Healthcare Services Group Inc (HCSG) 2012 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Healthcare Services Group Incorporated first-quarter 2012 financial results conference call. I will now read the Healthcare Services Group Incorporated cautionary statement regarding forward-looking statements. The discussion to be held and any schedules incorporated by reference into it will contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended, and Section 21E of the Securities Exchange Act of 1934, 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 risks associated with this industry; several significant clients who each individually account for 3% or more of revenues in the three-month period ended March 31, 2012; 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, 2011 in part one 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 number of major laws and regulations during in the past decade, including the March 2010 enactment of the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010. Most recently on July 29, 2011, the United States Center 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 provisions of group rehabilitation therapy services to Medicare beneficiaries. Currently, the US Congress is considering further changes or revising legislation relating to health care 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 threatened to alter overall government reimbursement funding rates and mechanisms. The overall effect of these laws and trends in the long-term care industry has 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 using in performing services could not be passed on to our clients. In addition, we believe that to improve our financial performance, we must continue to obtain service agreements with new clients, provide new services to existing clients, achieve modest price increases on current service agreements with existing clients, and maintain internal cost reduction strategies at our various operational levels.

Furthermore, we believe that our ability to sustain the internal development of managerial personnel is an important factor impacting future operating results and successfully executing projected growth strategies. As a reminder, today's call is being recorded, and now I would like to turn the call over to Mr. Daniel McCartney, CEO. Please go ahead, Mr. McCartney.

Thank you, and thank everybody for joining us. Good morning. We released our first-quarter results yesterday after the close, and we will be filing our 10-Q the week of the 23rd. But the first quarter, the revenues were up 25% to $260 million. Housekeeping and Laundry grew at about 16%, and Food Service better than 50% for the quarter.

As we discussed in the fourth-quarter call, we expect to continue to accelerate the expansion of Food Service, really due to the past investment we made in regional and district management people in the past few years. Their progress has allowed us to begin more Food Service clients within the existing operational structure. In addition, Housekeeping and Laundry services continued to grow, really slightly better than our traditional target of 10% to 15% top line. All quarterly revenue numbers were Company records. Net income increased by 10% for the quarter to $8.545 million(Sic-see press release) or $0.13 a share, compared to $0.12 a share in 2011.

Our direct costs were above 87% for the quarter, due to the amount of new business we started in the fourth quarter, and really the first quarter this year. With the expansion, we just did not implement the operational changes and get the jobs running on budget as quickly as we should have. We expect the operating improvements to be in line and March's results demonstrated that. It just took us longer than it should have. We will continue to work to get the direct costs down to 86% and below and expect to do that. And like I said, March's results indicate the changes have been made, it just took longer than we expected or it really should have.

Our SG&A costs were reported at 8.1% for the quarter, but due to the expense of the gain of $1.296 million in deferred comp accounts held for and by our management people, the real or adjusted SG&A was about 50 basis points lower, or 7.5%, a little above our range of 7%, 7.25%, but I expect that will be back in line as well. The SG&A costs we expect in that 7%, 7.25% range, because it also includes changes in some of the state tax policies like Ohio, Michigan, Texas, to a gross receipts tax, and those costs are now reflected in the SG&A line as opposed to our tax provision.

The expanded resources and improvements we made in the benefits and payroll departments continue to allow us to meet the new hire and personnel record-keeping requirements, be more efficient with the employee benefits, especially with so much new business and the increase in employees, that's become even more critical. And the insurance areas, and we have been able to be the beneficiary of certain job tax credits that are still available. The human resources expansion, adjusting for the state tax changes, again, I said our target is 7%, 7.25% going forward for our adjusted SG&A. Our earnings from operation were reported as $12 million, but with the adjustment in the deferred comp, our earnings for operation were $13.445 million, and improved by 16%.

