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Executives

Joseph H. Capper - Chief Executive Officer, President and Director

Heather C. Getz - Chief Financial Officer, Principal Accounting Officer, Senior Vice President and Secretary

Analysts

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

Alex Silverman

Nicholas Leventis

CardioNet (BEAT) Q2 2013 Earnings Call July 30, 2013 5:00 PM ET

Operator

Good day. Thank you for joining us for the CardioNet Second Quarter 2013 Earnings Conference Call. Certain statements during the conference call and question-and-answer period to follow may relate to future events and expectations, and as such constitute forward-looking statements within the meaning of the Private Securities and Litigation Act of 1995. Such statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the company in the future to be materially different from the statements that the company’s executives may make today.

These risks are described in detail in our public filings with the Securities and Exchange Commission, including our latest periodic report on Form 10-K or 10-Q. We assume no duty to update these statements. [Operator Instructions] It is now my pleasure to turn the floor over to your host, Mr. Joseph Capper. Sir, you may begin.

Joseph H. Capper

Thank you, operator. Good afternoon, everyone. I'm Joe Capper, President and CEO of CardioNet. I'm pleased to be with you this afternoon to report on another highly productive quarter for the company. I will provide brief highlights on the second quarter performance, as well as a review of the corporate realignment we have just completed. I am joined by Heather Getz, our CFO, who will provide more detail on our operating results. After our prepared remarks, we will open up the call to your questions.

I'm very pleased to report that our second quarter was successful on many fronts, as we demonstrated tangible progress toward our strategic objectives. I am confident these significant advancements will be transformative for the company and will have a meaningful impact for years to come.

As you will hear, our second quarter was filled with considerable operational activity and excellent financial results. For the fourth consecutive quarter, we experienced year-over-year revenue growth up 17% over the prior year quarter to $32.1 million. EBITDA was $3.4 million, the highest quarterly EBITDA in 4 years. This compares to $1.7 million in Q2 2012 and $2.4 million last quarter.

For the second consecutive quarter, patient services achieved record volume and we ended the quarter with $19.3 million in cash and no debt, up $1 million from last quarter.

In addition to these strong results, we signed a key new payor agreement, launched another exciting new product, continued to build our research services pipeline and completed the process to realign our corporate structure, which officially takes effect in a few days.

As has been my practice, I would like to remind everyone that we continued to manage the business around 3 broad strategic objectives: first, we seek to solidify our leadership position in cardiac monitoring; second, we are building a leading research services business around the Cardiocore brand and platform; and third, we look to identify diagnostic markets that would benefit from the application of our wireless platform and proprietary technology.

The second quarter was particularly fruitful for our patient services business. The comprehensive sales approach we implemented at the outset of the year has been greeted with resounding success in the market, resulting in year-over-year growth in all 3 service lines: MCOT, wEvent and Holter. As a reminder, late last year, we launched the market's most advanced wireless event monitor. To date, we have serviced over 17,000 patients, up significantly since our last report.

The comprehensive strategy was further bolstered in the quarter with the introduction of MCOTos 2:1. This new device gives physicians the ability to choose MCOT or wEvent monitoring service on demand in the convenience of a single system. By combining these 2 life-saving technologies in one device, we are able to monitor patients more effectively while providing increased efficiency and ease-of-use to our physicians.

Other noteworthy news in the quarter was the signing of a 3-year in-network national provider agreement with United Healthcare. The agreement took effect on July 1 and applies to United Healthcare and affiliated entities including managed Medicare and managed Medicaid plans. While the agreement covers all lines of service, it is particularly timely given United's recent change to a positive coverage policy front cut. This agreement is a milestone for the company, as it dramatically expands the available market for all of our life-saving technologies. Just as important, it makes MCOT technology further entrenched as part of the physician's arsenal for detecting and treating life-threatening arrhythmias.

