Healthcare Services Group Inc (HCSG) 2008 Q4 法說會逐字稿

Good day, everyone, and welcome to the Healthcare Services Group Incorporated reports results for the third quarter of 2008. Just a reminder that today's conference is being recorded. Before introducing your speaker today, the Company would like to read a cautionary statement regarding forward-looking statements.

The discussion this afternoon will contain forward-looking statements within the meaning of section 27A of the Securities Act of 1933 as amended and section 21E of Securities Act of 1934 as amended. They 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, anticipate, 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 statement, whether as a result of new information, future events or otherwise. Such forward-looking statements and 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 counting for approximately 15% of revenues in the year ended December 31st, 2008.

Risks associated with our acquisition of Summit Services Group Inc., our claims experience related to worker's compensation and general liability insurance. The effects of changes in or interpretations of rules 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 for the year ended December 31, 2007 in various parts.

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 and could adversely affect the liquidity of our clients, resulting in their inability to make payments to us on agreed-upon terms. These factors in addition to delays in payment from clients have resulted in and could continue to result in significant additional bad debt in the near future. Additionally, our operating results would be adversely affected if unexpected increases in the costs of labor and labor-related costs, materials, supplies and equipment used in performing our services could not be passed onto our client.

In addition, we believe that to improve our financial performance, we must continue to obtain service agreements with new clients, provide new services through 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.

Thank you. Now I would like to introduce today's speaker, Mr. Daniel McCartney, CEO. Mr. McCartney, please go ahead.

Okay. Thank you. Thank you, everybody, for joining us on this conference call.

We reported our year end fourth quarter results and our 10-k we plan to file in about two weeks, but the release was a little early. We reported revenues were up more than 5% to $154,563 million for the quarter and $602,718 million or up 4% for the year. We continued to make up for the impact of the loss of two of our corporate chains in the first quarter 2008, which we had mentioned in previous releases and quarter. That reduced our revenue $13 million in annualized sales and $3.5 million per quarter. Going into the first quarter 2009. we won't have that comparison to deal with anymore. But, our new business has been steady, especially the third and fourth quarter. And we still expect to be at our double digit revenue target in 2009, and if not in the first quarter 2009, certainly close to it.

Our net income was $7,283 million or $0.17 a share for the quarter or $26,614 million or $0.60 a share for the year. The direct costs were a little bit above 86%. Our housekeeping supplies, food purchases and bad debt reserve were a little higher than historically they had been. Our SG&A for the quarter was 6% and 6.5% for the year. In the fourth quarter, the 6% SG&A also includes a reduced deferred comp expense for the deferred comp balances and investments that took a loss. So it also reduced our net income, had no P&L impact. But that's why it looks distorted.

If you added that back, the SG&A was about 6.5% for the quarter as well. Our investment income was about $2.7 million less than it was in 2007. The balance sheet we ended the quarter and the year with over $87 million in cash and marketable securities. We took about $50 million of our cash balances and put them into income yielding securities, tax exempt, marketable securities just to try to get a little better return. Very short term and very safe, but try to improve the return a little bit. The receivables stayed at 56, 57 days as they were in the third quarter. We still managed the receivables and credit as aggressively as we have the past few years.

I guess in summary, our direct costs were a little bit higher than we expected them to be with the housekeeping and food purchases a little bit higher and the bad debt reserve above our historical levels. We expect still to be able to reduce the direct costs and get them closer to 85% over the next year.

Food service has continued to improve and impact the direct costs in a positive way. Food service pre-tax income was up 15% on a 4% increase in sales. So we expect that improvement to continue as the districts and regions in food service get more fully utilized. And with a little bit better investment income next year and be the beneficiary of easier comparisons, we think, we go into 2009 in pretty good shape.

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

Sir, are you ready to take questions now?

Yes.

Thank you. (Operator Instructions). We'll pause for just a moment. We'll take our first question today from Michael Gallo, CL King.

Hi. Good afternoon.

Hi, Mike.

Couple questions, Dan. The gross margins, nice improvement sequentially from Q3 but still below your longer term targets. Wondering if there is any additional worker's comp or bad debt reserve billed in those numbers or just anything that affected that comparison? Thank you.

The real -- the housekeeping supplies were up about a little less than half a percent and food service were up -- food purchases were up close to a percent. That's really what caused the direct costs to be over 86%. We still -- we expect that to not be on a continuous basis. A lot of new start ups. You have some initial purchases for housekeeping. Supplies, for example. But we expect those expenses to be back to their historical levels and do expect to get below 86%. And frankly, work our way down to 85 in the direct cost area over the next year.

So there's nothing really unusual sounded like just some timing in purchases and things like that? Is that a fair way to characterize it?

Yes.