Investment income is reported as $1.6 million, but with the $1.3 million adjustment for deferred comp, the Company's real investment income was $357,000 for the quarter. Our tax rate was 38%, as Congress has not finalized one of the job tax programs, the worker opportunity tax, that we have previously benefited from for 2012 yet. Now in the past, when it is passed, they have done it retroactively, but they haven't gotten done for us to at least recognize it in the first quarter. We filed our proxy statement last week, and announced the appointment of John Briggs as Lead Outside Director and nominated John McFadden as an additional Outside Director candidate. And we also announced the promotion of certain executive officers, not only to clarify what their responsibilities are as it exists presently, but to give the kind of executive support, especially anticipating the growth we have had now, and what we expect in the years to come.

And finally, the Board approved an increase in the dividend to $0.1625 per share, split-adjusted to be paid in the second quarter on May 18. The cash flow and cash balances more than support it, so we felt comfortable with increasing the dividend. It's the 35th increase since we instituted it in 2003. And when you see the balance sheet, we ended the quarter with $70 million in cash and securities, a current ratio better than 5 to 1 and the receivables still remained in very good shape, well below our 60-day threshold. With that abbreviated review, I will open it up for questions.

(Operator Instructions). And our first question will come from Ryan Daniels with William Blair.

Good morning, Dan. It is Kristina for Ryan today. You commented in your prepared remarks that direct expenses should revert back below the 86% level going forward. Is it safe to assume you that you met this targeted level during the month of March, when facility level budgets were back on track?

Yes, and that's really -- not only January and February, but December, when we started up the accounts, our anticipation is to get the accounts on budget within a 30 to 60 day period, and it just took us longer than it should have. But March's results substantially improved, and confirmed that the majority of the reductions at the facility level were made, and that is what gives us the confidence. And I guess, in retrospect, whether we should have done the phase-ins differently or more incrementally, if we have demonstrated anything in 35 years, we know how to manage the accounts and get them on budget quickly. It just took us longer than it should have, and March confirmed that we were there, so we are confident going into the remainder of the year we will be in good shape.

Great, that's helpful color. Can you provide a rough breakdown of what regions you added new clients in the food services segment during the first quarter? Just trying to get a sense for which regions you have more capacity for right now.

We are really spread out evenly. I would say the area that is probably closest to full capacity has been the Northeast. But that is because they have been allowed to grow more rapidly for over a year, where some of the newer areas, we just allowed them to start expanding more rapidly in the fourth quarter and first quarter this year.

But they are going to continue to grow, but their growth may be in the 10% to 15% range, where the others still will be able to have a more accelerated pace to them because they are still not as utilized as our model will call for with the district, managing 10 to 12 properties and a region managing four to six districts. The other areas, particularly in the Midwest, far West, and Southeast and West aren't there yet, but the Northeast is the area and mid-Atlantic are the areas that are closest to that model.

Great, that is helpful. And one last one if I may. As it relates to the new business wins, any change in the portfolio, meaning mix of large, small, or medium-sized operators?

I would say modestly it's been more the national chains that have had enough pent-up interest in food service over the past years, that have been long-term clients. And then as we are in a position to be able to operate more effectively and felt confident we could expand, that's where I would say the bulk of a lot of new business opportunities came from. It's more low-hanging fruit and we have a relationship with them already and they were really anxious for us to expand with them in that area than before. I would say our client base, I usually describe it maybe 30%, 35% are the large national chains. It's probably over 40% now, and I guess 35% are privately owned chains and the other 25% or so were individual operators, religious facilities. I would say the change in our client mix has really been more in the national chain expansion than some of the other areas.

Great, thanks for all the color today, Dan.

Next, we'll hear from Michael Gallo with CL King.

Couple questions. Just wanted to dig in a little bit to the margin and the cadence of growth. I guess the question is, do you need to slow down the pace of growth? Or is it something about the additions or just how you managed, or maybe what you learned from managing that pace that for whatever reason took them a little longer to get on budget, or do you think you have to slow down a little bit in the second quarter? Can you handle that pace? How do you feel with the management realignment? Will that help you absorb the pace, or help us to think about the framing of what you added and whether that was outstripping your ability to manage it, or if it was just, for whatever reason, took you a little longer to get stuff on budget.