It is fair to say that the implementation of the comprehensive strategy, coupled with the introduction of new products, has reinvigorated the patient services business. And there's more on the horizon. We expect to introduce at least 2 new products in the near future, resulting from the previously announced multiyear development agreement with IMEC, a worldwide leader in nanoelectronics. In the months ahead, we expect the United contract pull through and further rollout of MCOTos 2:1 to help soften seasonal impact typically experienced during the third quarter.

Turning to the research services division. With the business now fully integrated and at now being 3 full quarters post acquisition, it is clear that the business has been an excellent addition to the company. Revenue was up in the period. Pipeline was growing and we continued to attract new customers.

While research is performing well in the near term, we are also focused on nurturing the business for the future. To do so, we are concentrating on enhancing our position outside of the U.S., particularly in Europe and Japan, creating a competitive advantage in terms of equipment cost and differentiation and adding services to complement the current core lab offering. Doing these 3 things will make us more competitive in this large and growing market and will have the added benefit of dampening some of the revenue choppiness typically associated with research businesses.

With that overview, I will now turn the call over to Heather for a detailed financial review of our quarter. Heather?

Heather C. Getz

Thank you, Joe, and good afternoon, everyone.

As Joe mentioned, revenue in the second quarter was $32.1 million, a 17% increase over the second quarter of 2012. While this increase was largely attributable to the acquisition of Cardiocore, we posted increased revenue on our patient services business of $0.5 million and saw a 4% increase in total patient volume. All products contributed to the patient services growth.

Compared to the first quarter of 2013, revenue declined 1%. After a very strong first quarter, we still experienced sequential growth in our patient services and research services businesses, combined of $600,000 or 2%. This increase was more than offset by a decline in our product segment of $1 million. The strength in our patient services business can be attributed to our CardioNet comprehensive strategy and the launch of our wEvent and 2:1 device.

Gross margins came in at 61.5% in Q2 2013 compared to 62% in the prior year quarter. Growth in the research services segment due to the acquisition of Cardiocore reduced margin by approximately 300 basis points, while efficiencies in the patient services business and favorable mix contributed 250 basis points. We do expect margins to remain around this level for the remainder of the year.

For the second quarter, our adjusted operating expense increased $1.7 million to $19.1 million due to the addition of Cardiocore. Excluding Cardiocore, our adjusted operating expense was lower, reflecting operational improvements, which led to a reduction in headcount-related expenses and lower bad debt. On a sequential basis, our expenses decreased as a result of period expenses that typically occur in the first quarter and not in the subsequent quarters. These expenses include higher payroll taxes and certain sales and marketing expenses.

With the increased margin dollars stemming from the higher revenue more than offsetting the increased operating expense, we generated positive EBITDA of $3.4 million for the second quarter of 2013 compared to $1.7 million in Q2 2012. When you add back stock compensation of $1 million for Q2 2013, adjusted EBITDA reached $4.4 million or a 13.5% return.

Our second quarter EBITDA is the highest EBITDA in 4 years.

Also worth noting, on an adjusted basis, we were operating income positive in the quarter and breakeven on a year-to-date basis. Again, this has not occurred since 2009.

Now turning to the balance sheet. We ended the quarter with $19.3 million in cash, which was up $1 million compared to year end. This includes a reduction in cash for the prepayment made to IMEC for over $1 million, and a delay in Medicare cash of approximately $1.5 million due to a processing error at Medicare, which has since been resolved. Year-to-date, we generated $4.2 million in cash from operations, which was partially used to invest in new devices as well as our new operating system, bringing us to free cash flow positive of $700,000. We continue to make progress on reducing our accounts receivable, causing our consolidated DSO to decline to 53 days, an 8-day improvement from year end.

Finally, before I turn the call back to Joe, the CardioNet comprehensive strategy should continue to bolster patient services volume in the second half of the year, but we do expect some pricing pressure. As Joe mentioned, we anticipate that the United contract and MCOT 2:1 will help mitigate the typical Q3 seasonality.