Okay. And then just second question, obviously everyone's looking at the state budget gaps and California's certainly front and center of that. I was wondering if you have any sense for what might happen from, sort of the state reimbursement side of things, as we head through this year?

I think most of the state budgets, as far as their Medicaid payments, have been put in place. The cash flow issues in California are certainly a different issue, but what we're getting from most of our clients, are they expect to be paid. Not like in the summer where the budget impasse precluded them from passing the budget until almost October and they didn't get any funding. They still expect to get paid. So with maybe some slight disruptions, we don't see that really as being a problem for us. California being, the most egregious. But all of the states are at least rhetorically talking about the same kind of issues, but I think the Medicaid rates have been set, unless there's an acute cash flow issue state by state. I really don't think it'll impact us to any great degree.

Okay, and just any further comments just overall health of the customer base? Obviously, you had those, two customers that you left earlier in the year, and so haven't had any significant new issues since then. Any kind of update on where things are in terms of do you see anything problematic in customer base or it's pretty much things pretty much the same?

I think our issues are still customer-specific that state by state, you hear a little bit different rhetoric as far as what their deficits are and how it's going to impact future spending. But the way we've managed the credit really the last seven or eight years is we really look at it rather than in the aggregate customer by customer and try to make our judgments like we did the first quarter 2008.

If a client's getting beyond the terms we feel comfortable with and we're not comfortable with the explanation or their projection on when they'll get back to the credit terms, we still keep the clients on a shorter string and leave buildings faster than historically we ever have. We're going to continue to do that regardless of the state issues. If it becomes more acute because of specific states we'll assess that but we really don't see that being the case for the time being anyhow.

Okay. Thanks a lot.

Okay.

Up next we'll take a question from Ryan Daniels, William Blair.

Yes. Good afternoon, Dan. Just a couple of quick follow-ons. First off, sticking with the change that had issues earlier in the year. I know there one was entered bankruptcy in September. I was curious if you had any updates there regarding recapturing some of your accounts receivable or if they've gone to the creditors committee yet, where does that stand and what are your thoughts there?

Haven't yet but they had an exclusivity period to put their plan together. That's been extended twice. Now it's to be extended till the end of February. They're still saying they expect in the reorganization to give the creditors an option to either be paid in full over a period of time or take a discount up front which, we'll assess when it's put in place. So they're not saying anything different but the plan hasn't been submitted to the court yet. So until that happens, we're going to keep the reserve as it is and not look until we have more definitive recovery options to assess to determine what we should do.

Got you. So maybe some '09 upside but at this point just wait and see?

Yes.

Okay. And then in regards to the market, if we look at the macro environment and unemployment spiking up recently, does that position your organization better on the hiring front, on the retention front? Are there somewhat counter cyclical advantages to your model almost that will allow you to continue to grow through this period?

I think what'll happen for the most part and it'd be around the edges, it won't have any dramatic impact. Because we match whatever the wage rate or benefits are that the facility pays, perhaps the future increases won't be as generous as they have been in the past won't be as generous as they have been in the past because the labor market is changed to some degree. But I think that's going to be specific in different areas, too. I think some will be impacted more. Others to be competitive will still have to give the kind of increases they've given before. So I don't think it's going to help or hurt to any great degree. If I had to say on which side of the ledger, I'd say maybe the increases that customers give their blue collar workers and therefore the increases we would look to get may be a little less than they have been in the past. But I don't expect them to be too much.

And that would impact your pricing and therefore revenue growth a bit but probably wouldn't touch your profitability whatsoever, is that fair to say?

Yes. Instead of getting a 3% increase across the board it may be 2 .5 because they feel to be competitive you only have to give that kind of wage increase.

Sure, okay. Can you talk maybe about the proposal pipeline? I think you've stated in the past it takes around 60, 90 days from the time you enter a facility to where that might actually be in operation and generating revenue? So any color there of how you ended the year maybe how you are starting '09 given the pressures on your clients? Is it still a good selling environment for you?

I think really the last -- the third and fourth quarters were the best quarters we've had in a long time and the new business we've added in the fourth quarter will have the full benefit of the first quarter. So we think if we're not at double digits by the first quarter, we'll be very close to it as far as revenue growth. And we don't have then the facilities, the two chains that we discussed from the first quarter 2008, hurting the comparison after the first quarter.

Right. Okay, great. Two more quick housekeeping ones. I don't know if you have this offhand but do you have the breakdown between food and housekeeping/linen laundry revenues? Or maybe just food revenues?

Both been about 4% or 5%. They're both in the same neighborhood for the year. Food service is probably a little bit higher in the fourth quarter.

Okay. That's helpful. Total number of clients, do you have that offhand?

It will be over 2400.

2004. Okay, great. Thanks. Nice quarter.

Thanks.

