Tivity Health, Inc.
Q2 2016 Earnings Call Transcript

Published: 10 Aug 2016

[Operator:]

Please standby, we're ready to begin.

[Chip Wochomurka:]

Good afternoon. This is Chip Wochomurka, Vice President of Investor Relations for Healthways, and welcome to our Second Quarter Conference Call Today. The call today is being recorded and will be available for replay beginning later today and through August 17 by dialing 719-457-0820, and the replay pass code is 5896427. The replay may also be accessed for the next 12 months on the Company's website. To the extent any non-GAAP financial measures discussed in today's call, you will also find a reconciliation of that measure to the most directly comparable financial measure calculated according to GAAP in today's news release, which is also posted on our website. This conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements among others, regarding Healthways' expected quarterly and annual operating and financial performance for 2016 and beyond. For this purpose, any statements made during the call that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words believes, anticipates, plans, expects, and similar expressions are intended to identify those forward-looking statements. We hereby caution that these statements may be affected by the important factors among others that are set forth in Healthways' filings with the Securities and Exchange Commission and in today's news release. And so consequently, actual operations and results may differ materially from the results discussed in those forward-looking statements. The company undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events, or otherwise. And we thank for being with us today. And we’ll start by letting me turn it over to our Chief Executive Officer, Donato Tramuto.

[Donato Tramuto:]

Thank you very much, Chip, and good afternoon everyone. Thank you for being with us today for Healthways' second quarter 2016 conference call. In addition to Chip, I'm here today with Alfred Lumsdaine, our Chief Financial and Administrative Officer. Alfred will lead us off this afternoon with some remarks about our results for the second quarter, and how we see things developing in the second half of 2016. Following these remarks, I also have some brief comments on the quarter and how I see us moving forward as this new company. Thereafter, we’ll open it up for questions and now I will hand it off to you Alfred.

[Alfred Lumsdaine:]

