Koninklijke Philips NV (PHG) 2005 Q1 法說會逐字稿

Good day, everyone, and welcome to the Lifeline Systems, Inc. First Quarter 2005 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 would like to turn the call over to Mr. Ronald Feinstein. Please go ahead, sir.

Actually, Jeff, it's Mark Beucler. And thank you, and thank you, everyone, for joining us this morning. I will begin by reviewing our first quarter financial results, and Ron will follow with a business update. Then we'll be happy to take your questions. I'd 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.

As we announced after the close of business yesterday, Lifeline posted solid results for Q1. Total revenue grew 13 percent to $35 million from $31 million for the first quarter last year. Net income was $3.3 million in the first quarter. This includes approximately $400,000 associated with the favorable settlement of an income tax audit. Excluding the tax settlement, net income increased 31 percent to $2.9 million, or 20 cents per diluted share, from $2.2 million, or 16 cents per diluted share, for Q1 a year ago. Our recurring service revenue grew 15 percent in Q1 to $28.4 million, up from $24.7 million for the first quarter of 2004. This was driven by nearly 10 percent year-over-year growth in our subscriber base, which now stands at more than 433,000, and by continued improvement in the average revenue per subscriber. More than half of our subscriber growth in Q1 was attributed to our Lifeline OneSource service offering which, compared with our other offerings, allows us to retain a larger portion of the subscriber revenues seen [ph].

Product revenue for the first quarter rose to $6.5 million from $6 million a year ago. This reflects not only the growth in our senior living business, but our success in encouraging our core health programs to upgrade their install base of Lifeline equipment. Total gross margin increased to 56 percent from 53 percent for the first quarter of 2004. Lifeline's service gross margin, one of our chief profitability drivers, improved by nearly 500 basis points to 54 percent from 49 percent in Q1 last year. This reflects the success of our strategy to leverage our fixed costs and improve the productivity, utilization, and scalability of our business processes and systems. At the same time, product gross margin remained consistent with Q1 last year at 64 percent, even with the continuing increase in our senior living product mix.

SG&A expenses increased to $14.4 million from $12.1 million in the first quarter of 2004. As a percentage of total revenue, SG&A expenses rose to 41 percent in Q1 from 39 percent a year ago. The increase in SG&A was largely driven by over $1.4 million in increased spending on sales and marketing programs related to our channel development initiatives, as well as our health care direct mail and e-commerce activities. The increase in SG&A this quarter also reflects over $800,000 associated with the PROTEC emergency response systems business we acquired in June of last year, and ongoing Sarbanes-Oxley expenses and other corporate activities.

Q1 was another successful quarter from a liquidity standpoint as our working capital initiatives continued to produce good results. We're beginning to see success in migrating subscribers to credit card payments and our outsourced leasing program, called Lifeline Capital, is also doing nicely. In addition, our health care programs are getting the support they need from Lifeline to be successful from a cash flow standpoint. This success translates into customer satisfaction and prompt payment for us. As a result, DSOs fell to 29 days from 31 days in the first quarter of 2004.

As a final note, we ended the first quarter with cash and short-term investments and working capital balances of $46 million and $51.2 million, respectively, and no debt. This compares with cash and working capital of $23.9 million and $35.4 million a year ago.

That's it for the financial review. I'll now turn the call over to Ron.

Thanks, Mark, and good morning, everyone. Our results this quarter provide more evidence that we're on the right track with our growth strategy for Lifeline. It was a quarter of solid progress on our strategic initiatives in Lifeline's U.S. and Canadian operations. As a reminder, that strategy is three-fold. First, to improve service profitability. Second, to achieve increased organic subscriber growth, and third, to extend the breadth of our distribution in the scope of our services.

Let me highlight some things we accomplished in each of these areas in Q1 starting with our service profitability initiatives. These focus on two objectives. First, enhancing the lifetime value of our subscribers by extending the length of time they remain on our service, and increasing the average monthly revenue per subscriber. And second, improving processes and productivity in all aspects of our business.

