Technology Solutions Company Q3 2007 Earnings Call Transcript

Technology Solutions Company (TSCC)

Q3 2007 Earnings Call

November 14, 2007 9:00 am ET

Executives

Milton Silva-Craig - CEO

Tim Rogers – CFO

Gene Marbach - IR

Analysts

Richard Greulich - REG Capital

Presentation

Operator

Welcome to the Technology Solutions Company third quarter 2007 conference call. Today’s call is being recorded. At this time for opening remarks and introductions, I would like to turn the conference over to Mr. Gene Marbach. Please go ahead, sir.

Gene Marbach

Thank you, Daryl and good morning, everyone. Leading our call today will be Milton Silva-Craig, CEO of Technology Solutions Company. Also joining us on the call will be TSC’s Chief Financial Officer Tim Rogers.

During this call, we plan to make remarks regarding our expectations, plans and prospects. These remarks may constitute forward-looking statements under federal securities law. Actual results may differ materially from the statement as a result of various factors. These factors are discussed in our SEC filings, which we strongly encourage you to read. The forward-looking statements included in this call represent the company’s views on November 14, 2007. The company disclaims any obligation to update the statements to reflect future events or circumstances.

Thank you for joining us on today’s call, and I would now like to turn the call over to Milton Silva-Craig.

Milton Silva-Craig

Thank you, Gene and good morning, everyone. It’s a pleasure to be with you. We appreciate your participation and your support as shareholders. Before I turn it over to Tim to provide a summary review of third quarter results, I would like to take a moment to officially introduce Tim to today’s participants.

Tim joined us nearly six weeks ago and has already been making a significant impact in helping us drive key financial discipline in support of our turnaround efforts. Tim has over 20 years of financial expertise and success in helping organizations restore profitability and grow enterprise value, and we are glad to have him on board.

Also, I want to take a moment to thank Sandor Grosz for his ten years of service to TSC, and we wish him well in his future endeavors.

Now, let me turn it over to Tim.

Timothy Rogers

Thank you, Milton. Revenue before reimbursements were $5.5 million for the third quarter of 2007 compared with $8.7 million for the third quarter of 2006. Third quarter of 2007 declined over second quarter of 2007 by $0.5 million or 8%. The net loss for the third quarter was $2.3 million or $0.89 per share versus a net loss of $2.3 million or $0.93 per share in the third quarter of 2006. The net loss per share improved by $0.17 or 16% from the loss per share realized in the second quarter of 2007.

In terms of third quarter revenue concentration, our top three clients accounted for 47% of revenues, and our top five clients accounted for 60% of revenues. This compares to 44% and 57% respectively in the second quarter of 2007.

Utilization for the third quarter was 69% as compared to 67% in the second quarter of 2007, a pick up of 2 percentage points as we more effectively managed our billable staff. Our average hourly billing rate was $146 in the third quarter as compared to $148 in the third quarter of 2006. Our billing rate declined from $157 in the second quarter of 2007, as our revenue mix was more weighted towards our SAP business, which bills at a lower rate than our other service lines.

Days sales outstanding were 71 days at September 30 as compared to 68 days at June 30, 2007. Our DSO increased during the quarter as we received certain collections one day after the close of the quarter. Assuming a one-day earlier receipt, our DSO would have improved to 65 days, or a decrease of three days.

Cash and cash equivalents at September 30, 2007 were $10.7 million, which is a decline of $1.6 million from the balance at the end of the second quarter of 2007. This $1.6 million decline was $1.1 million better than the $2.7 million burn realized in the second quarter of 2007. Overall, cash burn should continue to improve.

I will now hand the call back to Milton.

Milton Silva-Craig

Thanks Tim. Let me add some additional insight into these results, and then I will transition the discussion into our progress on our turnaround plan. Of the $2.3 million loss, roughly $1 million of this loss, or $0.39 per share, was associated with one-time charges including severance, branding and infrastructure investments. As I mentioned in the previous call, I expected to have some additional severance costs, which at this point are nearly complete, and the branding and infrastructure investments are limited to 2007. So, again, we don’t expect to have such costs in the future. If you remove these costs, our loss would have been about $1.3 million or $0.50 per share, which is trending favorably to our goal of profitability.

