Healthcare Services Group Inc (HCSG) 2008 Q3 法說會逐字稿

This report contains forward-looking statements within the meaning of the section 27A of the Securities Act of 1933, as amended, and section 21E of the Securities Exchange Act of 1934, as amended. 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 sorted with this industry; one client accounting for approximately [15%] of revenues in the nine-month period ended September 30, 2008; risks associated with our acquisition of Summit Services Group Incorporated; our claims experience related to Workers' Compensation and general liability insurance; the effects of changes in or interpretations of laws and regulations governing the industry, including state and local regulations pertaining to the taxability of our services; and the risk factors described in our Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2007, including Part 1[thereof under government regulation compliance, competition, and service agreement collections], and under Part 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 decade. These laws have significantly altered or threatened to alter overall government reimbursement funding rates and mechanisms. The overall effect of these laws and trends in the long-term care industry have affected a -- adversely affect the liquidity of our clients, resulting in their inability to make payments to us on agreed-upon payment terms. These factors, in addition to delays in payment from clients, have resulted in 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. (OPERATOR INSTRUCTIONS)

I would now like to turn the call over to Mr. Dan McCartney. Please go ahead, sir.

Thank you. Good morning, everybody. Our second conference call in the history of the Company, but last night after the close we released our third quarter results. Our 10-Q will be filed by Monday of next week, but in the release we reported results. Revenue increased to $152.9 million, up 4.5% from the third quarter last year, but up almost $6 million from the second quarter. We hit our new business targets for the past two quarters and our client retention was good within -- our Company targets of better than 90%, as well. So we started to make up the ground from the two clients we discussed previously from the first quarter that were some credit concerns of ours that cost us about $13.5 million in annual revenue that we left and went management won and about $3.5 million in sales per quarter. So the new business targets are being hit. The client retention the last two quarters has been where it should and we targeted it to be and we started making up the loss of those clients and the adjustments we discussed in the first quarter of this year.

Our direct costs were affected this quarter by an increase in bad debt reserve to $2.2 million for the quarter, or about $1.9 million higher than our historical averages for the past years, which cost us about $0.03 a share. One of the clients that we talked about as a credit concern at the beginning of this year filed for bankruptcy in September. They're early in the process and we're not sure what our recovery's going to be but we booked a bad debt reserve to reflect our exposure for what we know now and may know more going down the road, but we felt it necessary to bump up the reserve to reflect that. But that cost us about $0.03 per share.

Our SG&A was 6.25% but you'd really to compare apples to apples have to -- the SG&A was affected by the decrease in deferred compensation investments for our management people. with their investments in mutual funds going down about $700,000 so really that should be added back to the SG&A component, which would put our SG&A expenses at 6.75%. And in our investment income we don't have any debt, so there is no interest expense. You really have to add the $700,000 back to investment income and our actual investment income for the quarter was $500,000, but it was down from the $1.1 million in the third quarter last year so that cost us about $0.01 a share.

Our balance sheet, we still had over $93 million in cash, no debt. Our receivables were 56 days, so our credit issues are really isolated to the particular clients as opposed to anything in the aggregate going across the industry. And the receivables were up a day or two more than they would have or could have been due to California's budgetary arguments where they passed their budget finally towards the end of Dec -- end of September hadn't paid the healthcare facilities and our clients for July, August and most of September. They played catch up at the end of September, but about $4 million or so came in October and missed the September 30th cut off, so the receivables are still in good shape. The cash balances are still where they had been and we don't see any trends in the industry but our credit issues are typically client specific.

In addition, the board improved the -- approved the 22nd consecutive increase in the dividend to $0.16 a share in spite of us only earning $0.13 for the quarter because we feel that back in the fourth quarter that problem is addressed and we should be back where we expect to be in the fourth quarter so we saw no reason to not continue the increase in the dividend payment. We've hit our new business targets the last two quarters. Our client retention has been good. Bad debt reserve certainly impacted us but if we hit our targets and continue with the client retention we should incrementally improve the revenue growth in the fourth quarter and be back to double digits by the first quarter in 2009 and certainly the run rate at year end.

So with those abbreviated comments I'll turn it over to questions.

(OPERATOR INSTRUCTIONS) Our first question comes from Matthew from Sentinel Asset Management. Please proceed with your question.

A couple questions. What has your history been? I know you've (inaudible) to this bad debt thing now and again just nature of your business, what has your history been in the past with the amount of recovery or is it just really a case-by-case basis?

Our history in most -- in many of the instances has been relatively good where we've gotten $1 on a dollar. Our strategy with some of the debtors has been to be listed as a critical vendor. Because we're payroll and payroll related we typically get a preference as long as we continue to service the properties and give them the same credit terms post petition that we did before the bankruptcy, which typically we're happy to do. But some of the debtors are in different circumstances and really aren't trying to organize but may be force to do liquidate and that's the unknown. So when we know more facts we typically are able to more accurately estimate what we think our exposure and recovery is going to be.

