciliation of non-GAAP financial measures discussed in this call to their most directly comparable GAAP financial measure.

I will begin by talking about the operations of our division, after which Chris will provide you with more detailed financial information. In our physician services division, we achieved net new business sold during the third quarter of approximately $1 million. Net new business sold is new business sold less client terminations in the quarter. Our new business sold, excluding the impact of client terminations, increased approximately 40% over our third quarter 2003 performance. And our new business sold on a year-to-date basis is also up approximately 40%.

Our third quarter was one of our strongest new sales performances and represents not only the momentum of our largest sales organization, but also a growing demand for our services by all specialties of our hospital-based physician market. Our pipeline of new business, which we expect to close during the fourth quarter, is one of our largest, and I believe we will meet our net new business sold forecast for the full year 2004.

Our retention rate was lower than expected during the quarter. However, we still expect to meet our targeted retention rate for the year. We believe there is approximately 5% annualized churn in the physician services market, and 50% of that churn can be attributed to physicians who dissolve their groups or lose their hospital contracts or retire and so on. However, the other 50% of the annualized churn, which can actually be higher in any one quarter, can be attributed to groups who seek alternative outsourced or in-house services in an effort to improve their income. This higher quarterly level of churn, we now believe, is more likely to occur in the third quarter as physician groups can transition to their new service provider by the beginning of the new year. Despite the higher attrition in the third quarter, we expect full year retention to be in line with our expectations. And combined with our strong new sales performance, will result in record net new business sold in 2004.

Turning to our hospital services division, we achieved new business sold of $5 million in the third quarter compared to 7 million in the third quarter of last year. On a year-to-date basis, new business sold in 2004 is $27 million in the division compared to 19 million in the prior year. Sales of our resource management products were strong in the third quarter, up 19% over the third quarter of last year. Our new sales performance is being driven by the new functionality we introduced in the resource management products earlier this year.

During the third quarter we had our first shift bidding sale. Shift bidding is a new functionality we introduced in our staff scheduling product that allows nurses and other hospital personnel to bid for their work shifts. This functionality allows hospitals to lower their costs and provide hospital staff with greater job satisfaction by working the hours that best fit their lifestyle.

During the third quarter we also had our first subscription-based staff scheduling sale. While sales of certain of our revenue cycle management products were strong in the quarter, we are still experiencing some challenges related to sales of other revenue cycle products, especially our claims management product, during this HIPAA conversion period. We believe there is demand for claims management and associated products, such as denial management and secondary billing, among hospitals that’ve been reluctant to implement these solutions during the HIPAA conversion process. While the HIPAA pressure in the market has started to lighten, we believe sales of these products will increase during 2005.

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

Thank you, Phil. First, reviewing our consolidated results, revenue was 90.6 million as compared to 84.5 million in the third quarter of 2003. During the third quarter we recorded a one-time gain of 1.5 million at the time we received the $16.2 million cash settlement from our resolved litigation with our former insurance underwriters, Lloyd's of London. Also during the quarter we recorded a one-time non-cash expense of $1 million associated with the relocation of our corporate offices in July, as well as a credit of $100,000 related to the additional procedures requested by our company's external auditors as part of their year-end 2003 audit. These items are excluded from the financial measures I'll now review.

Operating income was $9.6 million, or 10.6% of revenue as compared to $9.8 million or 11.6% of revenue in the prior year period. Income from continuing operations for the third quarter was $8.2 million, or $0.25 per share on a fully diluted basis, compared to a loss from continuing operations of $100,000, or $0.00 per share for the third quarter of last year.

In the prior year quarter, we incurred approximately $6 million in expenses associated with our September 2003 refinancing of our long-term debt. Excluding these costs, income from continuing operations in the third quarter of last year was 5.9 million or $0.18 per share on a fully diluted basis.

During the third quarter we deferred approximately $900,000 in revenue in the physician services division related to a contract which has interim performance goals. The interim measurement periods related to this contract are not based on calendar quarters. While we are ahead of our performance targets on this contract, the current interim performance period defined in the contract overlaps our third and fourth quarters. As such, in accordance with GAAP, we deferred a portion of our third-quarter revenue related to the not-yet-completed interim measurement period, which reduced our revenue recognized in the quarter. All third-quarter expenses related to the contract we recorded during the quarter, and cash flow related to the contract was not impacted.

