Healthcare Services Group Inc (HCSG) 2011 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Healthcare Services Group Inc. second-quarter financial results conference call. 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 27-A of the Securities Act of 1933, as amended, and Section 21-E 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 believe, 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 enacted legislation and/or regulations to reform the US healthcare systems, in an effort to contain healthcare costs, one-client accounting for approximately 9% of revenues in the six-month period ended June 30, 2011, our claims experience related to the 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 one, thereof, under government regulations of clients, competition and service agreements, collections and under item 1-A, 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 in the past decade, most recently, the March 2010 enactment of the Patient Protection and Affordable Care Act and the Health 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, may impose cost containment measures impacting our clients. These enacted laws and proposed laws and forthcoming regulations have significantly altered or threatened to alter our 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 as 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 to performing 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. I would now like to turn the call over to Mr. Daniel McCartney, CEO. Go ahead, Mr. McCartney.

Okay, thank you and good morning everybody. Thank you for joining us. We released our second quarter results yesterday after the close, and we will be filing our 10-Q by the end of next week. But, for the quarter, our revenues were up 10% to $211.5 million for the quarter, and our revenues were up 11% for the six months to $419.8 million. Housekeeping and laundry revenues were up less than 7% for the quarter, and less than 9% for the six months, while food service was better than 20%, although growth was organic.

Our net income increased by 13% for the quarter, to $9.8 million, or $0.15 a share. Adjusted for the three-for-two stock split in the fourth quarter 2010, compared to $0.13 a share in the first quarter 2010. For the six months, our net income was up 9% to $17.5 million or $0.26 a share. All of the results were new Company highs, both for the quarter and the six months. Our direct costs were below 86% for the quarter, as we were able to control our operating costs. We got the new business that we added in the first quarter of this year on budget, and continued to control the food cost, as we expanded it more rapidly than we have historically.

Our SG&A costs were 7.3% for the second quarter, $118,000 of the expense is due to the gain in the deferred compensation investment accounts held for, and by, our management people. The SG&A costs, as previously discussed in other calls, was also included to changes in states like Ohio, Texas and Michigan, to a gross receipts tax, which those tax cost now reflect in the SG&A expense, where previously they were in our tax provision. In addition, we expanded and added to the payroll department some resources and personnel to meet the new hire and record keeping requirements that were able to take advantage and benefit from some of the job tax credit programs that were recently instituted. Those changes increased our SG&A expense, but provided more than enough in the additional benefit by lowering our tax rate. With the new business now running normally, the divisional startup costs back in line, and adjusting for the state tax changes and the payroll department changes, we expect our SG&A to be about 7% to 7.25% going forward.

Our investment income was reported at $463,000, but when the $118,000 adjustment from the deferred comp is out, is reversed, our investment income was about $340,000. Our tax rate was lower than our historical levels at 33% for the quarter, and 35% blended for the six-month period, due to the shift of the states, the gross receipts tax, as well as being the beneficiary of the tax credits. We really now expect our adjusted tax rate to trend at about 35% to 36% going forward. Our balance sheet, we ended the quarter with over $76 million in cash and securities, a current ratio of better than 6 to 1. The receivables remained in good shape, well below our target of 60 days.

The Board of Directors approved an increase to the dividend to $0.15875 per share, split adjusted, to be paid in the third quarter on August 9. The cash flow and cash balance is still more than supported, and we still expect the EPS to catch up before the end of the year. Since the tax laws for dividends, at least, appears to still be in place until the end of 2012, we still feel it's the most tax efficient way to get the value in the Company's free cash flow back to the shareholders. It's the 32nd increase, consecutively, since we instituted the dividend back in 2003, when the tax law first changed, and that is after four three-for-two stock splits. So with that abbreviated review, I will open it up for questions.

(Operator Instructions). Ryan Daniels, William Blair.

Good morning, Dan it is Kristina Blaschek for Ryan today.

Hey, Kristina.

How are you?

Good.

Good. Can you first talk about the employment tax credit that you received during the quarter? I was wondering, do you actually have the actual dollar amount? And also, is this something that is a one-time credit or something you think will continue throughout the rest of the year?

Well, I guess it's always dangerous to predict what the policies will be, but over the last year, the job tax credit programs have appeared that they would be valuable to us, but it required some additional record keeping and employment changes, and we really have more longevity and have benefited even more, although the requirements, administratively, were a little more extensive than we expected. So, it appears what is going on in Washington, we will at least be the beneficiary for the next year or 2. It required a little bit of an investment, but the offset more than made it make sense to us. So, my best guess is, it will certainly be for the next year or so.

Okay, that's helpful color, did you actually have the actual amount of the credit for the quarter?