Looking at research services, we expect the full year revenue growth to be slightly softer due to the timing of certain studies and the cancellation of 1 study, resulting from a shift in strategy by that study sponsor. We continue to have a strong relationship and we have since signed additional agreements with the sponsor.

To reiterate, in 2013 on a consolidated basis, we expect to see organic top and bottom line growth and expect to remain EBITDA positive for the full year.

We expect to generate cash from operations and also be free cash flow positive.

And with that, I will now turn the call back over to Joe.

Joseph H. Capper

Thanks, Heather. As you have witnessed, we have made several significant improvements to the company in the last few years. These enhancements have been borne out of our strategic growth plan, which has increased the profitability of our operations, driven the acquisition of key assets and led to the addition of seasoned leaders, experienced in managing high-growth health care service companies. Given the considerable scope of these initiatives, it has taken time to put many of these elements into place. But that is exactly why I'm so pleased that we are now beginning to see the results of all of our planning and hard work.

The company is now on a trajectory, which is driving improved revenue growth and increased diversification, as well as generating higher margins. Given the success of our more balanced go-to-market strategy, it is only fitting that we update our corporate structure and company name. I'm excited to report that our plan for corporate realignment was approved at our Annual Shareholders Meeting last week and will go into effect August 1, at which time the company's name will officially change to BioTelemetry, Inc. trading under the same symbol BEAT or B-E-A-T. BioTelemetry, meaning remote detection and measurement of a human condition activity or function, is the best description for what we do today and how we plan to grow the company.

Nearly every company in health care makes the claim as an element of their mission to improve outcomes and reduce costs. We are no different in that regard. Where we are different is that we have proven our ability to do so. By providing technologically advanced remote monitoring services, we are eliminating the need to keep the patient in a high-cost acute care setting for a prolonged period of time. Given the well-publicized trends in health care, particularly the projected growth in costs, proven solutions to curb in-patient expenses will continue to be sought out and implemented. This bodes well for the future of BioTelemetry.

Before I open the call to questions, I want to take a minute and thank all of those at CardioNet who helped deliver the highest EBITDA in 4 years and record patient volumes for Q2. We have never been better positioned in our history to grow the business and leverage our technology. We are just starting to see the results of our strategic initiatives take hold and don't expect us to take our foot off the gas.

Today, we use telemetry-based technology to remotely monitor over 1 billion heartbeats a day. Expect us to find new ways to employ our technology, grow the number of patients using our systems and streamline our operations. We have a new name and new momentum that will undoubtedly carry us to new heights.

With that, we will now pause and open the call to questions. Operator, we are ready for our first question.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Brooks O'Neil from Dougherty & Company.

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

I have a couple of questions. I'd like to start first by asking you if you could just describe a little bit about the history of your relationship with United? My sense is that, historically, they reviewed your device and services and have rejected a reimbursement. And I'm just curious, in particular, what changed?

Joseph H. Capper

That's an accurate statement. They had reviewed the material that we have put forth several times over the past few years. And guess what has changed, is we continue to provide more and more studies, both clinical and economic. We provided that information to them. They don't share a whole lot about their review process with us publicly. But from what they published, our understanding is that they've done a pretty thorough review of all the available information and made a decision to reverse their long-standing negative coverage policy towards MCOT and cover for it.

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

That's great. And I don't know if you comment about it in the past, but would you anticipate other payors taking a look at your materials and considering reimbursing for the device?

Joseph H. Capper

I would. We have pretty good coverage policy -- pretty good coverage today for all of our services, but it's something that we're constantly trying to improve. And there are still a few decent-sized insurance companies that don't provide any coverage, or adequate coverage, for the service. So it's a constant and -- or should I say ongoing effort. And certainly, we anticipate that improving over time.

