Koninklijke Philips NV (PHG) 2004 Q3 法說會逐字稿

Good day and welcome everyone to the Lifeline Systems, Inc. third-quarter 2004 results conference call. Today's call is being recorded. With us is the President and Chief Executive Officer, Mr. Ronald Feinstein; and Vice President Finance, Chief Financial Officer and Treasurer, Mr. Mark Beucler. At this time, I'd like to turn the conference over to Mr. Ronald Feinstein. Please go ahead, sir.

Thank you, Candace, and thank you everyone for joining us this morning. Mark will begin with a review of our third-quarter financial results. I will follow with an update on our business and operations during the quarter. At that point, we will be happy to take your questions. Mark.

Thanks, Ron, and good morning. I would like to remind everyone that the matters we are discussing include predictions, estimates, expectations, and other forward-looking statements. These statements are subject to risks and uncertainties that could cause actual results to differ materially. You should refer to our recent SEC filings and public announcements for a detailed list of risk factors.

Lifeline's third-quarter financial results, which we announced after the close of business yesterday, continued our record of consistently generating double-digit increases in revenues and net income. Total revenues grew 13 percent to $33.1 million in the third quarter, from $29.4 million in the third quarter of 2003. Third-quarter 2004 net income was 3.2 million, or 23 cents per diluted share, up from net income of 2.7 million or 19 cents per diluted share that we reported for the comparable quarter in 2003.

Recurring service revenues grew approximately 13 percent to $26.2 million, from $23.3 million in the third quarter of 2003, and accounted for 79 percent of total third-quarter revenues, consistent with the percentage we recorded in Q3 a year ago. The year-over-year increase in service revenue was attributed to organic subscriber growth, where our subscriber count increased to 411,000, up 7 percent from the third quarter of 2003, and which is driven by our OneSource strategy combined with ongoing success for the channel initiatives focused on helping our health care partners grow. Our Lifeline OneSource offering captures a larger part of the subscriber value chain, because we handle everything from the initial subscriber increase to billing and collections, and providing our rented equipment and central monitoring services directly to the subscriber, rather than indirectly through the channel partner. More than half of the organic subscriber growth for the quarter and year-to-date has come from our OneSource programs.

Focusing on our health care partners who are primarily in our Lifeline Monitoring Service, offering which we called LMS, channel initiatives include our direct-mail campaigns, e-commerce strategy, training and development seminars, and various marketing and channel automation tools focused on freeing up more of their time for local sales and marketing activities. LMS programs buy our equipment but outsource the subscriber monitoring to us. Therefore, as they grow, there is an increased demand for our products as well as additional subscribers to monitor.

Product revenues in Q3 of $6.7 million were up 14 percent from last year's third quarter. As Ron will discuss, our plan is that the growth in our senior living revenues, which we include in product revenues, may offset or overtake the planned decline we expect in sales of our traditional hardware products. Total gross margin increased to 57 percent in Q3, up from 52 percent in Q3 last year, reflecting our continued improvements in leveraging our fixed costs base in our margins and the senior living equipment sales. Our service gross margins, one of the key drivers of profitability at Lifeline, improved by 6 percentage points to 54 percent, from 48 percent in Q3 last year. The improvement in service gross margin reflects the improved infrastructure utilization and the scalability of our systems in our core business, both of which help increase the lifetime value of our subscribers. Focused productivity improvements, along with cost reduction initiatives, also contributed to profitability.

Product gross margin improved by more than 2 percentage points in the third quarter, influenced by mix in the health care channel combined with increased efficiency in manufacturing and other areas in the senior living division. Quarterly SG&A expenses increased to $13.2 million, from $10.3 million in the comparable quarter in 2003. The incremental SG&A for the most recent third quarter relates to nearly $1 million for the PROTECT acquisition which closed in June of 2004, and one small PERS acquisition which closed in January of this year; $1.4 million related to marketing initiatives covering our health care direct marketing campaign, e-commerce, and the addition of 3 senior level marketing managers who are providing leadership and depth in our service revenue business, our health care equipment business, and marketing communications.