Also continuing to impact profitability is the use of subcontractors in the SAP business. SAP’s global success is creating high demand for SAP resources, the market is tight, and hiring times remain long. This is a phenomenon faced by many in this market. We have hired a full time recruiter to assist with our efforts here in an attempt to lower our reliance on independent contractors, reduce recruiting costs, and improve overall SAP service margins. In summary, we believe the overall operations management of the company has improved.

I would now like to direct our discussion to several elements of the strategy we have discussed in the past. We are now three quarters into executing the turnaround plan. The five elements of the strategy include:

1. Unifying the operations of the business for greater leverage.
2. Investing in demand generation for predictable growth.
3. Re-branding the organization to forge a clear value proposition to the market.
4. Establishing a product development platform for clarity in our offerings and diversification of revenues.
5. Increasing our focus on healthcare.

I will now spend time talking about the last four of those strategic elements. First the demand generation. With respect to top line growth, we are not where we expected to be at this stage of the turnaround. As discussed in our previous call, of all our strategic efforts, this is the one we have not made sufficient progress on. Since that point, I did make several mid-course corrections on leadership and have placed greater scrutiny in this critical area, as well as devoting more time to it.

Specifically, this past quarter we added two resources to our demand generation team, including a channel partner and a direct sales executive in our healthcare business. Further, we recently launched three direct marketing campaigns that have already yielded prospects and leads, which we are pursuing aggressively. We have removed the impediments, and expect these efforts to yield positive impact in the coming quarters.

Second, let’s discuss branding. In the coming days, we will announce our new branding platform. These efforts and the packaging will apply to all three elements of the business -- healthcare, our business consulting, and SAP. The healthcare and business consulting portions of our business will be positioned under the new brand. The SAP portion of the business will continue to utilize the TSC brand due to its many years of use and familiarity in the market.

We seek to position the company as the first and only services organization in the country that helps clients identify value, realize value, and sustain value as measured through the eyes of their customers, guaranteed. Using unique intellectual property, we will take an outside-in approach through the eyes of our clients/customers identifying those areas where value, opportunities exists either from a product, cost, engagement or access perspective in order to help our clients drive profitable growth.

We ensure that a client’s external perspective -- what we call experience -- is balanced with their internal efforts -- what we call certainty -- to ensure maximum value creation. Again, all our customer engagements will begin with an experience assessment, an outside-in view, identifying where value creation opportunities exist, and then developing a blueprint on how to realize that value. Certainty is our approach to ensure realization of that value in an accelerated manner. We are all very excited about this launch as it helps unify our positioning, communications and differentiation within the market.

I would now like to progress our discussions to product development. My first hire upon starting at TSC was a leader of product development. We felt that was critical to diversify our offerings to include product-based revenues with our people-based services in an effort to build the solutions company of products and services, which would not only diversify revenues, but enhance overall shareholder value.

Over the past three quarters, we have invested in the development of two new product offerings which are targeted for introduction in the healthcare market. The first offering, which we highlighted previously, is code-named Blue Ocean. Blue Ocean is a critical piece to our positioning strategy of ensuring attainment to value creation. It is an application that allows us to measure and display key performance indicators, KPIs, associated with the value creation efforts of our experience and certainty services.

Blue Ocean is a visual performance management application that allows the user to aggregate disparate data across an enterprise, and display that data real-time into meaningful and easy-to-use actionable data.

In the case of healthcare, metrics are critical. We’ve recently visited a customer who is using two full-time equivalents to manually capture and crunch data in Excel documents. We believe the market deserves much more innovation. Blue Ocean is ready for external pilot evaluations. We have two to three customers that we are actively now in final discussions with to begin pilot tests. The customer feedback we have received is completely endorsing of our direction with this application.

The second product offering is a data management application where we help customers characterize and transform legacy data into cleansed data as part of a new system deployment effort. The digital imaging market is experiencing a 60% system turnover rate in the enterprise market. Our data management solution is targeted at helping these customers better manage this transition. Our data management application is ready for commercialization and we expect our first customer contract to be signed shortly. The development of these products supports our strategy of providing both products and services, which we believe will positively help to improve margins, and ultimately increase value for our shareholders.

