Healthcare Services Group Inc (HCSG) 2012 Q2 法說會逐字稿

Good day, everyone, and welcome to the Healthcare Services Group Inc 2012 second-quarter conference call. Today's conference is being recorded. 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 from having several significant clients who each individually contributed at least 3% with one as high as 7% to our total consolidated revenues in the three and six month period ended June 30, 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 IA Risk Factors.

Many of our clients' revenues are highly contingent on Medicare and Medicaid reimbursement funding rates, which Congress and related agencies have effected through the enactment of a number of major laws and regulations during the past decade, including 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 Center for Medicare Services issued final rulings, which among other things, will reduce Medicare payments to nursing centers by 11.1% and change the reimbursements for the provision 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 significantly 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 costs of labor and labor related costs, materials, supplies and equipment used in performing services could not be passed on to our clients.

In addition, we believe that to improve our financial performance we must continue to obtain service agreements with new clients, provide new services to existing clients, achieve modest price increases on current service agreements with existing clients, and maintain internal cost reduction strategies at our various operational levels. Furthermore, we believe that our ability to sustain the internal development of managerial personnel is an important factor in impacting future operating results and successfully executing projected growth strategies. At this time, I would like to turn the conference over to Daniel McCartney, CEO and Chairman. Please go ahead.

Thank you, and good morning, everybody, and thank you for joining us. We released our second-quarter results yesterday after the close, and we'll be filing our 10-Q the week of the 23rd. For the second quarter, our revenues were up 26% to $267.108 million. And for the six-month period our revenue increased 25% to $527.715 million. Housekeeping and laundry grew at about 16% and food service better than 52%, 58% for the quarter, and 16% and 56% for the six-month period.

As we discussed in our fourth- and first-quarter calls, we expected to continue to accelerate our expansion in food service, not because of any change in demand in the Medicare environment necessarily, because demand has never been our issue, but due to the investment we made in regional and district management people over the past few years, that have gotten better and gave us the confidence we could expand more aggressively as they got better at executing in their positions. Their continued development allowed us to begin new food service clients within the existing operational structure and expand more rapidly than we had in the years past. In addition, our housekeeping on laundry services continue to grow at slightly better than our targeted range of 10% to 15%. All quarterly and six-month revenue numbers were all Company records.

The net income increased by 15% for the quarter to $11.320 million, or $0.17 a share, compared to $0.15 in 2011 and 13% to $19.899 million, or $0.29 a share for the six-month period. Again, all company records. Our direct costs for the second quarter were 86.2%, as we got the new business we started in the fourth-quarter 2011 and the first quarter this year, and the new districts and regions progressed in implementing the changes we needed to make, and frankly, just getting the jobs running on budget. We expect to continue that progress with the new business. The margin improvement should continue without taking our eye off the ball and giving the proper attention to our existing clients. We continue to work towards getting our direct costs back under 86%.

Our SG&A costs were reported at 6.9% for the second quarter, but due to a loss of about $359,000 in the deferred comp accounts, for and held by our management people, which should be reversed, our SG&A adjusted was really 20 basis points higher, or about 7.1%, within the range of our 7% to 7.25% range for the SG&A. That is what we think our SG&A costs are going to remain with no deferred comp impact considered. As in past [quarters, the SG&A also includes some states like Ohio and Michigan and Texas that change to a gross receipts tax that is expensed in the SG&A], and the additional resources we added in the benefits and payroll department that have allowed us to meet some new hiring, personnel record-keeping, and be more efficient in the employee benefits insurance areas and the benefit from certain job tax credits when they are available.

Our earnings from operation were reported as a $18.378 million, but again, adjusting for the deferred comp impact, our earnings from operation actually were $18.728 million, an increase of better than 28%. [Investment income is reported as part of the thousand dollar expense. Obviously we have no debt, so there is no interest expense when that $359,000] adjustment from the SG&A is made and reversed. The company's investment income was actually about $250,000 for the quarter. Our tax rate was 38% compared to 34% in the second quarter of 2011, as Congress has still not finalized the Worker Opportunity Act and some other tax credits that we've benefited from; at least they haven't approved it yet.

On our balance sheet, we ended the quarter with over $77 million in cash and securities, a current ratio of better than four to one. The receivables remained in good shape, well below our target of 60 days. And finally, the Board of Directors approved an increase in the dividend to $0.16 and about one-third cents per share split-adjusted to be paid in the third quarter on August 24. The cash flow, cash balances, and earnings per share for the quarter more than support it, and as we have discussed in the past, since the tax law is in place still, at least for 2012, we still feel it is the most tax efficient way to get the free cash flow back to the shareholders. The increase is our 36th consecutive quarterly increase since the dividend was originally instituted in 2003 when the tax law first changed, and that is after four three-for-two stock splits during that period of time.

