Healthcare Services Group Inc (HCSG) 2008 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Healthcare Services Group, Inc. discussion of its operating results for the three- and six-month periods ended June 30, 2008. Today's discussion may contain forward-looking statements within the meaning of Section 27 A of the Securities Act of 1933 as amended and Section 21 E of the Securities Exchange Act of 1934, the Exchange Act, as amended, which are not historical facts, but rather based on current expectations, estimates, and projections about our business and industry, our beliefs, and assumptions.

Words such as believes, anticipates, plans, expects, will, goal, and similar expressions are intended to identify forward-looking statements. The inclusion of forward-looking statements should not be regarded as a representation by us that any of our plans will be achieved. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

Such forward looking information is also subject to various risks and uncertainties. Such risks and uncertainties include, but are not limited to, risks arising from our providing services exclusively to the healthcare industry, primarily providers of long-term care; credit and collection risks associated with this industry; one client accounting for approximately 15% of revenues in a six-month period ended June 30, 2008; risks associated with our acquisition of Summit Services Group, Inc.; our claims experience related to workers compensation and general liability insurance; the effects of changes in or interpretations of laws and regulations governing this industry, including state and local regulations pertaining to the tax ability of our services and the risk factors described in our Form 10-K filed with the Securities Exchange Commission for the year ended December 31, 2008, including part one thereof under government regulation of client competition and services agreements collections and under part one 1A risk factors.

Many of our clients' revenues are highly contingent on Medicare and Medicaid reimbursement funding rates, which Congress has affected through the enactment of a number of major laws during the past decades. These laws passed significantly altered or threatened to alter overall government reimbursement funding rates and mechanisms. The overall effects of these laws and trends in the long-term care industry have affected and could adversely affect the liquidity of our clients resulting in their inability to make payments to us on agreement upon payment terms.

These factors, in addition to delays in payments from clients, have resulted and could continue to result in significant additional bad debts in the near future. Additionally, our operating results would be adversely affected if unexpected increases in the cost of labor and labor-related costs, materials, supplies, and equipment used in performing services could not be passed on to our clients.

In addition, we believe that to improve our financial performance we must continue to obtain service agreements with new clients, provide new services to existing clients, achieve modest price increases on current service agreements with existing clients, and maintain internal cost reduction strategies at our various operational levels. Furthermore, we believe that our ability to sustain the internal development of managerial personnel is an important factor impacting future operating results and successfully executing projected growth strategies.

I would now like to turn the call over to Mr. Daniel McCartney, CEO of Healthcare Services Group, Inc. Please go ahead Mr. McCartney.

Thank you. Good morning, everybody, and thank you for joining us for our first conference call regarding our quarterly results. Yesterday after the close we announced our results for the second quarter and our 10-Q is expected to be filed by Monday, July 21. But the results had our revenues up 4% to a new company record for quarterly earnings, but a little bit short of where we expected to be at a $147.918 million.

We were affected going into the second quarter by the leaving of the two corporate clients in the first quarter, which reduced the revenue stream about $13.5 million annually and $3.5 million per quarter. In spite of that, our new business targets were generally met and our client retention for the second quarter was good and back to the Company's historical norms.

But most of the starts that we had in the quarter were begun later in the quarter, so we didn't get as much of an impact with the new business as we will in the third quarter and, obviously, going forward. Both Housekeeping, Laundry, and Food Service grew at a proportionate amount of rate. Although Food Service a little bit lower because the new business that we added did not make up for the shortfall in the first quarter of the facilities that we left, which affect Food Service more dramatically because of the lower revenue base.

The net income was $6.953 million, or $0.16 a share. The net income was impacted in the direct cost line by an increase in workman's comp of about 0.6%, higher than our historical norms, due to just more claims. In the direct cost area we made progress in the Food Service in the labor and management section as the Food Service has added more properties and the management base continues to get expanded incrementally over more properties.

The food costs and purchases have continued to increase. But because of the restructuring that we accomplished in the fourth quarter last year, having the Food Service regions and districts under the seven, now divisional, management people for Housekeeping and Laundry, adding Food Service to their responsibility, we were able to get the increases more timely. But, frankly, with commodity costs continue to go up, it's an ongoing process. We are getting more increases more regularly to reflect those. We are just able to address them more quickly than we were in 2007.

The SG&A was 6.75 and we expect it to be in that neighborhood going forward, a couple basis points more or less. I guess we still expect over the next year or year and a half to get the direct costs below 85% and work to get them closer to 84% on a consistent basis, primarily over the next year and a half as Food Service becomes more and more fully ramped up as far as the district and regional coverage. Their margins should reflect Housekeeping and Laundry's margin.