Finally, with respect to healthcare, we are making nice progress. As previously discussed, we are currently targeting the $600 billion healthcare provider space, and more specifically, the services associated with the $40 billion information technology sector of the healthcare provider space.

This past quarter we signed an agreement with McKesson Healthcare to provide our experience in certainty services to their existing and future customers. McKesson is one of the largest providers within the digital imaging market. McKesson sales reps will market our solution directly to their customer base. As you can readily appreciate, their channel is much larger than ours, and provide a good fundamental basis of growth going forward. We believe we were chosen by McKesson for our unique and differentiated solutions, which in turn can assist them in their efforts.

All in all, the healthcare portion of the business is well-positioned going into 2008 with our new branding efforts, marketing campaigns, new sales executives, channel partner and product offerings, we should begin to make an impact in the coming quarters.

So before we turn it over for questions, let me attempt to summarize my comments. We are three quarters into our turnaround, excluding one-time charges, our goal of achieving profitability is trending in the right direction. We are applying better cash management principles and running a more unified operation. While our sales and demand generations are behind plan, we believe we have taken the right steps to resolve those issues. Our branding efforts are ready for launch, our product development offerings are ready for customer deployment, and our healthcare practice has a strong foundation for growth.

With that, it’s time to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Richard Greulich - REG Capital.

Richard Greulich - REG Capital

With the tight market in the SAP consulting business, are you able to get a little bit better pricing as a result of that or is that not a problem?

Milton Silva-Craig

No, actually there is lot of pricing pressure, Richard. What you have, specifically in the market we target which is mid-market, you have a lot of the larger players that are moving towards the mid-market and then on the low end you have some of the lower market players moving to the mid-market. So, you actually do have a lot of pricing pressure in that segment. The macro factors are not favorable at the moment.

Richard Greulich - REG Capital

How long will it be before the person that you hired, do you think, will be able to attract some people to work for you, so that you can save a little bit of money on the outsourcing?

Milton Silva-Craig

That actually has already happened. We’ve brought that person in probably about two months ago, and she has already made an impact. We have actually lowered some of our recruiting costs, and we are moving out some of those independent contractors. We’re not there yet Richard, we still have some work in front us, but she has already paid for herself, in essence.

Richard Greulich - REG Capital

In the healthcare area, the Tenet Health business that you had, is that continuing?

Milton Silva-Craig

It is. But, I will note that Tenet is under extreme pressures financially, and they were a significant revenue contributor in 2007. We do expect that to decline a bit, but we also have some other anchor accounts, as we call them, in healthcare that should cover any of that decrease from Tenet. But, Tenet has slowdown their core radiology implementations, but they are actually opening up their cardiology. So although we see a little decline on their radiology implementations, again we think we’ll make up a portion of it via cardiology, and then as I mentioned some other anchor accounts we have.

Richard Greulich - REG Capital

Can you give me a little bit better idea what McKesson is actually going to be marketing to their people? I mean McKesson doesn’t really implement imaging systems, do they?

Milton Silva-Craig

They do. McKesson is actually two businesses in one, they have the pharmaceutical business, which is their largest revenue producer and then they have a portion of the business called McKesson Provider Technologies, which is their medical informatics business. Richard, that’s a $2 billion plus organization.

Richard Greulich - REG Capital

Shows, how much I know about them.

Milton Silva-Craig

Well, their external marketing is primarily in the pharmaceuticals space. But, talking about the $2 billion portion of their business, they are one of the leaders themselves -- Cerner, General Electric, Siemens, and Medical Informatics -- and they are currently the largest provider in the digital imaging space. So, what is the case with a lot of these OEMs, and part of it being driven from revenue recognition, is they get their systems installed quickly, they get the lights on, they establish revenue recognition, and then they typically are moving on to their next implementation.

That is really where we shine. Our ability to help customers derive value from that information system that they have just purchased. So we pickup from implementation all the way through adoption and value sustaining. So, we call those as part of our new branding efforts, experience and certainty. What McKesson will sell in their price pages are our experience and certainty services, which will apply both to new installations or that might be legacy installations where the customer has not derived the maximum value from their information system investment, and they would like us to come in assess what their issues are, and then put a plan in place to resolve that and then get them back into value creation. So, that is what McKesson will sell.

