Healthcare Services Group Inc (HCSG) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Healthcare Services Group third-quarter 2010 earnings conference call. Today's call is being recorded. Today's discussion and any schedules or reports incorporated by reference into this discussion may 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, The Exchange Act, as amended, which are not historical facts but rather are 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 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, 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 risk associated with this industry; one client accounting for approximately 11% of revenues in the nine-month period ended September 30, 2010; risks associated with our acquisition of Contract Environmental Services Inc., including integration risks or 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 described 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 agreement collections, and under Item IA, 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, most recently, the March 2010 enactment of the Patient Protection and Affordable Care Act and Healthcare and Education Reconciliation Act of 2010.

Currently, the US Congress is considering further changes or revising legislation relating to health care in the United States, which among initiatives, may impose cost containment measures impacting our clients. These laws and proposed laws and forthcoming regulations have significantly altered or threatened to alter overall government reimbursement funding rates and mechanisms. The overall effect of these laws and trends in the long-term care industry have affected and could adversely affect the liquidity of our clients, resulting in their inability to make payments to us on agreed-upon 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 will be adversely affected if unexpected increases in the costs 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 project growth strategies.

I would now like to turn the call over to Daniel McCartney, CEO. Please go ahead.

Okay, thank you, and good morning, everybody. Thank you for joining us.

Last night, we released our third-quarter results after the close and will be filing our 10-Q by the middle of next week.

But, for the third quarter, our revenues were up to a new record of 9% -- up 9% to $195 million. All our increase in revenues was organic. As you might remember, last year in the third quarter of 2009, is when we fully integrated and recognized the CES acquisition and its impact and CES's revenue was about 50% food service and 50% housekeeping and laundry.

Our net income was up 12% to a new record as well, $9.1 million or $0.21 a share. Our earnings from operation, when certain adjustments to the deferred comp gains in the SG&A expense was up more than 12% from 2009 as well.

The nine-month revenues increased 12%, and our net income for the nine months is $25,319,000 or $0.57 a share.

Our direct costs were above 86%, impacted by a slight increase of about 0.6 of 1% in workman's compensation and general liability claims, a little bit higher than our historical norms. We expect going forward our claims to be at the historical levels -- and get the direct costs below 86%.

The SG&A costs were 7.4%. About 0.05% or $840,000 was due to gains in the deferred compensation accounts and investments held for and by our management people. The SG&A costs were also affected with the finalization of our state tax returns in September as some of the states revised their tax policies and implemented a gross receipts tax as opposed to a state income tax, which had no P&L impact per se for us, but changed the allocation of the costs where the gross receipts tax will be reflected in our SG&A expense, and it will lower our affected tax rate.

We also were the beneficiary of some tax credits and job tax credits with the new policy. But if adjusted, our SG&A was below 6.7%, which has been our historical target.

The investment income was reported as $1,182,000, but in that gain, $840,000 was the deferred compensation gain for our management people. So if adjusted, our real company investment income was about $340,000 for the quarter, down from $1.7 million from the third quarter 2009 due to lower interest rates. That was a difference of about $0.015 for the quarter.

Our tax rate was lower due to the shift of these states to the gross receipts tax, as well as certain tax credits that we earned and finalized during the period. We expect to benefit in a more modest way with a more modest reduced tax rate in the future, we would estimate between 37% and 38%.

Our balance sheet -- we ended the quarter with over $70 million in cash and securities; our current ratio of better than 8 to 1. The current liabilities were reduced by about $11 million due to a cutoff of the payroll in the second quarter for our third quarter when compared to the second quarter.

The receivables remained in good shape -- well below 60 days. The Board of Directors approved a 16% increase in the dividend to $0.02325 per share to be paid in the fourth quarter on November 5. The cash flow and cash balances more than support that increase, and we still feel it's the most tax-efficient way to give value back to the shareholders. So we've increased it now for the 29th consecutive quarter since the dividend was originally instituted in 2003. And the Board of Directors also declared a three-for-two stock split in the form of a 50% stock dividend to be payable on November 12.

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

(Operator Instructions). Rob Mains, Morgan Keegan.

Good morning, Dan. Could you talk a little bit about after the split, where you think the dividend policy will be going forward?

I think we still expect increases quarterly, and we really expect the increases to be proportionate to what we have.

But I would say that the dividend increase will probably not be as the same as our expected earnings-per-share increase until the EPS catches up a little bit with the dividend. But we still expect increase as long as the tax policies stay where it's still an efficient way to get the free cash flow back to the shareholders, so I think the increase will be proportionate what we would've done before the split.

Okay. And then, returning to the income statement, I know that this isn't perfect because there's a lot of timing issues that are involved, but the growth of revenues from the -- sequentially from the second quarter to third quarter was lower than what you saw in the first to second. I know that in the second quarter you had the benefit of a lot of sales at the end of the first quarter. But could you kind of talk about where you see -- you saw business developing during the third quarter and where you see it going forward both overall and also housekeeping versus food?