The balance sheet -- we ended with over $90 million in cash. The receivables were 54 days. Still have no debt and for the 21st consecutive quarter we increased the dividend another $0.01 to $0.15 a share. We hit our targets, kept the client retention where it should be for the quarter. The incremental increase in the revenue in the second quarter compared to the first should be back increasing at a more rapid rate in the third quarter and fourth quarter. We expect by the end of the year we should, if we hit our growth targets and keep the client retention where it should be, be back to double digits by year-end.

So with that abbreviated summary, I will open it up to questions.

(OPERATOR INSTRUCTIONS) Michael Gallo, C.L. King.

Dan, just a couple quick questions. You have mentioned that the client retention and the new facilities adds in the quarter were generally in line with your expectations, but that some of them came on late in the quarter. I was wondering what kind of impact do you expect to see then as you head into the third quarter.

I know you started the first -- or ended the first quarter and started the second quarter with fewer facilities than you would have liked as you chose to leave several of them. But I was wondering if you feel that that issue is now behind you, that you are starting to replace the business, and that we should start to see a sequential growth acceleration again in the third quarter as, obviously, you were still feeling the impact of that in the second quarter.

Yes, I think we try to target the amount of facilities, although there is a wide variance depending on where they are added. But in the second quarter, most of the facilities we added are a great deal and started at the end of the quarter. Now, that gives us a much higher run rate where we will get the full benefit in the third quarter, but it didn't have as much of an impact in the second quarter as it would have had we added them proportionately in April, May, and June.

So going into the third quarter we feel very optimistic that the base is where it should be because we started those properties already in June. If we add in the third quarter, our targeted amount of properties keep the client retention where it should be. The revenue growth as a percentage, even though the third quarter comparison from last year is more difficult, it should start to accelerate and increase to a few percentage points higher in the third quarter, a few percentage points higher in revenue growth in the fourth quarter, and be close to double digits by year-end where our ultimate target will be.

Okay, great. That is very helpful. Then just a question on -- you mentioned the worker's comp reserves were little bit higher in the quarter. I know that, as I recall, this is an issue that has cropped up from time to time, although not recently. I was wondering whether you expect that to be a trend that continues going forward where worker's comp trends are going to be high, whether there was some unusual claims that hit in the quarter, whether we should expect the direct costs to return more into the 15.5% -- or the 85.5% range going forward?

I expect our workman's comp to go back down to its historical levels. I think the last time we had a bump up like this was the fourth quarter 2005, if I remember right. So our claims are still mostly small, modest claims, soft tissue claims, but when they get a lot of claims in the estimates and the reserves, it has some kind of impact like this. It cost us more than 0.5% of revenue for this quarter, but we expect it to be down to its historical levels going forward. It was just an unusual amount of claims for the period in time although a lot of small ones.

Okay, that's helpful. Thanks a lot.

Eric Gommel, Stifel Nicolaus.

I just had a couple questions. On your AR, I noticed it did tick up little bit, Dan. Is there anything unusual that happened from a collection standpoint in the quarter, from a timing standpoint on AR?

No, for us it's 54 days, which I think anybody in the healthcare industry would kill for that kind of days outstanding. But for us it will fluctuate 52 days, 53 days, 54. Sometimes it's a timing. In some of the clients, we got paid July 2 for the monthly payment because of some timing reason. But, no, as long as it stays at these levels we are pretty happy.

Just a question related to sort of the rising food costs and also a softening labor market. How does maybe the softening of the labor market benefit your business? The second question is do you believe -- how do you think your underlying customers might look at the attractiveness of outsourcing dietary as food costs increase and maybe some of their operating costs increase in the dietary business? Do you think that maybe pushes people to look at your option or perhaps to keep it in-house? I'm just interested in your thoughts on that.

I think as far as the labor market first, we are not really impacted by the macro labor trends. Our management development is the key for us and the candidates we get at the entry-level management training position are really not impacted to any great degree by any broader sense, although the more or the less opportunities certainly leads may be better and more qualified candidates in a modest way to our industry since it's not typically the career of choice.

As far as the food purchases are concerned, I think one of the attractive parts are, because of our purchasing power, we are able to benefit the client and the food purchases with more purchasing muscle than they are able to get, in most cases, by themselves. I think that will, ultimately, increase the demand for this service. However, at this stage in the Food Service division's development, adding the new business opportunities are still nowhere near as critical for us as the continuous improvement in the development of management people.

