Transcend Services Inc. Singular Research's Annual "Best of the Uncovereds" Conference Presentation

Transcend Services Inc. (TRCR)

Singular Research's Annual "Best of the Uncovereds" Conference Presentation

September 4, 2008 2:30 pm ET

Executives

Joe Lambert – Director of Marketing, Singular Research

Larry Gerdes – CEO

Presentation

Joe Lambert

Our next company presentation will be from Transcend Services. I would like to, from Transcend Services, before I introduce Larry, our analyst Gary Holdsworth said this about the company in describing Transcend Services. Based in the land of Georgia, provides accurate, reliable and timely medical transcription services to medical professionals, hospitals, clinics throughout the U.S. It has developed BeyondTXT, the Internet-based speech recognition and editing systems that substantially boosts the productivity and profitability of the transcriptions nearly all of whom work from home. The company also utilizes third-party transcriptionists located in India which provides lower labor costs and 24/7 work flow capability. Gary Holdsworth has given a price target of $17 for the stock.

And now I’d like to introduce Larry Gerdes, who is the largest investor and has been CEO of Transcend Services for several years. He’s been a private investor for several years. He’s been involved in several start-ups and several public companies. He currently sits on the Board of Chicago Mercantile Exchange as well as several charitable foundations. He spent a large part of his early career at another healthcare start-up, HBO & Company, now part of McKesson. He served as their CFO, COO and Director. Please let’s welcome Larry Gerdes.

Larry Gerdes

Thank you. I want to thank Singular for having us here, Transcend (inaudible) – and I am encouraging you to ask questions as we go through and we can spend sometime afterwards too. And for those of you who already know something about Transcend, I apologize, because it is a little bit fundamental in the beginning. As they mentioned, we capture dictation from physicians around the nation predominantly through hospital customers. And once we capture that dictation, we create reports that are then sent back through electronic interfaces and other medium back to the hospitals to populate their records, whether those are electronic records or whether they just want those reports entered or faxed.

The transcription market if you don’t know is very large. It's some $12 million in annual revenue, $5 billion or so, about 40% of that is currently outsource and that's continuing to grow. The marketplace is very fragmented with thousands of small companies and only a dozen or so will collect revenues greater than $15 million. The competitive landscape is unique in fact that there are only four or five large companies, Transcend being the third largest. MedQuist is the only other public company in our market and 70% of that company has just been sold by Philips to CBay who you’ll see in this list along with the private equity partner. Spheris is a large bird, also backed up a roll-up [ph] private company and then you’ll several other national firms that are $15 million to $30 million in revenue.

The market trends are compelling for Transcend. The baby boomers are aging, that increases demand for healthcare and as a result reporting. There’s an expanded use of electronic documentation as there’s concern for HIPAA and patient medical security.

The domestic transcription labor market is in not growing fast enough to meet our needs. It's aging, it's early 50s now. It's not replenishing itself, so there – actually my estimation 15% to 20% of our demand has to be delivered from overseas because it can't be delivered domestically. There is increased outsourcing of medical records by hospitals and that makes it our growth model a little unique. We can grow two or three ways. One, more and more households are moving it out of the hospitals to outsource companies like ourselves. Two, there’s an increased need for documentation. Three, we do take market share away from competitors.

Pricing has stabilized. We think that there is actually a return-to-value. There had been some low price offshore competitors that drove market prices down in the late '90s, early 2000; it just feels like that they’ve risen now. We’re pricing to the margins that we need to realize.

Speech recognition is one of those great tackles [ph] in our business that's finally being realized. People have been talking about it for 15 or 20 years but in the last two or three years, it’s starting to be practical and Transcend is the leader in that area. I will get into that in a second.

Our market position, we do only transcription right now in the medical field. We provide the highest level of customer service in the industry at a reasonable price. As I mentioned, we’re the third largest. Our staff turnaround and consistent staffing is key to our industry. We have – actually this is why it's promulgated. I think we have over 1,000 domestic trainees. We have about 1,000 transcriptionists most of whom are full-time – those are domestic and then 20% of our work is done outside the US.

We are flexible on how do we deliver our service. We have our own platform as they mention BeyondTXT. It does about 65% of our business. If we can do it, we’d love to have a 100% (inaudible) but there are still hospitals out there who can have their own typing platforms, their own dictation platforms and they like to control that environment. We are flexible enough that we will work on their platform. Our technology is somewhat (inaudible). We’re little unique in our industry in that we early on made an investment in technology and the personnel that run along with it.