Before I open it up for questions, I wanted to review some areas that those who know the Company are very familiar with, but some others may not be. First, as far as our market potential, since the Company's inception in 1977, we have traditionally targeted long-term care facilities. And as we have expanded state-by-state over these 35 years, we always introduced ourself to those markets. All industry estimates project that there are about 16,000 nursing homes, over 6,000 acute-care hospitals, over 20,000 assisted living [and retirement communities, without considering any of the (inaudible) types like sub acute care, rehabilitation centers, psychiatric hospitals and many other healthcare related facilities and tenets et cetera. Usually a new facility like below 60 birds is typically too small for us and so would not support the full-time management teams we feel we need of other our exceptions.]

Our point in going over any of these industry facts is no matter how it is calculated, after 35 years, servicing [3,400 facilities approximately, we have not come close to maxing out our potential client base. Finally on this topic, it is supposedly with the company know, more than 35% of our clients are facilities that are part of large national chains and in fact it has been the market niche that we have grown the fastest with over the past few years. A second topic is our] service agreements. Our service agreements have always been at will contracts, with a 30 to 90 day cancellation clause by either party. The recent Medicare, Medicaid debates and rate setting have increased the demand for our services, but again, demand for our services has never been the constraint on how quickly we could grow.

Those again, who are familiar with the Company are aware that our approach in our service agreements have us mirroring the wage rates and conditions of employment, union or nonunion, that our clients operate with. Due to this approach, as the facility increases its wage rates for its blue-collar support staff, our contract prices adjusted as well, and our employees receive the same. If a client decides for whatever reason to freeze or not give any type of increase to its staff, we would follow their policy so our employees are treated no differently. In spite of the cost pressures from Medicare and Medicaid, very few clients have frozen their wage rates, and I would say that the average increase has remained in the 2% to 3% this year as well as the past few years.

And then finally, our dividend policy, since we have instituted the cash dividend when the tax law changed, we felt it was still the most tax-efficient way to get the free cash flow back to the shareholders without affecting the Company's growth or stock buyback program if and when the opportunity presented itself. That is still the case. With the Company having more than sufficient cash balances, [no debt, continuous growth for 35 years, we have increased the dividend of 30 6/4 consecutively, with] four stock splits and with the tax law in place, we expect that trend and policy to continue. So that I'll open it up to questions.

Thank you. (Operator Instructions) We'll go first to Michael Gallo with CL King.

Question, Dan, could you talk a little bit about the opportunity in hospitals? Obviously, an area historically, you still have certainly plenty, plenty of opportunities in long-term care. But is hospitals an area that you see some opportunity? Obviously, you tend to be willing to operate on much lower margins, at least on the gross level than some of your big competitors in the hospital space. Thank you.

I think for the hospitals, they've always been part, but a small part of our client base. You want to be identified or recognized as an expert, quote unquote, in one marketplace or another. But I would say out of the 3,400 facilities, probably 100 are hospitals. How we have really handled the hospitals, typically, whether it is community hospital or part of a chain, they're much more bureaucratic in their approach. They get a consultant to put an RFP out. And when we are in those marketplaces, we are invited in to bid, and we get our fair share of the hospital market. And every two or three years typically, it goes out to bid again.

So we have developed the expertise required, the specifications, and the modification of certain procedures, infection control and the like. And more recently, we have done the same thing in the food service area that translate well for the hospitals when we bid those jobs as well. So I don't see our focus changing; although hospitals have continued to be a bigger part of our expansion than they had, certainly in the early stages of the Company. Typically, somebody else convinces them of the outsourcing option, and then we are invited in to bid; although, we have been more attentive in the initial contact with hospitals than we had maybe five years ago.

Dan, the second question, obviously nice improvement in the margins this quarter. Better job getting the business on budget. You still had, obviously, very robust revenue growth this quarter. I guess my question is, as you got this business online, do you feel comfortable being able to manage the margins of these levels of revenue growth? And then also, when I look at the 10% to 15% longer-term growth targets that you have out there, certainly you have managed that over the years, even housekeeping has been growing much faster than that, and obviously food service for the foreseeable future should grow a lot faster than that. So I was wondering if you feel more comfortable at the high-end of the range in the near term at least as food service rolls out? Obviously, it's going to continue to be above that, certainly at least in the third quarter, just by what you have already added.

I certainly feel more comfortable than I did in the first quarter when we were having a more difficult time getting all the new business on budget. But as I said in the first quarter call, March showed improvement, but it was important for us to sustain it throughout the second quarter. The guys have done a good job in not only absorbing the new business in housekeeping and laundry and food, without taking their eye off the ball from the existing clients and having too much margin erosion. Although I think there is still margin improvement to be had within the existing business, but now it is more a grind-'em-down, business-as-usual type of approach rather than try and digest the new business.