If March's results weren't that much better I would feel a lot more nervous than I did. But frankly, in retrospect, we probably could have or should have done that a little more incrementally. Or, our approach should have been different and micro-managed it. When you create 35 new districts for example, to absorb the new business, in retrospect, this is the first time a lot of those district managers have been in that position. And to have eight facilities in a district and add two new pieces of business, and expect them to get it on budget, within this 30, 60 day interval is one thing. To create new districts and 8 of the facilities out of 10 need that kind of introduction, change and startup, and expect them to get them on budget.

In retrospect, we probably could have done that more efficiently and better. But the fact it just took them an extra 30 or 45 days to do it and March's performance indicated they made a lot of the adjustments, it just took longer than it should have, looking back, I'm a genius and I never make mistakes, but that gave us the confidence. It just took longer, and the newer district management people are growing into their job and performing the way we expected them to.

Would you expect to add similar level of business in the second quarter?

As far as the new business is concerned, what we really have to do is make sure we maintain that, do that properly. And most importantly, not take our eye off the ball from the older base business and the existing clients. The balancing act is the key. If we do that, then our growth rate will be in this range for the next three and four quarters, without adding that much more significant amount of new clients. We just have to maintain what we have, growing at our normal growth rate doesn't put the pressure operationally that it did in the fourth quarter and first quarter this year.

And we will be the beneficiary of the longevity of our services with those clients we started to pass. I don't think the same issues will be the case going forward. We just have to make sure, because they are still all at-will contracts, to keep all of the clients happy, both the existing ones, the new ones, and the ones that have been around for 20 years.

Right. Second question I have, Dan, I don't think I heard in the prepared remarks. Maybe I missed it. Did you break out how much the one-time management realignment costs hit in the first quarter?

We didn't. You have 35 new districts that were created with a Training Manager and District Manager at each. And in our model of 40 to 50 facility regions, you created 10 new regions with a Regional Director and Regional Manager, in theory, according to our model. So, it's a pretty expensive 70 new middle management positions that were created, that needed to be offset by the operational changes at the property. And we just didn't do that as quickly as we expected to.

I meant more specifically to the management realignment, what might have hit on the SG&A line?

That was more modest for the divisions. We created now 10 new divisions instead of the 8 that we had before. As they become more and more established, the expense are included. That was just a couple basis points higher, and that should be back to the 7%, 7.25% range going forward.

All right, okay. And I know you said previously expected 33% to 35% on the tax rate, is that still the expectation?

In the previous years, when the Congress has passed that job opportunity tax, they did it retroactively. So, there's a good possibility that will still be the case, but it is not in place now, and that is why the tax rate went back up to 38%. Until they pass that, it will be our normal 38% tax rate. But we are getting at least some information that this is just an interim, so we didn't make any record-keeping changes, and expect if Congress does pass it, they will do it retroactively.

Right, okay great. Final question. Obviously, we are coming into the time of year when the industry will start to get prepared for the next round of cuts or not. Given what happened last year, are you seeing an accelerated interest in maybe wanting to get ahead of that? Obviously, there is a view that one way or another, they are certainly not going to let the industry get fat and happy. I was wondering just given what happened last year, you are about to get the preliminary stuff here in a few weeks. Do you see the industry trying to get ahead of that? What you see?

I think as it pertains to us, the demand for the services has never really been our issue. So, in more flexible times, better times, steadier or times, or more difficult times, in reimbursement environment for our clients, they have never been reimbursed generously enough to where they don't have to be cost efficient. So the constraint in our growth has always been our ability to develop management people to be able to execute in a low margin business effectively, and that is still the case. I think a lot of the national chains that we have had good relationships with over the years, but weren't as aggressive in outsourcing our type of services in the past, in this environment, because of the confidence and the relationship we have been able to develop with them, and then the reimbursement environment, they have been much more aggressive in looking to outsource services, where before the decision-making was more property by property.