The core of that team had worked with me at HBO, back in the '80s when we developed some of the large established financial applications in that market. We have about 170 customers nationwide as you can see here. From a historical standpoint, our records show that we went public in ’90, but that’s only because we did a reverse merger in '95 with a company that was already public. For all practical purposes, we started Transcend in ’93 and we actually begun it two ways. We outsourced the medical records departments and hospitals in their entirety. While we did that, I became intrigued with transcription. So we bought seven little transcription companies to learn that business. In the late '90s, we realized we need to focus on transcription, so we sold our non-core assets, developed a new national platform and I actually sold off about 60% of our revenue that I couldn’t move to the national platform and actually restarted the company.

In 2005, one of the most significant events to happen at Transcend would be acquisition of Medical Dictation Inc. in Florida. MDI is at a little town of Brooksville, north of Tampa. They were a $6.5 million company that wasn’t growing anymore, didn’t have the bandwidth anticipated additional growth but tremendous customer commitment, tremendous management team and we made that acquisition in 2005. We also, at that time, launched BeyondTXT for speech recognition and we started the customer-centric reorganization based on MDI’s model.

In 2006, we started looking at offshore partners to see if that could help the company and expend our margins and the rollout of speech recognition took hold. 2007, we made a small acquisition. The two important issues in 2007 were the contained growth of offshore delivery of part of our services as well as speech recognition. We have a very mature senior management team. I have been in this industry for over 25 years; I think they lowered that number to make me feel good.

Sue McGrogan has been in the industry for over 20 and she’s about half my age. Sue came through MDI and she's just a tremendous operator and runs all of our field operations. Leo Cooper is our latest arrival; he is our EVP of sales and marketing. This was really the last thing I felt we have to work on a year ago, once we got everything else in order. Leo has done a tremendous job; he cleaned out the sales team, three of the four people are new and it has been with us about six months. Lance Cornell who some of you may have known is our CFO and has been with us almost three years. He’s got over 20 years of experience predominantly in healthcare and has made over 40 acquisitions in his career and is doing a great job for Transcend.

Our company’s starting to become recognized. Last year in 2007, we were ranked the number one growing public company in the State of Georgia. Granted [ph] by the newspaper of Atlanta, it's based on four financial criteria – I’ll probably hit the wrong [ph] – mezzanine growth, profitability growth, return on assets, and stock price. I think that is immediate return on equity.

The year before, we were assessed, so we felt very good about that. It’s an excellent moral boost. This last year, we have been ranked number one in our industry in terms of quality by our customers. This is really significant. Our client is the market research firm in healthcare that started at five, six, seven years ago in the IT area. About three to four years ago, the industry has been moving [ph] to transcription because they needed help in vendor selection. Perhaps called us to see if we could participate and I thought they wanted to just do a report. I told them we participate more than (inaudible) provide a report.

So, we participated, we got surprised. I gave them a whole customer base because they did not know any better and we came out first. Well, we felt pretty good about it. The second year, we were second or third and we just started focusing. Not doing things differently with our customers, but just looking at how we ranked in the various areas.

And this last report is amazing; you’ll see Transcend second from the right. Classics or local criteria and as customer bases (inaudible) your expectations, would you do it again or is the investment worth it. The most compelling thing about this line is the fact that Transcend ranked number one in seven of the eleven performance categories and I actually think we were in second in all the others. It has really somewhat taken the market a little bit by storm because we were so clearly number one.

Now that doesn’t mean things come easy, but it does mean when we go into those hospitals 50% to 75% of the time, (inaudible) and makes our sales guys' job a lot easier. The keys to our success, first and foremost, is consistently to provide effectual service to our customers. We don’t just make it up when we say that every decision in our company is based on the customer; it is. Whenever we make a decision, we say how will this impact our customers and what should we do in that regard. That means high quality documents and fast turnaround times. But most importantly is number two and it is being responsive to those customers in the county and Sue McGrogan and her organization have done that in spades. As a result in an industry that is characterized by high customer churns, maybe 85% customer retention; our customer retention is 98% and 99%. And that is our number one goal in the company, to retain all customers.

Second key to our success is going to be to increase market share and grow the top line. I had mentioned the sales force will be expanded. We've done a great telemarketing effort that has been going on for a couple years; it is one of the few times in my career I’ve seen one that has actually been productive. We want to capitalize on our rankings and we are just starting now to pursue national purchasing groups and national partnerships and I think we’ll see some impact of that in the next year.

Our gross margin improvement has been compelling. I'll show you on the slide in a minute. It's gone from 17% to 37% in the last 2.5 years. It will still continue to grow but not at that pace, but it's going to happen a few different ways. We'll leverage new sales on strict operations, so that’s going to in its own way expand our margins. We'll continue this (inaudible) speech recognition and our target suggests by the end of ’09 that 40% of our revenue is going through speech. The only reason we can’t get higher is because we’re still on pro-customer platforms. Then finally, we want continue to grow our offshore dimension from the 20% of that now to hopefully 30% by the end of 2009.

