Healthcare Services Group Inc (HCSG) 2009 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen. Welcome to the Healthcare Services Group 2009 year end financial results conference call. Please note that this call is being recorded. I would now like to turn the call over to Mr. Daniel McCartney, CEO of Healthcare Services Group. Please go ahead, Mr. McCartney.

Hey, thank you, and thank everybody for joining us this afternoon. Today after the close we announced our 2009 results, and we expect to file a 10-K by the middle of next week.

But in summary, the revenues for the fourth quarter increased 18% to $182,561,000. About 12% of the increase was organically driven, and 6% was due to the acquisition. And for the year, revenues increased 15% to $692 million, with about 11% organic and 4% from the acquisition we made this year.

Net income for the fourth quarter was $6,566,000 or $0.15 a share, and for the year, $30,343,000 or $0.69 a share. Net income was impacted by the settlement of some employee-related matters that we reached in January. About half the cost is reflected in the direct costs, which increased to almost 87% and includes payroll costs, payroll-related taxes and insurance, and employee benefits. The other half of the cost is reflected in the SG&A with an increase of over 7.5% rather than the 6.75% we typically target, and it included temporary accounting staff, professional and legal costs, and the penalties. With this issue resolved, we expect our costs to be back to historical levels with our direct costs in the 86% range and the SG&A back to 6.75%.

Before I leave, I guess just as a comment, the segmented business, the housekeeping and laundry margins improved modestly, and the food service margins from the tables that you'll see more than doubled. So we're continuing to make progress in improving the food service performance in particular.

The balance sheet, we ended the year with over $84 million in cash and investments, still no debt. The receivables are under 60 days; in fact, they're 52 days outstanding, and we increased the dividend, for the 27th quarter consecutively, to $0.21 a share.

So with that abbreviated summary, I'll turn it over to questions.

Thank you. (OPERATOR INSTRUCTIONS.) The first question is from Rob Mains of Morgan Keegan. Please go ahead.

Yes, thanks, Dan. Good afternoon. In looking at this in numbers rather than percentages, is it roughly on the order of $1.8 million, $1.7 million, around there? That's the amounts that are added to the costs of services and SG&A lines?

Yes.

Okay. And then the (inaudible) growth that's pretty strong in the quarter, will that, how was that split up between housekeeping and food?

In the fourth quarter, it was predominantly housekeeping, where earlier in the year, it was predominantly food service. So housekeeping had more momentum. I'd say housekeeping is probably close to 10% for the year, and food service over 35% for the year. But I don't have the fourth quarter breakdown exact, but the K will have that.

Okay. And anything in particular to attribute the re-energizing in the housekeeping group?

No, I think it's just still the blocking and tackling, you know. Enough proposals. There's certainly more demand for our services than ever before. You don't need much to indicate the cost containment pressures that operators are feeling, and it's continued to create opportunities. But for us, the demand has always been never the problem, and it's just a matter of timing the closes. But I think it's just the work that they've done for a while, and we're just fortunate enough to have a few more closes than we had in quarters previously this year.

Okay. And then the last question, can you give us an update on the food services business, where you feel it stands regionally?

I think the Northeast is where the bulk of the improvement has continued to come. Some of the structural changes we made in the Southeast has been doing better. The Midwest is making progress, but I think they'll still be a little further down the road before we let them ramp up to the right amount of properties. And the Far West has continued to do well.

So I think the investments we made in the district and regional managers in food service are close to being fully utilized, and we're now in a more business-as-usual fashion, expand in the Northeast. I think the Southeast is almost there with some of the operational changes we made, and the Far West, we're letting them ramp up to the right amount of complement. And I would expect by the middle of 2010, the Midwest should be in a good position to do the same.

So if I were going to monitor it, I would look quarter to quarter for continued improvement in the margins in food service, and if we've done the right things, get closer to housekeeping's and laundry's margins by year end 2010.

Great. Thanks a lot.

Okay. Thanks, Rob.

Thank you. The next question is from Mitra Ramgopal. Please go ahead.

Yes, hi, good afternoon, Dan. Could you give us a sense as to how much of the growth was organic?

For the quarter, about 12% was organically driven, and for the year, 11% of the 15%. So 4% was acquisition driven for the year, and 6% acquisition driven for the quarter.

