Healthcare Services Group Inc (HCSG) 2011 Q1 法說會逐字稿

Good day, and welcome to the Healthcare Services Group first quarter 2011 financial results conference. As a reminder today's call is being recorded. Today's discussion, as well as all schedules and tables 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, as amended. Such 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 Company's reference 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 risks associated with this industry proposed and in enacted legislation and/or regulations to reform the US healthcare system in an effort to contain healthcare costs, one client accounting for approximately 10% of revenues in the three-month period ending March 31, 2011, 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, 2010 in Part 1 thereof under government regulations of clients, competition, and service agreements elections, and Item 1A, Risk Factors.

Many of our clients' revenues are highly contingent on Medicare and Medicaid reimbursement funding rates, which Congress has affected through the enactment of a number of major laws during the past decade, most recently, the March 2010 and enactment of the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010.

Currently, the US Congress is considering further changes or revising legislation relating to healthcare in the United States, which among other initiatives, and may impose cost containment measures impacting our clients. These enacted 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 would be adversely affected if on the expected increases in the cost of labor and labor-related costs, materials, supplies and equipment used to perform services cannot 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.

At this time, for opening remarks and introductions, I would like to turn the conference over to Mr. Daniel McCartney. Please go ahead, sir.

Thank you, and good morning, everybody. Thank you for joining us. This morning we released our first quarter results yesterday after the close, and we will be filing our 10-Q by the end of next week. But for the first quarter, our revenues were up or 13% to a new high of $208.39 million. All the growth was organic. Housekeeping and Laundry grew at better than 11%, and Food service grew at better than 20%, again, all organically.

It was more business than we typically start in our first quarter of the year, especially when compared to the fourth quarter. You've got 90 days of revenue compared to 92 in the fourth quarter, so we are very happy with that. Net income was up 5% to $7.767 million or $0.12 a share, adjusted for the 3-for-2 stock split compared to $0.11 in the first quarter 2010. Our direct costs were above 86% for the quarter. Direct costs were affected by the final conclusion with a former client that filed for bankruptcy in 2008; reorganized, continued to operate during the debtor in possession period, and really operated up until the last week of March 2011 when their REIT foreclosed and it resulted in their eviction and now their ultimate liquidation.

Although we reserved for the pre-petition balances, we now will be unable to recover our administrative post-petition balances that were owed. The balances and the related legal, forensic accounting and administrative fees probably cost us about $0.015 a share split between the bad debt and the direct costs of about $800,000 and the balance in the SG&A cost, the administrative accounting and legal fees.

Direct costs were also affected by the new business that we added in the first quarter not getting on budget with some start-up costs as quickly as we normally do and some divisional expenses transferring management people, et cetera. The payroll and divisional costs in March improved and confirmed we are operating on budget, but it took a little bit longer than it should have. The SG&A costs were 8% for the first quarter; $450,000 or 20 basis points was due to the gain and the deferred comp investments held by and for our management people.

The SG&A were also impacted by some of the divisional start-up costs I mentioned for the new business, and also as we had discussed in previous calls, the change in some states like Ohio, Texas and Michigan, to a gross receipts tax that are now expensed in the SG&A, where prior they were part of our tax provision. That cost us about 30 to 40 basis points, which impacted our SG&A and the reason that it is up. Our tax provision with those adjustments, though, and certain tax credits lower our tax rate to about 37%.

With the [dune] business running normally know, divisional start-ups back in line, and adjusting for the gross receipts tax, our SG&A going forward should still be at the 77.2% range. Investment income is reported at $714,000. When the $450,000 adjustment from the deferred comp gain is reversed our real investment income for the quarter was $300,000. Like I said, our tax rate is 37%, and with the job tax credits and the gross receipts change, we still expect our tax rate to be 37% going forward. Our balance sheet, we ended the quarter with over $77 million in cash, no debt, our current ratio better than 6 to 1.

The receivables remained in good shape, well below our target of 60 days, in fact, below 50 days for the quarter. Because of that and the cash flow, the Board of Directors approved an increase in the dividend to $0.1575 per share split-adjusted to be paid in the second quarter, or third quarter, May 13. The cash flow and cash balances for the quarter more than supported, and we do expect the earnings per share to catch up and be back to earning the dividend by the next quarter or two. Since the tax law is still in place for the next two years we still feel it's the best, the most tax-efficient way to get the free cash flow back to the shareholders, and it's the 32nd increase in the dividend since we instituted it in 2003, and that's after four 3-for-2 stock splits. So with that abbreviated review, I will open it up for questions.

Thank you. (Operator Instructions) We'll pause for just a moment to assemble the queue. Your first question comes from Michael Gallo with CL King.

Good morning, Dan.

