Healthcare Services Group Inc (HCSG) 2010 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Healthcare Services Group first-quarter 2010 earnings conference call.

The following remarks and discussions will contain 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 forward-looking statements 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 identified -- 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 11% of revenues in the three-month period ended March 31, 2010; risks associated with our acquisition of Contract Environmental Services, Inc., including integration risks and costs, or such business not achieving expected financial results or synergies or failure to otherwise perform as expected; 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; our workforce and services provided, including state and local regulations pertaining to the taxability of our services; and the risk factors describing (sic) in our Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2009, in Part 1 thereof under Government Regulation of Clients, Competition and 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 effected through the enactment of a number of major laws during the past decade, most recently the March 2010 enactment of the Patient Protection and Affordable Care Act and the Healthcare and Education Reconciliation Act of 2010.

Currently, the US Congress is considering either revisions to or additional legislation to reform healthcare in the United States, which, among other initiatives, may impose cost containment measures impacting our clients. These laws or proposed 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 the inability to make payments to us on agreed-upon payment terms.

These factors, 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. Additionally, our operating results would be adversely affected if unexpected increases in the cost of labor and labor-related costs, materials, supplies and equipment used in performing services could not be passed on to our clients.

In addition, we believe that to improve our financial performance, we must continue to obtain service agreements with new clients, provide new services to existing clients, achieve modest price increases on current service agreements with existing clients, and maintain internal cost reduction strategies at our various operational levels. Furthermore, we believe that our ability to sustain the internal development of managerial personnel is an important factor impacting future operating results and successfully executing projected growth strategies.

I would now like to turn the call over to Daniel McCartney, CEO of Healthcare Services Group. Please go ahead, Mr. McCartney.

Okay, thank you, and good morning, everybody, and thank you for joining us today. We released our first-quarter results last night after the close, and we will be filing our 10-Q by the beginning of next week.

Our revenues were up 15% to $183,801,000. $13 million or about 9% was organically driven, and about $10 million or 6% was due to the acquisition that we made. Housekeeping and laundry revenues were up 13%, and foodservice revenues were up 25%.

Our net income was $7,426,000(Sic-see press release) or $0.17 a share. Our net income was affected by an increase in the SG&A expense of about 0.75% to 7.5%, up from the 6.75% we typically target.

Divisional costs in the SG&A were up for the quarter as we finalized the transition of the payroll, personnel management and administrative functions from the seven divisional offices to the corporate office. During that transition, there was some duplication of effort and some overlap in the services, but now it's complete. There were also some higher divisional costs due to the planning, management transfers due to the unusually high amount of new facilities we began during the end of the quarter, specifically in the month of March. We expect the SG&A expense to be back at the 6.75% level by the second quarter.

Direct costs were up about 30 basis points due to the startups in the month of March, but it usually takes us 30 to 60 days to get the job on budget. So we fully expect them to be where they should be as normal with our startups. And investment income was down about $200,000 for the quarter due to interest rates. The impact of all those considerations is about $0.03 to $0.04 a share.

On the balance sheet, we ended the quarter with over $73 million in cash and securities, and that is after a $12 million reduction in current liabilities due to the timing and cutoff of the payroll to $22 million. Our current ratio is better than 7 to 1 for the quarter.

The receivables remained in good shape, well below 60 days. The Board of Directors also approved an increase in the dividend to $0.22 a share. The cash flow, considering the payroll cutoff and the balances for the quarter, more than supported it, so we saw no reason to change our past practice, and we increased the dividend another $0.01 a share for the 27th consecutive quarter.

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

(Operator Instructions). Ryan Daniels, William Blair.

Thanks for the color on the duplicative SG&A spend in the first quarter. You mentioned in your prepared comments that it should be back to 6.75% by the second quarter, and I'm curious if you mean Q2 will average 6.75%, or by the end of the second quarter we should be back to that run rate, but in Q2 overall it could be a little higher. Any color there?

I think it will be 6.75% for the quarter.

Okay. So it really was isolated to the first quarter.

Yes. And the transition was complete really towards the end of the quarter. It just took us longer than I would have liked to finalize it.

Okay, great. And do you see any longer-term maybe operational efficiencies or gains by moving it from seven divisions to one central division? Could your SG&A technically be lower, I would assume, supporting one versus seven unique sources, or is that not really a big factor?