There really is within our client base, even under old circumstances, without the commodity increases being that much of a factor, more opportunities for us. Our constraint is still getting on a consistent basis enough management depth to take full advantage of those opportunities. But certainly the food purchase pressures that the customers are feeling as well will only make outsourcing of our type of services more in demand.

One last question and I will hop off. Just you are, obviously, your customers are nursing home providers. What are your observations of the industry now? It sounds like collections are good and your DSOs are down. How would you characterize the health of your underlying customer base at this point?

I think for -- our measurement being how they pay us, frankly, our credit issues are typically client-specific. That the environment in general, I think, has been a pretty favorable and consistent one for the industry as a whole, in spite of a lot of the rhetoric about the Medicare, Medicaid football being tossed back and forth between the government and the industry.

But where we have operators that don't operate as effectively, they get in financial trouble. Like I have mentioned the past few years, we have kept the clients on a much shorter string, that if they get behind in the credit terms from what we had agreed to and we try to assess what we think the risk is going forward. We have left more buildings for credit issues the last six or seven years than we did for the first 25 years of the Company's existence.

Even though the industry has been in better shape the past few years, we have still managed to credit the same way. I think in general the condition is more state-related than any Medicare or national trend. For example, in Florida they lowered the Medicaid rate for a lot of operators in Florida. But as an offset, then they lowered the nursing requirements for the industry as far as nursing hours per patient. So although it's not the best way to do it and the providers complain, there is no real financial impact, although you could make the case there is a patient care impact.

In California, they are having difficulty passing the budget come the end of July. This has happened a few years ago, most recently, and two times since we have been doing business in California. It usually extends a month/month-and-a-half to where nursing home operators get only a percentage of what they should be getting for Medi-Cal, the state payments. Now we will work with most of the clients and then when it's caught up, they will catch up with most of our vendors.

So it's usually those kind of nuances state-by-state, which we always have to deal with. But I would say as a general observation as an outsider looking in, the way they pay us is our best measurement and we see no difference. I would say it has been a pretty consistent environment, although the industry would always say they would want more reimbursements and the government will say there is too much waste, so the reimbursement levels are fair.

Great. Thanks, Dan, for doing the call.

Rob Maines, Morgan Keegan.

If I could just build on that last question there, it seems to me you have got a little bit of a push-and-pull in your client base right now in that on one hand they are probably seeing some easing of their own labor rates. But on the other hand, as you suggest, in some states you have got some reimbursement issues. Are you seeing just generally in the market any increased or decreased receptivity to outsourcing and what you see as the drivers for the business?

As a general rule, the demand for our services has still never been greater. Now, you could say, well, why are you growing at only 4%? It's more a process of when we get the closes rather than the activity. We are developing the right amount of proposals, so I think as a general rule, in fact, I would encourage everybody by the end of the summer, Modern Healthcare, for the last 20 years, has done a survey. The trend to outsourcing of all kinds and makes some of the arguments that I try to make in explaining our company.

But I think their theme this year will be no different than previous years, that outsourcing of all type of services has become more and more accepted in the industry. Certainly, we have been impacted favorably as well. It's just the process of doing the survey, getting the price that we need, giving the client enough savings to entice them, and getting the starting date. There is more demand really for our services and maybe the title they get squeezed, obviously, to the better it is for outsourcing companies of all kinds, including ours.

Okay, then when you look at the pattern that you saw in this quarter with a lot of the sales closing in June, are you concerned at all about a robbing Peter to pay Paul type situation where some of those -- a lot of June sales might cannibalize business you would otherwise get in July and August or that is that not really the way to look at it?

No, I think that we are really -- we looked at them because it was skewed a little bit more than normal. They were facilities they were working on relief for months. Like our process is maybe a 60-/90-day process from the first close or the first client contact to the development of the proposal to the delivery of the proposal to finally getting the signature and the starting gate.

So the things that they closed in June they had really been working on from the beginning of the year to one degree or another, certainly the beginning of the quarter. That is not going to impact the activity they generated in the second quarter for the third quarter's closes.

Okay, then last question, just want to make sure I got this straight. You had said that Housekeeping, Laundry growth was a little bit better than Food. Are you talking on a year-over-year basis or a first quarter to second quarter?

Really from the first quarter the second quarter. The facilities we left in the first quarter -- one of the customers, one of the chains were a food service chain. Obviously, leaving that much business affects Food Service because it's a smaller base, so you need to make it up. So I think the revenue breakdown in the growth was probably a little better than 4% for Housekeeping and Laundry and a little worse than 4% for Food Service. That is what I meant, but from the first quarter.

Okay, thanks.