Unfortunately this bankruptcy is in September is still in its new stages and we just weren't able to estimate it as thoroughly as we will be by the end of the fourth quarter. They should put their preliminary reorganization plan together. They have an exclusive period until December and then it'll be up to the approval of the creditors committee and then we'll be able to assess more what we think the recovery will be. But we just didn't have enough time by the time they filed to get enough information to do it so we took the more conservative approach and booked more than maybe we'll have to going forward .

Our next-generation is from Rob Mains of Morgan. Please proceed with your question, sir.

Good morning, Dan. A couple of things. $1.9 million, that's the sum total of your receivables for this account?

Yes.

Okay. And the four -- when we get the Q is it fair to say that the cash flow statement will effectively be understated by the $4 million that got held because of MediCal stuff.

Yes because the cu -- we got it after the September 30th cut off so the $4 million that was still some catch up from some of the California clients we got the week or ten days after, it just didn't make it by September 30th.

Got you. And then, even if I take out the $1.9 million --

Hello?

I see that he's dropped out of the queue, should we take the next question?

Okay.

Our next question comes from Ryan. Please proceed with your question, sir.

Good morning, Dan, it's Ryan Daniels.

Hello, Ryan.

A couple quick questions for you, first on the revenue growth. I know it was actually fairly strong, I think the best sequential performance you guys have ever had ex the acquisitions in probably three or four years. Anything in particular there? Is it more strength in the food services side or have you started to sell that as a preliminary offering versus just as a cross selling?

I think the revenue growth was really just a matter of more of the divisions on a consistent basis hitting their targets as far as new business, but it wasn't even as bad. The client retention, the buildings that we left at the beginning of this year for those two larger clients really affected us and we had needed some time to make that up, as well. If you remember, in the second quarter a lot of the new business that we added, we added really towards the ends of the quarter so we didn't get the full impact of it.

Now, the guys have done a good job as far as new businesses in the divisions. We're certainly on a more consistent basis expecting grassroots as well as the corporate accounts to be added, so we expect to sustain this. It may not be $6 million sequentially but certainly to be able to incrementally improve it quarter to quarter and get us back to the double-digit run rate by year end or certainly the first quarter 2009. Fourth quarter should be better and the first quarter back to where our historical norms are. But it's mostly housekeeping and laundry, and food service is still a secondary service that we're allowing the Northeast to ramp up a little bit more aggressively but the other areas are still in the stages of management development to where we're still controlling how quickly they can grow.

Okay, that's great color. In the Northeast with the food services are you actually allowing that team to sell that as an initial offering or is it just more aggressive ramp within existing linen and housekeeping clients?

We're still only selling it to the existing housekeeping and laundry clients because there's really enough pent-up demand that we can just address that and there's enough for to us chase without having to go to the outside for the time being. Although if they got the opportunity for a client that was really only interested in food service in the Northeast we would let them pursue it. although the majority of the growth even in the Northeast is still coming from the existing clients.

Got you. Then you mentioned California, I know they've had some issues out there with the budget and they're now getting paid but at reduced rates. Have you seen any pressure with your clients there just in regards to the outsourcing or any worries about credit worthiness? I know it's a fairly substantial market for HSG.

I think for us the tighter they get squeezed, frankly, the better it is for us as long as it's not as draconian enough to put their business models at risk. In California, for example, even though the MediCal rate has flattened out a little bit that's kind of helped us and the clients out there, other than the tug of war with the budget that July, August and September affected the cash flow we had been through that twice before in California, although not as long as it took to settle the budget this time, so it was not the same concern. As soon as they passed the budget they retroactively paid them and then all the creditors, including us, then get caught up and that had been the history and it happened at this time. as well. But I don't see them significantly being under any more cost pressure than ever before, frankly.

Okay, great. And then one last question and I'll hop off. I think this was what Rob was about to ask, even if we add back the $1.9 million in the incremental bad debt due to the bankruptcy I think the gross margin was probably a little bit lower than what we had seen in the past few quarters. Was there anything unique there, maybe the spike in food costs pressuring that division a little bit or labor costs? Anything you would mention that might be driving that a little bit lower? Thanks.

The housekeeping and laundry supplies were up a little bit. You'll see in the Q a couple basis points for no real reason other than purchasing cycles. And the food purchases are up a little bit but we've been -- they've really plateaued to where they had been maybe three or four quarters ago when the commodity costs were really increasing too dramatically. We've just been much more aggressive in getting the price increases from the customers and more timely in doing it than we had been before, so that really hasn't hurt us. We can always be a little more efficient in both those areas that affected the direct cost a little bit, but the significant changes is really the bad debt reserve. So we should be a little more efficient in those areas and expect to. but there was nothing really significant. It was a lot of smaller things that maybe impacted them a little more than they ever could have or should have.