Thanks. And if you look ahead, I think the gross margin is running around 14%, and I think you've always hinted we could see that get up to the 15%, maybe even 16% range. What are your thoughts as to margin expansion?

I think that food service continues to improve to the levels that we expected to. We're already eating the cost of the district and regional managers. As the other areas start to get the right complement of properties, I think we can consistently get the direct costs below 86%, but it will be incremental improvement quarter to quarter and get it closer to 85%. So that's still our internal target, and we think it's doable, and certainly more confident about it when we see the improvement food services had, you know, the last four quarters.

Okay, and given the unemployment rate, are you benefiting at all in terms of being able to attract qualified personnel at even more favorable--?

I think for us, the management candidates. The hourly employees, I'm sure in some of the areas it's easier to recruit than others, but there's never been that much difficulty, except maybe back in the mid-'80s in some areas, that we can't get sufficient hourly employees. Because the property has to react to the same labor market pressures, we'd have to change the wage rate scales that we try to mirror and match, and benefits as well.

As far as the management candidates are concerned, I think as we become more established as a Company with a longer track record, we've become a more attractive career choice for them more than any macro employment sense. I don't think we're affected that much by that.

I think we're getting better management candidates, and have better management, probably in the history of the Company, but I think it's more because we've, after 33 years, continued to grow, have a more specific track record for somebody to hang their hat on. We're still only hiring people at an entry level, so when they get out of college, we're probably getting more candidates. But I'd say they're as good as ever, but I think it has more to do with us than the macro employment sense.

Thanks. And finally, on the acquisition front, (inaudible) how well (inaudible) has worked for you, are you more inclined to be a little more aggressive in terms of looking for acquisitions?

We have looked for opportunities, but they really have to fit our niche. We just don't see that many that really fit our criteria. But if the opportunity comes along, like in the past, that we think the management people would fit and the client profiles fit our approach. We're not looking to diversify, so there aren't that many opportunities, but we will certainly look at them.

Okay, thanks again.

Okay, thanks.

Thank you. The next question is from Michael Gallo of C.L. King. Please go ahead.

Hi, good afternoon, Dan.

Hi, Mike.

Just a couple questions. I think, if I go back a quarter or two ago, you'd indicated you'd been replenishing some of the supplies and things as it related to CES. Was that all worked through in the fourth quarter? Was that still an issue early in fourth quarter or how was--?

It was really early in the third quarter. We were just getting the inventory levels up to the levels because our deliveries are more monthly to the levels that, not only with the CES business, but some of the new business that we started then, and what's why the supply expenditures were a little bit higher than they typically had been.

They're at the levels that we're managing now, so it's more business-as-usual type of purchases as opposed to that one-shot thing getting the inventory levels. But in food and housekeeping and laundry and linen to the levels that we feel we operate the best. So that was a third quarter issue, and that's where it should be now.

Right, okay. The second question is just a high-level question as it relates to the SG&A. In terms of just the whole number, I guess, has flattened out here after the overtime issue at around $12-ish million the last couple of quarters. As you start to ramp--obviously, you've made a lot of investment already in the districts and regions on the food service side--shouldn't we start to see some just leverage of the overall G&A base as you continue to grow the revenues? And I know (inaudible) seem to buy money, money you spent went there, but just conceptually, it would seem like there shouldn't be a lot of need for additional SG&A as you fill in the districts, particularly on the food service side.

The district and regional costs are in the direct costs, and the divisional and corporate costs are in the SG&A. But I think, if I were going to model at 6.75%, where I'd stay. But I think you can make the argument that it shouldn't proportionately go up, and we should get some margin improvement in the SG&A as well. But I've always said that I think the real margin improvement substantially will come in the direct cost area, and primarily as food service continues to improve.

But we'd like to see the SG&A come down proportionately, but like you said, there's always some investment we're going to make that justifies never having the overhead down as low as we'd like.

Right. But incrementally, there's nothing--.

(Inaudible).

That's why you shouldn't be able to leverage it as you build sales.

That's right.

Okay, and then just a final question. I just want to flesh out interest income. I know it's something that bounces around a lot, and some of that's due to the deferred comp program. But I think it was only $821,000 in the quarter. I think it had been $1.7 million in Q3, $1.2 million in Q2, and $900,000 and change in Q1.