I would say was maybe $200,000 or $300,000.

Okay, great, thanks. And then, moving along, can you give us some color on contract retention during the quarter and new customer additions, particularly maybe timing of those contract starts during the quarter?

Really, our client retention, for the last year and a half, has been substantially better than the 90% that we historically have targeted. I don't like to say it out loud, it may jinx us, but the client satisfaction levels, if we want this to make changes, I guess in this environment, and the beneficiary of outsourcing in general, and our performance, is really giving us client stability as high as we have ever had in the history of the Company.

As far as the new startups, the first quarter, last year, or this year, if you remember, we added an unusually amount of new business the first quarter, compared to what we normally do, so we digested that well in the second quarter. But, the new business has still come on, most of the divisions are surpassing their targets, a few are lagging, but that typically catches up. So, we still think 10% to 15% is the range that we've targeted and will easily be able to hit, but I'd say it's not even, quarter-to-quarter, but we are very happy with the new business procurement and the third quarter's momentum to continue.

Dan, it's Ryan, morning. I have one quick follow-up, too, on the food side.

Sure.

Obviously it's seen very good growth there, I think you mentioned it was 20% or more growth and I'm curious with food costs near an all-time high, are you guys passing those along and getting a growth benefit, if you will, from that? Have you tried to break out what might be kind of the true, organic growth versus what kind of benefit you're getting from food cost inflation that you are pushing on? Because clearly, you're doing that to protect your margins, which came in pretty nicely.

Yes, I think for us, the benefit we have is we've locked in the bulk of our food purchases for the year, so we haven't been impacted by the month-to-month or quarter-to-quarter fluctuations in food costs and commodity costs rising. But, we are still vulnerable with some of the local, smaller vendors in produce and dairy, vendors that don't have those kind of national account preferences, and we've been able to, with the restructuring done 3 years ago, putting the food service in the divisions, get the appropriate cost. But, I would say, it is probably been less than 2% impact, that the growth has really been expansion of the client base and new business more than any inflationary -- I'd say the labor impacts have been about 2%, 3% annually, and the food, above and beyond that increases that we needed for that small piece of our food purchases has probably been less than 1%.

Okay, that's great color. Thanks, Dan.

(Operator Instructions). Rob Mains with Morgan Keegan.

Thanks. Dan, when you look at where the new contracts are coming from, we've talked about this in the past, can you give us kind of a breakdown, large chain, smaller chain and not-for-profits?

I'd say, the majority of them, have still been the larger chains. Not so many public anymore, although, we have been doing well with the few that are public. They have always been clients, but it has in a more rapid expansion with some of the large, national chains for the facilities that we hadn't been servicing before, even though we have serviced the majority of them. And, I think that is because they felt the cost pressures and have seen, within their organization, we use an alternative that have benefited them.

So, if I had to break it up, I'd say it's probably been disproportionately with the chains, rather than individual operators, and that's always a danger for us. We have to make sure the guys in the field don't keep chasing the great white whale and hit looking for the big hit and ignore some of the nonprofits and the individual operators as well. We've always made it a priority to have a balance in the kind of clients that we have pursued and marketed to. And, but, I would say the last 6 months or so, it's probably been weighted more heavily on the large, national chains.

Okay, thanks. And then, when you look at kind of, a key facet of HCSG's value proposition, that is your ability to save money over what your clients are spending, has the persistent, low inflation, low employment growth environment, has that blunted that advantage at all? Are nursing homes doing a better job of managing their costs relative to what you can do?

Far be it from me to criticize our clients and their business acumen, but it really isn't -- the initial decision-making in our model is that we will do it less expensively than they can do it themselves. And, this -- how much that influences the initial decision, we don't even get a time up at bat unless that is the premise that they begin with. I think, subsequent, after a client is doing business with us, I think the benefit they perceive him after the fact in running their business, is they know what ever departments they have outsourced, away from the initial cost benefit savings, they know we are going to hit their budget every month or every quarter with no unfavorable variance, because the fixed price and risk is transferred to us. So, if you send the comfort to concentrate on the core business, the nursing department and the patient mix, rather than these support service areas that, in the past, might have become an issue or got them in trouble at different times.

So, the savings is the initial part, I don't see any change in the savings we are able to propose to the clients, proportionally. It's still averaged at about 10%. If they're really efficient, maybe the savings will be 5% or so. If they are really inefficient, maybe we can save them 15% to 20%, but that percentage is less important than the original premise that you are going to reduce the cost and then give them a fixed price going forward. And, I -- if I had to put my head in theirs, I think that is what has prompted the decision making as much of the initial savings.