In our customer care operations, we continue to make progress in retaining customers for a longer period of time. We are closing orders and activating new subscribers faster. We're also becoming effective at postponing deactivations, for example, by encouraging subscribers to take their Lifeline service with them when they relocate. In addition, we're seeing continued success in our efforts to improve overall quality in providing our core monitoring services. Enhancing the caring aspect of our relationships with subscribers is an ongoing focus of Lifeline. In our response centers, for example, our ongoing training programs are helping our personal response associates improve their interpersonal skills when responding to non-emergencies that represent the vast majority of our incoming calls. Continually improving our churn rate by finding new ways to satisfy subscribers is crucial to extending average service lifetime.

One of our strategies for growing average monthly revenue per subscriber is focusing on migrating more of our health care programs to Lifeline OneSource. For programs that choose this option, we handle everything from initial subscriber inquiry to installation, billing, and collections. We also rent the equipment as opposed to selling it. And in addition, we provide central monitoring service directly to the subscriber.

The OneSource model is a win/win solution for our health care program and for Lifeline. The program sees all the subscriber and caregiver benefits of a high quality Lifeline program with none of the traditional operational overheads. At the same time, we capture a larger percentage of the subscriber revenue stream, and assure the program that the subscriber has excellent service throughout the entire value chain. Lifeline OneSource has been growing faster than our other service offerings. And as Mark said, it generated more than half of our subscriber growth in Q1.

In addition, we're making gradual progress in transitioning some of our other traditional programs to OneSource. This mix change was one of the major reasons for the increase we posted in average monthly revenue per subscriber, which grew by $1 from Q1 last year. As we work to increase the lifetime value of our subscribers, on the other side of the equation are steps we're taking to improve service gross margin. Here again, it's a function of providing caring with quality and fast, accurate service for both subscribers and health care channel partners.

In customer-facing parts of the organization, such as the response centers, we continue to find ways to work more efficiently and accurately without compromising either value or performance. For example--an example of this is last year's reengineering of our personal health button, which is steadily reducing accidental calls. As another example, by migrating subscribers to credit card payments, we're improving productivity, reducing the operational costs of servicing our subscribers, and enhancing the scalability of our infrastructure.

Heading up the service margin initiative is a staff of four full-time process engineers who focus on areas such as reducing new customer service strategies to practice and improving our business processes in IT systems. Focusing on efficiency and quality also benefits our health care program partners. We're providing them with the best practices, automation tools, and continuous improvement mindset that they need to make program management more seamless and less resource intensive, while we're still providing subscribers with the highest level of service.

The centerpiece of this effort is our partner relationship management platform, Care Partner Connect, or CPC, as we call it, which is a benefit to all of our centrally monitored programs. CPC gives the program managers secure web-based access to the Lifeline database. This allows the partner to perform a range of subscriber account management and data entry tasks online. Although paper-based processes still dominate, CPC is making steady progress in penetrating the channels, increasing automation. The results are two-fold.

First, CPC enhances the efficiency for health care programs locally, which translates to better service for subscribers and caregivers. Second, automating their manual processes enables the program managers to free up time they can use to focus on marketing and expanding their programs. As programs grow, they are more likely to see the benefit in outsourcing non-core administrative functions like billing and enrollment. And we're positioned to respond with the OneSource option. At the same time, CPC will reduce partner support costs for Lifeline, leading to a commensurate expansion of service gross margin. And since CPC is integrated with our monitoring and billing platforms to provide the full Lifeline OneSource service, the impact on service gross margin is even greater.

We're also continuing to make progress in improving the profitability of our government services division. After centralizing this operation last year, we've identified additional opportunities to improve the efficiency of our Medicaid program infrastructure. As you may know, last year government services implemented a HIPAA-compliant data entry billing and cash application system. This is now integrated with our monitoring platform and it's helping us in complying with the HIPAA requirements of the individual states increasingly so as the states roll out their own HIPAA-compliant IT systems. As this process goes on, we're gaining a better understanding of the reasons for the reimbursement glitches that can make the Medicaid business so problematic, and having greater success in solving these problems. We're also improving our ability to target the states where it makes the most sense to grow this portion of our business.