I think the $800,000 more fairly reflects what the investment income is. The $1.7 million in Q3 had about $700,000 or $800,000 in deferred comp, and that's why the SG&A was so low in the third quarter.

Right, so you the shift between those two lines. But based on our interest rates today, that $800,000 a quarter is a reasonable run rate?

Yes.

All right, okay.

And if there's some fluctuation or an impact by the deferred comp gains or losses, and we talk about it and I give you the adjustment appropriate. But this is fairly flat, so this really reflects what the actual investment income was.

All right, okay, great. Thanks a lot.

Thank you. The next question is from Ryan Daniels of William Blair. Please go ahead.

Yes, Dan. Let me just ask a couple of routine ones we get from you every quarter. Can you talk a little bit first about the sales pipeline, obviously? It sounds like there's some good momentum, particularly in housekeeping in the fourth quarter, but maybe talk a little bit about heading into 2010, what your expectations are and what you're hearing from the field? And then also as part of that, maybe you could just address attention, I think it was around 93% or maybe a little bit better last quarter. But any insights there would be helpful, too.

I think, in general, the demand for the service is as strong as it ever has been. We feel, and frankly, even over the years, the demand for the services is probably the thing we worry about the least. 10% to 15%, managing the growth is really, still remains our challenge. And 10% to 15% top line is where we feel it's most manageable. Whether it comes from an acquisition, I mean, spreading out our district and regional resources, however the new properties come on, they still have to be serviced according to our MO. So that's the constraint on our growth more than anything else.

At 18% for the quarter, it's on the higher end, and it's manageable, and I think we did a good job getting the jobs on budget right away, even though it was a little more than we typically would add in the quarter. And I think the CES additional management, additional facilities worked well in merging them with some of the things we were in the Southeast, and that's gone well.

But I'd still say 10% to 15% is where I think our revenue or top line should grow. And if we do the right things, that should give us a 15% to 20% net income improvement.

And as far as the client retention, the client retention was better than 93% for the quarter. And really, more importantly for us, for the year as well, so we did a very good job as far as keeping the business that we had while we had a more aggressive growth rate than we typically have had in previous years.

Okay, great. That's helpful color. And then you mentioned in your prepared comments that the food services margins roughly doubled, and I just want to get the timeframe. Is that fourth quarter, year over year, is that full year 2009 versus--? Both?

Yes, for the quarter. In fact, it's--now, 2008 was a bad year, so it's like comparing a lower bar. So the fact that it goes up incrementally quarter to quarter is a more accurate barometer. As long as we continue to show improvement quarter to quarter, the fact that it's so dramatic from 2008 is nice, that it's gone up and improved quarter to quarter, just confirms that we're on the right track as far as consistently improving them as well.

Okay. That's helpful. And then I know the sentiment with the Department of Labor was kind of a non-event, effectively, going forward. But I'm curious if you've had any employee push-back in the, I think you guys had to change a little bit how you staff due to overtime hours, spreading hours more effectively week to week versus trying to average it over a two-week period. Any push-back yet from the labor force, or is that pretty much done?

We did it as soon as it became an issue, and we were convinced that the exemption in the 80-hour criteria was going to be available to us. So that was really done during the fourth quarter in most of the facilities that were addressed. So there's no push-back; it's just, we think, an unfortunate interpretation.

Okay, fair enough. And then the last question, and I'll hop off here. Just in regard to CES, now that you've fully integrated that, I think that was a company that probably had a little bit more revenue skewed towards the food services side as a percent of the total business versus HCSG, and I'm curious, one, if that's what's really helped advance the Southeast region, taking that part (inaudible), and number two, just curious--I don't think you've talked about this in the past--if there's anything that maybe they did differently that you guys can leverage across your network in perhaps the Midwest or Far West? Or is it just they had been doing it longer and just built it up quicker? So any color there would be great.

I think, first, they did have a higher percentage of the revenues coming from food service. I think merging the management, we're able to take the best of both. But really, I think the Southeast has improved because the management people have another year under their belt and have done better. And across Cal and with the management people that we're involved with are not--I think their performance in food services is more effective because they were more concentrated in a local area and clients, and it allowed them to concentrate on that client base more and sold two-thirds of their clients to food service, where ours is still less than 15% of our clients that we're doing food service. The strength of our growth is development of management people, but the Northeast is demonstrating, because it's focused in one particular area, that we can make the same kind of progress. So we just expect to incrementally to be able to continue to improve.