We don't think that the reimbursement environment is much different than it has been in 30 or 35 years. Some days or some years it's more generous, because the government didn't do a good job, and as they perceive it, created some loopholes for the industry to take advantage of. On the other hand, the industry says our job is to take care of the patients, maximize the returns, and maximize our reimbursement, and reduce the cost. In that environment, it works well for outsourcing companies of all kinds, not just for our services. So, I don't think it will be anything dramatic.

Even last year, with all the horror stories for the Medicare reductions that were publicized in October, most of the industry adjusted and adapted to it, and we are performing okay. From our vantage point, the receivables and the collection and credit is a barometer for us, and we have never been in better shape as far as the accounts receivable. So, our guys have done a very good job in managing the credit collection function, both in the field and in the corporate office. So we don't see any client stress any more than in previous years, and don't expect it going forward.

Great, thank you.

(Operator Instructions). Next, we'll hear from James Terwilliger with Benchmark Company.

That's an outstanding food service revenue number. You said the business was up over 50%. Is that correct?

Yes.

When you pick up the food service business, what are some of the start-up costs when you pick up those new clients?

The two components are really the purchases. First, to get the inventory levels up to a level we feel to operate most effectively is the bulk of the startup. A lot of the cupboards are bare when we take over a food service contract. Somehow the ordering isn't done the same way, anticipating us coming in, that it was if we were not. So that's one.

But then the other start up is the staffing. For us to save money at these customers, and support the middle management people, we typically do it with less people. But the first 30 to 45 days, optimally we are paying more people than we budgeted the job for, and as we go through the training and evaluating the personnel, it usually takes us that 30 to 45 days of absorbing the surplus payroll expense, until we get it on budget. And in this case, it just took longer than it should have. Both in housekeeping and laundry and food, frankly. But that is the startup costs.

The additional payroll and labor cost that we are absorbing at the start up and then whatever inventory investment and equipment to get, whether it is the linen and laundry inventory, or in the food purchase inventories to get them up to the level that we need. And then any modest equipment that may be required to be able to run the job as efficiently as we budgeted it.

Okay, my next question was going to be the tax rate, but I think you have already discussed that. That should be about 37%, 38%.

Really for us, we are so payroll-centric, that job opportunities tax requires some additional record-keeping and some resources, but the benefit more than offset it. If it gets passed again in the past years, they did it retroactively back to the beginning of the fiscal year. If they do that, that will go down. If they don't, then we will modify what our SG&A expense will be. Because we won't have the same record-keeping and reporting requirements if we're not going to get the tax benefit.

Okay. And some of your comments, you mentioned while there may have been looking backwards in January or December or February, kind of a hiccup or maybe a one-time blip on getting some of the businesses back up to where you are more comfortable with the margins, but you do believe you have got back to your 14% gross margin in the month of March, or as you exited Q1. Is that correct?

The operating performance and how we measure each of these accounts and divisions and districts demonstrated the improvement that we really expected to take place mid-January and certainly February. But it took us to March to show those operational profit improvements.

Last question. When you look at the growth, the revenue growth that you have done here in Q1 and Q4 of last year, is there any change or any catalyst with your customers that they are moving faster and accelerating this outsourcing trend? Or would you define it as stable, you're just getting more business? I mean, when you look back historically at your Company, and you average the last four or five years, each quarter's growth rate. When you look at this 25%, this 24% for Q4, these are some of the best growth numbers in my model that you've ever done. I know you have built this infrastructure to support this. Is there any change at the customer that is a catalyst, where you are seeing more customers embrace this outsourcing?

I think there has been, really over the 35 years we have been doing this, each year, outsourcing of all kinds has become more accepted in the industry. I remember at the beginning, when we started the Company, almost everything was done in-house, whether it was part of a national chain or an individual operator, And over 30 or 35 years, outsourcing companies, whether it's medical records, whether its pharmacy, whether it is therapy, or even the most mundane services like ours, have become more and more accepted in the industry. That is more so today than last year and we expect next year.