In addition, we also reported nearly $600,000 for Sarbanes-Oxley compliance and other corporate initiatives, including our previously announced company reorganization. All told, the higher SG&A was in line with our expectations. Q3 was also another good quarter as measured by our operating cash flow and balance sheet. Net cash provided by operating activities, less property and equipment expenditures, increased to $6.3 million in the third quarter of 2004, up from $4.3 million a year earlier. Nearly all of the increase in cash flow from operations resulted from growth and profitability, indicative of our success at controlling operating expenses and improving gross margins.

We ended the third quarter with a cash position of $36.6 million, no debt, working capital of $40.4 million, compared with working capital of $25.2 million in Q3 of last year. Our inventory turns also continue to improve, reaching 3.6 times in Q3 of '04 versus 1.9 times a year ago. The improvement is mainly a result of our growth in product revenue and our continued focused on working capital drivers. DSOs with the inclusion of PROTECT were at 37 days in the third quarter, consistent with last year, and 1 day better than the 38 days 2 years ago. In the PROTECT acquisition, we acquired a balance sheet which meant taking on a lump sum of receivables that momentarily inflates our DSOs. With that, I will turn the call back to Ron.

Thanks, Mark. The growth strategy that we have outlined on prior conference calls has 3 key components. First, increasing service profitability; second, achieving organic growth through our core hospital channels; and third, extending the breadth and packaging of our product lines and the scope of our services with complementary programs and channel strategies. As we discuss each of these components, our message to you this morning is simple and straightforward. We are continuing to successfully implement this growth strategy and generate incremental gains for our company. We are continuing to find new ways to do things better. Ours is a game of fitting the singles and doubles and producing game-winning statistics that enhance our top and bottom-line performance, strengthen Lifeline's position as a cost-effective, nationwide resource to promote safe, independent living for home-based elders, and bolster our number one ranking in the personal response service industry.

The numbers that Mark presented speak for themselves. What I want to do this morning is to discuss some of the anecdotal evidence of our success that backs up the numbers. One of the means by which we are able to do things better is by increasing the visibility with which we are able to address opportunities. The first component, increasing service profitability, starts with improving the lifetime value of subscribers, primarily by continuing to upgrade the success rates of our response center and consumer sales staffs, and extending the length of time a subscriber stays on our service.

Our primary service focus continues to be on providing the fastest, most accurate, and caring overall response, and successfully addressing emergency calls. We have reduced our average response time by more than 20 percent in the past year, without compromising any other areas of call center performance. However, as we have discussed in the past, nearly 96 percent of incoming calls to our response centers constitute nonemergencies. Since this group represents such a large percentage of our call volume, we continue to seek ways to improve the handling of nonemergency callers. We have complemented our training curriculum with a module named sound of success that coaches our response center professionals to handle nonemergency calls more efficiently and effectively, without compromising caring and respect for the subscriber.

Remember that we encourage our subscribers to press their pendant as often as they need to, and part of our protocol is that we encourage them to talk with us at least once a month. In addition, we have increased our focus on preventing accidental calls, usually when a subscriber accidentally hits the call button, from coming into our response center through the re-engineering of our pendant and button and technology, which simply means that the subscriber has to be slightly more deliberate in hitting his or her call button. We believe we are avoiding a large number of accidental calls based upon the extensive metrics we use to track call volume and customer service. It has a very real impact on our response center statistics and customer satisfaction. Reducing the accidental calls along with many other process improvements has increased the number of subscribers monitored by each professional, and the overall workstation performance by more than 50 percent during the past 2 years. Increasing the average efficiency of response center professionals is one more way that we are able to steadily improve our gross service margin. We are also continuing to improve our visibility in addressing the challenges inherent in our small Medicaid government business, and stand to increase its viability and profitability. Because of the prior actions we took in centralizing operations, managing the contracts more skillfully, divesting unprofitable Medicaid subscribers, and improving the efficiency of our Medicaid infrastructure, business processes and support systems, we are now able to more accurately analyze this business.

One of the chronic problems in Medicaid reimbursement is the holdback for disputed items. Generally, where a state referred a subscriber for us, for our service, but failed to provide a formal authorization or reauthorization for our service being built. We're now able to analyze the payment behavior of Medicaid reimbursement authorities by state and by agency for all subscribers. In addition to identifying a few hundred thousand dollars of billing in the third quarter that we did not recognize in revenue because of the uncertainty of their collection, we have also identified certain states where we will probably not grow our business until there is a discernible improvement in reimbursement practices. With the upgrading of our systems platform, we are able to accommodate the specificity of the HIPAA-compliance needs of individual states, which both gives us a competitive advantage and enables us to be more selective in deciding the states where we want to conduct business.