Richard Greulich - REG Capital

Three things. (1) how much of a set of time or training time will it take for the McKesson people to understand what you actually have in order to be able to speak knowledgeably about it to their customers? (2) Will they actually be selling you or simply listing you as a person of resource that the customer can go to? (3) Will they be preferring you to other people or not?

Milton Silva-Craig

All very good questions. Let me see, if I can take those in order. The first question was generally around time, when will the McKesson channel start generating revenues? I will tell you that that has already begun. In Q3, some of the mix of revenue within the healthcare segment has been McKesson derived. We have already trained both their new sales, and their installed base sales. We signed the agreement at the beginning of the quarter. And as you can appreciate just working through an organization of that size and getting their resources trained, takes a bit of time.

As a matter of fact, we have the largest trade show in Chicago called the Radiology Society of North America that will begin right after Thanksgiving and we will actually be in their booth supporting them on their professional services sales.

Which leads into your second question, which is how are they positioning us? We are private labeled on their price pages, so they provide professional services of adoption and optimization and value creation that is delivered by TSC.

Which then leads into your third question of their preference, and who they work with. We are their only provider right now in that space, and we were recently on a call where they are now mandating our services to be put on all their contracts moving forward.

It goes back to the issue that I identified when I was talking earlier. In the imaging space, you have a 60% turnover in the enterprise market. If you just pause for a moment and think of what that means to an OEM if they lose that socket, that’s about a $5 million plus annuity stream that they just lost in future upgrades and services. So why are services are so critical is that we help them ensure adoption and value creation, and ultimately make their solution stickier, and so that they continue with their revenue stream going forward.

Richard Greulich - REG Capital

When you say turnover, so an institution decides to upgrade at that point in time, 60% of the time they change?

Milton Silva-Craig

Today in today’s market, I would say significant penetration in the market started over the last six years, the digital imaging space. That market, the enterprise market, which are what we call IDNs or integrated delivery networks, that market is now upgrading to new technologies at roughly a 60% rate. No one wants to lose a socket, because it’s so valuable. So, our services help protect that and drive value for them.

Richard Greulich - REG Capital

GE recently acquired a company called Dynamic Imaging LLC. Do they provide what you are providing for McKesson? Are you familiar with them?

Milton Silva-Craig

Yeah, I’m very familiar with them. GE purchased Dynamic Imaging in an effort to go to the ambulatory setting or the outpatient or rural market hospital, Dynamic Imaging has a presence there. GE does have a set of services packaged under Six Sigma. So, they take a little bit of a different bend, but their approach again is to try selling some higher value added services on top of their implementation. I would say that from our experience and market intelligence, it is not necessarily all that effective.

Richard Greulich - REG Capital

Last question regarding the McKesson, if so, if they basically private label it, the profitability for you, is it better or less than other kinds of businesses you have?

Milton Silva-Craig

The pricing model is where we have offered a price on our services to McKesson, they put a markup on it. I would tell you that they’re still favorable margins. Any discounting that we would do frankly is de minimus to our overall pricing. So, I think we’re well positioned there.

Operator

(Operator instructions) We will take a follow-up with Richard Greulich - REG Capital.

Richard Greulich - REG Capital

I might as well take advantage of my time. Milton, the outside observer looks at the stock price, customers must look at the stock price too. To what extent is that an issue with them at this point, what do you say to them?

Milton Silva-Craig

Frankly from our perspective, we are also surprised at the price of the stock. We basically trade at cash or below cash. We are not essentially getting any value for many of the things we talked about today. Our assumptions about what our value is are certainly far different what I think the market is valuing us. I believe we have a differentiated platform. I think the branding that we will announce in the coming weeks is going to be very powerful. I believe in the value of our products, they are going to have significant growth moving forward. I believe in our channel partner; I believe in the value work that we are doing with customers like Owens where we’re truly helping them drive an outside-in perspective.

I think where we have failed is that we haven’t communicated that understanding to the market sufficiently. I foreshadowed a little bit of that, Richard in our previous call. We need to do a much better job of getting that message out into the marketplace so people believe we are more than just our cash balance.

