Healthcare Services Group Inc (HCSG) 2009 Q1 法說會逐字稿

Good day, and welcome to the Healthcare Services Group first quarter 2009 earnings conference call. Today's conference is being recorded.

During the course of the upcoming discussion we may reference to or make forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended, and section 21E of the Securities Exchange Act of 1934 as amended.

Such statements or references 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 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 14% of revenues in the three-month period ended March 31, 2009; risks associated with our pending acquisition of Contract Environmental Services, Inc.; 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, 2008, in Part I under Government Regulation of Clients; competition; service agreements collections; and under Item 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 threaten to alter overall government reimbursement funding rates and mechanisms. In addition, the current economic crisis could adversely affect such funding.

The overall effect of these laws and trends on the long-term care industry have affected and can adversely affect the liquidity of our clients resulting in their inability to make payments to us an agreed-upon payment terms. These factors in addition to delays in payments from plants, 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 agreement 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 project (technical difficulty) strategies -- growth strategies.

At this time I would like to turn the conference over to Mr. Dan McCartney, CEO.

Thank you, and good morning everybody and welcome. Thanks for joining our conference call.

Our 10-Q will be filed by the end of next week, but yesterday we released our first-quarter results. We reported a revenue increase, 9%, to $160 million. Housekeeping and laundry were a little bit less than 6% of the increase and food service, about 25%.

Our net income increased 13% to $7.7 million, or $0.18 a share.

The margin improved with direct costs coming below 86%, and the SG&A in our normal target of 6.75% with the deferred comp component really being more stabilized in the first quarter than it had been in the past.

Our investment income improvement reflected the change from the overnight investments we had to short-term investments, and we are the beneficiary of the rates giving us an improved investment income.

We still look to improve the direct cost over the next year, year and a half, and expect quarter to quarter to be able to try to work it down and get it closer to 85%, the SG&A we believe staying in the 6.75% range.

We had some efficiencies in food service with the new operators in the districts and regions primarily in the Northeast being were fully utilized. And that should continue to improve.

Our balance sheet, we ended the quarter with $96 million in cash and marketable securities. Still have no debt. Our receivables were still below 60 days at 55 days. And we increased the dividend for the 24th quarter consecutively to $0.18 a share.

In addition, we announced the acquisition or the purchase of assets of a privately owned company in the Southeast, CES, for about $15 million in consideration, $5 million of which is purchase, $5.5 million is debt, and a [320,000] (technical difficulty) shares of our stock. A privately owned company located in the Northeast servicing about 75 facilities of which they do food service in 43 of them.

We expect to be able to have them folded into the Company and be a good addition to what we are doing. The people were good people we think will fit in well with our Company and be able to add some resources in the Southeast and continue to allow us to expand there. There [it] should do a little bit better than $40 million in revenue, and we expect them to be accretive to earnings per share in the first quarter. The closing date is May 1.

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

(Operator Instructions). Mitra Ramgopal, Sidoti.

Again, just starting off with the acquisition, and as you look to integrate it, you already have facilities in both states where they are largely concentrated. So is there a lot of synergies you can realize from the transaction?

I think our plan is for some SG&A benefit, but operationally they have done a very good job, and we expect them to be able to continue to operate and get the benefit then of our divisional structure there as an additional resource, but to be able to have them continue to operate as their own division. And as we add resources to assist them and get the benefit of what they can contribute to the division, we think it will mesh well. But there are some areas we think down the road as far as mostly in overhead and SG&A that we will be able to get some improvement.

But I think that they've mirrored kind of the approach in operation that we've tried to take, and that's what made it at least more interesting to us as well. So we're going to let them operate and try to make the additions and improvements as we get to know each other and go along, go along.

Typically you don't do a lot of acquisitions. Are you seeing, as a result of the economy, you're getting more interest in terms of operators looking maybe to cash out or consolidate?

We really don't see acquisitions as being a significant part of our expansion -- as it hasn't been in the past, as you said. There aren't that many acquisition opportunities that fit our niche, so we're not really looking to diversify, whether it is commercial cleaning with a few healthcare facilities and the like.