The one area that I would say Lance and I are frustrated in is acquisitions. We would have hoped to have made an acquisition or two by now. We've got a lot of M&A experience in the company. We are targeting medical transcription companies. We want to buy growing profitable businesses that have a reputation for service, that can grow faster than we can in their particular regions. Our cash flow from operations is sufficient to fund smaller acquisitions and we’ve proven that we got access to bank lines that could help us fun larger ones. But we haven't done recently as I mentioned. Evaluations are somewhat high and we don't want to chase them. In some cases, the owners aren't quite ready to sell and you've heard this before, and we’ll call you when we're ready. So, I am not sure we want to wait around by the phone. And then we have turned some down with concerns during due diligence.

Our balance sheet you are probably aware of, we're generating quite a bit of cash. We were happy to see June end with over $8 million of cash. Our days in AR are the best in the industry. We have about 35 days in AR and our industry average is above 60. We have almost no debt and amount of bad debt is zero interest debt that we have with the panel of revenue [ph] in Texas to recruit people there. So, our balance sheet is very clean.

From a P&L standpoint, our revenue growth is compelling even though it is not as fast as we want. We're going at 13% to 14% now; we are not satisfied with that. And our sales engine started firing up about 3 or 4 months ago that it hit – there is a lag time of revenue hitting transference books. It takes a while to get them installed, they start slowly. So, we are not satisfied with top line growth. I'd like organic growth in the neighborhood of 20% and then I'd like to see acquisitions are part of it. We also see that we are a little bit seasonal. Our second and third quarters are usually pretty soft because of the way hospitals admissions run. And we are seasonal with attracting [ph] customers in Florida. Sales, as I said, have been growing. We are actually through the 3^rd week of July. We have sold more than we did last year. So, year-to-date sales are over $7 million, probably pushing $8 million right now and they're picking up speed.

Our revenue per customer is actually going up. I had to learn this by looking at the slide [ph]. I didn't realize that until I saw this, but I know we have won bigger customers. We have been able to surprise in this business. It's not hard to find a customer who is spending $1 million a year on transcription. So, it's bigger than you might think but hospitals are large. And then, like (inaudible) annual revenue generated from customers once fully implemented. So, they don't need contract value, they really just need how much annual revenue that will generate.

I talked about margin improvement; I think this is a nice slide. It shows that the gross margins have improved from 17% to 37%. But it shows the drivers underneath that. It shows the implementation of speech recognition, and it shows the amount we’ve outsourced to overseas and that really is a big factor in our company.

Operating income is likewise strong because our operating income margins are about equal to EBITDA margins. So, we're pushing 19%. Our EBITDA margins are actually a little over 20% now. If you asked Lance and I, three years ago, what we would dream for? We would have dreamt for EBITDA of 15%. We didn't know if the service model like ours could pass 15%, and now we've gone through 20% and we're going to continue to improve. So we feel pretty good about that. I think this slide is intriguing. It's metrics of different kinds of returns, that our return on our tangible assets and our equity are about 33%, and so we've done a nice job of taking advantage of our balance sheet and leveraging it in their great returns. And you’ll see that in your books, you can see the footnotes, how Lance did that.

And then finally, our stock performance, if you look at the last 3 years, it has been dynamite; if you look at less than three years, it looks normal. There are plenty of [ph] problems in the market and we have been impressed with the Singular reports – we think they're very well done and we like the work they've done and we actually buy into their targets and where they – we think our company's value should be. But, I don't think we probably have to present today; we didn’t think this company is (inaudible) so I've been surprised.

We are about 26% that's held by insiders. I actually think if you look at the whole group, it might be a little north of that. We did increase our institutional base quite a bit in the last few years. I actually think it's a little over 30%. But that's up from 5% three years ago and then others are 44%. Our market cap is about a $100 million; our enterprise value is $97 million. EBITDA this year will be between $9 million and $10 million, still our multiple times EBITDA is not all that high at about 10 times. And our trading volumes are at about 32,000 shares. We were very (inaudible) 3 or 4 years ago, that's improved a lot. So, I'd like to see us trading 50,000 to 60,000 shares a day or at least over 30,000 most days but we're still a little liquid [ph]. We've got about 8.9 million shares outstanding, got lots of cash. We would rather use cash in acquisitions than our stock right now. We'd probably use part stock but maybe not over 20% and then the rest cash use it off of our balance sheet to drive [ph] debt.