Has it posed some issues to the potential customers? Certainly they look at the stock market, but they also look at our track record of helping customers create value, and I think that’s carrying more way than with the stock trade there.

Richard Greulich - REG Capital

When you introduced the two new products, are these going to be priced on a software basis where there would be an initial license fee and then recurring revenues after that from maintenance or upgrades?

Milton Silva-Craig

Let me break those two down. On the data migration services that will be priced as a service. So for instance, if I’m going to move one terabyte of data from legacy system A to new system B and that takes me three months, for the purposes of this call that would simply be balanced over those three months, depending on our work effort over that period of time.

Now Blue Ocean, I’ll tell you, I mean it’s just very, very exciting about what the opportunities are there. We are looking at both service pricing model and then perpetual license sales. We believe at the moment -- and we’re going to learn a lot more in our pilots. Our intent is to pilot over the next three to four months and then begin true commercialization efforts at the beginning of Q2. We are going to learn a lot about the value that this application has with customers and we’ll ultimately drive a market-based pricing approach.

But there is kind of one school of thought, which is time to market is critical, we want to move quickly, we want to drive value so a perpetual license sale maybe appropriate, which would include a fee for the software, an annual maintenance fee, then we would also have our packaged services with that not only in the adoption of the application, but helping customers change their workflow optimization based on what the metrics tell us, the key performance indicators.

Those are sort of the elements that pricing could evolve. But we’re keeping an open mind to it right now, and we are going to learn a lot more over the next four months Richard.

Richard Greulich - REG Capital

Can you give us any idea at all, I mean, any ballpark number at all is to really what the market opportunity is for a product like that, in whatever terms you choose?

Milton Silva-Craig

What I can tell you is the following. The marketplace in healthcare, and I will talk about the provider space, has really done generally a very poor job of measurements and metrics. It is done manually, my impressions are that it is haphazard. This area of visual performance management, which frankly in other industries like manufacturing and financial services is more significant and pronounced, you saw that IBM purchased Cognos for $5 billion and SAP picked up Business Objects for $8 billion. There is a lot of attention from those players in this business intelligence space.

We think we are in the front end of that trend in healthcare. It so perfectly ties with our overall positioning of value creation. Again when I mentioned earlier, we think we would be the only services organization that not only identifies measures and captures it, but we would be able to sustain it through these applications like Blue Ocean. I will tell you that they was a company, and it’s just one data point you can interpret it as you will, called Awarix, that did visual performance management for bed turnover. That’s all they did. They wanted to get greater efficiencies in bed turnover for hospitals. That company was purchased for significant premium by McKesson.

We think we are on the front end of that and our application, we just talked to a customer that uses the Awarix application and they feel our application just sort of blows the doors off that.

Now again, we are not focused on bed turnover; we are looking at broader operational and clinical performance indicators, but we think we are in a perfect position right now that’s going to help the installed base of hospitals and nicely complements our positioning and the new branding.

Richard Greulich - REG Capital

Do you happen to know how long if any, McKesson had been working with Awarix before they purchased them?

Milton Silva-Craig

I am taking a pretty educated guess here. It was about a year-and-a-half, it was an early stage company out of Birmingham, Alabama and then about a year-and-a-half into their creation where they had a few pilot sites installed they signed an agreement for McKesson to channel some of those applications. It was about a year-and-a-half later that they were acquired.

Richard Greulich - REG Capital

Weren’t you down in Alabama with your acquired company?

Milton Silva-Craig

I was. That’s why I’m very familiar with the visual performance market. The founder of Emageon was a gentlemen named Gary York. Gary York is a serial entrepreneur, and he came across this opportunity to build a visual performance management solution specifically addressing the bed turnover market, and he built that application.

Operator

It appears there are no further questions at this time. I would like to turn the conference back over to Mr. Silva-Craig for any additional or closing remarks.

Milton Silva-Craig

Thank you, operator. Thank you for participating in our call today. We really continue to work with a sense of urgency, we remain firmly committed to returning the company to profitability and ensuring shareholder value and we appreciate your continued interest in our company. Thank you, everyone.

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