Healthcare Services Group Inc (HCSG) 2011 Q3 法說會逐字稿

Good day, everyone, and welcome to the Healthcare Services Group Inc. third quarter results conference call. Today's call is being recorded. The discussion to be held, and any schedules incorporated by reference into it 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 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 inclusion of forward-looking statements should 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, one client accounting for approximately 9% of revenues in the 9 month period ended September 30, 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, and Part I 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 and related agencies have affected through the enactment of a new major -- a number of major laws and regulations during the past decade during the March 2010 enactment of the Patient Protection and Affordable Care Act and the Healthcare and Education Reconciliation Act of 2010, most recently on July 29, 2011. The United States Senate for Medicare Services issued final rulings, which among other things, will reduce Medicare payments to nursing centers by 11.1%, and change the reimbursement for the provision of group rehabilitation therapy services to Medicare beneficiaries.

Currently, the US Congress is considering further changes or revising legislation related to healthcare in the United States, which among other initiatives may impose cost containment measures impacting our clients. These laws and proposed laws and forthcoming regulations have significantly altered or threaten 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 unexpected increases in the cost of labor and labor-related costs, materials, supplies and equipment used to perform these 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 our 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. Healthcare Services Group is the largest provider of professional housekeeping, laundry and dietary services to long-term care and related healthcare facilities. I would now like to turn the call over to Mr. Daniel McCartney, CEO. Please go ahead, Mr. McCartney.

Okay. Thank you, and thank you everybody for joining us this morning. We released our third quarter results yesterday after the close, and we will be filing our 10-Q by the end of next week. But for the third quarter, our revenues were up 12% to $218.929 million. Housekeeping and laundry grew at a little less than 10%, and Food Service better than 25% for the quarter. Although the quarter-to-quarter comparisons from last year were a little more difficult, we were still able to grow within our target of 10% to 15% top line. And for the 9-month period, the revenue increased by over 12% to $638 million.

Our net income increased by 9% for the quarter to $9.996 million or $0.15 a share, adjusted for the 3-for-2 stock splits in the fourth quarter 2010, compared to the same period in 2010. For the 9 months, our net income was up 9% to $27.591 million or $0.41 a share. All results were new Company highs, both for the quarter and for the 9-month period. Our direct costs were below 86% for the quarter, as we controlled the operating costs, got the new business we added in the second quarter on budget, and continued to control the food costs as we expanded.

Our SG&A costs were reported at 6.5% for the third quarter, but due to the loss in the deferred compensation investment accounts that are held by and for our management people, of about $1.5 for million the third quarter, the real or adjusted SG&A expense was about 70 basis points higher, or 7.2%, still in the range of our target of 7% to 7.25% for SG&A. The SG&A costs, as we discussed in past quarters, also included changes in states like Ohio, Michigan, Texas to a gross receipts tax, with those costs now being reflected in expense in the SG&A, but lowering our tax provision.

The expansion that we put in place last year in the payroll department has continued to allow us to meet new hire and record-keeping requirements, be more efficient in the employee benefits and the employee insurance areas, and to benefit from the job tax credits that are available. So with the human resource expansion and new business running normally, and the divisional startups in line, and adjusting for the state tax changes, we still expect our SG&A costs to be in the range of 7% to 7.25% going forward.

Our earnings from operations were reported as being -- as having a 33% increase. But with the adjustment in the deferred comp, our earnings from operations really increased 22%. Investment income is reported as a $1.3 million expense. Obviously, we have no debt, so we have no interest expense. If you make the $1.5 million adjustment in the deferred comp, our real investment income was about $150,000 for the quarter. Our tax rate was 35% for the quarter and the 9-month period, and we still expect our tax rate to trend at the 35%, 36% going forward. On the balance sheet, we ended the quarter with over $68 million in cash and securities, our current ratio better than 7 to 1. The receivables remained in good shape, well below our target of 60 days.

And the Board of Directors approved an increase to the dividend to $0.16 a share, split adjusted, to be paid in the fourth quarter on November 18. The cash flow and cash balances for the quarter more than supported, and we still expect the earnings per share to catch up before year-end 2011. Since the tax law still in place, at least for the next year and a half or so, we still feel it's the most tax efficient way to get the value in the free cash flow back to the shareholders. And it is the 33rd consecutive quarterly increase since the dividend was originally instituted in 2003, when the tax laws first changed, and that is after 4, 3-for-2 stock splits. So with that abbreviated summary, I will open it up for questions.

(Operator Instructions).

Our first question today comes from Michael Gallo, CL King.

Hello, good morning.

Good morning Mike.