Okay, great. Thanks for the color.

Okay.

Our next question comes from Rob Mains, Please proceed with your question, sir.

Thanks. Yes, Dan, I don't even know how to drop out of queue. (LAUGHTER) Just following up on that question, so when we see the Q is the deterioration -- the sequential deterioration in gross margin, actually the bad debt reserve, you said that's going to be more on the supplies line than the labor line?

Yes. In fact food service -- with the segmented report food service pretax income was up over 40% from the third quarter, so we're progr -- now it was so lousy last year it's easy to increase it, but we're showing the progress and they're getting better and the labor costs are getting spread out over a bigger base as we add more properties because we've had the district and regional structure underutilized and in place already so you'll see that in Q. But I think housekeeping supplies were a couple basis points higher than they had been in the third quarter last year and food costs were a little bit higher.

Okay. And then the housekeeping supplies, just because that's kind of a small part of revenues there, is that going to be mostly chemicals and things like that that were affected by commodity prices?

It's really chemicals, but frankly I think because we added so much new business the last four quarters there were probably more significant purchases than there typically would be on a more ongoing basis. When we start up new places that's usually the heaviest part of the purchases so I think that was part of the impact. But we really can control those pricing, so it's not the unit pricing, it's more the ordering and sometimes there'll be over budget a little bit or there maybe some start-up cost.

Okay, so that's something that with more moderate revenue growth would flatten out?

Yes, or we should improve that as well even without the -- the revenue growth's a nice problem to have and I don't mind investing in the increased supplies as long as we continue to expand. but some of the other things we can do a better job and grind that down a little bit, as well.

Okay, great. Thanks a lot .

Our next question comes from Bruce, Please proceed with your question.

Good morning, Dan, it's Bruce Baughman of Franklin.

Hi, Bruce.

Could you just go back over some of your opening comments having to do with how the credit market conditions have affected some of these line items? I lost my way as you were going through that.

I think our clients are really not that affected by the overall credit atmosphere. I think most of our clients and most long-term care facilities don't have the typical banking relationship with lines of credit. Some do but most do not. They mostly live from Medicare and Medicaid check month to month to Medicare to Medicaid check month to month, so if they do have any financing mechanism it's typically where they factored their receivables as opposed to having a line of credit with a financial institution. So from that vantage point the overall credit atmosphere doesn't typically affect our client. Our credit issues are typically client specific, that I think the last six or seven years there's been a pretty -- since the balanced budget amendment fiasco in '98 and '99 I think the atmosphere has been pretty stable and they're never reimbursed enough according to the providers and the government always thinks its too generous, but I think objectively as an outsider looking in it's pretty stable.

Where we have credit concerns in this atmosphere is client specific, that even in a steady atmosphere a bad operator, either who mistakes operationally or too aggressive acquisitions, outstrip their ability to manage it effectively and that's why we have to look at the credit issues client by client and try to make our assessment more than anything that's going on across the board industry wide. And the two clients that we mentioned really fell into that category in the first quarter of this year that we had to change one and go management and the other we left. But I'd say the last six or seven years we've left more buildings than we did the first 25 years of the Company's existence. When we changed the way we manage the credit and collection, kept the clients on a much shorter string, our bad debt reserve historically had been less than one half of 1% what have we billed and that's still our expectations and target. But when we have an issue like this we have to address it and it certainly impacted us negatively, but I don't see it being an industry-wide issue, it's more client specific. We identified it in the first quarter and they were trying to work out of their problems but had the bankruptcy proceeding happen in September.

Okay. And then in terms of compensation expense, could you --?

The deferred compensation plan that we have for our management people there's an investment in their mutual funds. In the last quarter their mutual funds haven't done that well so it's expensed or credited in SG&A and then the adjustment is made to our investment income line on the income statement. So it's more confusing, I think, than it has to be but the deferred comp for the management people in their deferred comp program, their investments were reduced by $700,000 because their investments went down during the quarter. And then the balance is on our investment income line so it understated our real investment income. I would ad -- if you really were going to compare it accurately I'd add $700000 to the SG&A and add $700,000 to our investment income and that more reflects what our actual expense and investment income was.

Okay, thanks. Thanks for clarifying.

Our next question comes from Eric. Please proceed with your question.

Good morning, Dan..

Hi, Eric.

I just really have one question relative to SG&A. Given your growing revenue and growing the business and the fixed overhead of your corporate level costs and such, how much leverage can we get out of that SG&A line do you think over time if you were trying to look at modeling that?