I don't think it will be a big factor. I think the benefits will be more consistency in the payroll records, where the seven divisional offices for 30 years, we've done the payroll through the divisional offices. So this was a change for us bringing that corporately.

But I think the benefits are we will be more consistent in the payroll processing, but also the personnel records, and automated a lot of the things that were done manually in the divisional offices before. And I think the other benefit will be less administrative responsibilities in the divisional offices to hopefully allow more time in the field and working with the clients and the customers rather than the administration of the payroll processing.

So I think it will improve the operations, and what impact it has as far as efficiencies and lowering the costs will be modest at best. But I think the benefits of consistency in the reporting and administration and freeing up the guys in the field to be able to spend more time rather than with the payroll issues is what our hope is.

Okay. No, that makes a lot of sense. And then you commented briefly on March being kind of a big quarter for the Company, and I know sometimes that is detrimental with startup costs and getting plans on budget. My curiosity, was March a bit of an anomaly, meaning that maybe February is slow and stuff spilled into March, or did you pull forward April business into March? Or is it just a reflection of kind of a strong pipeline and stronger interest in outsourcing services, given some of the cost pressures? Any color there?

I think -- January and February were on target as far as the new business. March was very unusual in that we added as many new properties in the month of March that we typically add in a quarter. And it was more potential clients that are guys who have been working on it a while that just happened to make the decision and execute. And the guys in the field felt comfortable that we can open those up in that frame, because a lot of them, even the corporate clients that we added during the month of March, were spread out over a lot of different divisions. So they weren't concentrated in one area, where it may overburden them with too many startups.

So everybody felt confident we could absorb that much in the one month, so that's what we did. But March was unusual in that it was almost the amount that we add in a quarter that we added in the month of March, but it wasn't because February and January were behind schedule. We were really right where we expected to be.

Okay. No, that's great. And then I guess last is, just any update on food? I know you've typically provided a quarterly update for on everyone on the calls about the status and how the divisions are looking at margin structure. So any color there? And then I will hop off the line. Thanks, Dan.

I think the foodservice has continued to do well. It's up 25%. But like I've told everybody, adding the new business is the easier part, whether it was through acquisitions or organic. Really, our mission was to be able to improve the margins quarter to quarter.

And the margins, when you see the Q and the segment, the margins for foodservice for the quarter were up over 60%. So the guys are still doing a better job, more consistent. The Northeast is doing well. The Southeast is doing better and the Far West is doing better. And we think with the split-up of the Midwest divisions into two now, their foodservice division certainly by the end of the summer will start performing better as well.

So it's been a long time coming, but the foodservice has now been consistent last year and got off to a good start with a 60% improvement in the margins for the first quarter this year.

Okay, perfect. Thanks, Dan.

Michael Gallo, CL King.

I just wanted to drill down a little bit on the new business divisions in March. Was it primarily housekeeping related, or was it foodservice, or was it a combination? And was there anything in particular that drove that, i.e. would you expect that the level that you might add in the second quarter is going to continue to be above normal? Or is March more of an anomaly, where there was just a lot of stuff in the pipeline, you closed more than expected, and going forward you will go back to kind of the normal run rate?

10% to 15% topline is where our -- still our target is and where we feel better. I know the past few quarters, with the acquisition and the organic growth, we were doing 16% or 17%, but 10% to 15% is where we target.

Now, going into the second quarter, we have more momentum because of the new business added, but I think that would be the exception rather than the rule. I think a lot of the new business that we've started, we've been negotiating or the guys in the field have been negotiating a long time with some corporate clients that just happened to fall into place. And when we made the decision on when to start them, it was really made because they were spread out amongst the country as opposed to being concentrated in one division or another, where we couldn't, if that was the case, we couldn't have added as many buildings as we did.

So it was just the circumstances, but I don't want to get ahead of ourselves. The constraint on our growth is still the ability to development management people to be able to manage it effectively. So 10% to 15% is still where I see the topline and we do our best job -- a little bit better if we get some momentum and all, but it really would be difficult to sustain that, and we wouldn't do it.

How many facilities did you add in the quarter in aggregate?

I don't really like to add the amount of facilities, but it was more than we add in a quarter.

And then -- okay, great -- any just preliminary thoughts on the impact or potential impact, if any, on your business from the healthcare bill? I know we're a little far down the road here, but obviously everyone is trying to get their arms around that. So any color you have on that would be helpful.