Including the revenue deferral of $900,000, as well as excluding the gain related to the settlement with Lloyd's, the corporate office relocation expenses, and the additional procedures credit, reported consolidated revenue would have been 91.5 million and operating income would have been 10.5 million or 11.6% of revenue. And income from continuing operations would have been 9.1 million or $0.28 per share on a fully diluted basis.

In the physician services division, revenue was 66.1 million in the quarter as compared to 63.5 million in the third quarter of last year. Operating income for the division was $7.2 million, or 10.9% of revenue for the quarter, compared to 7.5 million, or 11.8 % of revenue in the prior year quarter. Including the approximately $900,000 of revenue that was deferred during the third quarter, reported revenue for the division would have been 66.9 million and operating income would have been 8 million, or 12.2% of revenue.

In our hospital services division, revenue for the third quarter was $28.1 million as compared to 24.1 million in the prior year period. Operating income in the division was 6.4 million, or 22.9% of revenue for the quarter, compared to 5.8 million, or 23.9% of revenue in the third quarter of 2003.

As expected, margins in the quarter were impacted by a large print and mail customer contract signed in the second quarter of 2004, which was profitable in the quarter, but below normal profitability levels for print and mail contracts. As discussed last quarter, as part of the transaction in signing the customer, we acquired substantially all the production assets and personnel of the customers' hospital and physicians' patient statements and paper claims print and mail business. We'll consolidated this operation into our existing print and mail facility located in Lawrenceville, Georgia during the first half of 2005, which is expected to improve margins for this contract.

Moving to the balance sheet. Our cash position at September 30, 2004 is approximately $36.6 million. Our strong cash position is primarily due to a good cash flow generation from our operations in the current year, as well as the cash settlement with Lloyd's. Cash flow from continuing operations for the first nine months 2004 was $41.5 million compared to $17.1 million in the first nine months of 2003. Current year cash flow included the $6.3 million in cash spent associated with the additional procedures, as well as the $16.2 million cash received associated with our settlement with Lloyd's.

For accounts receivable, our day sales outstanding by division at the end of the third quarter were 48 days outstanding for physician services and 52 days outstanding for hospital services. As discussed in the release this morning, on July 30th we relocated our corporate offices to a new location in Atlanta. This move will result in a cash flow savings for the Company of approximately $5 million over the life of the ten-year lease compared to our previous office lease. As part of the new lease arrangement, the new landlord is funding the remaining lease obligation from our previous corporate facility which expires in February, 2005. While this arrangement is neutral in the current year from a cash flow standpoint, we recorded a one-time non-cash expense for approximately $1 million related to the remaining lease obligation on the previous office upon or exit of that facility.

Also discussed in our release this morning, we have exercised our right to commit to pay in cash the principal amount of 125 million subordinated contingent convertible debt we issued during the second quarter. This election provision was considered in the convertible debt indenture and no amendment to the document was necessary to make this election. Any stock appreciation amount above the conversion trigger price of $17.85 will be paid through the issuance of common stock. By electing to pay the principal amount of the convert in cash, we'll not be impacted by the recent emerging issues task force's decision that contingent convertibles should be accounted for as traditional convertible.

Under current generally accepted accounting principals, the potential dilutive effect of a contingent convertible is not included in fully diluted earnings per share until the contingent conversion share price is reached. Under the new accounting guidance, which is expected to be finalized during the fourth quarter of this year, the potential dilutive effect of the convertible should be included in fully diluted earnings per share immediately upon issuance. Going forward, there will be no dilutive impact from our convertible debt until the average stock price exceeds the conversion trigger price of $17.85. The company will then use the treasury stock method of accounting for the difference between the weighted average stock price in a quarter and $17.85. The shares required to cover this difference will be included in calculating fully diluted earnings per share.