Secondarily, there aren't that many in the areas that we are looking to expand. So we expect our growth to continue to be organic. The last acquisition we did in 2006 fit this criteria. And then three years later after long discussion and getting to know each other, the time was right for them and for us, so that is why we pursued it. But I wouldn't expect acquisitions to be a significant part of our expansion going forward.

If we see the opportunity and the circumstances are right, we certainly look at all of them, but we expect our expansion to be organically driven.

Than just coming back again to the first quarter, the revenue number was the best we have seen in some time. Anything in particular that led to the improvement?

I think for us -- those of you who remember -- the first quarter there were (technical difficulty) two chains of 2008, two chains that we had some issues with and left. That put us short of what our objectives were for the growth in 2008. So as long as we continue to expand quarter to quarter, get the client retention where it should be -- and those two chains were really an usual circumstance -- that we left -- that cost us about $13 million in revenue. You just don't make that up as instantaneously as some would like. But we've built it quarter to quarter, and we fully expect it to be organically back to double digits in 2009, and that is where we were.

So with or without the acquisition we would have been in that 10% to 15% top line that we try to target in 2009, and it was really a matter of making up the effect that those two chains had on us going into last year.

But even there from the fourth quarter we saw a nice ramp in revenue.

Yes. But I think that is our normal marketing effort, and sometimes you get a little hotter than others. So quarter to quarter it is more difficult for us to control it. But 10% to 15% top line is still our target. It is not like there is any increase in demand that we can see, although outsourcing has never been more accepted in the industry and more in demand -- for all kinds of services, not just ours.

Ours is more a matter of execution, consistently having our name out, growing with the existing clients, and having a consistent regional marketing and sales effort. Then if we do the fundamentals, then the results start to catch up to where we think they should be.

Finally, again, if you look at the gross margin and SG&A, the first quarter, would these be good numbers to look at going forward and maybe some improvement off of them?

Yes. We really hope and expect if we execute properly that we can keep improving the direct costs and get them closer to 85% over the next year, year and a half. I know I have spoken at length at different times about the investment we made in the middle management people in food service, and as we add more properties we will get the benefit of that investment in management people without the proportionate cost. But that will be incremental quarter to quarter. For example, a lot of the food service business we added, it's in the Northeast where those district and regional managers will now be more fully utilized -- as we model it, eight to 12 facilities per district, four to six districts per region -- because we are adding the properties now.

So that is where -- there is always efficiencies in housekeeping and laundry where we can do better, but we think the substantial improvement in the direct costs is going to come as food service becomes more profitable and that their margins start to mirror housekeeping and laundry's.

(Operator Instructions). Ryan Daniels, William Blair.

It is Kristina Blaschek for Ryan today. I guess Dan, to start, can you comment on contract retention during the quarter? Any new customer additions in pipeline?

Our client retention was really above or better than the 90% that we have always targeted, so we're very happy with that. In fact, even last year when -- putting the first quarter and those two chains aside, which made it unusual -- our client retention after that was better than 90% as well. So as those of you who know the Company for a while know, that that is really a founding block for us to maintain the client base more solidly so we are not in a position to keep out-selling our mistakes. But -- so we are very happy with the client retention.

As far as the pipeline and new business, I think we have been more consistent the last five quarters really with having regional attention and the right amount of proposals locally than we have been in years past, where we are the beneficiary of more corporate type of clients with momentum within organizations. So we're very happy with the attention that is being done regionally as far as the marketing and sales effort locally, and we haven't abandoned or seen a diminishing in the corporate account momentum either. As you guys know, we sell the corporate accounts, property by property as well, with separate service agreements, separate bidding structure; and we continue to do that.

So we are happy with the pipeline, the amount of proposals being delivered and the closing rate. We just have to execute and consistently have that done quarter to quarter rather than at sometimes we lost a little momentum and maybe chased the big fish too many times without the local and regional type of firms. So we are really doing both.

And the demand, frankly, has never been greater, but that has never been our issue. It is really execution for us. There is really more business than we can really do, and the constraint on our growth still remains development and management people.

That's helpful. Thank you. Do you happen to have a breakout of the -- how many clients you had in the housekeeping and food services segment?