Okay, fair enough. And then last question. When you look at the reimbursement environment, obviously, a little bit of pressure. It sort of helps you in terms of new business formation, but, we have had now another year of flat and in some states down, Medicaid. We have got threatened Medicare cuts. Are you seeing any erosion in the credit quality of your customers?

No, but it's something that the guys in the field and the credit and collection department here have diligently monitored and really done a very good job to keep it. But, we've kept the clients on a much shorter leash than we had historically, and we've left more buildings, again, the last 5 years for credit issues and concerns than we did the first 25 years of the Company's existence. Where our flexibility before, was, we ultimately collected. Now, we work too hard to get the cash and keep our risk to a minimum, so, to keep the receivables below 60 days, we've been 8 or 9 days better than that, so we monitor the credit, client by client, rather than anything in the macro sense.

Good customers and good operators in bad times still can pay their bills, and bad operators even in good reimbursement times, get into trouble. So, we have to monitor more client-specifically. But, we put a lot of resources, a lot of attention in it, but that's why the cash balances have continued to build and we've stayed relatively unscathed and out of trouble. But, it's something that we have to diligently do on a regular basis. And, in this environment, because of the Medicare and Medicaid pressures, it's almost more critical to look at, make sure we dot the i's and cross the t's.

But it sounds like, that being said, you're not seeing an uptick in the number of clients that you've got to terminate?

No.

Okay. That's all I have. Thank you very much.

Thanks, Rob.

Mitra Ramgopal with Sidoti.

Yes, Hi, good morning, Dan. Two questions, first just following up a little on the Medicaid issue. I saw, efforts being made by Washington to cut Medicaid spending to move some beneficiaries out of nursing homes, back into community settings, et cetera. I was wondering what your thoughts were on that and the potential impact down the road?

I think, our clients have still kept the census high. Very few are having census issues. They would all like to have more, higher-acuity Medicare patients and more private pay patients, but, I haven't seen -- and our guys in the field haven't seen any decrease in the census numbers in our clients, so I don't think the Medicaid impact has had any impact up until now, and I don't really see it having a significant change.

The home health care convenience, has always been an option that a lot of families are just not in a position to take full advantage of. So, I don't see it really having a significant impact. I think a lot of the states have different nuances on what the Medicaid impact on how they administrate it is going to be, but, look at California, for example. For the first time in 4 years, they have passed their budget on time, July 1, whereas some of you guys who have known the Company for a while can remember times where California delayed the payment to the nursing home operators in the budget fight, sometimes until October, and created some cash flow issues for us. That is not the case now, so, you would think in this environment, with so much rhetoric and so much of a political football game going on, those states that were problem children before, would be impacted and it's not the case.

So, it's tough to really predict. We just have to monitor each state's impact and more importantly, for us, each client's performance and payment stream to stay out of trouble more than anything on a macro sense. I think the Medicare issue, come October, is going to be a factor that could impact our clients. But, there is always a lot of saber rattling from an 11% decrease to a 1.5% increase. How that ends up during Congress's argument in August, I am not smart enough to know, but I know that the tighter our operators get squeezed, as long as it is not anything too draconian, like in 1998 and 1999, the more they need outsourcing help and services of all kinds, including for our kind of services, so, it kind of works to our advantage.

Okay, thanks. And, just quickly on acquisition front I know it has been just over 2 years since the CES acquisition with nursing home operators feeling potentially more pressure from reimbursement, et cetera. Are you getting more operators sort of approaching you in terms of additional acquisitions?

There really aren't that many acquisition opportunities that fit our niche and we are really not looking to diversify. We would look, if the right opportunity came, in only the healthcare field. We are not looking to have a Company that does commercial cleaning and some other functions in a few healthcare facilities as really being a candidate for us. And, we have no competition, relatively speaking, so there are not that many acquisition opportunities that fit our niche. So, we would look, if it folded in, met our criteria, we would certainly pursue it. But, we expect our growth at 10% to 15% to continue to be organically driven.

Thanks again.

Okay, thanks, Mitra.

Stephen Charest with Divine Capital.

Good morning, Dan, nice quarter, thanks for taking the call.

Sure.

I may have missed this before, but what was the split on the cost of goods between housekeeping and food? Did you provide that?

No, but it will be in the queue, more specifically. But, the margins in housekeeping and laundry improved modestly, and food service continue to improve, since that is where the most upside is with more expansion, just spreads out the district and regional costs more equally.

Yes, I know the food is looking better every single quarter. Thank you.

Okay.

(Operator Instructions). James Terwilliger with Duncan-Williams.

Hey, Dan? Can you hear me?

Yes, Hi, James.

How are you?

Okay.