Our fully diluted earnings per share for the third part was calculated under current GAAP, and therefore the dilutive impact of the convertible debt was not included in fully diluted earnings per share. Including the dilutive effect, it would have lowered the fully diluted earnings per share by $0.02 in the third quarter.

In the release this morning we also discussed our deferred tax asset and the analysis we are currently undertaking as to whether there should be a partial release of the valuation allowance. By way of background, as of December 31st, 2003, we had net operating loss carryforwards, or NOLs, for income tax purposes of approximately $406 million. The NOLs expire at various dates between 2004 and 2022. As of December 31st, 2003, we had a deferred tax asset of approximately $185 million. In accordance with GAAP, our deferred tax asset has been fully reserved since 1998 due to our history of operating losses. As we have been profitable for the last three years, the deferred tax asset is currently being reviewed to determine the appropriateness of the reserve.

During the fourth quarter of 2005 we may release a portion of the valuation allowance based on projections of the amount of pre-tax income that could be offset by NOL carryforwards in the coming two to three years. Any release of the valuation allowance in the fourth quarter would result in a tax benefit. We expect that for 2005 our GAAP tax rate will remain at our taxpaying rate.

Thank you, Chris. In our release this morning, we updated our 2004 full year guidance and provided a first look at our expectations for 2005. For the full year 2004, we expect consolidated revenue growth of approximately 6% compared to previous growth expectations of 7% to 9%. And consolidated operating margins of approximately 10.5% compared to previous expectations of about 11.

Revenue and operating margin expectations reflect the deferral of $900,000 in physician services revenue and slightly higher corporate overhead expenses related to Sarbanes-Oxley 404 compliance. We expect fully diluted earnings per share from continuing operations of $0.89 to $0.92, which tightens our previous range of $0.88 to $0.95. Earnings per share from continuing operations guidance excludes the gain on a settlement with Lloyd's, the non-cash lease expense, the additional procedures expenses, the debt retirement expenses, and the impact of any potential release of the deferred tax asset valuation allowance.

In the physician services division we expect revenue growth for the full year 2004 to be between 4.5% to 5% over 2003 revenue. And operating margins to be in the range of 10.5% to 11%. The revenue growth and operating margin expectations reflect the deferral of approximately $900,000 in revenue as discussed previously.

With our hospital services division, the Company expects revenue growth of approximately 9% and operating margins of 22% to 23%. We expect to generate cash flow from continuing operations for the full year 2004 of between 46 million and $49 million, a doubling of our 2003 cash flow performance. Our cash flow guidance reflects strong cash flow performance from our operations and includes the costs of the additional procedures and the positive net cash flow impact of the Lloyd's settlement.

We have had a record new business sold performance in both our divisions through the third quarter of 2004. Net new business sold for the physician services division is one of the most important factors in forecasting 2005 revenue. Our fourth-quarter net new business sold in particular has a significant impact on our forecasted revenue growth rates for the physician services division. Therefore, we will be providing detailed segment guidance for 2005 in conjunction with our fourth-quarter earnings release. Having said that, if our 2005 revenue growth was equivalent to 2004, we would forecast 20 to 25% growth in fully diluted earnings per share from continuing operations, which approximates to $1.05 to $1.15 per share. With earnings at these levels, we would also expect to continue to generate strong cash flow in 2005 with cash flow from operations consistent with 2004 levels of near $50 million.

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

(OPERATOR INSTRUCTIONS). Sean Jackson, Avondale Partners.

Talking about the $900,000 referral. It sounds like it's going to be deferred until '05? Can you provide a little more insight into that?

In addressing the deferral of the revenue in the third quarter, we expect future quarters, as we look out in relation to the timing of the measurement periods, that in future quarters we expect to have three months of revenue related to this contract that had the deferral related to it. We would pick up any revenue that had been deferred at the end of the contract period. So we'd get that incremental revenue back at the end of the contract, which is beyond 2005. So it would not be expected to -- (multiple speakers)

And regarding the client retention rates, again, you said it was somewhat a seasonal effect in the third quarter. Was that similar to what happened last year at this time?