Thanks Donato, good afternoon everyone, thanks for being with us today. I'd like to take some time to walk through the important thesis of what's clearly a complex set of numbers specific to our second quarter results. I will follow that with some comments for the back half of 2016 for both our ongoing network solutions business, as well as our discontinued operations in light of the fact that with the sale of the total population health services business, we withdrawn formal financial guidance for 2016. Finally I will add some comments with regard to the pro forma financial statements filed in an 8-K last Thursday, August 4. Turning first to our second quarter 2016 results, I would like to start by recapping some of the key financial metrics. Starting with our discontinued operations, we completed the sale of our total population health services business to ShareCare on July 31, as expected. Our financial results for the quarter reflect losses from discontinued operations of approximately $195 million or $5.25 per diluted share. These losses include both the operational losses from these businesses for the entire second quarter, as well as an estimate of the impairment loss resulting from the classification of the businesses as held-for-sale as of June 30, 2016. However, since the sale to ShareCare occurred after June 30, the finalization of the transaction will largely be recorded as a third quarter event and I will provide a little more color on that in just a moment. So now let’s turn to our results from continuing operations which again consist entirely of our network solutions business. Our revenues for the second quarter were $125 million compared to $113 million for the second quarter of 2015. Net income from continuing operations was just under $20 million for this quarter, compared to just under $11 million in the second quarter last year. This year-over-year increase is driven principally by the elimination of income tax expense for the second quarter this year. As you may be aware given our near term history of operating losses, we’re unable to record to the balance sheet any tax benefit from the losses associated with our discontinued operations. At the same time our continuing operations benefitted this quarter by having earnings fully offset by these operating losses. Given the expected forward profitability of the continuing business, we would look to record the asset value of our net operating losses at some point over the next few quarters which would establish a more normalized pattern of income tax expense recognition thereafter. Just for reference, at June 30 we had approximately $70 million of unutilized federal NOLs, so this amount will increase significantly with the closing of the ShareCare transaction and occurrence of related expenses. Our continuing operations generated EBITDA of just over $26 million for the quarter or an EBITDA margin of approximately 21% and that compares with $23.7 million also approximately 21% for the comparable quarter last year. I would like to now move into some comments regarding our expectations for the second half of 2016. As we indicated in our release, we expect an additional 35 million to 45 million to be charged to discontinued operations over the remainder of the year, primarily during the third quarter. These charges are expected to include the previously discussed payment of $25 million to ShareCare operating losses from July from the businesses held for sale, non-cash equity vested to colleagues moving to ShareCare and transaction related fees and expenses. In addition to these additional charges to discontinued operations, during the remainder of 2016 we expect to incur certain costs in an expected range of $4 to $6 million that will be required to fully separate the network solutions business from the discontinued operations and create a fully autonomous business. Some examples of these costs include expenses to fully separate the IT infrastructure, stand up separate back office systems as well as the rebranding of the company. We will be sure to quantify these costs for you the rest of this year since they are non-operating in nature and aren’t expected to continue into 2017. Also during the third and fourth quarter's, we will be reorganizing our corporate support infrastructure to fit the ongoing needs centered on our network solutions business. We've estimated that the restructuring cost related to this work will fall into a range of $5 million to $7 million. We expect the annualized savings from this reorganization which we anticipate will largely be complete by the end of 2016 will fall in a range of $14 million to $16 million. As we reported in our release today, we anticipate that some of these savings will be utilized to invest in specific long term initiatives to foster additional growth in 2018 and beyond. Last week we completed an amendment to our credit agreement that extended the maturity of approximately two-thirds of the outstanding and available credit to June 8, 2018. This was an efficient way to keep the majority of our credit agreement from going current and to push out the maturity to just before our convertible notes matured in 2018. As we indicated in our release, our leverage ratio has dropped significantly as the amended credit agreement excludes the drag of our discontinued operations from our covenant calculations. Although we expect that our absolute level of funded debt will likely tick-up in the third quarter as we finalize the dispositions of the discontinued operations, we expect that we will end the year at approximately the same level of funded debt that we are at as of the end of Q2 and with a leverage ratio of approximately two times. Before I turn this back over to Donato, let me make a few comments to aid you in interpreting the backward looking pro forma financial statements filed with our 8-K last Thursday. First is a general statement, there are certain aspects of this pro forma statements principally general corporate overhead costs that are not allowed to be allocated to the discontinued operations which are not necessarily indicative of the performance of the network solutions business going forward. Second, the revenue and gross margins reflected in the pro forma statements are quite consistent with how we look at the network solutions business. I would also note that we see very little seasonality to the quarterly profile of the network solutions business within each year. Third, we have seen some amount of gross margin compression in the network solutions business over the last three years. This compression stands primarily from a few factors one, is pricing concessions and/or tiered pricing that we’ve provided in exchange for longer contract terms and revenue growth. Second, we’ve made a couple specific contract changes that have resulted in short-term revenue reduction but with an opportunity to expand revenues longer-term. Specifically one of these contract changes in 2015 removed exclusivity in a certain region which now allows us to grow revenue with more clients in that same region over time. A second contract renewal in 2015 moved our pricing model from a fixed PMPM to a participation format that we believe provides us significantly more revenue opportunity over the contract term. One final note, one final item of note on the 8-K pro forma financial statements, we've uncovered a classification correction in the 2014 total population health numbers were by 11.8 million of the 45.1 million of SG&A expense should have been displayed on the legal settlement charges line. This reclassification thereby resulting in increased to SGA&A expenses and a reduction to legal settlement charges for the continuing operations by the same 11.8 million all the totals remain unchanged. We will be preparing an amendment to the 8-K over the next few days to reflect this adjustment. And with that I’d like to turn the call back to Donato for some additional remarks.

[Donato Tramuto:]

Thank you, Alfred. As you can see we were pleased with the second quarter results which were ahead of our expectations for the quarter. As Alfred mentioned with these financial statements you get a much clearer picture of the financial profile of a company, post transaction of the sale of total population health service business. Our revenue growth of 10.2% for the quarter for the network solutions business is in mind with or a little bit ever been the upper single digit expectation we have been discussing with all of you. And as Alfred reviewed our EBITDA for the quarter was nearly 21%. We believe our early results illustrate the powerful financial insight of the network solutions business. With the ShareCare transaction now complete we can know fully focus on actively implementing strategies to drive the growth of our three businesses within the network solutions business, SilverSneakers, Prime and Physical Medicine. We plan to go into greater detail about our approach to these businesses at our Analyst and Investor Day on Thursday which begins at 8 ‘o clock AM Eastern time with the webcast beginning at 8

[Operator:]

[Operator Instructions] We do have our first question from Ryan Daniels with William Blair.

[Ryan Daniels:]

Yeah, good evening and thanks for taking the question. Let me start with one about the restructuring efforts in the back half of the year. Can you talk a little bit more about where the focus will be is that mostly SG&A level or there's some direct cost benefits you think you can capture on the business as well.