Still, we have a long way to go before the majority of the states had deployed HIPAA-compliant systems and we are confident that their billing and collection processes are as reliable as their private pay counterparts. Even though the government service division represents less than 10 percent of our volume, we see significant opportunities to have it favorably impact our profitability and cash flow.

Let's turn to the subscriber growth side of the business. Our health care direct marketing, traditional referral marketing, and other partner initiatives are succeeding in raising awareness within our core health care channel. At the same time, we're continuing to add functionality to the channel automation tools we provide to improve our health care partners' marketing reach and productivity. Along with our new e-commerce initiative, this is driving increases in the flow of sales leads coming into our consumer sales call center. During the past year, we doubled the number of people taking inbound sales calls and we continue to improve their closure rates in Q1. The increased subscriber growth we reported for the first quarter demonstrates our success with these efforts.

We are also continuing to refine and expand our Lifeline Academy partner training and development seminars. Our Academy programs for this year are scheduled over the next several months and plans for the programs were essentially completed in Q1. We expect this year's Lifeline Academy to attract the leaders from our Top 200 programs with a wide range of content designed to help them better understand and refine what's driving their business from a sales and marketing perspective. At the end of each session, every one of our health care program managers will return home with highly detailed annual growth and marketing plans customized for their specific needs. Reinforcing these initiatives, we're increasing our investments in direct marketing to potential health care referral sources. These investments are currently running in excess of $2.5 million annually.

We're expanding and refining our database of health care professionals who could potentially refer subscribers to Lifeline. Most importantly, we're using this database to deploy direct mail campaigns designed to generate awareness and interest and ultimately participation as active referral sources. We believe there are ultimately close to a million potential health care referral sources in the U.S. and Canada, and Lifeline is making steady progress in adding their names to the database. We're also continuing to improve our database analysis capabilities, which allows us to create individual referral profiles that have far more value than a simple name. Using and continually refining these profiles, we can build on intelligence gained from prior direct marketing campaigns to improve future response rates.

Lifeline's direct mail response rates stack up favorably against industry standards and continue to improve. We estimate that about 8,000 of the subscribers were added in Q1 and that they were attributable to health care direct marketing, and that between 60 and 70 percent of those were truly incremental. As you may remember, our initial objective for 2004 was to add around 22,000 direct marketing subscribers and we achieved that. As an added benefit, we continue to see direct marketing produce a proportionately higher number of Lifeline OneSource subscribers. This contributes to growth in the average monthly revenue per subscriber while improving the leverage in the--in our model.

In our budget for 2005, we've already increased our direct marketing investment by around $750,000. We're targeting approximately 300,000 new direct marketing generated subscribers for the year, an increase of about 35 percent from 2004. In the health care channel, our direct marketing is aimed at health care referral sources, such as hospital discharge planners, nurse practitioners, social service professionals. Our new team of inside market development coordinators is building--is beginning to build and complement these marketing campaigns and our field sales force by building relationships within the channel.

Another objective for this year is to continue our marketing initiatives designed to grow Lifeline's national accounts, such as the American Red Cross or the Visiting Nurse Association of America. The ARC and the VNA are still substantially under-penetrated in terms of the number of local chapters that have active Lifeline programs. Our go-to-market strategy assumes that we're continuing to invest a portion of our free cash flow to boost organic growth, whether the cash comes from incremental revenues, sales from operational improvements, or other sources.

The third component of our growth strategy is to extend the breadth of our product lines and the scope of our services. One of these new objectives this year is to build our senior living equipment business. Our goal is to make Lifeline the leading provider of emergency call systems in the segment by offering the best suite of retrofit and new construction solutions for senior living facilities. As you may know, in June of 2004, we acquired PROTEC emergency response systems and integrated PROTEC's product line with Lifeline's to allow us to expand our addressable senior living market and increase our emphasis on new construction. With PROTEC, we've broadened our product portfolio to include a wireless voice and non-voice emergency call system. Lifeline equipment is now available to more than 100,000 residents in facilities across the U.S. and Canada.