Your next question today will come Mitra Ramgopal of Sidoti.

-- ability to hire personnel?

Mitra, we missed the first part of your question.

Yes, hi, Dan. Given the environment out there, I think one of the things constraining your growth is the ability to hire personnel. Are you finding it a lot easier now to recruit and likely accelerate your expansion?

I think we've -- we're really not affected. The management development for us is where we've concentrated our efforts, and that's always been a constraint on our growth. So we're really not affected to any great degree by any macro employment sense. It's really the profiles that we've been able to procure really are dependent on us getting them through the orientation and training more than them being committed. I can't work in the financial community now so I'm going to look at different options and perhaps end up in the service area and the healthcare field.

The candidates we still look for really pro or con are not affected to any great degree by the macro sense. Maybe modestly. Our success is really getting through that 90, 120-day period and being in a position to get through the difficult parts, and to understand our business and be skilled and entrepreneurial enough to start up. And because we're committed still to promote from within, there's just no shortcuts for that. So it may modestly improve the candidates or the amount of candidates we get but it's still really up to us to efficiently run the training program which will dictate our success more than any overall labor view.

Okay. If you go back in '08, I think the top line grew about 4%, and you seem pretty confident that we should be seeing double digit top line growth for '09. I don't know if you can give us a little more color in terms of what will help us to get there?

Well, I mean, I think first of all we just have to hit our targets. If you have facility expansion, keep our client retention where it should be. What hurt us, if you just add the $13 million in sales that the two chains hurt us for the year or $3.5 million per quarter that we had to make up, you add that back to it, and that's more our typical year and it puts us close to double digits even in 2008.

So that's why we feel more optimistic and have always, even though maybe the results hadn't always shown it that we would get back. It would just take ace couple quarters to get back to the double digits 10% to 15% top line that we try to target internally.

Okay. And did you buyback any stock in the quarter?

In the quarter I don't think we did. I think we bought back a little less than $5 million in stock for the year, but I don't think we did any in the fourth quarter.

Okay. Thanks again.

Okay, thanks.

Next up we'll hear from Rob Mains, Morgan Keegan.

Good afternoon, Dan.

Rob.

You said food costs went up. What was that related to?

I think we had a lot of new start-ups and the prices plateaued a little bit, but perhaps with the new start-ups they just spent about -- almost a percent more than it had been in the previous quarter. It's still below 40%, but we were down around 37.5 in our best days. So we still expect it to be below 40%. But, I think there were a lot of new start-ups where we do our original -- or the bulk of our start up purchasing both in food and housekeeping and laundry. I think that more than anything contributed to the increase in the expense.

Okay. So it's analogous to the growth with the housekeeping and supplies expense?

Yes.

Okay. The retention rate in the quarter was that still within the targets?

Yes. That was better than 90%. The first quarter 2008, that was just unusual to have that many properties affect us. It put us behind as far as the revenue growth and impacted us until we worked those quarters out.

Okay. And when you look at the new contracts that you signed in the quarter, was there a typical breakdown between food and housekeeping or is one stronger than the other?

No. They both were in the same category. The difference is the food service has a bigger impact because it's double the revenue. And secondarily, the food service expansion that we're concentrating on are primarily in the northeast part of the country where there's higher wage rates so they're higher valued contracts than if they were in other parts of the country where the wage rates are lower. So, I think in 2009, you'll see food services growth be a little bit more accelerated than housekeeping and laundry because the area that we're concentrating on for housekeeping and laundry are growing throughout the country. So the same amount of facilities won't have the same impact.

Okay. What's the food service geographically, do you think that the growth we'll see this year will be still mostly in the northeast or looking at opening up some of the other regions?

We're growing in the other regions, but the ones that we're really letting be more aggressive and fully ramp up as far as the district and regional coverage are in the northeast because that's where we have been the strongest. The southeast is a little farther behind. The midwest is coming along maybe faster than the southeast in some areas, but both still have good potential. And frankly, the far West which is our newest area, was performing better than expected.

We haven't added new business yet, but as far as consistency and performance, they've really done a good job out there as well. But hard growth and food service will primarily be in the northeast although the other areas will add some new business just by being around.

Okay and then last question, on the balance sheet, any kind of idea about what the investment in the marketable securities might be able to do for investment income?

It'll be modest. It'll be some. It'll be a better return than we've gotten where we've had it before, but it won't be dramatically different. But it's hard -- I'll have a better feel for it when the k comes out.

Okay. Fair enough. Thank you.

Okay. Thanks, Rob.

Up next, we'll take a question from Eric Gommel of Stifel Nicolaus.

Hi, Dan.

Hi, Eric.

Hi, I don't you might have addressed this -- you did -- I think you said SG&A was 6.5% of revenue.