The second component of our growth strategy is achieving organic growth within our core community hospital channel. To achieve organic growth, we are continuing to develop our marketing and distribution capabilities, and leverage the success of our health care direct marketing campaigns. To we have doubled the number of professionals taking inbound calls to our 1800 Lifeline sales call center, and increased their closure rates from 38 percent at the end of 2002 to over 50 percent by September of 2004. In addition, we have refined our direct marketing campaigns so that we are able to more accurately track referrals, new subscribers, and service selections that are attributable to direct marketing. For the 2004 third quarter, Lifeline added 4600 new marketing-related subscribers, direct marketing-related subscribers, up 64 percent from 2800 direct marketing subscribers in the third quarter of 2003. 70 percent of the new direct marketing subscribers are covered by our Lifeline OneSource service offering.

With the momentum the direct marketing program achieved in the first 9 months of the year, the campaign is on track towards reaching our target of nearly 20,000 attributable subscribers for the year. We are on track to spend more than $2 million on direct marketing initiatives, enhancements and expansion in 2004. Along with continuing to improve our analytical capabilities, we expect this investment to expand our database and enable us to generate 2.1 million contacts up from the first quarter forecast of 1.7 million and from 1 million contacts in 2003. Clearly, our direct marketing campaign is generating positive results. Given the gains we have made in terms of programs, operations and execution, we expect more than half of the new subscribers attracted through the direct-mail campaigns in 2004 will be truly incremental.

Moreover, the benefits of the campaign are sufficient to have made it accretive for both the quarter and the year-to-date, and to make a small margin contribution in the fourth quarter as well. We continue to complement our direct marketing campaign with new market development initiatives. Our new market development coordinators are responsible for stimulating referrals from some of Lifeline's most important referral sources. As a result, we are better able to cultivate our distribution channel and add organic growth with a higher value-added service offering, particularly by Lifeline OneSource.

As Mark mentioned earlier, OneSource puts most of the subscriber value chain and caregiver contact in our hands, from direct marketing to enrollment to service and billing, making it one of the key drivers of organic growth for the company. As a complement to our core marketing development activities in hospitals and home care, we continue increasing our channel initiatives and distribution capabilities. By continuing to refine our service offerings for health care customers with an emphasis on clinical referrals and indication selling, by growing our national accounts including the Visiting Nurse Association of America, the American Red Cross, Ceridian and other non-medical Homecare providers, by pursuing e-commerce options to reach adult caregivers who are increasingly involved in care plan designs and decisions and payments for their parents.

We have expanded our investment in e-commerce by engaging in specialized sales and marketing on the Internet. We're continuing to upgrade the content of the site and the interactive accents on the site with our channel partners. During the next year, we expect to invest in a new telephony platform that further enhances our inbound sales call handling capabilities, which will also support a direct-to-consumer pilot marketing program we plan to launch next year.

Finally, by developing technology and hardware enhancements that add value for our subscribers and health care partners. An example is the new care partners 6700 communicator unit which we introduced last quarter, which you may recall is easier to install and service, has a greater operating range, and a longer battery backup life. We mentioned earlier that we encourage subscribers to test their equipment once a month. One advantage of the improved functionality of the 6700 is that the equipment checking occurs right in the subscriber's home, eliminating unnecessary calls to the response center and providing one more opportunity for service margin improvement. The key metrics of Lifeline's organic growth are subscriber additions, average monthly revenue per subscriber, and the length of time the subscriber stays on our service.

As Mark mentioned, we increased the total subscriber count to 411,000, up 7 percent from Q3 of last year. In all, including 3000 subscribers we added through a small acquisition in January of this year, we have added an incremental 27,000 subscribers year-to-date in 2004, compared to 20,000 in all of 2003. With improved contract management and revenue mix, we increased our effective revenue yield per subscriber to $21 in the third quarter, up from $20 in the third quarter of last year. By shortening the time it takes to get a new subscriber activated and postponing deactivations, we've reduced our churn rate by nearly 4 percentage points to approximately 39 percent from 43 percent year-over-year. At the same time, we will continue to look at acquisition opportunities that offer the ability to increase market share, improve profitability, and add additional, high-quality referral sources. The third component of our growth strategy involves extending the breadth and packaging of our product lines and the scope of our services with complementary programs in channel strategies. One example involves the developing and growing our senior living business, realizing the synergies between senior living and Lifeline.