This is just the beginning in terms of our senior living potential. The mainstream assisted living industry currently provides homes for more than 2 million senior residents in the U.S. alone. In addition, as the nation's elder population expands in size and affluence, the growing popularity of non-traditional residential environments, such as naturally occurring retirement communities, should provide us with more opportunities to serve the senior living market. With product volumes growing as this segment of our business expands, we have an opportunity to scale the senior living product business and make it even more profitable.

This illustrates our vision for Lifeline as a whole, understanding the forces that are changing the ways we approach eldercare in our society, building a profitable business around this understanding. Given the changes taking place today, our opportunities have never been greater.

With that, Mark and I will take your questions. And I'll ask Jeff to open the wire to questions.

Thank you, sir. (Caller Instructions.) And our first question today will come from Ryan Daniels from William Blair. Please go ahead.

Yes, Mark. A couple quick housekeeping questions up front. First of all, can you give us a breakdown of product revenue by senior living and the traditional product sales for the quarter?

Sure, Ryan. As we discussed in the last call, we expect senior living to have a run rate in '05 of slightly more than $10 million. And for the quarter, it was a little bit less than a third of the $6.5 million for the quarter. So a little bit more than $2 million.

Okay. And then, can you give me an update on the conversion from LMS to OneSource in regards to the CapEx for business purchases during the quarter?

We--total CapEx for business purposes for the quarter was $2.1 million. And that would include small competitive acquisitions along with the OneSource transitions that are also acquisitions. The breakout is probably half our competitors and the other half are OneSource transitions.

Okay. And can you actually give us the number of acquired patients during the quarter or subscribers during the quarter?

When you net it all together, it really wasn't a material number for the quarter. Probably around maybe close to 1,000.

Okay. And then, on the SG&A side, obviously, you guys had a nice bump up there and your explanation earlier was helpful. And I know you don’t really give line item guidance there, but is that something you think will continue to expand, I guess both as a percent of revenue, going forward and on an absolute basis? Or is this kind of a nice run rate that will continue throughout the year?

Well, the range we sort of have been trending towards is between say 39 to 41 percent of revenue per quarter. And what we've tried to illustrate to the investment community is what we're spending it on. For an example, if we accelerate our spending in direct mail, in that quarter that we expend that money, then it's a hit to SG&A because we don't get the subscribers for 90 days later.

Okay. So there's usually kind of a one-month lag for the revenue growth to come from that spending?

Sure. Maybe two to three months.

Okay. So within the next quarter?

Yes.

All right. And then, a little bit broader picture I guess for Ron. Can you talk a little bit more and give us the latest update on the direct to consumer marketing efforts, both in regards to potential launch time for the pilot program and maybe the status of bringing someone in to help run that effort?

Well, as we've said before, Ryan, the expectation is that we'll be doing research and potentially the strategy to set up some tests and pilots sometime towards the fourth quarter of '05. And I'm optimistic that within the next quarter we'll be able to make some announcements about the new leadership of that division.

Okay, great. And then, last question. Ron, you mentioned an improvement in closure on the inbound calls. Can you actually give us your closure rate during the quarter?

Well, I can give you an estimate. I don't have the exact number in front of me, but I think our closure rates are in excess of 50 percent, maybe even sometimes 55 percent.

Okay, great. And then, I'm sorry, one quick follow-up. The average length of service for subscribers during the quarter. Did that change much?

I don't think so. I think it may have trended up a little bit. We--Mark, are we tracking around 28 months, somewhere in that--?

That's right. And it's trending to the positive.

Okay. And is that--some of that due not only to service, but the switch to OneSource if those are longer length of stay customers?

No, I don't think that length of stay is dramatically influenced by OneSource versus the other categories because the various initiatives have a broad application to all categories of customers.

Okay, fair enough. Thanks, guys.

Thank you.

And we will now hear from Jim Bartlett with Bartlett Investors. Please go ahead, sir.

Yes. Is there any seasonality or special factors that would have influenced that 8,000 new subscribers to the direct marketing in the first quarter?