Questions?

Question-and-Answer Session

Unidentified Participant

You are at 13; you want to be 20. $13 a share?

Larry Gerdes

No, (inaudible).

Unidentified Participant

(inaudible)

Larry Gerdes

Yes, we're growing 13% to 14% a quarter now and we'd like to get 20% and how can you make that happen? There are two or three ways

One, we have expanded the sales team from really nearly 2 to 4 and they are starting to get traction. And so, last year was $7 million of sales. This year could be almost close to double that. That's the most fundamental way to increase that growth rate. The subtle way is to retain all the customers. We've been doing that for about 18 months. So that everything (inaudible). We will start seeing some expansion of same-store services because we're expanding some of the things that we're doing with things that I can't announce now, but additional services we are going to offer, and that will help.

What it really comes down to is I think our sales team of four to six led by our VP of sales with maybe some leverage group relationships, we ought to organically grow 20% and I think you are going to see evidence of that part by the fourth quarter of this year and the first quarter next year.

Unidentified Participant

So thank you.

Unidentified Participant

(inaudible – microphone inaccessible)

Larry Gerdes

Yes, I'd use that.

Unidentified Participant

(inaudible – microphone inaccessible)

Larry Gerdes

$25 to $30 million. Yes, we've already had indications with all the acquisitions we've looked at that we could borrow $45 million. But that was on pro forma EBITDA of $15 million with the other company with us. But no, you're absolutely right. I want to use 15% to 20% of equity just to keep their (inaudible) but the other 80% I would – and when I say cash, I use cash loosely [ph]. I've used available cash off the balance sheet, but I’d use that. I couldn’t agree more. And then in a perfect world, if the stock price (inaudible), we can always do a secondary to retire that debt (inaudible).

Unidentified Participant

(inaudible – microphone inaccessible)

Larry Gerdes

I can almost visualize it actually. If you took a $5 million company, in our industry they might be doing EBITDA as little as 5% and they might not even know that they might make $200,000 to $250,000. They’re going to hit the low-hanging fruits, things will be around. (inaudible) order drags out in different (inaudible) and that might take it up to 8%, 10%, 12% EBITDA. But then what you do is you move them over on our platform, you start running it through our data centers, running it through our speech recognition and once we can either convert it to speech or convert it to overseas, we can improve margins 10 points on speech, 10 point on overseas and if we want the overseas partners to add it, its almost additive [ph].

So I could see taking that $5 million company just making $250,000 easily to $1 million which would be 20% EBITDA, but probably a little north of that because they wouldn’t need any of our stuff. They wouldn't need sales; they wouldn't need R&D or any of that. And the thing I left out, we got an operational model now that Sue has developed, with regional operations managers, each of which manage $5 million to $8 million. So a $5-million acquisition, we would treat like adding another region. So, all we would take from that management team would be one line operator and then some team leads, the rest would be superfluous. We wouldn't need the rest of the team. So, it's compelling. So the key to us when we look at an acquisition is how their pricing it. And if they're pricing prices to gross margins of 45% to 50%, the rest of that P&L will take care of itself. But the real compelling thing is that they capture their dictation and you can move it over to our data centers. That's – really you could create enough margin right there just by the acquisition.

Unidentified Participant

What about property? How would characterize the current pricing environment?

Larry Gerdes

That's too high. On acquisitions or do you mean on sales?

Unidentified Participant

(inaudible – microphone inaccessible)

Larry Gerdes

Oh, on the base business?

Unidentified Participant

Yes.

Larry Gerdes

Transcend is competitive. When hospitals allot more and more fees, they want the best price they can get, they want quality, we don't necessarily always have to be the lowest price, but we probably can't get away with being the highest. And in this class survey I mentioned, they have very interesting graphic that we should have in here and it's price on the horizontal axis and value on the vertical, and Transcend is half of the value and at the middle of the price, which surprised me because I've always thought we were at the higher end, but not the highest. We will lose business because of price, especially with the Indian base predominantly overseas and somebody wants to buy the business, we were adjacent [ph]. We try the price to 45% to 50% gross margins. We can slip off that a little bit and be okay, but it's competitive, I can't – but I think it's stable. I think it's – I think there's still – there have been some return to value.

Now, my other answer, on acquisitions, valuations have gotten away because there have been a couple overpriced acquisitions recently in our industry. So there are a few deals that we might have been able to get if we had wanted to chase them. And those valuations where people used to expect one times revenue and 4 to 6 times EBITDA, (inaudible) were 10 times EBITDA and 2 times revenue. And that just gets a little steep for a little (inaudible) $5 million private company.

Other questions?

Okay. Thank you.

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