Hi, Mike.

Couple questions. Dan, did you have much impact from the increase again in state unemployment insurance costs this year, Q1 over Q1 last year?

No. Our unemployment and tax rates for payroll related taxes have stayed pretty stable.

Okay. Second question I have is just on the SG&A. When I look at just the corporate heads you've added, in the management structure, looks like you've added about 30 heads year-over-year. Is that just stuff that, as you get ready to ramp up Foodservice, or is that more just how you -- are we kind of re-cutting up some of the districts and regions like you talked about in the fourth quarter? Any other costs to their? It looked like a lot of heads certainly have been added in that area in the last year.

It's always in the anticipation of the growth. We have split up the Southeast division into really three smaller models, smaller divisions, so there's some modest impact their with the divisional costs. And in the Midwest we split up into two divisions, both for Housekeeping and Laundry and Foodservice with the divisions providing both services.

But they are modest impacts, and we've always had them, anticipating the next year or two's structure to be able to absorb our anticipated growth. The real impact in the increase in the SG&A has been a change in the tax structure, and certain divisional costs that have upped it from the 6.75% that we historically had targeted to the 7% to 7.25% where we expect it to be going forward.

Okay. You mentioned there was some, I don't know if "unusual" is the right word, but there were some divisional costs, additional divisional costs related to (inaudible) that was brought online in the first quarter?

It was more transportation, transfers, and management divisional expenses that really were incurred in January and February. In March it's more leveled off, and then a lot of the new business, with start-up costs, we disproportionately added Foodservice in the first quarter, up 20%. But that's the most expensive start-up, and in a lot of instances [their inventory] and purchases are anticipating us coming in and to bring the inventory levels and a lot of the structural investments we have to make up to snuff, that's the worst, the first 60 days of the start-up. And we could've done a better job, frankly, getting them on budget quicker, but in March where they could've been, it just took us a little longer than it should have.

Do think you'll add a similar amount of business in Q2 versus Q1? In other words, could you have the same issue again or do you think --

No, I think if we demonstrated anything, we are able to manage and get the jobs on budget quicker, but just sometimes depending on where the new business is and what locations, and maybe the sense of urgency we have, we don't do it as quickly as we could have. But like I said, for 30 or 40 years that's been our business. You stub your toe little bit, do it a little quicker or little slower that you'd like, but I'm less concerned about that, frankly.

Right. And then just a housekeeping final question. How many days will you have in the second quarter this year? I think you had 90 in the first.

It's 91.

Right, 91 in the second.

It's really what the month is. That's why -- the variances aren't really that great, except the first quarter, if you look, has always been with the first or slowest -- not it's really not because of a lack of new business. It's more the days of revenue for the quarter, and that's why it's unusual to have that big a bump in the first quarter for us.

Right, okay, thank you.

Okay. Thanks, Mike.

You next question will come from Ryan Daniels with William Blair.

Good morning, Dan. Just a couple of financial questions up front. First, a point of clarity. You talked about the bad debt from the client that went effectively bankrupt during the period. Was the $800,000 totally related to that client, or was the $800,000 your bad debt overall in the quarter?

No, $800,000 is related to that client.

Okay, perfect. And then looking at the balance sheet it looks like there was a reasonable swing in the accrued interest claims, maybe cost you a couple pennies in the quarter. I know that is somewhat of a volatile line but --

Yes, I mean, it depends on the claims for that period. That's really more -- I mean, obviously, the bigger base we have, the less volatility there is, but it's really a byproduct of how many claims that quarter. That was more in line than some of the previous quarters. I think the third quarter last year, I think we had unusually high claims in the fourth quarter we had much less.

We look at that more quarter-to-quarter obviously with the claims, so we've managed the claims much more aggressively the past two years. It's, typically evens itself out to be 3.7%, 3.8% of our revenue, and if we have a good quarter it's a little lower, if we have more claims than typical it may be a little higher. But it typically balances itself out.

Okay, so it hit you this quarter but you don't envision that --

It's more in line this quarter than the fourth quarter, frankly.

Yes, okay, that make sense. And then I know you guys typically -- your pricing is based on the wage inflation at your client sites in most of your contracts. Was there any deviation this year, I think, with the economy improving and the employment outlook a little bit better? Maybe those wages went up. Is that actually helping you guys on a gross basis this year?

For us it does, but, frankly, between the environment of reimbursement, the cost containment pressures these guys feel, coupled with the jobs in the blue collar areas, not just for our jobs but for the facilities, are not that attractive. So they typically had to give some kind of increase, even if the labor market would indicate in the aggregate it may not be necessary to keep the employees working.