[Alfred Lumsdaine:]

That you can - Ryan you can think of it entirely at the SG&A level it should - you can imagine with the sale of the total population of health services operations that the SG&A is - needs to be sized differently for a smaller and less complex we’ll call it a organization.

[Ryan Daniels:]

Okay. That's helpful. If we think about the reinvestment up to 50% of the annualized savings going into 2017, any color on where we might see that dedicated? Is that kind of expanding the sales force? Is it launching a variety of new programs? Is it more sophisticated marketing? I know you probably talk about in a lot of detail Thursday but just any initial kind of thoughts on where that might be dedicated to push growth?

[Alfred Lumsdaine:]

I think you’ve covered a number of them. Certainly on Thursday we will go into more details but listen we have an opportunity to expand market and customer share. And I think that that happens with sales and marketing investments. We think that in the 50 plus category the estimates tells that that group is going to spend 30 billion on digital programs for well-being and health programs. And so we see an opportunity to invest in digital programs that help to increase engagement. So I think on Thursday you’ll hear more about us A, utilizing those dollars appropriately in terms of driving greater revenue greater growth for the company.

[Ryan Daniels:]

Okay. That's helpful. And then in regards to seasonality, it sounds like the sales seasonality is pretty diminimus in the network solutions business. I'm curious that the margin profile fluctuates a lot as you, maybe particularly in Q4 have ramp up costs ahead of open enrollment and try to drive more utilization, or are those also reasonably stable through the year.

[Alfred Lumsdaine:]

Well, those are going to be pretty diminimus Ryan I’m not going to tell you nonexistent. There is small seasonality factors you get the people participating in higher rates early in the year with new year’s resolutions, but as you go through the year you get A, people aging into M.A. that gives you a little uptick and so sometimes it gives you real cold spell, a polar vortex that causes a little blip in the winter. So it’s very modest, it’s a business that is highly consistent as you go through the profile throughout the year.

[Donato Tramuto:]

And Ryan even though it’s de minimus from an expense perspective there is little uptick at the very end of the year and then early in the year. In those engagement expenses those marketing expenses each year it’s again to Alfred’s point, it’s not significant, there is a little bit of it.

[Ryan Daniels:]

Okay, that’s helpful. And then final one I’ll hop off and save it for Thursday but just the cash tax yield, do you have any ideal, you had post the sale and the restructuring what that level will be I assume it’s going to be fairly sizable and really increase your cash flows over the next few years.

[Alfred Lumsdaine:]

Yes, I think that’s fair. You're talking certainly north of $170 million, $180 million when all is said and done. There is more work to do as we finalize as you know the disposition, but you can think of that order of magnitude somewhere between $170 million to $190 million it’s not unreasonable.

[Ryan Daniels:]

Okay. Great. Thanks and congrats on all the momentum.

[Operator:]

Our next question comes from Dave Styblo with Jefferies.

[Dave Styblo:]

Hi there. Thanks for taking the questions. I’ve got three broad ones and so revenue, EBITDA and the balance sheet a little bit. So starting on the revenue side, can you guys just walk us back a little bit into 2015 and help me reconcile some of the slides that you’ve provided showing how Medicare Advantage was going around 5% in '15 and we know that SilverSneakers was the vast majority of that, just opposing against your actual results are well north of 10% now. So that would almost imply that the Prime business and Physical Medicine are growing much more rapidly. Can you just help me connect the dots of what I am missing there?

[Alfred Lumsdaine:]

Well there is other factors to that beyond just the ones you sited which are all important ones. Two in particular, one would be out participation rates and how are we able to increase particularly on contract where we’re paid on a participation basis. Generally speaking we’ve been able to in fact I would say specially speaking we’ve been able to drive participation increases on a year-over-year basis. And then two existing customer books often we’re able to expand with as well, meaning we might not have every geography with a particular customer so there is also same-store opportunities to increase penetration in our existing customer base. So those are things that would also be contributing to the overall growth percentages.

[Dave Styblo:]

Okay. And then also on revenue what sort of revenue visibility do you have on ’17 at this point? In other words what percent of the current approximate $500 million pro forma revenue is locked up?

[Alfred Lumsdaine:]

Well first of all most of the clients, we have most of them locked up right now and those that we’re focusing in on in terms of final stages we’re pretty confident that the will be locked up. But keep in mind that we’re sitting here in August and we don’t have from our claims a membership enrolment profile yet and so I think we’re waiting for that to come in but we feel very confident that the numbers we’ve provided that we’re pretty confident in that.