And do you guys think you can get to levels like that in your more concentrated markets? I mean, (inaudible) cross-selling into the majority of your clients?

This is not a study, but if I had to guess, I'd say 50% of our clients would be less likely to outsource their food service. But I think 50% of our clients would be as anxious as anybody to do it. It's just up to us to get the management depth that we feel comfortable with, expanding that rapidly. And I think that will be a--I'll be able to say it more confidently when we have the national organization in place all operating consistently. But in five years, I'll have a better feel for that. But I'd say 50% of our clients, I think, would be reluctant to outsource food service, because they see it more as a direct patient care (inaudible) and it helps their marketing.

But if you get the other 50%, I think you've got decades of growth there.

A long time.

All right, thanks a lot.

Okay, thanks, Ryan.

Thank you. The next question is from Eric Gommel of Stifel Nicolaus. Please go ahead.

Thanks for taking my question. Just a follow-up to Ryan's question. If 50% of your target base would likely not outsource the dietary, but there's another 50% that would, could you talk about the quality piece and the marketing piece? Do you think the cost piece as a percentage of their operating budget actually helps you to sell that? Because it is certainly a bigger piece of an operating budget in a nursing facility versus housekeeping, I think maybe double.

I think it does, and as they switch from marketing to the 15% pool of private-pay patients to survival mode, the cost containment and cost efficiency and cost reduction that we really sell our outsourcing services--both in housekeeping and laundry and food--become a more determining factor than in days of more generous reimbursement.

And I don't see days of generous reimbursement coming back in the immediate future, certainly. So I think even those who might have been reluctant in a different environment may be less reluctant when the cost savings now becomes more important to their survival as opposed to marketing for the few private-pay patients that they may think controlling the menus would afford them.

That actually leads into my next question. Are you seeing--you obviously see a wide swath of operators in different states. Anything you're picking up on the Medicaid side that we should be concerned about or that you're concerned about?

I think our credit issues--I mean, the guys in credit collection have really done a good job, and the guys in the field are much more in tune to it, and I think it's reflected in the receivable balances at year end.

But we have to manage the credit client by client, more than anything in the macro sense, that operators who are performing well, even in tough times, do okay and pay their bills. And bad operators, even in good times, get themselves in trouble. I don't see anything even state by state that shows any macro trend. It's more client by client.

Now, that may change over the years, but frankly, the tighter they get squeezed and the more cost pressures that our clients feel, I think the more anxious they are to outsource all kinds of services, not just ours. If they can demonstrate in a cost-efficient way, they're good alternatives. So they're feeling those pressures, they're more aware of it, they're trying to do some preparation ahead of time, and I think that is one of the factors that has allowed maybe the growth rate to ramp up a little bit. But, like I said, the demand for the services is something we worry about least.

Great. Thank you.

Okay, thanks, Eric.

(OPERATOR INSTRUCTIONS.) The next question is from Clint Fendley of Davenport. Please go ahead.

Thanks for taking my question, Dan.

Okay, then.

Some reasons to believe that we could be poised potentially for some modest food inflation by the middle of the year. So how quickly now can you pass any potential inflation on to your customer base?

I think in 2008--we always have had the ability to go back to the customer for increases. The primary driver for the increases aren't contracts; they're labor rates going up. But in 2008 when commodity costs were such an issue and food and commodity costs were going up more dramatically, and certainly more rapidly than labor costs at that time in the food service area, we still had the ability to go back to the customer to get the increases that reflected it in an arm's-length way. "Hey, the commodity costs are up. These are the price increases we've experienced. We need this kind of increase for our services." They would be experiencing the same price increases that we'd experienced. They obviously want us there or else we wouldn't be there. So it required a negotiation, but we were always able to get those increases, just not as timely as we'd like.

And we have a 30-day cancellation clause, as they do, because they're all at-will contracts, if we were unable to get the kind of increase we thought we needed. So we're only there because the customer sees us in their best interest.

When we were slow in getting those increases in 2008, we folded the food service regions into the seven divisions, where up until that point, there was one division for food service. And those divisional management people just didn't keep up and get to the customers as quickly as those price increases were needed to be negotiated.