Hi, Dan. A question on the gross margins. I know you have indicated in the past, that you believe over time we could bring that up to the 14.5% to 15% range. I was wondering from here, what you think you kind of need to get there? Also was there anything in the quarter, any changes you are seeing with regards to workers comp? And then, whether it is just better absorption as you start to kind of layer in the next level of food service revenue, or any other initiatives that you think will help you [break] that up, to another 50 plus basis points? Thank you.

We still expect to be able to work our direct costs below 86%, and work our way down to 85%, I would say over the next year or so. The primary margin improvement is going to come from better utilization in the Food Service district and regional structure, which still on our model are underutilized. But there is always things that we can do better in housekeeping and laundry. I mean, the real targets are, when you add the new business, you have to get it on budget as quickly as possible. Usually, we have a 30, 60 day threshold at the latest, to get it on budget, and when there's some startup costs, it impacts it. But we think our direct costs should consistently be below 86%. And if we execute properly, should work our way down, new business startups aside, down to 85%, with the primary improvement being the district and regional complement of management people being spread out over the right amount of facilities.

I'd say in the quarter, we're kind of -- the margins continued to improve in Food Service. In fact, when the Q comes out -- but I mean the margins were really, up over 30% from the third quarter last year. And so it's the execution in the district and regional costs being spread out, as we continue to expand at. And right now we are in a position where we feel comfortable with [owned] divisions in Food Service. So we're going to be a little more aggressive in expanding it, not only in the northeast, southeast and the far west, which I had spoken about before, but we feel comfortable now that the midwest, beginning in the fourth quarter, and certainly 2012, is a good position to expand as well. So that's where the bulk of the margin improvement will come from. And we still expect to get the direct costs consistently below 86%, and down to 85%. And then the SG&A, as I said, will still be in the 7%, 7.25% range.

Were there any change -- did the other part there, Dan, was there any trends you're seeing in workman's comp, any notable change?

The workers comp, I think we're doing a better job, really for the last year -- the resources we put in, the risk management and some of the department head changes in resources, the expansion, that were triggered not only to take advantage of tax credit environment and the record keeping, but to manage our risk, and workman's comp, and the benefit area. And we have really been able to be much more efficient in those areas, just by instituting some back-to-work programs, and some case management that were more active internally, with the resources for the last year, than we were maybe, when we were more dependent on the insurance carriers. So we see that trend in the insurance areas to continue to improve, and they certainly improved in this quarter as well.

Second question, Dan, was wondering if you could just comment on what you have seen, in terms of trends in your business since the CMS ruling? Obviously, you added a lot of business, it looks like on a sequential basis in the quarter. Given the increased demand for your services, as many of your customers look to reduce their costs, is this an unusual level of adds, or is this something that we could see kind of ratcheting up, with demand for the next several quarters?

I think for us, the demand for the services has never been greater, but it is never been bad. I mean the constraint on how quickly we can expand, really has always been our ability to develop pipeline of management people. Clearly, there's more interest, there's more cost pressures on the operators now, but they have never been reimbursed generously enough, where they didn't have to be cost-conscious. But there's certainly plenty of opportunities, more than we can chase, even with the adds now. But the constraint is how quickly we develop management people, to be able to be assigned to these properties. So that still remains the case, although this is certainly a good environment for us.

Outsourcing has never been more accepted in the industry, both with the national chains, the individual operators or privately-owned chains. These guys are getting squeezed, and scrutinized like never before. And it is easier for them to outsource support services, than it is to cut back on the direct patient care services. So -- and we have still limited or no competition, so these are pretty good times for us. We think because our management structure has been more consistent, especially in food service throughout the 8 divisions now, that we will be able to expand to the higher end of our range, more than maybe we had before. But the constraint is still the development of management people, but there are plenty of opportunities for us.

Great. Thank you.

Okay. Thanks Mike.

And at this time will take a question from Ryan Daniels, William Blair & Company.

Good morning, Dan. It's Kristina Blaschek this morning.

I was going to say, that didn't sound like Ryan. Hi, Kristina.

I guess I will start off, Dan, given the ongoing rate pressures among the skilled nursing providers, are you experiencing any pricing pressure for your services recently?

Rhetorically, a lot of the response is -- because our contracts are triggered by the employment and conditions of employment decisions that the clients make, because we match the wage rates, benefits, absorb all of the employees when we take over a new account, we really follow the pattern and policies that the facility sets, union or non-union. And I know when Medicare football was first proposed in the summer, and the arguments were going back and forth, the initial reaction was wage freezes and those kinds of things from the clients. Now that is their policy, and that's what they do, we will match the same. But as far as cost improvements that we can give, we gave at the office.