Mitra Ramgopal, Sidoti.

A few questions. First I believe you said over the next year and a half you hope to get the Food Service segment margins close to the Housekeeping, Laundry, Linen. Anything specific we should be looking for on how soon you think we get there?

Well, I think, if I were looking at it from the outside looking in, I would look for continued progress in the labor cost. That it's going to be reflected in the direct cost but, although it's not exact in the segment breakdown, as long as we continue to make progress as a percentage of costs in the labor area being reduced as the district and regions get a full complement of properties, we will be making progress.

The food purchase -- the two components, labor and labor-related costs were typically 60% of the costs and food purchases were typically 40% of the costs. As we keep improving in the Food Service areas as far as the development of the organization, right now the district and regional management people are underutilized based on our model, where a district should oversee eight to 12 properties. In Food Service, they are averaging six to seven properties. A region should oversee four to six districts. In our model where in Food Service, they are averaging three to four districts.

As we add more properties we are already eating the labor costs, so the labor costs as a percentage should be continued to be reduced over the next year/year-and-a-half just folding in the new properties. We are bidding the jobs at 12% to 15% gross profit, so the margins, once we hit our optimum level of operation, should mirror Housekeeping and Laundries. But that is going to have incremental improvement, or it should, quarter-to-quarter over the next year/year-and-a-half.

Okay, and as you implement your price increases in light of the environment out there, is there a fear that some of the operators might be more hesitant now to outsource and be more inclined to do it themselves, thinking they can --?

It's really the exact opposite. I guess, administratively, it's much more time consuming than it was in days of more stable food and commodity costs. The bulk of our purchases are locked into national accounts with the U.S. food and SYSCO, so that is like 75% of our food purchases. But the other 25% or 30% we buy from local vendors for dairy and produce products and those prices are going up. We don't have the same purchasing muscle because they are typically local vendors in many cases that the client used before.

As those prices have continued to go up, we don't have the same purchasing muscle to resist those price increases to us from the vendor. So more timely we have gone back to the client more regularly than we would like to have $50 or $60 a week, very modest weekly increases, to reflect those vendor price increases to us.

But even though it is more frequent than the customer or we would like, it's not a surprise to them because, first away from the publicity, these are vendors that they were dealing with before. They know that had we not been there they would be experiencing the same kind of price increases. So we have been able to get the increases and we have been able to get them more timely. It's just not -- it is much more frequent pricing changes at the property than our norm is.

But I think that makes them want to outsource even more, because they would be experiencing the same price increases that we would. And they get the benefit of the national accounts because of our purchasing power with SYSCO or U.S. Food, which they wouldn't have themselves

Right. Finally, just looking again, I think it looks as though you bought back some stock in the quarter. If you could just get a sense of how much and how much is remaining in the authorization buyback.

We bought about 300,000 shares for the quarter. I think we have maybe 800,000 shares left on the last authorization. When that is done, this is our fifth authorization, we would go back to the Board for an increase in that as well.

Finally, aside from the dividend increases and share buybacks uses of cash, I noticed some of the acquisition was a really nice fit for you. Any thoughts on anything on that front?

We would look if the right opportunity was there. But frankly, because in the market niche we have concentrated on we don't have that much competition, there aren't many companies or acquisition opportunities that really fit our niche. For the time being anyhow over the next few years we are not looking to diversify into commercial cleaning or that kind of thing. Healthcare-related properties are the only ones we really want to focus on.

Okay, thanks again.

Clint Fendley, Davenport.

You mentioned in the intro that your new business targets generally were met. Which areas were you weaker than you might have hoped?

It is more geography. When we add new business, the areas really matter. In the Northeast, for example, where the wage rates are higher, 180 bed facility for us may be a $500,000 a year contract where they have -- are paying $15 an hour and have a substantial union fringe benefit package.

On the other end, that same size property in Omaha, where they have a more modest wage rate and fringe benefit package, staffed exactly the same way with the same management responsibilities may be $180,000 a year contract. They are both one facility, but one obviously has a greater impact in new business than would if it was in a more rural area. So it's more those areas.

I would say in the second quarter, we have probably added more properties in the Northeast, the higher revenue. We just added them later, so I would say some of the other areas were a little light and the best performance, as far as new business, was primarily in the Northeast for the quarter.

As you look forward to some of the opportunities in the pipeline, do you think there are more opportunities in areas like the Northeast, the more urban areas, or is it -- would it be the latter?

I think the opportunities are pretty similar throughout the country. Certainly the more urban areas for us, and the Northeast in particular, is where we got our start. So you would think if there was any area that you were coming close to saturating, it would be the area you started 31 years ago. But that is not the case and that is why I brought up the Northeast.