I have a couple of quick questions, most my questions have been answered, but I look back at my model and I look at the growth in housekeeping and laundry and linen, the 7% is a little bit below what you guys typically have been doing. Was there any type of slowdown in the second quarter that you saw in terms of the new business activity in housekeeping and laundry and linen, and do you see that -- this type of growth in those areas going forward for the rest of this year and into next year?

I think, the housekeeping and laundry were impacted by 2 things that make the comparison more difficult. First, from the first quarter to the second quarter in 2010, some of you, who know the Company will remember, we added $9 million in new business, primarily in housekeeping and laundry in 2010. That was an unusual amount of business, and it made this comparison, for housekeeping and laundry, clearly, the most difficult. And then secondly, we had more new business in the first quarter than we typically do, of this year, and that needs and requires some of the divisions to take more time to digest it, make sure we operate it effectively, get it on budget. So, it slows up a little bit, the new business.

We expect that the housekeeping and laundry will continue to grow, maybe at the lower end of our 10% to 15% range, maybe modestly a little bit above or little bit below quarter-to-quarter, and food service, maybe 15% to 20%. But, in the aggregate, 10% to 15% top line is still our target, and to tell you the truth, adding the new business is the easier part. I'm not saying it is easy, but the part we worry about least, and it typically evens itself out, but I'd say housekeeping and laundry, was the little bit on the lower end because of the comparison in the second quarter of 2010 adding more new business that we typically did, and the amount of new business we added first quarter of this year, that had to be digested.

Okay, great. Thanks. And, my second question is, when I look at the growth in the food or the dietary services or the food services, can you kind of update me where that growth came from, from a regional perspective? And where you stand from a regional perspective to take on additional business?

Right now, all the divisions, the Northeast, primarily, which has been the most mature and better performing, but the Southeast has added a lot of new business as well in food service, and the Far West, right now, the Midwest, I think, is getting close to where we feel comfortable organizationally, that they will have the capacity and I would say by the end of the year, we will feel more confident in having them ramp up to the right complement of properties. But, I'd say the other 4 areas of the country, the Northeast, the Southeast and the 3 divisions that we carved out in the Southeast, and the Far West division, is where the growth has come from. And, the Midwest has made consistent improvement as far as the food service and we think, by the end of the year, they will be in a position to expand as well. So, we are really happy that nationally, the food service has continue to expand and more importantly, been consistent in its operational performance, and we just have to make sure that sustains itself as we expand it in a controlled way.

Right, great. And my last question is, when we talk about Medicaid issues and reimbursement issues and they vary by state, is there any one particular state that has you worried about anything that is happening at the local level?

No, not really. California was usually the bigger concern for us, although our track record was, in spite of the political arguments, as soon as they pass the budget, retroactively, the clients caught up on whatever arrearages were occurred during the summer, and that has not been the case. Illinois was always an issue, but California was more the issue because it became the state where we had the most facilities and, but, that is not the case anymore, so I would have to say we are cautiously optimistic. It won't be anything draconian, but we monitor all the states and the impact, more through our clients than the legislative branches.

Okay, great. Thanks for taking my questions.

Thank you.

And that concludes the question-and-answer session today. At this time, Mr. McCartney, I will turn the conference back over to you for any additional or closing remarks.

Okay, thank you. I guess in summary, going into the remainder of the year, we expect to continue to expand our client base in housekeeping and laundry, certainly in housekeeping and laundry, the comparisons will be even easier in the third and fourth quarter in a more uniform way in 2010, the new a more uniform weight in 2011 in the new business that we added. In this environment, as I said, the demand for our services is great as it has ever been so, we think that we have to balance our expansion with our ability to manage it effectively, but if we have demonstrated anything in the 34 years or so we've been able to do that, we'll continue to grow our client base in a controlled, but more accelerated way in food service, all the regions and districts and the divisions are performing more consistently.

But, we have to keep the attention on the new business startups, getting them on budget timely, we will look to keep the direct costs below 86% and over the next few quarters, work our way down to 85%, with the changes in some of the state tax policies, and the changes we have made to take advantage of some of the job tax credits, we think the SG&A is going to be in the 7% to 7.25% range, excluding any deferred comp investment impact. Our tax provision, more than offsetting that cost, that we think will average about 35% to 36% going forward. Maybe a little better, but that's what we are anticipating.

As far as investment income, with interest rates, who knows, it will be modest. But, in our business, the demand for the services is still strong but for housekeeping and laundry and food, our management people in all the divisions, especially in food service, continue to develop and overall, in this environment, if we are going to write a scenario for ourselves, these are pretty good times for us. So, thank you for joining us, and onward and upward.

This does conclude today's conference. We thank you are your participation.