[Dave Styblo:]

Okay. And then moving down to EBITDA you guys talked a little bit about the pressure on margins in the last two or three years, is there again in the first half it looks like they were down 70 basis points. Can you give us a sense of what they we're? I don’t think the 8-K does a great job of showing the true underlying margins, but can you give us a sense of what they were three years ago what they came to and then more importantly was that more so driven just by some of the customer transitions that you talked about going from a fixed PMPM to participation where eventually that catches back up.

[Donato Tramuto:]

Yes, I think that’s exactly right that with a couple of these contract structures particularly as we went from the 2014 to 2015 timeframe that contributed to some of the margin pressure over that time. I personally think of them and this will be a broad range but the contract margin range long term and we’ll call it in about the 28% to 31% range contract margin range. And it can vary a little bit. Some other things we’ve done Dave, we’ve made investments in the business, we’ve done that very deliberately this year as we stood up these separate divisions. We’ve strengthened the management team. We’ve de-linked the incentives for this business from the rest of the organization, which hadn’t paid colleague incentives for a number of years to really increase our engagement levels with our colleagues. So there are some investments that we’ve made into the business that’s a component of some of this, I’ll call it margin degradation. We feel very solid about our ability to sustainably run this at a contract margin level in that upper 20s to 30% range.

[Dave Styblo:]

Okay. That’s very helpful and just to make sure I understand the cost savings that you’ve put there $14 million to $16 million gross, is that the actual level in ’17 or is that sort of what the annualized level is exiting ’17 and you get additional benefits in ’18.

[Donato Tramuto:]

We’ll be done by the end of ’16 so we’ll see that benefit fully in ’17.

[Dave Styblo:]

Okay. So that’s all in '17, great.

[Donato Tramuto:]

That’s correct.

[Dave Styblo:]

And then just lastly on the balance sheet, it looks like there is some mixing of full business with everything with total population, health in the prior years and now obviously you are just have it stripped down. So CapEx looks like it’s running about $10 million for the first half of this year. It seems like that includes everything including Silver, population, health. Is that right or can you give us a better sense of what the underlying CapEx is right now?

[Donato Tramuto:]

That is correct. This is not I think as we’ve been clear highly CapEx driven business. It’s a lot of hard work and sweat, but it doesn’t require a lot of CapEx. It doesn’t mean there is not going to be opportunities to increase it as we talk about other areas of growth drivers. However, we think sustainably this is a business that will run at CapEx at below 2% of revenue.

[Dave Styblo:]

Below 2%. Okay, great, thanks for taking the questions and we’ll look forward to seeing you Thursday.

[Donato Tramuto:]

Sounds good. Thanks Dave.

[Operator:]

[Operator Instructions] And we’ll take our next question from A.J. Rice with UBS.

[Unidentified Analyst:]

Hi, everyone this is [indiscernible] filling in for A.J. A couple of questions if I can ask, first just following up on the question around the investment plan. Will that we later this year or it will be spread across 2017?

[Donato Tramuto:]

Let me kind of answer it, listen I think Alfred said it very well, we continue to invest, I want to make sure that we do clarify that. We continue to invest in the current business and as we get through the strategic presentation on Thursday I think it will become very clear to you that we intend to expedite some of those investments now and certainly they will be in flow during’17. But I do want to make sure I stress that we’ve brought new leadership in. We’ve increased our sales focus. We’ve brought digital czar in about six or seven weeks ago who is focusing on the digital engagement. So there is a significant amount that’s in play right now and will continue into next year.

[Unidentified Analyst:]

All right, that makes sense. And then can you remind us on what percentage of your network solutions revenue is on fixed PMPM today and do you see any further opportunity where you can work with your clients to move from fixed PMPM to member participation format.

[Donato Tramuto:]

Yeah, and we’re going to talk about this more on Thursday as well. If I had to off the top of my head I think the fixed will be about a third of the SilverSneakers revenue is on a fixed and that’s absolutely right. We've over time that percentage has been coming down because as we’ve been very clear in demonstrating the important outcomes that we achieve and that participation matters and driving higher participation yields better outcome for the customers.

[Unidentified Analyst:]

But in terms of financial impact is there any way to quantify what that means of revenue or margin with respect to the foundation.

[Donato Tramuto:]

Opportunity to transition those is the question.

[Unidentified Analyst:]

Yes.

[Donato Tramuto:]

I wouldn’t be able to do that off the top of my head, but clearly we don’t see the same kinds of participations at those fixed fee contracts, so you are absolutely right that there is more opportunity and that’s something we can take off line.