I mean our target is still 10% to 15% top-line growth. And granted, the third-quarter revenue growth is a more difficult one because one, the third quarter last year, we integrated and had the full impact of the acquisition, which was an unusual factor for us. And frankly, in the second quarter, we added a disproportionate amount of new business and digesting that typically slows up what new business we can procure. But we're happy with an increase of 9% with all those factors, frankly. But we fully expect 10% to 15% growth going forward. May not be ideal quarter to quarter, but certainly, that's still our expectation and target.

And for the nine-month period so far, both revenue for housekeeping and laundry are up about 12%. So we're still in the neighborhood that we've always targeted as well, although quarter to quarter -- for example, in the third quarter, the food revenues are a little bit lower than they historically have been. But that's comparing to the CES acquisition, where 50% of their revenue in the third quarter last year were food service revenues and clients. So 10% to 15% is where we still expect to be. We still expect food and housekeeping to be in that arena. And we expect food to probably grow a little bit at faster pace because it's a smaller base than housekeeping and laundry.

Okay. And could you give us an update on where you see the food rollout at this point?

Well, it's still -- I would say the Northeast now and the far West, we're letting them ramp up to the right amount of properties. With the split of the Southeast divisions and the Midwest divisions, we think or expect by the second quarter of next year, they should be in a position with enough management depth to be able to have them accelerate their expansion as well. But we expect each quarter to be able to grow the area in the ranges that we discussed and to improve the margins. But the real payoff will be if we have accomplished the management objectives and development first that by the second quarter, we will be able to more definitively say now all divisions have the capability of expanding faster. And then we will be able to be more confident to be more aggressive in what we think food can grow at.

Great. Okay, thanks a lot.

Michael Gallo, CL King.

Just a quick question on the food-service front. My recollection is that you just shifted further some of the supply procurement to more national versus local. What kind of impact do you expect that to have on the direct costs for food? And when do you expect we will start to see that impacting you going forward? Thank you.

With the food, we have always negotiated national accounts. And October is usually when we lock them in for the next year with the national providers, the Cisco and US Food types. And that still makes up about 75% of our food purchases and costs. And the final 25% are typically local vendors, distributors for produce and dairy type of products, where you don't have the same kind of purchasing influence and muscle because the volume isn't the same. They're more property by property type thing.

But as long as we keep the food costs, which we did this quarter as well, when the Q comes out, you will see that. But as long as we keep the food costs below 40% of our costs and the labor costs down in the 60% range. Because they were as high as 42% I would say a year or so ago, the food purchases. So we've locked in the national accounts. We're negotiating next year's.

We feel pretty confident because we become each year, more astute purchasers, more volume and more attractive to them. And we think it gives us more leverage in negotiating. So, I think we will modestly improve our food purchases going forward. And it still makes up the bulk, but the uncertainty or the wild card has always been the local produce and dairy guys where we don't have the same influence. But as long as we keep the food components costs below 40%, we're happy.

Talk about just a little bit, a follow-up on that front, obviously you've seen a significant rise in commodities of all types. Can you talk about how you've improved the mechanism to pass that through? As I recollect, in 2007, it was a little bit -- there was a little bit of a lag effect there.

I think about two years ago when commodity costs were continuously going up -- not as dramatically -- or more dramatically than they are today -- but the difficulty for us was, because of the trigger in our contracts are usually payroll-driven, commodity costs were going up faster than the payroll increases we could get or procure from the clients. It needed meetings, but we had to go to the clients to get the increases that we were required. And we were slower than we could have or should have been at that time. And that was really what prompted us putting the food-service regions into the seven divisional offices, where prior to that, we had a separate food-service divisional vice president, who is responsible for all the food-service operations.

Now that it's in the divisions, if the commodity issues became a problem like they did two years ago, we can much more timely get the appropriate increases from the customers because it's more localized and we're in a much better position to be able to not have that happen again.

Thank you very much.

Okay, Mike. Thanks.

(Operator Instructions). Ryan Daniels, William Blair.

Good morning. It's Kristina Blaschek for Ryan today. To start off, I guess, can you give us some color on contract retention during the quarter and perhaps any new customer additions on both the housekeeping and food services side?

Our client retention has really, for the year, been as good or better than it has been in years, well below -- well above 90%. And frankly, the new business procurement is really a byproduct of our ability not in the aggregate or corporately, but region by region, to be able to absorb it. That when we add as much new business for example as we did in the second quarter, some of the regions have a lot more to digest than others, so their enthusiasm for new business isn't the same as those that were unaffected. But really there's enough pent-up demand, both in housekeeping and laundry with new customers, and food-service within our existing client base, which is all we are selling the food-service to even presently in the Northeast and far West. So adding the new business is the easier part.