I think it is still a moving target as far as the impact. I really don't see -- I mean, the state budgets are getting a lot of publicity about the difficult straits they're in, and certainly 60% of the revenue comes from the Medicaid and Medi-Cal budgets that are run through the state, federally funded 50%, but state as well.

So, frankly, the tighter the budget becomes, the more outsourcing becomes attractive, not of our services alone, but of all kinds. So in a way, it kind of helps us as long as there's nothing draconian enough that affects the industry to where they put them in duress. The better way we can measure it is by our clients and, frankly, our credit and collection results, and it's never been easy to collect, but it is not more difficult, either. Good clients pay their bills in difficult times, and bad operators get in trouble, even in good times.

So I think, in an overview, the tighter the budgets become, the more outsourcing of all kinds of services, including ours, becomes an attractive alternative and kind of helps us, and we have to manage the business client by client to make sure we don't get in trouble.

Rob Mains, Morgan Keegan.

Could you give a comment on the couple things we've talked about in the past on these calls -- food costs, where they're going?

Well, I think we've -- first of all, I think the food costs in general over the last three or four quarters have plateaued from the commodity cost spiral of increases over a year ago. When the Q comes out, you'll see for the first time in a while our food costs were under 40%.

So they've certainly plateaued. We think we've done a good job with the national accounts and some of the associations we've affiliated ourselves with recently as we have become more volume purchasers and, frankly, more astute in the purchasing mechanisms. But to have the food costs below 40% for the first time in a while is a good sign, but I see them much more stable than they had been a year ago, certainly. And I think our efforts have been more effective more recently as we become bigger purchasers, more attractive, and have stronger negotiating positions in negotiating. So it's been pretty good recently.

Great. And you've been talking about on some of the calls kind of an increasing proportion of your business that you're getting from the chains. And that, I assume, would imply that a lot of the new businesses would change. Is that what you experienced in the first quarter as well?

Yes, I would say a disproportionate amount, and that's why they started in one fell swoop, where four or five chains that we had been talking to for a long time but have a lot of facilities spread out amongst our divisions. So it made it easier to digest than if they were just concentrated. But that's why there was a disproportionate amount of bump-up, because once they decided, they were given to us in bigger pieces of facilities than it would be had they have been mom-and-pop or even smaller privately owned chains. And I think that reflects, even in the larger chains, whether they are regional or national, the cost pressures they're feeling and the looking to outsourcing to help cap the costs.

Right. And those contracts, are those still one facility at a time, or do you have kind of like master contracts covering a number of facilities?

We really survey each of the buildings and want separate service agreements with each of the facilities. Even if they are negotiated in a standard form, we want to survey each of the buildings, walk through the buildings with the administrators and have separate service agreements with each of the facilities.

Okay. So the way we're thinking of it is, you know, in I think like '08, when you had a couple of smaller chains that [you held debt] for credit reasons, but you don't see a risk of getting contracts yanked from these entities since you're doing them one facility at a time?

It's always a risk, and right now we're on the honeymoon phase, so everybody kisses at each other. But we know most of these clients that we've started with and had done some business with them before, and that was the entree. So we have a frame of reference with them. But they have to be monitored no differently than any of our other clients, whether it is an individual operator or not.

Okay. And then last question. When you look across your contracts, what kind of rate increases are you getting, which I know that correlates to what kind of wage increases they're paying their employees?

The average has been 2% maybe, because the increases that they have given their blue-collar workers, which is the trigger mechanism for our increases, have been relatively modest the past year. So probably because of the labor market that they don't feel compelled that they have to be more aggressive. Some of the areas have union contracts that have built-in increases that are a little more than that, but I would say probably the average nationally has been 2% or in that neighborhood.

Okay, great. Thanks a lot.

Clint Fendley, Davenport.

As we think about the divisional offices, are there any other areas apart from payroll that you are planning to consolidate?

No, all the administrative functions were typically done in the corporate office. The payroll was a control mechanism that really from the Company's formative stages in '77 on was always in the field, because it was a check and balance, the theory went, before the payroll was improved to make sure that the district and regional guys reviewed the payroll to make sure if there were any facilities that were over budget, there were some controls.

But it became, in this environment especially, administratively just more complicated and a bigger administrative burden and became almost more of a full-time job to review them than we thought. And now, with a lot of the technology that allows the personal records to be more automated, we thought we could do a better job, be more efficient and take an administrative burden from the divisional offices, still have the availability to have them review each facility's payroll records without the approval mechanism so they could adjust and react to whatever facilities may have been over budget, and free them up from some of the things they had to do before to concentrate more in the field.