Deferred comp back, yes.

Okay, so in '09, I mean, I think you've talked about it being around 6.75% or 6.5%, I mean how do you think about that?

That's where I think it should be. If I were going to model it, shouldn't be higher than 6.75, but we could get some efficiencies and you could make the argument the overhead's spread out over bigger base should reduce. But we hadn't done it consistently, so I always use 6.75, a couple basis points more or less quarter to quarter is the target. But 6.5 to 6.75 is probably a safer target.

And then if I think about the quarters next year, I mean just to sort of sequential ramp up, maybe first quarter to fourth quarter,is that the right way to think about it? I think this year was a little bit more lumpy because of those issues you were talking about.

Yes. I think if you look second, third, and fourth quarter, we just continued to expand, just not as rapidly as we would have liked. When you dig a hole, that's such a significant to clients change their relationship in the first quarter, you just don't make it up. So as we continue to ramp up over the quarter, you start to recover. But I think going into the first quarter we'll be in good shape. We expect -- we hit our targets, keep the client retention where it should be. We should be back to our double digit target in 2009.

Okay. And then just a couple other little things. I mean, I get it from some of your comments that on the worker's comp side, no significant spikes or issues there?

The workman's comp was really a third quarter aberration so you expected that to go to historical levels. The direct cost were really impacted by the purchase of the housekeeping and food supplies more than anything.

And then the last thing, this is more of a big picture issue. I mean do you have any concerns with the new Administration that's maybe a little more pro labor that you're going to have any issues I mean from an organizing standpoint? Is that something you really don't have to worry about given, you're just -- you manage -- you are in charge of the managers, they manage the employees, it really doesn't impact you. How do you think about that?

We really don't manage the facilities differently. And if the facility is unionized, we assent to the contract and we're happy to abide by the union contract. If it's un-union, we match the wage rates and benefits as well. So it really doesn't impact us. Frankly, I know it's counterintuitive, but the more the employees get paid, the better it is for us.

Okay. Fair enough. Thanks, Dan.

Thank you.

Our next question today will come from Clint Fendley, Davenport.

Good afternoon, Dan.

Hi, Clint, how are you doing?

Doing well.

Good.

Wondered -- we did see a bit of a drop on the accrual for the insurance claims, I wonder what the reasoning for that was?

We perform better? I said -- you mean for the quarter, right?

That's correct.

Yes. I think the third quarter was just we had an unusual amount of claims. And we paid them off and we make our calculation or [Zurich] does of what the ultimate claims will be. And so we just had better claim experience in the fourth quarter than we did the third.

Okay.

We really expect it. I mean I think I said in the third quarter we had an unusual amount of claims from our historical levels.

Okay, and a higher level question here. I guess budgets are just expected to be under tremendous amount of pressure in almost any business in '09. I mean how does that affect both the value proposition as well as the decision making on the part of your customer base as they consider outsourcing?

Well I think for us the tighter our clients get squeezed, the more they look for outsourcing services of all kinds not just ours that can do it in a cost-efficient way. So I think from that vantage point, the tighter their budget pressures become, the more they look for outsourcing and really the better it is for us. We just have to make sure we manage the credit the way we have the past seven or eight years and not allow us to be the bridge to those budgetary differences.

That's why we've left more buildings the last six or seven years than we did the first 25 years of the Company's existence, but that's why the receivables have been below 60 days for the last seven or eight years. So in a summary, the tighter they get squeezed, the better as long as it is nothing is draconian as 1997, '98, '99 during the balanced budget amendment fiasco that impacted the industry so badly.

I may have missed it in the intro, but the DSOs for the quarter were?

57 days. A little less than 57.

Okay. Great. Thanks, Dan.

Okay.

(Operator Instructions). Next up we'll go to [Brian Sells, Peak Financial].

Hi. Quick question on the dividend. Is it the Board's policy or has the Board's policy changed at all in terms of how much it wants to pay out?

No. I think we really look at it every quarter, but we've we earned $0.60 and we paid out $0.58 in the dividend last year. I think with our balance sheet although it will be reviewed every quarter by the Board, we expect to be in a position to be able to distribute our earnings to a greet degree to the shareholders.

But in terms of policy, is that something that one would expect to continue to try to pay out as much as possible?

It's not a policy, but I would say that's a reasonable expectation.

I understand. Great. Thanks very much.

Okay.

(Operator Instructions). And Mr. McCartney, there appear to be no further questions. I'll turn things back over to you for any additional or closing remarks.

Okay, guys. Than you for -- like I said the 10-k will be filed in two weeks. Thank you for joining us for this conference, and onward and upward. Take care. Thanks.

Once again, everyone that does conclude today's conference. Thank you all for your participation and have a great day.