No, but it is over 2400.

Over 2400. Great.

And we are doing about 315 and food service.

Then I guess moving on, can you comment on the environment a little bit more, and market health. I guess what I'm trying to get a feel for is have you seen any issues with the health of your clients, or have you -- or do you have any comments about the impact from the Medicaid stimulus?

I think for us, in spite of the political debate back and forth, I think in the aggregate the atmosphere remains relatively stable for operators. Now you may not hear them concur with that because they are always feeling reimbursement isn't sufficient enough and the government is always saying "waste, fraud and abuse." But I think they've been pretty consistent, and in a stable environment for the last few years I think some of the state budgets that were having difficulty that could impact our clients next year are being supplemented by this stimulus package -- whatever you think of the validity of it.

California in particular, getting money. And after their budget fiasco last summer, which impacted a lot of our clients and delayed the passing of the budget really three months from its deadline, there was some rumor or buzz that they were going to be short, their reimbursement from a cash flow standpoint, California would be unable to pay healthcare facilities at the end of March. That didn't happen, and they've paid and made the announcement.

So there is always those kind of state-by-state issues that we deal with, but I think overall the government acknowledges that they don't pay long-term care facilities enough, especially through the Medicaid program. Medicare they are always trying to adjust around the edges -- it appears to us as outsiders. And if they acknowledge already that they don't pay them sufficiently to cover their costs, it is really difficult for a state to look for savings by reducing the Medicaid cost to the most vulnerable of patients.

So in spite of the publicity and the rhetoric, I think the issues are not going to affect our clients to any great degree, state by state or federally through the Medicare program.

That is helpful color. I have one last question, Dan. Can you help us understand a little bit more on how nursing home wages -- and specifically how a change will affect your revenue? So I guess, for example, if there was a 3% increase in wages in 2008 and we expect only 2% this year, does that correlate to a 1% decrease in revenue that you guys will receive?

No, because our contracts and because our approach as far as management is to mirror what the facility pays as far as wage rates, conditions of employment, and benefits -- which is somewhat different than maybe other service companies that have their own wage scale and conditions of employment -- when the client gives an increase to their blue-collar workers, we expect the same increase on our contract, give the same increase to our blue-collar workers. If they change the benefit plan, then that triggers the pass-through clauses as well and gives us the right to go back and get it to the client. So it allows us to keep pace with whatever the labor conditions are because the client's impacted by the same.

And if they determine to be competitive in their particular labor market they have to give a 5% increase, it triggers our pass-through [clause]. If their increases are more modest, then they're not going to give the same kind of increases, but then neither will we. So it protects us on both ends, and from the client standpoint it gives them the comfort. There's no surprises that we are asking for a bigger increase than they expected because they really control what our increase is going to be. And had we not been there, they would be giving those same increases to the housekeeping and laundry employees, for example, if they were doing it in-house. So it is fair to the client as well.

Michael Gallo, C.L. King.

The question I have is on the food service side. We see now two quarters in a row where the food service growth has started to accelerate. You have talked about adding in some regions again. Are we getting to the point where you're comfortable enough with the margins in food service where we will start to see later in the year more of a full-scale push on food service? Or do you still plan to hold off in some regions?

I think we still plan to hold off. We will be able to better assess that at the end of 2009. The primary growth driver in food service has been in the Northeast division, where -- and somewhat mid-Atlantic -- where we were the strongest managerially. That is where we started. That is where the management people had more depth. So that is where the bulk of the expansion had come from.

The Southeast, I think, is making progress but never as fast as we all would like. The Midwest is in a stage where they have stabilized and are doing better. And the far West, frankly, in food service has done better than we expected, so they are almost in a position world they will be able to grow a little bit faster.

But I would say that we really don't expect food service to be significantly expanded until maybe the end of 2009 when we can say, now we have a national organization in place, every division is sufficient enough to take advantage of the opportunities, we will take the shackles off them and let them sell it to anybody -- where right now we are still only selling it to our existing clients, even in the Northeast, because there is enough demand within our existing client base for us to achieve our growth.