The only seasonality, Jim, that would influence it would be the seasonality of our spending. In other words, if we chose to have campaigns in one particular time versus another, there may be certain times of the year when direct mail dollars are not well spent. I'm not an expert on it, but, for example, maybe in the summer. So there is a little bit of seasonality, but it's driven more by the deliberate decision of when you spend your money.

Right. And, of course, with the lag time that would really be more of a function of the fourth quarter spending, right?

Well, the fourth and early first.

Right. Because I'm wondering, you're already at a 32,000 annualized rate and you said your goal was 30. It seems like that's a little on the low side.

Well, we love to exceed the expectation. I'll pass that along to the team, Jim.

Okay. Just could you give us a little bit more about the--where your response rates are now, and you said they were improving. And also, just the database size where it is now versus where it has been recently?

I think that the database is probably somewhere around 300,000 and trending up at an accelerated rate. And the response rates, I would probably say the response rates are categorized first by response then by closure. I think the response rates are probably in the 4 to 5 percent range. And then, of course, you would have a closure rate that's going to be maybe in, I don't know, the 1.5 percent range.

The closure rate is in the range of 1.4 to about 1.8 percent.

We have some direct marketing expertise that's a lot closer to the metrics than I am on this that we could provide you with separately.

And those rates are both up from say where were they a year ago?

I think everything has been trending favorably. And, of course, most of the energy at this point is in increasing the size of the database and then doing the analytics to identify the richest prospects. And that's a relatively scientific process that the team goes through. And every month that gets better. And as we step up the spending in direct marketing in the direct mail area, some of that increased spending is to acquire additional names for the database so that we can do the analytics to get them to the point of prospects.

Could you just give me a little background on your relationship and the importance of that with SafeHome.net?

SafeHome.net?

Yes.

Don't know them.

Okay. Well, they just announced that they had--they are now putting Lifeline on their--I guess it's a sort of a safety related website that they supply. And that was announced. So obviously, it's not a big deal if you're not--.

--We have a Director of E-Commerce that is working on a variety of links with--on the Internet. And this very well could be one of potentially dozens.

Okay. One other question. You had mentioned--I believe it's in the Annual Report about a new CRM platform for the next generation. Could you give us a little information on that?

We're operating a Legacy system on inbound telemarketing that's been around for too long, probably half a dozen years or longer, maybe even a decade. It was designed for an environment that's different than what it's being used for. We have a team in place and we have approved in excess of $1 million to acquire and customize a standard platform to our own needs. And I'm expecting the CRM system will probably be turned on in Q2 of '06. So it's about a year project. In effect, what it is, it's a state of the art CRM system that's custom designed for the Lifeline industry niche that will have a significant amount of in and outbound power that our current Legacy systems don't have, including the ability to give significantly more alignment between ourselves and our 2,500 hospitals.

Okay, great. Congratulations on a super quarter. Thank you.

Thank you.

And we will now move on to Marvin Loh with Decision Economics. Please go ahead, sir.

Hi. 'Morning, guys. Could you comment on what the business environment looks like on the senior living sale side?

Well, I would say that we haven't seen a lot of changes. Marvin, are you asking about the industry or are you asking about our own specific business?

Your specific business.

We're new to this game, as you know. We're just getting started, so we don't have a lot of base yet. What we have is a lot of prospects. We acquired a very large customer base from March Networks and we acquired a customer base from PROTEC, and we had our own customer base. And we think that what this is is a very vibrant hunting license to retrofit and upgrade some Legacy systems that are probably not state of the art e-call systems, as they call them, emergency call systems. As you combine that hunting license with a significant investment in dedicated sales and marketing people and a gradually evolving nationwide service organization, we are very optimistic that we're going to be able to play a leadership role in this segment reasonably quickly. And by reasonably quickly I mean I'm hoping the scale of this ramps up in 2006 beyond the running rates that Mark quoted earlier in his comments, in terms of our current perhaps a couple of a million dollars per quarter running rate today. It's an untapped opportunity that we're just introducing a new division to.

Okay. Is there a bit of seasonality when it comes to selling equipment to the senior living channel? Is the first quarter weaker than others typically speaking or is it kind of a straight line?