And I'd say our increases have still probably averaged maybe 2%, 2.5% because if the client gives that increase it triggers our pass-through and we expect to get the same increase, give it to our employees, but it protects our margins and consumables as well. I think it's still averaged about 2%, 2.5%, in some areas it might be less but not many.

Okay, so not that big of a change. Two more and then I'll hop off. First, I've asked you this in the past, but just to get an update, commodity costs have really spiked, in particular over the last month, and I'm curious kind of real-time are you, or have you been able to pass those costs along or do you worry a little bit about the second quarter and what that could potentially do to margins in the food business?

Well, we do have the ability to go back and get the increase from the customers. Because had we not been there, they would be experiencing the same increase. So it's not us unilaterally asking for it as a surprise. And second, the bulk of our purchases are locked into the national account so we are protected there.

Where we still have some vulnerability and some risk, is maybe 25% of the purchases at a local dairy and produce guys, they don't have the same purchasing muscle where a national account, and if there increases go up they deliver daily or every other day, and you want to negotiate with them, you don't have the same leverage and they just won't deliver. But in that case, the client dealt with those vendors in most cases, and would be experiencing the same increases.

And we are in a better position now than a few years ago when this was a concern, because the foodservice is now under the umbrella of the divisional management people, so we are able to get whatever increases we may need more timely than we were before. But our food, well, when the Q comes out you'll see. But the food costs, we are still below 40% for the quarter, so we really haven't been impacted by that to any great degree so far.

Okay, perfect. I will actually hop back in the queue. Thanks a lot.

Okay, thanks, Ryan.

Your next question will come from Rob Ma ins with Morgan, Keegan.

Thanks, good morning, Dan.

Hi, Rob.

Just to clarify again on the bankruptcy, the problem was that this was a Chapter 11 that went to Chapter 7?

Yes. They filed for Chapter 11 and reorganized in 2008. So the pre-petition money we knew was exposed and we reserved against that. But during the debtor in possession period, we never got stuck for the bankruptcy period why they were reorganized in all the bankruptcies we dealt with, so we felt pretty comfortable, at least we'd get that.

We knew the pre-petition money was at risk. And we worked with them to reorganize, worked with the bankruptcy court because they were overseeing everything. And then when they came out and reorganized, their plan was approved, we left the buildings, we are still owed the pre-petition money, they've signed agreements on how they were going to pay, but they ultimately didn't live up to it.

We had to go back to court to try to exercise our rights and exhaust all of our efforts. And then finally what must have happened is they had a falling out with their REIT at the end of March of this year. And that's why it was -- we weren't certain exactly what our strategy on recovery could or should be, but it happened so late. But the REIT anyhow evicted them, took over the operation, brought a new management company in, and now our administrative claims and post-petition claims are now at risk and we don't think we are going to collect. These guys are now going to be liquidated and are in Chapter 7 now.

The charges that you took in the quarter, do anticipate that being everything, or could there be still --

That's what we debated. We have longshot options, but we felt the recovery -- we were not that optimistic about the recovery, so that's everything.

Okay. And then when you look at the business that you generated in the quarter, is there anything notable about the composition of where the new business is going? Has it changed, is there any particular impetus behind the really strong new signings you had?

The bulk of the new business, especially in the Foodservice, were primarily privately owned chains that we do business with already, and some of the larger national chains that we've been able to accelerate. The Foodservice area has still got enough pent-up demand within our client base that we can be more selective and we have to be careful not to over expand, but the guys have done a much better job. You will see the margins in the [queue] in Foodservice. Even though the start-up cost impacted us a little bit, we are still improved from last year.

So that gives us more encouragement that we can continue to expand it at a more rapid rate than we historically did. And are managing it more consistently and effective, and getting the benefit of the district and regional management people that we have invested in the past two years in Foodservice that theoretically have been underutilized. As we fold in the properties, the Foodservice margin should continue to improve.

Okay, and when you look at the regions for Foodservice, could you give us an update on where in your estimation you are in terms of how heavily you can stomp on the accelerator?

I'd say the Northeast has continued to expand and grow, and the Southeast, all three divisions now have been able to add more Foodservice customers and manage it effectively, more importantly, than it was when it was one division. So in retrospect, maybe we should've done that earlier. The Midwest we split into two, and they are still in some semblance of development. But hopefully by the fall their management people will be in place and consistently performing where we will let them ramp-up. And the Far West we added a lot of foodservice business. Even though that was the last area we started, they've done a better job and there is expansion there. So I'd say throughout the country, the Midwest is probably the area that we need to solidify the management team, but the other areas should now grow and it's part of their business plan on a consistent basis, and that's where the bulk of the margin improvement is coming from.

Got you, that's all I had, thank you.

Okay, thanks, Rob.

Your next question will come from Michael Gallo with CL King.

