Healthcare Services Group Inc (HCSG) 2009 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Healthcare Services Group, Inc. third-quarter earnings conference call. Today's call is being recorded.

During the course of the upcoming discussion, we may make reference to or state forward-looking statements within the meaning of Section 27a of the Security Act of 1933 as amended and Section 21e of the Securities Exchange Act of 1934, the Exchange Act as amended. Such statements or references are not historical facts but rather based on current expectations, estimates, 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, further 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 provided 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 13% of revenue in the nine-month period ending September 30, 2009; risks associated with our acquisition of Contract Environmental Services, Inc., including integration risks and costs; or such business not achieving expected financial results or synergy or failure to otherwise perform as expected; our clients' experience related to workers compensation and general liability insurance; the efforts of exchange in or interpretations of law and regulations regarding 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 ending December 31, 2008 in part one under government regulations of clients competition service agreements, collections, and under item 1a, risk factors.

Many of our clients' revenues are highly cognitive on Medicare and Medicaid reimbursement funding rates with Congress such affected through the enactment of a number of majority laws during the past decade. These laws have significantly altered or threatened to alter all government reimbursement funding rates and mechanisms. In addition, the current event economic crisis could adversely affect such funding. The overall effect of these laws and traits 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 payment terms.

These facts in addition to delays in payments from clients have resulted in and could continue to result in significant additional bad debts in the near future. Additional or 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 service to existing clients, achieve modest price increases on current service agreements with existing clients, and maintain internal cost reductions or strategies as our various operational levels. Furthermore, we believe that our ability to sustain the internal development of managerial persona is an important factor impacting future operation results and successfully excluding projected growth strategies.

I would now like to turn the conference over to Mr. Daniel McCartney, CEO. Go ahead, Mr. McCartney.

Okay, thank you and welcome, everybody. Thank you for joining us on our conference call this morning. Yesterday afternoon after the close we released our third-quarter results and we plan on filing our 10-Q by the beginning of next week.

But a summary of the results, third-quarter revenues were up 17% to $178,829,000. Of that increase, $16 million or 11% was organic and about $10 million or 6% was due to the acquisition. Food Service revenues were up about 43% and Housekeeping and Laundry revenues were up about 10%. For the nine months, our revenues were up 14% to $510,000 -- or $510 million.

Third-quarter net income was up 49% to $8,225,000 or $0.19 a share and for the nine months, net income was up 23%, $23.776 million or $0.54 a share. On the income statement, the revenues are a little bit higher than the 10% to 15% that we have historically tried to target. It is manageable and it's a little bit above the 15% threshold, so we feel comfortable it's not too aggressive to where we would be concerned about our ability to manage it effectively. But it's close, 10% to 15% is still our internal target where we feel best served with revenue growth.

The direct costs were a little bit higher than they historically have been and the primary reason for the increase was an increase in Housekeeping and Food purchases due to a disproportionate amount of new startups and getting the supply levels up in the CES or acquisition facilities to the levels that we typically target at the properties as well. We expect those purchases to be back down to their historical levels and the direct costs to get below 86% again.

The SG&A was 6.75%. We have eliminated some of the corporate duplication that we experienced in the second quarter with the CES acquisition and the SG&A line should really be adjusted as well for the gain in the deferred comp, which for the quarter was about $932,000, so the SG&A should be really reduced to reflect what our real expenses were by $932,000 and then the investment income should also be reduced by the same amount. But the earnings from operation were even stronger than the face of the income statement. The SG&A with that adjustment was about 6.3%, a level I don't know that we will sustain, but certainly it should be below 6.75% going forward as well.

The balance sheet, we ended the quarter with over $88 million in cash and investments. The receivables were under 60 days, in fact down to 54 days and we increased the dividend for the 26th quarter in a row to $0.20 a share.

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

(Operator Instructions) Ryan Daniels, William Blair.

Good morning, Dan. A couple quick housekeeping questions up front. I don't know if you have this available, but you mentioned the Food Services was up in the 40% range and Housekeeping and Linen and Laundry up about 10%. Do you have that broken down so that we could see the organic growth in those two segments and then what the CES contribution was there?

I don't have it right now, Ryan, but it will be in the Q and I will try to get it together before that. But I don't have that broken down as far as the revenue increases there.