I don't think that much. If I were going to model it I'd say it's going to stay in the 6.75% range, maybe a couple basis points more or less quarter to quarter. But there's always a reason, either in the divisional offices or not we never have gotten as much leverage as theoretically I thought we should have, but I think it'll stay close to that 6.75% range, at least for the next year or two.

And then -- actually one additional question. It seems to me your biggest competitor may be the administrator that's operating the nursing facility and wants to keep housekeeping and laundry, dietary management in house, are there any acquisitions out there or any other targets out there that you might look at to maybe generate some additional growth?

Our competition is still almost more than nine out of ten times them doing it themselves and we, as the outsourcing option, especially in the long-term care market, but the Arrowmark, Morrison's, Sodexho Marriott really haven't been a factor and focus more on sports complexes, schools and hospitals. So that competitive environment hasn't changed at or to any great degree. But there aren't that many acquisition candidates that really fit our niche and we're really not looking to diversify. If there's small local companies that are in a particular market we would certainly look at them, but I don't expect acquisitions to really be a part of our expansion. I expect it to be organically driven as it has been.

Okay, thanks.

Okay.

Our next question comes from Mitra. Please proceed with your question.

Yes, good morning, Dan. Just a few questions.

Hi, Mitra.

I know you'd mentioned there were two customers in the first quarter had credit issues. Now one went into Chapter 11. Is there any issue or potential issue with the other?

Well, the other customer paid us in full. And even this customer, frankly, had made $300,000 in progress from the original indebtedness. They just didn't make enough progress.

Okay, thanks.

It's a tough call for us, when you have to restructure it, when you leave a client. It's not something we do cavalierly and with the benefit of hindsight you either left too early or should have rode with them a little bit more. So it's not something we do, but we've worked so hard to get the cash balances where they have been. We don't want to go through a similar period like we did in the late '90s when our receivables were about 95 days outstanding that we've made it as a Company policy it's better to leave too early than not and even though it hurts when it happens it's still going to be the way we proceed.

Okay. And with regard to the gross margin, I know you said by first quarter '09 probably see double-digit revenue growth, what is your expectation for the gross margin?

That I think we should still be able to get the costs -- the direct costs down to 85%. That it's 87.5% now so if you normalize our bad debt reserve the 1.5% additional in bad debt reserve from our historical norms this quarter it'd be at a little less than 86%. But there's some improvement still in the food service margins, the districts and regions across the country are still underutilized and we're not doing as many properties as the capacity to manage them will. As the management people get more seasoned we'll add more properties and those margins should improve/ And then the housekeeping suppliers and food purchases we can do a little bit better and get some improvement there, too. So I expect us to be able to get the direct costs closer to 85% and below and over the next year-and-a-half or so, with the primary improvement coming from food service to get it closer to 84% and that's really our target over the next year-and-a-half or so. The SG&A, like I said, will stay in the 6.75% range, a little bit more, a little bit less, but I think there's still margin improvement for to us get, bad debt reserve aside in the direct cost line.

Okay. And again you had a good quarter in terms of the top line, do you sense that in this environment if it's going to get a little easier for you to get new business or really no change?

I think it's more execution. We just put a much more consistent effort in the divisions in more grassroots marketing and sales the past three quarters and I think we're doing a much more consistent job in that area with all the divisions performing. Where we had some corporate clients and other things that evened out some of our valleys and some of the divisions adding new business that I think the attention we're putting in it has been the result of the improved performance more than anything, the industry. The demand for the services -- outsourcing services of all kinds but certainly ours, as well, has never been greater so it's more of our execution and performance as opposed to a fundamental change in the environment and the industry.

Okay. Finally just your thoughts on the reimbursement environment going forward?

First they're locked in pretty good shape with Medicare and Medicaid in most of the states, California being the most significant last one, for the next year, certainly until June, July, and I think they've had a pretty stable reimbursement rate, both Medicare and Medicaid. A lot of the states are around the fringes because of their shortfall trying to make some adjustments in the Medicaid rates, but they already knowledge that most providers lose money on the Medicaid patients and they make -- even though that's 65% of their revenue -- and they make money on the Medicare patients and private pay patients even though that's maybe 10%, 15% Medicare and10%, 15% of their revenue in private paid. So there's not a lot for the states to come back in the Medicaid rate to look to save money there when they already acknowledge that it doesn't even cover the cost because they have to balance the patient care needs, as well. For example, Florida gave no increase for the Medicaid rate for the providers in the summer but as an offset they reduced the required nursing hours so it was neutral to the facility. So those kind of things more than trying to reduce what the Medicaid rate is already when they already acknowledge that it doesn't even cover the cost as it is.

Okay, thanks.

Okay .

We have no further questions.

Okay. Well, thank everybody and we'll talk to you soon. Thanks.

This concludes today's conference. Thank you all for joining. You may now disconnect