You would think since we have been there the longest, maybe that would be the area that we penetrated more extensively and maybe had less opportunities, but in this environment it's typically not anything in the macro sense. It's really more selling property by property. There are really opportunities throughout where they are all feeling the same kind of cost pressures, although proportionately saving in Omaha $40,000 a year is just as meaningful in that kind of property as perhaps saving $100,000 is to somebody in Manhattan.

Thank you, that is helpful. Switching gears a bit, could you talk a little bit about the turnover among some of your management people? Is it higher now than it has been in the past?

I think it's pretty similar. I think if you went to each level, the majority of our turnover takes place in the first stages of the management development program, where I would say probably 50% of the candidates don't make it out of the training program. But that is what it is intended to do.

I would say maybe 25% of our facility managers or assistants maybe turnover annually. Usually because they think they should be promoted perhaps before the district managers think they should. Out of the 230 or so district managers, if we have 10% turnover, it's a lot annually. That is still 20 districts that are turning over and at the regional manager level, if we lose two or three a year, it's a lot.

Okay, thank you.

Dale Dutile, The Boston Company.

The segment margins, are those -- can you give us those or do we have to wait for the Q for those?

You should wait for the Q.

Okay. Can you give us a more sense on food inflation? Can you kind of quantify what you are seeing year-over-year all-in, including your national contracts and the local stuff?

The national accounts -- I think our increase last year was less than 5%, where I know the inflationary pressures were more than that. They had been locked in for 2007 before we negotiated 2008's pricing, so we think we did pretty well there.

As far as the produce, it is really regionally impacted. Some areas have had the produce cost within the first six months, at least the cost us, go up 10%, where others have been more modest. But still over five and over the national account level. Even though property-by-property it's nickels and dimes, in the aggregate over 300 facilities, it starts to mount up.

I think that is why the restructuring we did in the fourth quarter of last year was really critical for us to get to the clients on a regular basis. That at the facility level we have to respond as soon as we get an increase to go into the client and the customer, the administrator and say we need $50 a week more.

On a per bed basis -- can you say that food costs on a per bed basis are up 5% year-over-year or --?

You can say -- I would say it's up more than that, maybe 6% or 7%. There is a wide range depending on the area.

Okay. Secondly on the -- you talked about the new business skewed towards the latter half of the quarter, but if I just looked at the annualized run rate of revenue that came on in the second quarter and compare that to either the first quarter or the second quarter of last year, can you give us some sense of the change adjusting for the time that it started just on an annualized basis of new business started?

Not that refined. I would just say that the majority of the new properties we added in the second quarter came on towards the end and the most came on in the month of June.

Okay. Last question on the worker's comp expense, back to that. Did you say -- just a clarification -- did you say that that expense was up 50 basis points as a percent of total revenue? Did I hear that correct?

60 really.

60, so why --? If your worker's comp expense is up it looks like your reserves are down again in the quarter --

Because they are reflected in how many planes were paid out as well so the reserves are always replacing not only the claims that are actually paid that go against the reserve, but replenishing what is Zurich estimates to be the reserves for the amount of claims we got for the period.

Okay, but if claims are going up shouldn't the reserve be going up?

It was offset by the claims that were settled for the month, or for the quarter.

Okay, but implicit in your assumption for reserving is the assumption that your claimed experience will revert back to a lower level after that --?

Yes.

Okay, right. Thank you.

There are no further questions registered at this time. I would like to turn the meeting back over to Mr. McCartney.

Okay, I guess, in summary, the quarter was lighter than we wanted it to be as for as new business, although as those of you who have known the Company for awhile have heard me say that adding the new business -- I'm not saying it's easy, but it's the easier part. Making sure the client satisfaction levels are there, the client retention is where it should be, and managing the nickels and dimes in the business is really the key.

There is still a greater demand for our services and I think it will ultimately be reflected in the more accelerated revenue growth in the quarters to come. The constraint on our growth is still a development of management people. Outsourcing is still much more accepted in the industry than ever before. Each year that becomes more the case in all kinds of services, not just ours.

We have never had better management people in the history of the Company. We just have to be able to take full advantage of the properties and opportunities that are in front of us. We think Food Service is making progress in the management development area, though never as much progress as I would like. We have all the financial resources to grow as fast as our ability to manage it.

So these are pretty good times for us. So the Q will be filed on Monday, but onwards and upwards. Thank you, guys, for joining us today.

Thank you. The conference has now ended. Please disconnect your lines at this time. We thank you for your participation.