I think in part that's true, Sean. You know, we've noted that there is an uptick typically in that third-quarter period. And when we've gone back to analyze that, it would appear that, based on contracts coming to an end towards the end of the year, that physicians looking for alternatives would want to have a new contract in place with whatever source of service they're looking for, so that they began the new year with that new provider. And so, that's really what we're seeing in the third quarter. There's nothing ominous. We've gone back and looked at everything we've done. We don't see anything ominous in that third-quarter uptick. And in fact, we expect our year to come in where we expect it to be on retention.

And regarding the business that had gone away, you mentioned two factors -- one, being the companies doing it in-house and the other being them going to another provider. Which one of those was more important in the third quarter?

Actually it was mixed. It was a combination of the two, I think, as we've gone back to analyze it, as opposed to one being more than the other.

So as far as competitively speaking, has there been any change?

No, we are not seeing that at all.

And lastly, just on the tax rate. Given that what your guidance is, what is the assumption of the fourth-quarter tax rate and even the '05 tax expense rate?

Excluding any adjustment to be valuation allowance, I would expect that our fourth-quarter taxpaying rate will be consistent with what we've seen. And I think it's going to be under a 5% taxpaying rate if we look at the fourth quarter. As we look forward, I think our taxpaying rate would be consistent with that going forward. In 2005, I would expect it to be in the 5% rate. And potentially as we look at years beyond that, gradually getting higher, but still staying well below the 10% rate.

And the last question I have, turning to share count. I'm trying to understand -- 32.2 million this quarter, significantly down from last quarter. However using the basic this quarter, not the diluted. Can you just expound on that a little bit more?

We are using diluted in the third quarter, as we did in the second quarter. The difference is primarily that at the very end of the second quarter, right around June 30th, we repurchased 2 million shares of our stock, associated with our issuance of the convertible debt. And we did simultaneously a share repurchase of 2 million shares. So, that 2 million shares, because it was at the very end of the third quarter, had very little impact on the weighted average shares for the quarter. Those 2 million shares were out of our share count for the entire third quarter.

Understandable. And the count for -- when you go to the "if converted" method, how much additional shares do you expect to be included in the EPS?

Well, we made the election, as I described there, that we will not be going to the "if converted" method in future periods. So we will not go under that new proposed accounting requirement based on the election that we made.

Gene Mannheimer, Roth Capital Partners.

Just to clarify, then, Phil, your revised guidance for '04 and '05 is based on current GAAP and not the "if converted" methods, correct?

That is correct, Gene. And the next question has to do with the University of Texas contracts. That had been ramping up in the first half of the year. Could you provide some color as to where that stands in terms of its operating margins at this time? Is it at full speed?

It is not -- in the third quarter it had improved over the second quarter very positively. It is not quite at our full normal margin rate. We expect to exit this year at the normalized margin rate. So we are continuing the integration and transition to our platforms and our operations. But that is tracking as we had anticipated and as we projected.

And as I recall, Chris, operating margins at steady-state are in the neighborhood of 25%, is that about right?

It will be in the mid-20% range.

Steve Halper, Thomas Weisel Partners.

Just a point of clarification on the convert -- once the stock price gets to $17.85, then you would have to show the convert on a converted basis, correct?

No, what we will do -- once the stock price goes above $17.85 we'll be using the treasury stock method to address the additional weighted average shares that we would've included in our weighted average shares outstanding.

Right. So you assume it converts, and then you assume, right, the --

Not quite. What we would do -- there's theoretically approximately 7 million shares related to the convertible debenture. So what you would do is you would take the average stock price in a quarter, subtract $17.85 from that. You would multiply that amount times the theoretical 7 million shares, and you would get a total dollar value that we would have to satisfy through issuance of stock. You would divide that amount by the average share price, and that would be the additional shares that we would add to our weighted shares outstanding.

Okay, but something will change at $17.85, obviously?

That's right. There will be some shares added once the average stock price exceeds $17.85.

Now the question I had is on your churn. You talked about 5% annualized. Two questions -- can you give us an order of magnitude about what the uptick was in Q3? And relative to the 50% of the group that is seeking alternatives, do you have an opportunity to go in and re-bid or try to save that business?