So I would say we will grow it 10% to 15%, maybe 20%. It is a smaller base so it is easier to have the impact in food service just by being healthy and being in the marketplace. But I think at the end of 2009 if we do the right things, we will be in a position where I could confidently say, okay, now we can expand it were rapidly.

It just sounds like -- if I am reading you right -- that incrementally as we go through the year, we may see additional regions, it sounds like, such as the West starting to add facilities as well? Is that (multiple speakers)

You could. I will update everybody quarter to quarter on the progress of that as much as I can. But if I were going to project out, I wouldn't look for any of the other areas significantly to expand until maybe the summer or the end of the year.

Then just final question, any update on potential recovery on some of the bankruptcy of the old customer last year?

No. I am hoping these clients would go look for a government bailout where they would have additional funds to help pay us. But none has been forthcoming yet. So they are still in bankruptcy. They haven't put their reorganization plan together, frankly, and have gotten another extension -- against our objection, frankly. But we will just play it out and see what the recovery is.

Kirk Streckfus, Stifel Nicolaus.

Good morning. This is Kirk Strekus in for Eric. Just two quick questions for you. You discussed the acquisition of CES here. I was just wondering if -- could you give us an idea of how quickly you could integrate this into your existing operating structure?

Well, they are going to be run as a division of Healthcare Services Group, May 1st, which is our anticipated close date. Then they are going to operate as a division like the other six divisions, handle their clients in the fashion that we collectively do. And administratively they're going to run their area as they had and as there are efficiencies to be able to eliminate some of the overhead in SG&A -- not the operational approach. We will be able to do that collectively going forward.

But they are going to be run as a division of the Company, day one, and we expect them to be accretive right away.

Just one other question. Are there any new developments with regards to the Golden contract?

No. We don't have a Golden contract. We have separate service agreements for all Golden living facilities, some of which who have been clients for 25 years. So the change in their corporate structure for Manor Care, for Genesis, for Sun, for Golden Living, for any of them really don't affect us because they are all separate service agreements with each property, with 30- to 90-day cancellation clauses by either party. So they are all at-will contracts.

So the decision making was really done in the field as opposed to corporately with obviously in some organizations corporate approval. But we never felt exposed corporately because we never sold that way, and we are only at the property servicing them like an individual operator, because the administrator or owner see us in their best interest, not because of a corporate policy.

Rob Mains, Morgan Keegan.

It has been a few years, but if memory serves, when you did the Summit deal, since you had to integrate their operations into yours in a number of regions, I think that you slowed down external growth a little bit while that was going on. Can I surmise from what you're saying that since CES is going to be its own division, this shouldn't affect your operations outside?

I think that's right. Also, the Summit impacted other divisions. So all of them were stretched because they were spread out in other states, although their primary concentration was in New England. They had properties throughout the country where CES's client concentration is mostly in one area. So perhaps because we are running it as a separate division but we are also going to give them the support needed and get them acclimated to us and vice versa, perhaps the Southeast division may not grow as quickly as it would otherwise, but the other areas are going to be unaffected, and we still expect to be able to hit our growth targets organically as well.

Then Summit I know is modeled after your management structure. How much of a translation is it going to be for CES?

I am sorry. Say that again, Rob.

Summit's management structure I recall is modeled very similar to the way that you run things.

They're modeled very similarly as well. The right kind of hierarchy, good individuals, people that we think fit in well with our Company. So we are optimistic that it would and should be -- if we all hold up our end -- a relatively seamless transition. That is what made it attractive to us other than the other factors we considered.

Right. Then just for modeling purposes, assuming that they hit their earnout targets, when are those payable?

Four years.

Spread over four years?

Yes.

And then last question, last quarter you had -- your supplies expense was a little bit higher than where you wanted it to be in both housekeeping and food services. Can you give us an update on where it came in in the first quarter?

It will be a little -- it won't be as high as it was the fourth quarter. It is still a little bit higher than it normally is. When we had that many new startups, that is really the worst as far as our purchases are concerned, to replenish the inventory, to make sure it's hit the levels that we need -- whether it is linen inventory, housekeeping supplies, food inventory. So both areas are still -- when you see the Q -- it is a little bit higher than historically it has been, but that is because of the amount of new business, and we expect that to level off and come back to our historical norms in those areas as well.