The divisional guys in housekeeping and laundry deal with these same customers for housekeeping and laundry increases, so folding it in allowed them in a more timely way to react to the kind of issues you described, because they're dealing with the same customers for other issues as well, and we've been much better the last year and a half in getting those increases timely.

Now, commodity costs have plateaued in 2009, which we prefer. It seemed for a while there, we were talking to customers on a regular basis, only asking them for money every three months, for an increase, and certainly, that's not the way to enhance the relationship. But since they plateaued in 2009, there was much less of that. If it reoccurred, we're in a better position organizationally to stay on top of it to where it wouldn't have the impact it did in 2008.

It sounds like if it did reoccur, you would probably have, maybe, what? A one-quarter lag before we could--?

No, we should be able to do it timely and weekly.

Excellent.

We're visiting those customers, we're talking about them. If we get an increase--in the national accounts, we're able to box in 75% of our purchases, so we don't have those kind of fluctuations. Where we're more at risk is with the local produce and dairy vendors where we don't have the same purchasing muscle that deliver those kind of products daily or every other day.

And had we not been there, the customer would be dealing with those same vendors, so it's a negotiation that's pretty transparent. If the price of those products go up, we need an increase, and had we not been there, you'd be buying from the same vendor and would have those same costs incurred. So, but it needed us to do it timely, and we're, more importantly, we're in a better position to do that as they come up much more timely than that quarter lag time that we were dealing with in 2008.

That's helpful. Thanks, Dan.

Okay.

Thank you. The next question is from James Terwilliger of Duncan Williams. Please go ahead.

Hey, Dan, can you hear me?

Yes, James.

First of all, nice quarter. I've just got one quick question. Most of my questions have been answered. But in today's Wall Street Journal, they talked a little bit in an article about the Obama initiative with this healthcare reform moving to the back burner and what that means maybe for some hospital corporations. Do you have any comment on what that means for your customer base, both the hospitals and the nursing homes?

I think it's such a moving target that, in the many key circumstances, as long as the federal government is supporting the states, they all collectively acknowledge they don't pay the nursing homes enough. So it's not even that waste, fraud and abuse dispute. The government acknowledges that operators lose money on Medicaid, and certainly, operators acknowledge they lose money on Medicaid.

The Medicare was where I think most of our customers had some kind of concern, and I think because it's still such a moving target, they don't know what--even though it's 10% or 15% of their revenue, in many cases it's 80% to 85% of their earnings. So there's some concern, but I think for 60% to 70%, which is Medicaid or Medical or whatever the state's description is, I don't see that changing very much.

The Medicare is still a wildcard, and they'll watch it cautiously, but--as will we--but I don't think it's clear enough to where they can say definitively what they think the impact will be.

Thanks. And then lastly, are there any particular states that you're concerned about as it relates to the state budgets and the reimbursement from the state budgets?

The headlines scare you, and certainly the bigger states and the urban areas and on the Coast get most of the headlines. But even, we don't see any difference between New York or California or Massachusetts or Florida markets as far as credit collection issues than we really do in Oklahoma or Louisiana or Mississippi. It's more client-specific than anything else. And unless some trend changes to impact that, I think that's the way we see having to manage the credit collection function for the immediate future, anyhow.

All right. Thanks, Dan. I appreciate your time. Again, nice quarter. Thanks.

Okay, thanks.

Thank you. There are no further questions registered. At this time, I'd now like to turn the meeting back over to Mr. McCartney.

Okay. Well, again, thanks for joining us. I know it's a little abrupt after the release, but we wanted you guys to get warm and not be in the snowstorm, so always thinking ahead.

But 2009 was a good year for us. I think a lot of the issues that needed solidifying, we did, and I think the demonstration of improvement, not only in the housekeeping and laundry area--which sometimes because there are incremental improvements that can be made, doesn't get the attention it should--but the dramatic improvement in the food service performance is reassuring for us as well. The seven divisions have put their business plans in place, and they're really what the Company's business plans are, to be able to go forward to 10% to 15% top line and give us the margin improvement and the 15% to 20% net income improvement we internally target.

Cash balances are still in good shape. We've managed the credit collection better than in any year in the history of the Company.

But frankly, we've never had better management people. The demand for the services has never been greater. So these are pretty good times for us going into 2010. So thanks again, and I'll wind it up for you.

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