Okay, but did the Food -- it looks like the Food even with two months of CES wasn't nearly that high. So is that kind of come in above your expectation to drive some of this enhanced revenue growth here, any thoughts on the Food division?

I think the Food division, we're still growing it strategically. If I had to estimate, it was about 25% increase in Food organically, and about 20% or so from CES, which disproportionately had a higher percentage of Food revenue than our model business. I would say maybe 20%, 25% was organic and 20% was CES in the Food [group].

Okay, that's helpful. And then in the past, you have given us kind of an update on where the regions stand on the food side. Any developments there? Are things pretty really consistent with the Northeast leading the way and maybe West close behind?

Northeast is still leading the way. The Southeast is doing a little bit better, thankfully, and the far West has continued to do better than we expected. So I think primarily the food growth is going to be concentrated in the Northeast division still, but the far West and now I am more encouraged that the Southeast and Southwest will start to gather some momentum as well and the Midwest will probably be the last area within maybe a six-month period that the management development gets to the level where we think they can expand a little more aggressively.

Okay, great. And then do you have anything on the retention numbers during the quarter still above 90%?

No, in fact I think better than 93%, frankly.

Better than 93%. Okay. And then I guess final question and I'll hop back in the queue, any thoughts on the sales pipeline? Maybe just change in leads that you are seeing or conversion rates given some of the macro pressures. I know you have talked about maybe enhancing the desire to outsource and get a fixed budget. So any color you have there on what you're seeing in the market or maybe stuff that you have -- you currently see in the pipeline that we are not seeing reflected in revenue yet?

I think throughout the industry there is -- demand and the new business development has always been the easier part. There's always been enough demand. It's really our execution that controls that. But I would say there's more interest and probably more demand -- Modern Healthcare I know came out with a survey that they do annually that makes mention of those trends of outsourcing opportunities of all kinds, including our type of business, in I think their September 30 issue. But I see even an increased demand because of the uncertainty in the industry and certainly the cost containment (technical difficulty). So I wouldn't say it's significantly greater demand, but certainly more than enough opportunities for us to chase around.

Okay, great. Thanks a lot for the color, Dan.

Rob Mains, Morgan Keegan.

Good morning, Dan. A couple questions. In the very brief list of risks at the beginning of the call there, one of the risks that you mentioned was the CES integration. It would seem to me that given what you did this quarter with your receivables and with SG&A that that's mostly done. Are there remaining tasks still to go?

No, I think there's some duplication. The corporate office is still there and there's some administrative duties that are still done. I don't know that I would categorize them as risks, but certainly factors in the integration. But the people in CES have been very good to work with. The client base has remained solid and they fit in very nicely with our Company and it's gone as good as we could have hoped, frankly.

Okay, then second, I don't know if you have this number handy -- Rob -- you mentioned the deferred comp kind of add in this quarter was $932,000. Do you recall what it was last quarter?

It was $760,000 last quarter.

Okay and that was also a positive, right?

Yes, yes.

Okay, last question, could you give us an update. You did a nice discussion of this I know on the last call on where you are seeing the new business coming in in terms of the big for-profit chains versus individual proprietary and not-for-profit and small chains?

I'd say it still continued that -- the large national chains have probably shown a higher degree of interest in outsourcing more aggressively than they had before than the other factors, but that may be because we're paying more attention to them and going after clients that we have done business with already, but not done all their business. So it makes the sales process that much easier. But I would say our proposals being developed are disproportionately with the large national chains than our normal marketing and sales efforts. Not greatly, but I would say more and that is where we are getting a higher degree of interest.

Okay, and then has the level -- if you look at some of the smaller ones, has the level of credit issues stayed kind of constant through this difficult reimbursement period?

Yes, I don't think that they haven't had the impact. It's more like the unknown going forward to any great degree yet, but our credit issues are still specific to the customers and the clients. And that's how we really manage the credit, that we assess really every two weeks the credit issues, the payment terms, who is not adhering to them, and what kind of reaction it requires from us. We spend a lot of time on credit and collection and have worked hard to keep the receivables below 60 days and we will continue to do so.

But our credit issues are still more client specific than we see anything macro across the country. Or for that matter, state by state. You know, even in the states with more difficult reimbursement environment, clients are performing well and are adhering to their obligations and operators who warrant that [might] need closer scrutiny and closer attention.