Well, I think when you have a small customer base, the seasonality is driven by the unexpected deferrals in construction and retrofitting. In other words, you have architects and you have engineers and construction people, and you have budgeted expenditures. And sometimes these are moving targets that you have no control over. So what we do find is at this stage, our forecasting accuracy within a quarter is not terribly accurate yet to the degree we'd like it to be because the volume is small and the customer base is small. We think when we get more scale, it will expand. And we do some business with people like Sunrise Assisted Living or Hyatt or people like that. And they're reasonably stable and predictable in the implementation of their plans. Some of the others that are smaller operations tend to move their dates around pretty materially.

Okay. One other quick question for you. On the pricing side, have you folks talked about or kind of gone through possible pricing increases on your service product?

We had a very miniscule price increase in '05 that took effect somewhere at the end of the first quarter. And some of that involved some contract maintenance. Some of it involved some one-time fee changes. We watch, for example, the impact that energy costs have on our installation fees and on our UPS shipments and things of this sort. But they were not material. They would be--if they were 1 percent that would be a lot.

Okay, great. Thank you.

And our final question today will come from Mitra Ramgopal from Sidoti. Please go ahead.

Yes. Hi. Good morning, guys. Just a few questions. First, if we are to look at the subscriber growth we saw in the quarter, how much of it you would say is sort of coming from just the direct marketing as opposed to maybe taking share away from competitors?

Mitra, the direct marketing related subscribers for the quarter was approximately 8,000. And, as you know, we think about 60 to 70 percent of those direct marketing subscribers are truly incremental.

Okay. So it's a case of where you're just expanding the market as opposed to picking up potential subscribers from competitors?

Yes. Mitra, the amount of growth in our business that is a result of a shift in market share from a competitor to ours is miniscule. We tend to put almost all of our energy into market development, which means market penetration. And while Mark will mention that we occasionally make a small competitive acquisition, the materiality of that in terms of market share or in terms of sheer subscriber numbers is tiny.

Okay. And I guess, as you mentioned, acquisitions. Given the strong cash flow position you ended the quarter with, I assume that's something always on your radar screen, a potential acquisition or two to get on the technology side or somewhere else?

It is, and we have dedicated resources that are both looking at technology strategies and the potentiality of some M&A opportunities. But, as you probably know, we tend to be both gradual and conservative about these. And we like to have a very fast accretive return on our investments when we make them.

And also, on the competitor space. Given how you have a large untapped market out there, and clearly, the margins in this business can be quite attractive. Are you getting a sense that there are more players coming into the space or no change?

Well, I think that's there is a little bit of increased consumer activity on the advertising side that's coming from some of our competitors. We are seeing a few new small regional competitors that are popping up across the country. Most of the visibility that we see of this are people who are coming onto the Internet that don't necessarily have a lot of infrastructure, and maybe even outsource most of what they do. So I would say that the materiality of it is insignificant in terms of either the number of subscribers that are occurring in this category or the number of new companies.

And one final question. Clearly, the gross margin--you had a very nice year-over-year increase. How much leverage do you still think you have there? Is it a case where you've pretty much picked off the low-hanging fruit and it incrementally gets harder going forward, or is there still just a lot of room to go?

Mitra, it's Mark. We continue to feel that revenue growth continues to leverage our infrastructure here through the monitoring platform and the billing platforms that we have, and the other use of technology throughout the operation. And we look at the growth margin on occasions and see where are we with that leverage point. And I believe if you look at the incremental cost of service first quarter of this year versus last year and the incremental service revenue, that margin is about 80 percent.

And the other thing, Mitra, that I would mention is that in a culture of continuous improvement and TQM, Total Quality Management, we don't believe we're done yet in driving costs down.

Okay, thanks a lot.

You're welcome.

And at this time, gentlemen, there are no further questions. I would like to turn the call back over to you for any closing or additional remarks.

Thank you very much, Jeff. And thank you all for calling in. That concludes our conference call.

Thank you, everyone, for your participation. That does conclude today's conference. And at this time, you may now disconnect.