Hi, Dan, just a follow-up. Can you tell us where you are in terms of starting to roll out foodservice more aggressively and selling it not just as a standalone, or as a standalone, not just as a cross-sell?

I think our plan still this year is to only sell it to our existing clients. As I said, there's still more than enough for us to chase around within the client base. But I think by next year, if the Midwest falls in line, the others do as well as we expect them to, then we will be able to more confidently say internally and to the outside world, okay, now we can grow it at a more rapid rate, take the shackles off and let them sell it to anybody as opposed to only our existing clients. But I'd say for this year, we are going to concentrate on our existing clients still.

And then to follow-up on that point, do you have the infrastructure now, the personnel with the regions restructured where you can do that with the existing personnel, or would you need some additional personal?

We will always need the additional personnel, but it will be done in a more businesslike fashion, where the past few years the district in our scheme of things should oversee eight to 12 properties, but they have been averaging in Foodservice six to seven properties we've been eating that cost.

As they get closer to the eight to 12 facilities that our model calls for, then as we add more divisions and promote from within like we did with Housekeeping and Laundry, it will be done more in a businesslike, or business as usual fashion, as opposed to these start-up expenses, and the margins should get closer and mirror Housekeeping and Laundry over the next year or so.

Right, okay, thank you.

You're welcome.

We'll take our next question from James Terwilliger with Duncan-Williams. And please go ahead, your line is open, please check your mute function. Mr. Terwilliger, your line is now open. Please check your mute function . Hearing no response, we'll move to our next question from Steven Charest with Divine Capital.

We won't take that personal from James Terwilliger, right.

I'll try not to disappoint but you did answer my question on the food side. A little bit more color on that, do have a long-term goal in terms of where you see food overall as a percentage of revenues?

Right now, it's better than 25%. It does have a bigger impact, because Foodservice is typically double the revenue stream of a Housekeeping and Laundry contract. So it does have a bigger impact when Foodservice grows at a faster rate than Housekeeping and Laundry. I think it will be incrementally -- as long as we don't stub our toe and continue to manage it effectively, because that's the determining factor for us on how quick we grow as opposed to opportunities. But for it to grow at 15% to 20% for the next few quarters is where we think it will be.

If it does that, it will go up incrementally, maybe it will be 26% of revenue come the end of the year. By the end of 2011, we will be able to see where we are, organizationally, and then we'll be able to more specifically and confidently say this is what we think it will be. But I think it could get to 30%, 35% of our revenue over the next five years.

Yes, that was the eyeball, ballpark figure in my head. Do you see more of that from the Midwest now?

No, I think that in the Midwest there's plenty of opportunity in those clients, but for us, it's putting the organizational structure together. We split up the Midwest divisions into two, and the guys are now in the process of putting their Foodservice organizations in regions, and we have good candidates that are doing well and improving. But we just need them to get more seasoned and more consistent in their performance to make sure we don't over extend ourselves and screw it up.

Right, so it goes hand-in-hand with that assiduous management cost containment.

Yes, as always, yes.

Okay. Thanks.

Okay.

And with no further questions in the queue, I'd like to turn the conference back over to Daniel McCartney for any closing remarks.

Okay, thank you. I guess going into the remainder of the year, we expect to continue to expand our client base. All of the quarter was impacted negatively by this issue that seems like we've been dealing with longer than we should've, at least it's over. We expect our client base in Housekeeping and Laundry and Foodservice to continue to grow.

And in this environment, that the healthcare industry, the uncertainty, the cost containment, there is still more demand for our services and it's been as great as it's ever been in the 34 years we have been doing it. We'll look to continue to improve the Foodservice margins (inaudible) and have shown, for us, really good progress the last few quarters. And if that continues for the year, we should be close to Housekeeping and Laundry's margins and keep the direct costs below 86%.

We think the SG&A will stay in the 7%, 7.25% range, but mostly the investment in the regional district and divisional management people are performing better. The divisional guys and regional guys have done a good job in absorbing the new business and have not taken their eye off the ball with the older clients in the old base business. So if we get the direct costs below 86% and over the next year or so work our way down to 85%, the SG&A we think will stay in the 7%, 7.25% range excluding any deferred comp gain impact.

Our tax provision is going to stay at 37%, investment income, who knows. But there is strong demand for our services, we've never had better management people in the history of the Company. The receivables and credit collection, in spite of all the pressures the industry is in, the guys have done a great job in keeping those receivables at a lower level. In fact, the best in days outstanding they've been in the history of the Company, frankly. So for all these reasons, that bankruptcy aside, these are pretty good times for us, and we look always to do better in the future, so onward and upward and thank you for joining us.

And, again, that does conclude today's conference. We thank you for your participation.