Okay. That's all I had. Thanks, Dan.

Mitra Ramgopal, Sidoti.

I was just wondering -- coming back to the gross margin -- how much of the sequential decline you attribute to the organic business versus the acquisition?

I would say it's probably half and half. The percentage increase, maybe 0.5% was the organic new business that we started and I would say half of the increase in the purchase, 0.5%, the increase in the purchases was getting the CES expenses up to the levels that we typically have in our properties.

And as you look ahead to the fourth quarter, would you say the acquisition is pretty much completely integrated now and think most of the costs are taken out?

Most of them, most of them.

Okay, and then just to get a sense again on the Food Service business and the overlap in terms of the amount of facilities you're providing in Housekeeping, Laundry, and how much you're in on Food and kind of the potential -- how many facilities you think you can capture out of the existing base?

Well, if we had the management structure, it's all projection. But I think we could double the Food Service with the management over the next few years but the management development both in Housekeeping and Laundry and Food are really -- has always been the constraint. But right now we are doing about 350 Food Service facilities and we are going to grow that at 20% without doing anything dramatic. But that means we will have 60 or 70 properties annually and primarily they're going to be in the Northeast, although the other areas will add some just by being around and being active.

But there's still more demand within our client base for Food far and away than we can really do and more interest, frankly too.

Just finally again coming back to your customer base, we haven't seen any issues again with any of them having financial problems, DSOs certainly improved this quarter. Any update in terms of the outlook or what you are seeing out there?

No, it's really -- we don't see much different. We have to manage the clients customer by customer and property by property. But we don't see any across-the-board momentum one way or the other, but it's always been a concern and something we put a lot of resources and we are certainly paying attention to it in this environment as well.

Okay, thanks again.

Michael Gallo, C.L. King.

My question just to come back to the sort of duplicate costs that are remaining, how much is still remaining? How long did it take you through the quarter to kind of get the costs down? You mentioned you still had I think the second overhead center and when do you expect that will be completely integrated?

Their corporate office is still open, but it's skinnied down and a lot of the administrative functions are being done now by -- we eliminated the duplication. So I think we are pretty much where we will be and operating that way. There's some administrative people and some loose ends that are being -- but it's very modest costs down there now. The bulk of the changes that had to be made were made late in the second quarter and early in the third quarter.

Okay, so it sounds like there will be a little bit more or probably you won't hit the full run rate of that until the fourth quarter and then maybe a little bit more to be taken out. But you are more or less there? Is that a fair --?

Yes.

Okay, great. Thanks.

[Kurt Strukfit], Stifel Nicolaus.

A quick question here for you. I think you said that most of the Food Service growth going forward I guess in the near term is going to be concentrated in the Northeast. Can you give us any color as to what proportion of your housekeeping clients in the Northeast currently have Food Service contracts with you?

I would say maybe 30%.

Okay, and --

So it's clear, I would just -- the past increases have primarily been in the Northeast. I think going forward the Northeast has the management depth that we feel comfortable with and we're letting them ramp up to the normal complement of properties that a district and region in our scheme of things would be responsible for. The other areas are still underutilized, although we have the district and regional structure the way we want and we just feel that the management people need a little more seasoning, more consistent performance before we let them get to the right complement. But that's the evolution that we really envision. It's never as quick as we would all like, but we are making progress and they will add properties over the next year and a half.

But the real payoff will be if we have done the right thing over a year and a half's period of time and each of the divisions in Food Service become more and more capable that we will have a national organization in place and then we will be able to more confidently say okay, this is how we can expand the Food Service. This is how we can take the shackles off and let them sell it to anybody, where right now we are only allowing it to be sold to our existing clients even in the Northeast because there's more than enough opportunities in our client base for us to pay attention to.

Okay and I guess just with regards to the CES acquisition, I guess how penetrated are you? I guess Housekeeping and Food Services in the Southeast? Are you looking to use that maybe as a platform to expand a little further down there or do they already have a sizable market share?

They are selling Food Service to a higher percentage of their clients than we are. So there's not the same kind of opportunity within their client base to add the Food Service to it that we have in our internal client base.

Okay, and you are still expecting roughly a $40 million revenue run rate from that business?

Yes.