At least they were all the reasons and the premise that we brought it back in the corporate office, which was a big change for us. We've been so decentralized for 33 years, have tried to keep the corporate office as sparse as possible and have the business really run through the field. So we went back and forth. So they were the reasons we made the decision to bring it in, but the other functions, the human resource, the recruitment, the management training, the inspection system, the customer relations, the marketing and sales effort, are still going to be done through the divisional offices, regional offices and district management people.

Okay, thanks. That's helpful. And any thoughts on just the pricing environment here?

On the pricing environment?

Yes.

Because of our contracts, and it's so labor-driven, it's always been the premise that the trigger becomes what the facility does for its blue-collar workers. And then we want to mirror it and do the same.

So I think the pricing has been somewhat muted because of the labor market, that the clients have not given maybe as generous an increase as they had in years past in tighter economic times, where instead of a 2% increase, they might have felt to be competitive in that labor market they would have to give a 3% or 4% increase. We don't see that being the case as much.

So historically, you've seen the pricing improve once the labor market tightens.

Because the clients are then forced to get warm bodies and get candidates to come in and fill the nurses' aide jobs and the other blue-collar worker type jobs that really are in our classification for housekeeping and laundry and foodservice workers, that they feel that they have to be a little more aggressive in the wage rate and starting wages to attract people. That is not so much the case right now.

Thank you, Dan.

Mitra Ramgopal, Sidoti.

A couple of questions. First, we've seen a nice pickup in the organic growth over the last few quarters, and now you mentioned your significant business in March. Is there anything you're doing differently from your end, or is it just a case of customers deciding to outsource more as they feel more cost pressures?

I think certainly that the clients are looking to outsource more, but really there has always been more demand for services than we could do. The constraint has always been the development of management people. And the differentiation between organic growth and growth that we achieve through the small acquisitions that we've done in the past really to me have been misunderstood, that the acquisitions still have to be managed by us.

So if our capacity is we think we can manage effectively a 10% to 15%, tops, expansion on the topline and facility growth, whether that growth came through an acquisition or through organic growth, the management of it is where our concern is. So when the acquisitions were digested, fell into place, we were more consistent with customer relations and our performance, and the transition went well, picking up the organic growth we fully expected to be able to do, because now the resources could be focused on that as opposed to doing all the things that were required to make sure the acquisition went smoothly.

So I think the demand for the services has always been there. And now that the acquisition has been digested and fully integrated into being part of our Company and the division and the guys are doing well down there, that the organic growth, to us at least internally, isn't that surprising. The unusual part is it's many more facilities in March than we typically do in one month. And that's the only reason I've mentioned it during this call.

And on the acquisitions, it's almost a year now since CES. Are you getting -- I know this is not something you go out and actively look to do, but are you sensing increased opportunity now in light of the environment?

There are opportunities of small privately owned chains focused in particular regions that could be candidates for us. But when I say 10% to 15%, our anticipation is that's through organic means. We certainly would look at any of those opportunities, and as long as they met the criteria which we've set out, and we're very clear to everybody when we talk to them, which is kind of rigid, but we would certainly look at it. And if it could be folded into our area and blend well, harmoniously, with our approach towards things, they've worked well in the past, but I think it's more been the people that we inherited have helped work it as well. They've been good people and good additions to the Company. So we would certainly look at those, but I expect our growth objectives to be achieved organically.

Okay, thanks again.

Thank you. There are no further questions registered at this time. I would like to return the meeting back to Mr. McCartney.

Okay, thank you. I guess in summary, going into the quarter, we expect to get the new business that we started in March on budget timely. If we've demonstrated anything in 33 years, we can do that. It usually takes us 30 to 60 days to get the new business on budget.

We expect to continue to improve the foodservice margins. Like I said before, they were up 60% for the first quarter this year. And as the foodservice continues to expand its client base, we think the impact is we're going to get the direct costs below 86% and over the next year or so work our way down to 85%.

We expect the SG&A to be back to our historical norms of 6.75%. There is still a strong demand for our services. Our management people, certainly in food but housekeeping and laundry as well, continue to develop and perform more consistently. We've never had better management people in the history of the Company. And frankly, the cost containment environment, the pressure that operators feel and all the demographic trends, as always, have been in our favor. So this environment is pretty good for us.

So, with that, thank you for joining us today, and onward and upward.

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