The key area of progress during the quarter has been in the integration of our PROTECT acquisition. From a staffing and facilities perspective, the acquisition is fully integrated. By adding a new Vice President of Sales, a new Director of Technical Services and Operations, and a manager of product marketing, we have been able to advance the benefit of PROTECT on several fronts. In addition, we have named the new Vice President and General Manager to our senior living division, Casey Pittock, who came to Lifeline as the founder and CEO of one of our PERS acquisitions in 1999, and who continues to distinguish himself. We are very excited by these additions and the prospects they bring to our senior living business. Prior to acquiring PROTECT, Lifeline's senior living focus had been primarily on retrofitting existing independent and assisted living facilities by eliminating the pull cord. Integrating PROTECT's product line with Lifeline's is allowing us to expand our addressable senior living market and increase our emphasis on new construction. We have broadened our product portfolio to include a wireless, emergency call system and a wireless emergency call system with a voice feature, as well as the traditional hard-wired call systems.

Second, we were then able to consolidate the manufacturing and assembly of the PROTECT communicators in our Framingham plant, convert PROTECT's Northern California plant into a sales office, and reduce overhead. Our productline strategy and the PROTECT product integration should be completed within next year, and we'll have more to say about the breadth of the senior living division's offering in 2005. Thirdly, under its prior ownership, PROTECT was known for having good products that needed to invest in its service support. Combining Lifeline's reputation for service with critical enhancements to the product line and the manufacturing process should provide a win-win situation for our customers.

Our long-term strategy is to offer the market a total array of products backed by a strong reputation for service from a single source. As a result, we are beginning to make inroads into many of the nation's largest senior living chains. Sales of emergency response communicators exceeded 4000 in the third quarter of 2004, and nearly 15,000 year-to-date, compared with when we sold 10,000 communicators for all of 2003. Our equipment is now used by more than 100,000 senior living residents, and our PROTECT acquisition is expected to be accretive by the end of the first year. As we rationalize this productline, we remain optimistic of our role in the assisted living industry, which is growing and currently provides home for over 2 million residents.

Let me conclude by discussing our recently announced plans to create a holding company structure, since it has the potential to benefit all 3 components of our growth strategy. As you read in our news release this morning, a definitive proxy will be filed soon with the SEC, and I direct your attention to the proxy for an explanation of the proposed terms of the corporate reorganization. A special shareholder meeting has been slated for December 8th. In recommending the creation of the holding company, our Board of Directors saw the opportunity to gain greater flexibility for Lifeline, to compete in strategic acquisitions and other growth initiatives, and to potentially increase profitability by more efficient utilization of available corporate and tax law provisions. In addition, the new corporate framework which shield assets from undue risk.

2004 marks our 30th year in business. The new corporate structure addresses the changes in our industry and business environment that have evolved over the time, and positions us to take advantage of a bright future and a very favorable trend in the demographics relating to the aging population and the pressures on the health care system. We look forward to announcing further achievements in the quarters ahead. With that, Mark and I will take your questions. Thank you.

Thank you. The question-and-answer session will be conducted electronically. (OPERATOR INSTRUCTIONS) Mitra Ramgopal with Sidoti.

Good morning, guys. Just a few questions. I was wondering if you could give us a sense how much the revenue in the senior living initiative business was for the quarter, or maybe if you have it for the year? Also, the gross margin was definitely a lot higher than I think anyone would have expected for the quarter, and I think looking back it's probably the highest you have had in more than 6 years. Going forward, how sustainable do you think the current level is, or if you had to look out to '05?

Mark, you want to take that?