[Unidentified Analyst:]

Okay. And my last question is there any expiration on the federal NOL in terms of when you can use?

[Donato Tramuto:]

Not significant, I am not going to tell you that there are no limitations at all but by and large it is fully usable to offset the preponderance is usable and available to offset future earnings.

[Unidentified Analyst:]

All right. Perfect. Thank you so much. See you guys on Thursday.

[Operator:]

Our next question comes from Mohan Naidu with Oppenheimer.

[Mike Ott:]

Good afternoon. Thanks for taking my question. This is actually Mike Ott on for Mohan. On the $4 million to $6 million of ShareCare separation costs in today's release, are those included in the $35 million to $45 million of additional charges for the discontinued ops?

[Donato Tramuto:]

No they are not.

[Mike Ott:]

Okay. And the timing-wise, are those also in second half, particularly the third quarter?

[Donato Tramuto:]

Certainly the second half. Yes.

[Mike Ott:]

Okay. And then on the --

[Donato Tramuto:]

Yes, I am sorry.

[Mike Ott:]

No go ahead...

[Donato Tramuto:]

We will continue to be very clear and transparent in terms of as we incur those cost.

[Mike Ott:]

Great, thanks. And then on the reorganization of the support organization, where the $14 million to $16 million of cost savings included in the $40 million to $45 million of annual savings that you had spoken about on your last call, first quarter.

[Donato Tramuto:]

Things get, if we are not careful, things could get confusing. The $40 million to $45 million as you likely know mostly -- most of that pertain to the business that has been sold. So essentially this is all new for all intents and purposes. The $40 million to $45 million was conducted that went with the sale of the business and now this is now making the appropriate adjustments for the remaining company as we go forward with our network solutions or above.

[Mike Ott:]

Great. Thanks. And if I could just squeeze one last one in. I believe you said sneakers is about 80% of the network revenues. Is the last 20% split roughly evenly between the Prime Fitness and Physical Medicine networks?

[Donato Tramuto:]

You won’t be dramatically off, maybe thought if that way. We not sized it that way.

[Mike Ott:]

Okay. Thanks very much.

[Operator:]

[Operator Instructions] We do have a question from Nina Deka with Piper Jaffray.

[Nina Deka:]

Hi, guys. Are you planning to use free cash flow to pay down debt and if so, what rate of debt will be targeted?

[Donato Tramuto:]

Also we are in a good position right having the increase in cash flow. Certainly we intend to deleverage the company. And I don’t think we've defined, just yet, what percent will be applied there, but we are going to reinvest some of that for our growth and as we get more to unfold the strategy and get to next year we will have more clarity around that.

[Alfred Lumsdaine:]

Yes. Obviously Nina as we sit here today we're in a very different leverage profile then we were two weeks ago before the transaction and before the amendment to our credit agreement. We’ve got roughly $45 million of debt that’s current, which clearly is very comfortable in terms of our cash flow profile. And with our leverage profile now we are in a position to -- as we move through and start looking at various capital deployment alternatives and that's something we have -- now again we're just -- we're in a very new profile of the business. So we wouldn’t want to commit to anything specifically, but as Donato said clearly deleveraging is an option. We do have $150 million convertible notes that are not readily pre-payable. So we will get to a point before too long with the cash flow generation profile of the remaining business that we need to look a variety of alternatives.

[Donato Tramuto:]

And I just thinking of conclude there. I think we said from day one of my tenures, that we wanted to focus on increasing the cash flow, which I think gives us now optionality on several you paths and vendors and I think that we'll continue to explore those over the next few quarters.

[Nina Deka:]

Great. Thank you.

[Operator:]

[Operator Instructions] That concludes today’s question-and-answer session. Mr. Tramuto at this time I will turn the conference back to you for any additional or closing remarks.

[Donato Tramuto:]

Thank you very much. And thank you all again for attending today's call. Please don't hesitate to contact Chip, Alfred or me if you have any questions. I do look forward and I know Alfred and other in terms of seeing all of you on Thursday. But before we conclude here, this will be Alfred's last earnings call and I'd like to take this opportunity on behalf of the Board and behalf of the entire organization, Alfred, to thank you for your many contributions to Healthways' over many, many years. It's been really a pleasure working with you as a partner. Thank you.

[Alfred Lumsdaine:]

Thank you. The pleasure's been all mine.

[Donato Tramuto:]

Thank you, operator.

[Operator:]

You're welcome. That does conclude today’s call. We appreciate your participation.