It's not always uniformly added like we would like to give us that 10% to 15% across-the-board region by region or division. But frankly, the demand in this environment where the operators are forced to have -- contain their costs more under cost pressures as never before, and, frankly, outsourcing has never become more accepted in the industry.

And we still have relatively no competition. So, it really becomes a byproduct of our ability to digest the new business and fold it into the regions and operate it effectively more than anything else.

So, our pipeline is fine. We are adding the right -- or developing the right amount of proposals and fully expect to be able to hit our growth targets not only for the remainder of this year, but going into 2011.

That's helpful color, Dan. And then I guess following up on that, you talked a little bit about your thoughts on the environment and how that's encouraged facilities to outsource. Have you seen more demand for one service versus another, whether it's housekeeping and linen and laundry, or food services? Or is it pretty much pretty even at this point?

It's pretty even, but housekeeping and laundry is still our main service and what we sell first. And the food-service is a secondary service as an add-on.

I think in some markets, ultimately, as we get food-service more and more established each year, in some markets like the assisted living or retirement community market, food-service may be more of a lead service and housekeeping and laundry secondary.

In the retirement communities, for example, the housekeeping and laundry needs may be done weekly as opposed to a skilled facility that's done daily. But the food-service is a more upscale menu-type of services, more to sink your teeth into, and that may be a more attractive management tool for those type of properties than a skilled nursing.

But I would say there's equal amount of demand. I think there's some clients that would be more reluctant to outsource food-service because they view it more part of their marketing effort and trying to control the menus and those type of things to attract the private pay census. But I think most of them, because of the cost pressures, most of our clients especially, at least 50% would be anxious to outsource or at least consider it outsourcing the food-service division.

Great. That's really helpful color. Thanks, Dan.

Rob Mains, Morgan Keegan.

Hey, Dan, a follow-up to that last question, the modern healthcare outsourcing survey talks about kind of accelerated receptivity to outsourcing. It seems -- the article mostly talked about hospitals and healthcare reform. But kind of big picture, are you getting the sense that anything has changed in your landscape because of what's been going on federally? Or is it really kind of a continuation of the trends that have already been in place?

I think it's a continuation of the trends that we have observed, maybe with a more accelerated and more specific focus on outsourcing of all kinds, like there was in that Modern Healthcare article. Because they talked about services that historically have not been outsourced -- call services and even though the emphasis was more on the impact on hospitals, it is affecting long-term-care operators to outsource more and more services as well.

Housekeeping and laundry is still and food-service are still the three services most typically outsourced certainly in hospitals, but even in long-term care.

And I'd say it's not significantly greater demand because of the cost pressures, but I would say around the fringes, more operators who may be years past were more reluctant to consider outsourcing, that's no longer the same hurdle. Whether it's with a large national chains or the individual operators, we are getting much more interest and much more bona fide interest and really pursuing it as opposed to it just being exploratory.

And I really think it's twofold. I think it's that outsourcing has become more accepted in the industry; that the cost pressures and the uncertainty in the industry has put operators looking at alternatives more consistently than ever before; and frankly, as we have expanded throughout the country, everybody in the industry good or bad knows of our Company and it's created a lot more opportunities for us that maybe eight to 10 years ago, operators who wouldn't have considered it at that time.

Great. Thanks.

At this time, I would like to turn the conference back over to Mr. Daniel McCartney.

Okay. Well, thank you. I guess going into the end of the year, we expect to continue to expand our client base in housekeeping and laundry. Frankly in this environment, the demand for our services is as great as it's ever been.

We look to improve the food-service margins as it continues to expand its client base in a controlled way.

But more important for us is to be able to have the management development throughout the country to the level where we think we can expand it even more rapidly, and then perhaps take the shackles off and let our management people sell the food-service to others outside our client base.

We want to work to keep the direct costs below 86% and work our way down to 85%. The primary margin improvement, we still believe, will be in food-service as we add more properties and extend it over the district and regional base that we have presently.

We expect our insurance costs to be more in line with our historical norms and the SG&A to level out, even with the change in the gross receipts tax to be about 6.75%.

Our tax rate, we think, is going to be a few basis points lower, but it's really a reallocation of the expenses more than anything, maybe at a 37% or 38% tax rate instead of the 38.5%, where we'll be the beneficiary of not only that change, but certain job tax credits that really affect us in a positive way because of the nature of our business, the job tax credits that the federal government has implemented.

As far as our investment income, who knows about the interest rates, but in our business, there's still strong demand for the services. Our management people in all divisions continue to develop. We've really never had better management people in the history of the Company, so these are pretty good times for us. So, onward and upward. Thank you for joining us today.

That concludes today's conference. Thank you for your participation.