James Terwilliger, Duncan Williams.

Real quick, my first question is on the gross margins. You did 14% for the quarter. And while year-over-year that was down by 50 basis points, there was a substantial increase from Q3 and Q4. So could you provide any color or visibility into what happened in the Q1 gross margins? And also, what should we be looking for for gross margins throughout 2009?

Well, we screwed up in Q3, Q4. But seriously, we were impacted by an increase in bad debt reserve, which we don't expect to continue to have that impact. As we added more a food service, we were able to get the benefit of the district and regional management investment that we made, the better utilization of those people as they added more properties, because we are already eating the expense. So if we do the right things, we think we can get the direct costs to improve quarter to quarter and ultimately get them down to 85%.

Is the 14% a good number to run for 2009, 14%?

We will do better, but it is certainly a safe number.

All right. Was there anything in there in terms of price increases in the new years, or wage increases that are significant? Or not really?

We have those on a continuous basis, but I would say because, depending on the customer, when they give their increases and when it impacts our pass-through clause, but I would say maybe last year they averaged 2%, 2.5% -- some a little bit higher, some a little bit lower. But I would say the average is maybe 2%, 2.5% as far as increases are concerned and therefore the proportionate of wage increases.

Could you provide just a little bit more visibility on the acquisition? And what I really mean there is if you could speak to some degree on the acquired company's gross margin, operating margin, and net margin as relates to your own.

Say they mirror ours.

So very similar as we model for that that the margins won't have a significant impact either way?

That's right.

Could you -- I think you said this and I missed this and I apologize. Could you go back and provide any additional color on the revenue growth rates for both food services, and laundry and housekeeping, and any significant changes within the gross margins of those two divisions?

Housekeeping was a little less than 6% of the growth, and food was about 25% of the growth. The margins improved modestly in both. I think they will improve more dramatically in food service as a lot of the new business came on-budget and the initial investment in inventory replenishment is more spread out to a normal level. But both -- the margins in both improved some, and food service has more room to improve.

Thanks. I know you said that earlier. And the last question -- the interest income was, in my opinion, a great number. What happened there, and what should we look for there going forward throughout 2009?

I think this is the level we should expect, we expect. But the real change was, we had it in overnight stuff for years and years, and as the returns became less and less it forced us to do something we probably should have done earlier. It is still in short-term, safe -- in short-term investments, but we are getting a much better return than we did in the overnight stuff that we had the money in.

Thanks. There is no distressed debt or auction rate securities there; correct?

No.

Matt McGeary, Sentinel Investments.

My questions have been answered. Thanks so much.

Clint Fendley, Davenport.

Most all my questions have been answered. I may have missed -- the DSO number for the quarter?

Was about 55 days. As long as it stays below 60 we feel comfortable, but it was down a couple of days from the fourth quarter, but it was 55 days.

That is all I had. Thank you, Dan.

Christian McCall, Arundel.

What was the cash flow from operations in the quarter?

I am sorry. Say that again.

What was the cash flow from operations in the quarter?

Well, you'll get the 10-Q out, but it was 16 -- a little less than $17 million.

There are no further questions. Mr. McCartney, I will turn the conference back over to you for any closing or additional remarks, sir.

First, thank everybody for joining us. I hope these are becoming more helpful and -- now that I am used to them a little bit better -- giving you more information.

But frankly we have controlled our expansion. The quarter continued to show progress in our controlled expansion. We improved the margins. I think generally the industry -- in spite of some of the political debate and publicity -- is relatively stable. From our vantage point, outsourcing of all kinds, because of the cost containment environment, has still never been more in style or more needed in the industry. So it has created opportunities for outsourcing companies of all kinds, including ours. Our management people have continued to improve and get better.

So for us, with all the demographic factors and the graying of America, cost containment pressures these -- our clients are feeling haven't changed any. These are pretty good times for us. So thank you, and onward and upward.

That concludes today's conference. We do appreciate your participation. Everyone have a great day.

Thanks.