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

Great. Could I just ask you, I have a sense there is some ongoing patent litigation. Could you give us just a quick update on where you're seeing with that? Whether you spent money in that effort this quarter and what you anticipate for the year?

Joseph H. Capper

I don't know if we've disclosed exactly how much money we spent. But we have spent money. We are pursuing potential violations of a set of patents that we own. We think that our position is pretty obvious but it will take a legal process for that to unfold. We have worked through a good portion of that to date. We expect one of those to go -- to actually start trial later this year and we'll see how it unfolds. But we like our position there.

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

Good. And then I guess, the last question, obviously, in light of the name change in your description of some of the things you're thinking about. Could you just help us think about what some of the broader areas you might consider for remote monitoring in the future?

Joseph H. Capper

Yes. Brooks, I'm a little bit reluctant to say that -- the specifics ones that we're working on. We're working on more than 1 potential line extension to the portfolio internally. We're always looking external to the company to see if it makes sense to accelerate this plan via acquisition. So with both internally and externally, anything that's going to keep a patient out of a high-cost setting via some sort of remote monitoring, particularly for those disease states or conditions that have caused the health care system a lot of money. So you can imagine the areas we're looking at.

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

But clearly beyond cardiology though?

Joseph H. Capper

Yes, clearly beyond cardiology, potentially related to cardiology. It's helpful if we can focus on chronic conditions for a lot of reasons, particularly their cost in the health care system, most of the dollars being spent somewhere in the neighborhood of $0.75 out of every $1. And still -- and there's so many affiliated conditions and crossover conditions now -- co-morbidities, I guess, you could say, that there's likely to be some relationships as we move forward. And for us, given the size of the company, it makes the most sense if we can leverage a lot of what we already have, right? So either leverage our call center infrastructure, our distribution channel, our nearly 100 sales reps with relationships in the top cardiology market, our patient base, our reimbursement capability and relationships with payors. So there's a lot of competencies within the company that we can leverage to kind of extend into sort of tangential business lines.

Operator

And our next question comes from the line of Alex Silverman from Special Situations Fund.

Alex Silverman

Can you spend a minute, Heather, on bad debt? It continues to tick down and, I mean, that's sound money. What's a good level going forward?

Heather C. Getz

So Alex, I think that you're not going to see as much of an improvement from a percentage standpoint as we've seen in the past, but we continue to improve our processes, getting things in faster and appealing quicker. So I do expect to see some more improvement in that number through the course of the year and a good number to think about is probably in the 7% range eventually.

Alex Silverman

Okay.

Heather C. Getz

Overall.

Alex Silverman

Okay. And then your adjusted EBITDA, if you add back the stock comp, works out to about 13.5%, 14% EBITDA margin.

Heather C. Getz

Correct.

Alex Silverman

Given the fixed nature of your business and the addition of United, can we assume that, that number should go higher?

Heather C. Getz

Yes, I think that over -- what we kind of look at is that we'd like to get to about a 15% EBITDA return. So if we -- over time, I'm not sure if we'll be able to get there this year, but that's our target. Alex, you have anything to add?

Joseph H. Capper

Yes. Alex, it's Joe. One of the things we learned as the business grows is we clearly got some leverage in the business. And how much leverage is yet to be seen because we've not run this efficient an organization at these revenue levels in the past. The last time the company was at these revenue levels, was early on and it was a very inefficient operation with a high cost structure. So we've made a lot of improvements to the operation. You would think logically, as you grow, to your point, there is some more leverage we can pull out of it. There is some fixed cost structure that we can take advantage of. Putting a number on that's difficult, I feel comfortable saying that this is a mid-teens health care services growth platform and it gives us enough money to continue to reinvest in the business. I think that's appropriate at and above where we are today and potentially better. We'll see.

Alex Silverman

Okay, and then what have you needed to put in place in order to on-board United as a customer?