Let me answer the second question first, Steve. We do have an opportunity to do that. And we're actually actively working those accounts on that basis. For the first question regarding where we were -- we were probably about 3 or 4 percentage points below where we would want to be for retention in the third quarter.

On the opportunity to re-bid on the contracts that you don't keep, do you have a sense of what you did wrong?

Well, it wasn't so much what we did wrong, because the interesting thing is sometimes we've found over the years, Steve, is that when we've had clients for a number of years, they test the market to see what other services are out there. And I think that's just a natural consequence of a client base. And so, if we present well and show how competitive we are, and how our value proposition is better than the market, then I expect to win those contracts back again.

(OPERATOR INSTRUCTIONS). Janet Loel, Chesapeake Partners.

It's actually Brian Long. I was wondering if you could just repeat what you said on '05 guidance. I think you said 50 million in cash flow. And when you talk cash flow, is that equivalent to EBITDA?

What we said is approximately 50 million in cash flow from operations. So that is close to being essentially equivalent to EBITDA, except that it does include cash used or incurred related to taxes and interest. The only thing that it doesn't include in getting to a free cash flow number is the level of capitalized expenditures and capitalized development.

Chris Susuni (ph), Eagle Asset Management.

I was curious to know -- and maybe I just missed it at the front end of the call -- as to why the projected growth rate in revenues for the full year has come down. What in your opinion is happening in the marketplace that isn't allowing you to achieve the growth rates that you had expected? If I understand you correctly, the revenue growth rate that you're forecasting for 2004 is going to be up 6% versus your previous guidance of 7 to 9%.

Yes, let me take that one. Part of the revenue growth was impacted by the deferral of about $900,000 in revenue in our physician services division, Chris. So that affects it. The other thing that affects it, based on where we expect it to be, was the timing of sales and implementation, particularly in our physician services division. We are very sensitive when you are ramping up new business as to exactly when it gets sold and when he gets implemented. And we expected to sell and implement a larger portion of our new sales revenue earlier in the year in order for us to recognize that revenue. So it's really the timing associated with new sales and implementations that affects our growth rate, which is why we are looking at our fourth quarter and expect our fourth quarter to be substantial for new business for us in the fourth quarter, prior to us giving specific guidance for 2005. It's because of the sensitivity of the timing of new sales and implementation. And that's really the reason why we're seeing the change.

So, let me understand. Does not imply then that, because of perhaps the slower implementation of sales that you had gotten but not implemented yet, that we would expect to say stronger-than-expected -- because it doesn't look like that from the guidance you are giving -- stronger-than-expected Q4 numbers?

The fourth quarter -- we're really talking about the as-sold, the new sales here, Chris, for the fourth quarter. What we sell in the fourth quarter of 2004 has a significant impact on our revenue growth rate for 2005.

Right.

And in the quarter itself, it can be very sensitive. For example, the new business we sell in October versus December has an impact on a revenue growth rates for 2005. So it's the timing of when we sell the business and when we implement it. And it's not so much the issue of slow implementation, it's really the issue of when we sell the new business.

And just refresh my memory in terms of revenue recognition. You're recognizing revenues when you begin to implement it or when you actually sign the contracts?

We actually recognize the revenue when we bill the client for the collected amount for the service.

And if you were two -- can you give us an update on the progress that your expanded sales force is achieving at these levels, and whether they are about where you had expected them to be?

The momentum, Chris, that we're seeing in our expanded sales organization is excellent. We are working the largest pipeline that I have seen in the fourth quarter. There are a large number of deals that we're working. Some of them are larger than we typically have been working, so I'm very encouraged that it's a good mix of business. We expect to have a very strong fourth quarter. And I think that will have a very positive impact on our growth rates for 2005.

At this time, I show no further questions. I'd like to turn the conference back to Mr. Pead for any closing remarks.

Thank you, operator. I'd like to thank you all for participating in this call, and look forward to speaking to you again.

That concludes today's teleconference. You may disconnect, and have a great day.