When we started, we proposed how much we're saving. And we can't do it for less of a margin, and we're not going to -- we will try to be more efficient if we can come up with ideas, but there is only so much we can reduce. But if they do have a wage freeze, or they do cut the blue-collar workers compensation or benefits, we will, like their other department heads, have that impact our employees. But there's not that much that we can do, because the cost benefit we gave them was on the initial contract.

Okay. That's helpful color. And then, one more question. I guess taking a closer look at the demand question that was asked earlier. Among your existing housekeeping and linen and laundry customers, in this environment, are you seeing more pressure for them to outsource the food services, and more demand for that from you guys?

Yes. I think that has always been the case. In fact, I know some of you have known the Company pretty well. I have always talked about the existing clients, looking to expand the relationship in Food Service, and what the opportunity within existing client base was. And how we had to be cautious not to expand too rapidly, first, because we are selling into our existing clients. The only reason that they are looking to outsource it is, one, they see the benefit of outsourcing, benefited from the cost reduction that we proposed in the housekeeping and laundry services originally, and have confidence in us as a Company.

If we weren't prepared, and went into Food Service and didn't do it that well, then all the goodwill goes down for the count pretty quickly. But now that the -- our management resources have improved to the level that we think we can expand better, the bulk of the demand and expansion is coming from the existing clients. Now those of you again, who know the Company well, know maybe I beat to death too much, the client retention rate. But because we have managed our growth, you don't get the opportunities to expand in the existing clients, if you are just another the other vendor.

But if you develop a relationship, where you have the client satisfaction levels where they need to be, then when you are ready, you are in a position to take advantage of expanding the relationship in other services. And that is really what is taking place in Food Service, with the existing clients. They clearly feel more pressure to reduce the cost, but that has always been the case. The real difference is, we're in a better position to expand with them in those services than we were, when the management people were in their more formative stages of development.

Okay, great. Thanks for all the color today.

Okay.

And next, we hear from Rob Mains, Morgan Keegan.

Yes, thanks. Good morning, Dan.

Hi, Rob.

So from what you're saying about new business formation, I can surmise that this isn't just a blip that you saw from companies looking at this 11.1% rate cut precipice on October 1, but you are continuing to see pretty strong demand for the services?

Yes. And I think the real quantifiable difference is that we are just in a better position managerially, to be able to absorb the new business more rapidly than we were a year ago, primarily in Food Service. But frankly, the divisions in housekeeping and laundry are getting stronger each year. They have more management depth each year. The regional directors, who are our sales arm, we don't call them salespeople, but the regional directors are more seasoned, and better at the grassroots, away from the corporate clients. So, on all those -- in all those areas -- in the mix of clients, there is a greater demand than there has been before. But we are in a better position to take advantage of that demand, because of the work that we have done the past few years in the management development area.

Got it. And then, are you seeing any kind of increased levels of distress among some of your customers?

Not increased, but we've managed the credit, client by client. I know that -- because of the publicity in the macro sense, Medicare reduction in the therapy area of 10%, getting the headlines. The bulk of our clients are less impacted by it -- unless that have the therapy subsidiary. But we have to manage the credit customer by customer, more than seeing any across-the-board kind of issues. But we put a lot of resources in that, we paid a lot of attention, really the last 10 years. Our target is to keep the receivables below 60 days. But that means every customer, not on average, we have to manage effectively, as far as the credit is concerned. And address it, or leave if we are nervous, and that is still the case. But the guys have done a real good job in managing the credit collection. The cash balances reflect that, and the days outstanding reflect that. But that's still -- we have to be very diligent in all the areas, customer by customer, as opposed to seeing anything across-the-board affecting the industry.

Okay. Then my last question is, it sounds like you kind have taken the wraps off the Food Services business nationally. Any thoughts on when you might be willing to sell that service on an al la carte basis, to a facility, that is not already a housekeeping customer?

I would say -- we will have a better feel for that, I'd say by the second quarter of next year. Right now, there's enough pent-up demand for the services with existing clients. We won't tell our people they can only sell it to the existing clients, which we have in the past. But I think there is enough for them to chase around, with the existing clients, that is more low hanging fruit. So I would still say that the Food Service expansion is still primarily, if not completely, going to come from existing clients. But it's not because we're telling them that they can't anymore, because we do feel better about the management consistency. It's going to be because that's where the opportunities are, right under our nose.

Great. Thanks a lot.

Okay. Thanks, Rob.

(Operator Instructions).

Our next question will come from Mitra Ramgopal with Sidoti.