Okay, great. Thank you.

James Terwilliger, Duncan Williams.

Dan, how are you? Nice quarter. I've got a quick question on CES. Can you give me the breakdown on how much was the percentage breakdown on their revenue for the quarter? How much was Housekeeping, Laundry, and Linen, and how much was Food?

It's about 50-50. 50% of their revenue is Food Service related, although they are doing less facilities in Food than Housekeeping and Laundry, but it's higher revenue numbers. So breakdown was about 50% of the $10 million in Food Service and 50% in Housekeeping and Laundry.

When you do a new facility -- first of all, thank you for the breakdown on the CES. When you do a new facility and you get them online from the Food Service perspective, I'm looking at this as kind of I hate to say an inventory stocking, I mean you have to stock the shelves is what I'm assuming. How much of that comes from, say, a large national contract, and how much of that is local in produce and dairy?

About 40% of our expenses are food purchases and the purchases that are consumables and some of them materials. I would say about 75% of our purchases are with the large national accounts that we have established, maybe 25% of the purchases in the local dairy and produce kind of vendors that deliver daily or every other day. So it's about a 75%/25% breakdown. 75%, we can use our purchasing power and 25% really subject to the local vendors.

Okay, and commodity prices have declined, but you are already locked up from the large national contract. So if there would be any change in commodity prices, it would really be at the local level. Is that safe?

Yes. And I think going forward, the fact is what we have observed is they really have plateaued to a great degree for us. For a while there up until nine months ago, the increases were rapid enough to where we had to get increases from our customers on too regular a basis. We are happy that it just stabilized as opposed to -- so it avoided us having to keep going back to the customer. But we don't see any significant decrease in the unit cost to any great degree.

Okay, thanks. And my last question and thanks for my time, just talk a little bit about some of the Obama initiatives. Have these Obama initiatives and kind of the discussions in Washington, have they been an increase or a decrease? Have they accelerated growth in outsourcing? Have they frozen the market? Or have they been watched and observed but they really haven't impacted it -- just the outsourcing trend in healthcare, you talked about Modern Healthcare . But has the outsourcing trend in healthcare just kind of continued at the same growth rate irrespective of the noise coming out of Washington? So one, just talk about that. And then the second part would be what are your customers saying to you guys about what's happening in DC?

We think the uncertainty has caused more of a discussion. Cost containment has always been the least in their dealings with us, the most compelling argument on why to look at outsourcing. I think the national change and the uncertainty and what it is going to go, they know that they're going to have more money in all likelihood and have to be at least s cost-conscious if not more so, and I think that has opened up opportunities for outsourcing companies of all kinds, including ours, to go in in a cost-efficient way and be able to have a higher demand for the services and the client base that maybe before were lukewarm or more reluctant.

So I think the uncertainty -- since nothing has really been finalized, some of the state's budgets have been tweaked as far as the Medicaid rate, but they have been tweaked, so it has not been anything draconian, but it has forced them to again be more cost-efficient as well, which has helped our cause also.

So I would say until it's finalized they won't know, but certainly the atmosphere has created concern on their part to look at any way they can be more efficient cost-wise going forward and outsourcing has become a good tool to help them accomplish that.

All right. Thanks, Dan. Those are my questions. Nice quarter. I'll jump back in queue.

Due to time constraints, that concludes today's question-and-answer session. I would like to turn the conference back over to Mr. McCartney for any additional or closing remarks.

Okay, thank you. Again, I want to thank everybody for joining us today. You know, in summary, the growth in demand for our services is still strong. I think the direct cost efficiencies will be able to get the direct costs back to historic levels below 86% with the purchases and the levels being at the degree that it should be. I think the SG&A certainly should be below 6.75% consistently and maybe some margin improvement to be had there as well.

In spite of a lot of the uncertainty, the cost-containment environment throughout the industry has certainly created a good environment for outsourcing companies of all kinds, including ours. We have never had better management people in Food Service and Housekeeping and Laundry in the history of the Company, so our objectives are pretty simple. We want to control our growth both in Housekeeping and Laundry and Food, but overall these are pretty good days for us.

So thank you for joining us. Like I said, the 10-Q should be filed at the beginning of next week. And onward and upward. Thank you.

That does conclude today's conference. Thank you for your participation today.