For the quarter, our senior living revenue was $2.1 million, which was a 62 percent improvement over last year Q3, and represented about 31 percent of total product revenue. That 31 percent is up from 22 percent last year. On a year-to-date basis, senior living was 5.6 million in revenue, which is 77 percent higher than last year. That will give you a feel for senior living revenue. From a margin perspective, as we have just described, there are lots of initiatives within the Company focused on cost reductions, process improvements, and which contribute both to our service gross margin and to our product gross margin.

We have an infrastructure here that is built all-around technology, which is very scalable as we add new subscribers to our monitoring platform. One of the items we look at is our growth margins in the service business in particular, and we see that in the mid-60 percent range. So as we add more subscribers, we think we get a higher margin on those subscribers. That is one of the real drivers behind that piece of the improvement. Within the product gross margin, we are getting better at the process, all-around manufacturing senior living systems, and billing them. As we grow and we add more resources to that area, we think we will experience some scale and improved margins in that division also.

One other point that I would add is that as we need address organic growth with our programs, we're focusing on all categories of programs which includes those programs that still buy equipment from us. Typically those are our smaller programs, so as they organically grow, while their average revenue per subscriber might be smaller than say OneSource, they do buy equipment and they buy it in small volumes at higher prices. So or average revenue per piece of equipment might be higher, which gives us a little bit of leverage from the organic growth as well.

Okay, thanks.

Marvin Loh with Decision Economics.

Good morning guys. Speaking on this margin theme, your gross margin on the service side, as you mentioned, were also better and as an interest point, they were probably as good as they have been. Can you break that out for me in terms of how much was because of a greater percentage of OneSource customers, and how much of it was because of the internal efficiency initiatives that you guys spoke about?

Typically Marvin, we don't break down any of the service offerings including the profitability of that. That really comes from competitive reasons.

Okay. Then can you give me a sense of the number of OneSource conversions this past quarter?

We really don't break that down either. I can tell you for the quarter, CapEx related to business purchases, that is how it is described in the cash flows which you'll see once we file the Q, was about $2 million. And on a year-to-date basis, it approximates $6.8 million. Compared to last year, it was $3 million on a year-to-date basis.

Marvin, I would just add one other point and that is, the margins and the profitability on the OneSource at this point are not necessarily, at least from a productline P&L perspective, dramatically different than the rest of the customer categories because we are investing as heavily as we are in the infrastructure to support that value chain change. We do know that as I mentioned in my comments, that the government component, which in effect is a subcomponent of the OneSource, is less profitable because of the nature of how some of the states behave in the payment practices. So in general, you have got a growth component of most categories of customers that is not yet at this point anyway, dramatically tilting the margin.

Okay, thank you very much.

(OPERATOR INSTRUCTIONS). Jim Bartlett (ph) with Bartlett Investors.

Another great execution. On PROTECT One, can you tell me how much that added to revenues and where that was?

PROTECT added about 450,000 in revenues (indiscernible).

Is that all in product related?

Yes.

There is no service, Jim, in that PROTECT.

I didn't think so. So you had two on in senior living and maybe then about four in traditional equipment and about four fifty in PROTECT One?

That sounds about right.

Can you give us a little update on Ceridian?

I will try to do that and I will come at it from a couple of perspectives. As it relates to our business and our P&L and our profitability, Ceridian is growing very slowly and is not a material number of subscribers yet. I have often compared it to the slow start we have had with people like the Red Cross. One of the reasons why it is growing as slowly as it is, is because Ceridian is out there presenting a broad offering to its employers for their employees, and in this environment of heavy cost containment and benefit planning, there is a lot of distractions from focusing on a single particular new benefit.

So they have their work cut out for them in both maintaining and growing their business, irrespective of what attractive new offering that Lifeline might unveil to them. On the other side of the coin, as you listen to our economy and the marketplace, and the demographics and care giving and productivity in the workforce, and the baby boomers and all of these characteristics that are becoming enormous characteristics in our society, the trends clearly call for helping the caregivers in the children relieve stress. We are long-term committed to seeing employers as a referral source and very patient in needing -- and being willing and needing to spend marketing dollars to put ourselves in front of those employers and employees without a rapid return.

Okay. Another question. You had mentioned direct-to-consumer next year. Can you give us a little more idea of when and what and how?