Hi. Good morning, Dan. First, I just wanted to follow up a little on the credit issue. It was a few years back, you had a couple of clients that you had to cut off. As we look at the environment as it is today, and the discipline that you have shown in the past as you said, I assume that we should not be expecting any such terminations in the future?

(Laughter). Well, I never expected them in the past either. So I mean, that's why it's really customer by customer. The unusual part that you are referring to, were the 2 chains in 2008. And that was unusual, only because of the amount of properties and the impact it had on the revenue. However, I'm sure that today, there are clients that our guys that are discussing and debating whether we should pull the plug or not, as far as credit issues. And that is an ongoing part of the business, and an important component of how we manage the credit, but it is usually much smaller piece. But it is business as usual, and that's why it has to be done customer by customer.

So, the best way that we can monitor it, is what the credit terms are, and if the clients are adhering to it, and then listen to their explanation if there is a delay, and try to determine if it is credible or not. And if not, then we will leave. We will try to propose, going management and giving them the payroll responsibilities back, but no clients really want to hear that. But we work too hard to get the cash, so we would rather leave too early than not. We don't see a 2008 reoccurrence, but that doesn't mean that it's not possible. We have to manage the credit customer by customer, keep the receivables as low as possible, that kind of reflects how well we are doing in that area. And if we can only remember in 2008, it happened once. That is not a bad barometer for predicting the future.

All right. No, thanks. And a separate note, if you look at the Food Service business, you are clearly having a lot of success growing it now. And you talked about leveraging that. I mean, can we expect eventually margins for that business to approach, the housekeeping laundry? Or is it just something that you make up?

Yes, I mean, that is still our objective as well. We bid the jobs at the same gross profit margins,12% to 15% facility level. But the district and regional costs which were underutilized with the amount of the properties they served in Food Service, compared to housekeeping and laundry, because we are ramping up the properties now, but have been eating that cost in the formative stages of the management development to get them there. As we fold in the right amount of properties over the next year or so, quarter to quarter, the margins should continue to improve. And ultimately, if we execute properly, should reflect housekeeping and laundry margins, and that will be reflected in the direct cost area.

Okay. Thanks, again.

Okay. Thanks, Mitra.

And we will take a follow-up question from Robert Mains with Morgan Keegan.

Yes, Dan, when you look at the new contracts that you added in the last quarter or so, could you give us an idea of the composition of big national chains, regional chains, kind of not-for-profit, et cetera?

I would say for the third quarter, the majority were the small privately-owned chains, and expansion with the national chains, more than the non-profits or religious groups. Although, we have added enough of them, I would say that it was more weighted towards the large national chains that are existing clients, and the privately-owned chains that have expanded, that we have had relationships with as well.

And that is, a discipline that we need to, to make sure our guys in the field, don't forget the individual operators and the religious and non-profits as well, and concentrate disproportionately their efforts on the large chains or privately-owned chains. So we really still want a balanced approach with all the categories of our potential clients, but I would say, in the third quarter was primarily the large national chains, and privately-owned chains in a particular area that we have expanded with.

Got it. Thank you.

Okay.

At this time, we have no questions in the queue. I will turn the conference back over to Mr. Daniel McCartney for any closing or additional remarks.

Okay, thank you. I guess, with the quarter, we are happy with the way -- you can always do a little bit better. I know the deferred comp adjustments makes some confusion, but with earnings from operations better than 22% increase on a 12%, it just reflects the improvement in Food Service. But going for the remainder of the year, we expect to continue to expand our client base in housekeeping and laundry. In this environment, the demand for the services is still as great as it has ever been in the 35 years we have been doing this.

We will continue to target our growth, to balance the expansion and the ability of our management people to manage it effectively, and still control our growth. We will look to expand Food Service margins as we continue to grow the client base. But still again, in a controlled way, but a little more accelerated than it has been in the past, because we are more confident now in the district and regional managers throughout the country in the dining service areas, in all 8 divisions. So we should be able to utilize and benefit from the management investment that we have really made the last 2 to 3 years.

All divisions have continued to perform better, more consistently. We have to keep our attention on the new business, as we add in a more accelerated way, to make sure the startups are getting on budget timely. And we look to keep the direct costs below 86%, work our way down to 85% over the next 4 quarters or so. We think our SG&A, with no deferred comp investment impact, will stay in the 7% to 7.25% range. And our tax provision should stay in the 35%, 36% range. As far as investment income and interest rates, who really knows for certain?

But in our business, there's still strong demand for the services. We have never had better management people in the history of the Company, especially in Food Service. We continue to develop. So overall, these are pretty good times for us. So thank you for joining us, and onward and upward.

And that does conclude today's conference call. Thank you for your participation.