Joseph H. Capper

There's a lot of implementation associated with that. Part of the agreement was, as I've mentioned in my script, managed Medicaid plans, that requires, in some cases, contracting and licensing at state level. So it's going to take time to fully implement and roll this out. And we are starting to see some early benefit from it, as you can probably imagine. But a lot of folks don't understand this is not necessarily a homogenous organization, it's a collection of 300-plus affiliated entities and we have to deal with some of them in different ways. So it's going to take a while to fully roll it out. The good news is, it doesn't require us to establish new market infrastructure. We have the relationships with the physicians, we have the sales, trained sales organization in place. It's just some of the administrative mechanics of rolling this out will take a little bit of time.

Alex Silverman

Okay. And then my last question, in your release, $2.5 million of restructuring in legal. I believe the wording is, much of it or most of it is legal. Can you help us with how much of that is discussions with the government regarding settlement of -- or discussions with them regarding the investigation? And how much of that was litigation for intellectual property?

Joseph H. Capper

Yes. Brooks sort of asked the same question. A disproportionate amount of that number is associated with pursuing a patent violation. A smaller portion of it is associated with the Department of Justice investigation. Most of that work is behind us and we're candidly waiting for the government to work through some of their processing.

Heather C. Getz

Yes. There's also in the overall restructuring number a little bit for Cardiocore-type -- integration-type expenses as well, Alex.

Operator

And our next question comes from the line of Nick Leventis from Balyasny.

Nicholas Leventis

So a couple of quick questions for you. Most of mine have been asked. But in terms of the sales force, I know you restructured that part of the business. Is the restructuring there fully done? Or do you have anything left to do to optimize or incentivize sales force to be able to sell across all the product areas in a more efficient way than they have in the past?

Joseph H. Capper

No. I don't think we have a lot more to do there. I think we have the right structure in place. This is sometimes more of an art than a science, optimizing the level of sales resources needed in marketplace. The big thing that we did this year that was different was structured comp plans, incentives, bonus, all throughout the organization, but particularly with the sales force around a more comprehensive approach to the marketplace. We've talked about that several times, that's been well-received. It's working. The strategy is being accepted in the marketplace and the sales organization is performing at a fairly high level.

Nicholas Leventis

Understood. In terms of sales force, would you look -- is the sales force the right size? Or would you be looking to grow sales over time?

Joseph H. Capper

Again, I think it's appropriately sized for the activity they are charged with today to the extent that there's more market. And believe me, we're always working on opportunities to extend the utilization of the technology. That may, at some point in the future, require us to cover more call points per se. And that would drive sales force sizing. But today, I think it's sized fairly well.

Nicholas Leventis

Understood. And then can we go to the MCOT 2:1 monitor. So are you going to eventually phase out all of your current MCOT monitors with the 2:1? Or is this going to be a separate product offering from the just-straight MCOT monitor?

Joseph H. Capper

Nick, one of the things I've learned with this company is we're not going to tell the market what they're going to do. We tried that with MCOT, and the market told us that they'd love it but it's not for every single patient. So the market's going to tell us, over time, what's the right mix. Would I love to be Southwest Airline and have one-size-fit-all, surely, but that's just not the nature of this market. So there are certain customers that MCOTos works much better for it. There are certain customers that don't want it but would rather inventory 2 devices. So we'll see, is the answer -- but over time, I'm going to let the market tell me what's the most appropriate product mix.

Operator

[Operator Instructions] And I see no further questions in the queue at this time. I'd like to turn the conference back to Mr. Joseph Capper for any concluding remarks.

Joseph H. Capper

Thank you, operator. Thank you, everyone. We're going to conclude the call. We will speak to you after our next quarter. Thank you for your continued support in the company. Operator, that concludes the call.

Operator

Thank you. If you joined the conference late today, you may listen to the conference call via digital replay, which will be available through the Investor Information section of CardioNet website at www.cardionet.com until August 14, 2013. That does conclude the conference for today, and you may now disconnect.

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