I think our growth has been because of the relationship we have developed with the customers that we hold up our end, they see the financial benefit, but the operating benefit as well. I know that -- after the initial savings, which is what clients, I believe, buy in the first place, we get no credit, we think we do a better job, more resources, we are certainly not perfect, but after the initial benefit, I think the more longer-term benefit they perceive, is they know whatever departments they outsource are going to hit their budget with no unfavorable variance every month, so there is no negative surprises for them, and in this environment, that is critical for them, because the risk is transferred to us. They have a fixed price.

It allows them the comfort to concentrate on the nursing department, far and away their largest department, and the patient mix and managing the Medicare, Medicaid, and private pay census, which is their lifeblood, without having to concern themselves with the fiscal surprise in housekeeping and laundry for example, or food. And as we performed operationally, I think a lot of the clients that have expanded have seen us as a more attractive alternative for all those reasons. I think that is where there has been stepped-up expansion of the relationship. But the constraint for us has always been the development of management people. The expansion in food, I have talked about it for two years, that our districts and regions were really underutilized, but that's the investment we felt we had to make and that the new business would be there when we felt the management people were capable, and that is still the case today.

So, I think for the next 1 year, 1.5 years, we will grow at a more accelerated pace because of the business we have booked, we will grow effectively, keep the client retention where it should be, and then after a 1.5 years, 2 years, we will be able to say okay confidently now, with this organizational expansion, with this performance, now longer-term, this could be our growth rate going forward. But we will be on the higher end or really exceed our historical growth rate for the next 1 year, 1.5 years without doing anything exciting, as long as we execute properly.

Thanks Dan, I will jump back in queue. Thank you.

At this time, that does conclude our question-and-answer session for today. I would like to turn the call back over to Mr. Daniel McCartney for any additional or closing remarks.

Okay, thank you. I guess going into the second quarter, we expect to continue to expand our client base in housekeeping and laundry. In this environment, I know we are a little above our rate in the first quarter, but 10% to 15% is still where we think the rate -- we can do a little better than that, but we can manage it effectively. In this environment, even in housekeeping and laundry, the demand for our services is as great as it's ever been. We will continue to target the growth rate in food service more rapidly, because of more surplus in middle management people.

But our execution has to be balanced with the client satisfaction measurements for the existing clients, and making sure we get the new business not only operationally sound, but on budget as quickly as we target. Since we are now more confident in the consistency of our district and regional management people, we should be able to utilize the investment we made and continue to grow at a more rapid rate over the next 1 year, 1.5 years, or so. All our divisions continue to perform better, and with the growth, they have to prove that we can operate consistently both for our client satisfaction levels and our own financial performance, division by division. And not taking our eye off the ball for the long-term clients, because we get enamored with the growth or expansion. That's always been our balancing act.

We will look to get the direct costs below 86%, and work our way back down to 85%. Food service margins are the area that well most significantly contribute to that margin improvement, but we can always do better in housekeeping and laundry as well. With the SG&A being 7%, 7.25% ideally, our tax provision depending on Congress' actions will be 35% to 38% with the Worker Opportunity Tax Credit still hanging in the balance. As far as investment income and interest rates, who knows for certain, but I think it will stay at the levels that it has been the past few quarters with no deferred comp adjustments.

Our business is still strong, with demand for the services as great as it's ever been. More important to us, we've never had better management people in the history of the Company. But it still becomes a blocking and tackling execution story, and we have to watch the nickels and dimes in the field. We believe the recent growth has been operating on budget, and certainly demonstrated that in March. And expect the remainder of the year to be in good shape where we historically have been. So all in all, these are pretty good times for us. Thank you for joining us, and onward and upward.

Thank you. That does conclude today's teleconference. We do thank you all for your participation.