Well, I can just say in general terms that '05 will be a pilot year for us. We will do some testing. We will hire some people who are skilled in direct-to-consumer that also have a background in what I will call the mature market segment, mature market segment being a combination of the caregiver levels, as well as the at-risk senior. Much the same as we started our direct-mail, direct marketing campaign a couple of years ago, we will expect it to be dilutive and not accretive in the first year or two. We will probably have a group of different media that we experiment with.

We are already beginning that process on the Internet, but the e-commerce component is a significantly different set of tools and talents than what will occur next year. At this stage, we are in the search process for a leading executive in consumer marketing and until we have that person on board we are reluctant to say much more about what we think will evolve over '05. Other than that we are allocating dollars in our plan for it. We are very optimistic that there are some systemic changes occurring in our society that are going to cause the children, the caregivers, women in their mid-40s to mid-'50s to become a potential new payer and buyer and decision-maker for our service.

One final detail. Mark mentioned the $600,000 in the quarter for Sarbanes-Oxley and some other things regarding the Company's organization. Specifically on Sarbanes, how much will you spend on that this year? What do you think you will spend next year?

Related to Sarbanes, this year we'll probably spend around $400,000, maybe a little bit more. I am not sure I know about next year. This year, of course, is the big year. As you know how Sarbanes works, we documented all of the controls this year which is probably half the cost.

But it could be 50 percent of this year, next year?

Good be.

Thank you.

Mitra Ramgopal.

Ron, I know you alluded to one special use of cash as acquisitions. I don't know if you could maybe help us a little in terms of a couple of things I guess you could be looking at outside of senior living and your core businesses potentially expanding into providing other services that competitors might be doing? I don't know if you've seen anything in a competitive landscape that might make you more willing to look in that direction?

First and foremost, there is still a large number of traditional competitors of ours in what we call the PERS niche, which we constantly examine the value of acquisition strategies with them and the quality of their referral sources. So that I would say is the primary priority in our potential use of cash on an acquisition basis. Secondly, as you have seen, we have been willing to make a couple of acquisitions on the senior living side because while we see this initially as a hardware strategy, ultimately we feel, and I think we have some foundation for it that the quality of response in some of the assisted and senior living facilities could be enhanced by the use of call centers, so that in the short-term or near-term we see it as an equipment strategy that later could be a combination of an equipment with selective recurring revenue opportunities.

During that process, our customers will tell us the scope of what they define as an e-call or emergency call productline, that they will want integrated together into a system. And some of them have an interest in wandering, some of them have an interest in fall detection, some of them have an interest in perimeter or integration of existing systems that they might even have around smoke and fire. So there is a little bit of software and systems opportunities here.

As we evolve through meeting the needs of some of our quality nationwide providers, on both an equipment and a service of that equipment perspective, that could influence our acquisitions or our strategic alliance perspective in terms of meeting their needs. And beyond that, we don't really have diversification plans that will take us outside of this arena because we are continuing to be convinced that we have a very underpenetrated core business that with a combination of new channel strategies, new payers, new marketing messages, has the opportunity to accelerate without us diversifying too far afield that.

Okay. Thanks.

(OPERATOR INSTRUCTIONS). Tim Hartch with Brown Brothers.

I just have a question. If you could go over again what the target margin is for the service business? And also, I am not sure if I heard correctly what the operating cash flow numbers are? Thanks.

We really don't have a target for the gross margins on the service business. One item that we do calculate from the financials are our growth margin and that is the incremental service revenue and the incremental service gross margin. If you average that out over the last couple of quarters, it is ranging around 65 percent. So that is one indicator of where service gross margins could go and it helps illustrate the scalability of the infrastructure we have here. Okay? Related to cash flows, you mentioned?

Correct, the operating cash flow numbers again.

Before he gets to the cash flows, just let me say one other thing. We have internal targets for margin improvement and service margin related to our process improvement engineers and our productivity gains and our pricing strategies and our average length of time on the service, and so on and so forth. We have very specific targets for 2004, 2005. We just don't share those externally. Cash flow?

Tim, the net cash provided by operating activities, it was $9.4 million.

Okay.

Is that it?

That does conclude our question-and-answer session today. At this time I would like to turn the conference back over to our speakers for any additional or closing remarks.

Thank you very much for your time and for your questions and for your support, and we'll look forward to the next quarterly conference call.

Thank you. That does conclude today's teleconference. Thank you again for your participation.