I think as long as we execute, put a couple quarters together where we demonstrate that we can sustain this kind of progress and improvement, then will be able to more confidently say what we think we can expand without compromising the day-to-day stuff that we need to do to make the Company that. But we think that the 10% to 15% growth is the minimum we should expect to do. And if we execute, but by the end of the we will have a good idea this could be our sustainable growth rate and that will be able to more confidently tell it to everybody that we have demonstrated not only can we digest this, but we have executed consistently and be able to more confidently say what we think our expansion can be going forward, which way maybe more -- is that it has been in the past. Certainly in food service but there is still plenty of activity and room to expand in housekeeping and laundry as well.

We'll go next to Mitra Ramgopal with Sidoti.

Just a couple of questions. Again, coming back to the business you're bringing on, is it more a case where someone is outsourcing if for the first time, or are you also taking business away from competitors?

In almost all cases, it is somebody outsourcing for the first time. There really is very, very limited competition, and I would say more than 95% of the time that we are awarded a new contract or enter into a new service agreement, it is where they were doing it themselves and we were the outsourcing option. In the hospitals, it may be a little different, but certainly 95% of the time in long-term care, that is the case.

And again, with regards to the business you're bringing on, is it more a case of just timing things coming together and having the right people in place, et cetera? Or is there something different you are doing that maybe you have not done in recent years?

I think it is more the case that the district and regional management people that had been promoted really in the fourth quarter and first quarter of this year that took new positions. If we added 300 new food service contracts, for example, that means that there were 35 district management positions that didn't exist before. And the district management people in the regional management people that were promoted were getting their sea legs, and for the first time, operating at a different level than they were before. And in retrospect, it took them a little more time. And maybe I should have been aware, we should have been aware of that, than it did in January and February to make the cuts, get the jobs running on budget, and simultaneously having the client be satisfied and happy with the services. So it was a lot to ask.

I think they have demonstrated the last four months significant improvement, not only in the margins but the client satisfaction levels. And that is what has allowed us to grow at a more rapid rate, more than anything else. There has always been more demand that we can do. The discipline has always had to been the development of management people and not getting ahead of ourselves rather than a change in the marketplace.

So which is a that maybe the economic slowdown has pressured providers to also outsource the business more, or has that really not been an issue?

I'm sure that is what has increased the demand. I think almost as important, outsourcing has become more accepted in the long-term care industry. It is not a new idea like it was in the late '70s and early '80s, when almost 100% of long-term care facilities, everybody did everything in-house. Now the trends are much different, maybe for financial reasons, certainly. But if there wasn't an operational benefit, the clients wouldn't do it. So I think it is both. We have demonstrated we can be a good asset, allow them to concentrate on their core business, where we take the support service or a more mundane part of their business. Financially and operationally the headache is away from them. So I think it is both. But the demand and our observation has always been that. Our execution and credibility with a lot of the clients over the years has been just as an important part of them making the decision.

We'll go next to Ryan Daniels with William Blair.

It's Andy O'Hara in for Ryan this morning. Just a couple of quick ones here. First, I was wondering why shares outstanding jumped by about 1 million sequentially?

There were some options.

There was nothing unusual there?

No.

Okay, cool. And then do you give the approximate number of clients in both housekeeping and food services at the end of the quarter?

Say that again?

The number of clients in housekeeping

We don't give out the clients. There is about 3,400 in total. We're doing about 700 in food service.

Okay, perfect. And then for the food services that you added during the quarter, was it pretty evenly spread out again? Or was there a particular reason it was strong?

Now it has been away for the last three quarters and it has been spread out over all of the divisions.

We'll go next to Rob Mains with Stifel Nicolas.

Dan, in the past, you have talked about why some of the bigger players in the hospital industry haven't moved down to compete with you in housekeeping. Are you seeing any of them looking at the dietary business, or does that also seem to be something that is exclusively your province?

No, I think that in our client base, in our food service proposals, we are typically, again, and I think the same ratio competing with them doing it themselves and we as the outsourcing option. So the margins that shows arrow marks have really not been a factor in our observation within of our clients in the food service area. Anyone in the service mix to our marks were in a housekeeping and laundry area.

Got it. And then any cost trends for commodities worth mentioning at this point?

No, it has been relatively flat. I would say the last three years for us. And the simultaneously, we have just become better purchasers and been able to negotiate better deals with different manufacturers and food service -- food distributors. But there has not been any significant commodity cost impact certainly like we experienced in 2009.

Okay. And then the last question, we saw the Genesis merger announced. And if one were to buy the various factors and that cause consolidation among nursing home operators. In your experience, when there has been M&A among the nursing homes, is that an opportunity for HCSG and that that is one of the housekeeping and dietary moved one of the synergies that the Pimlico business competition? Or is it kind of business as usual still selling a one facility at the time?

In most cases, it is still business as usual. I use the example that Beverly, for example, has been a client since 1983, but they have gone through so many changes, private, public, in Pasadena, in Fort Smith, Arkansas, now in Plano, Texas. The corporate entities have changed dramatically. Kindred, that our strategy with the corporate clients has been to educate and neutralize the corporate people, get them to feel comfortable with outsourcing in general, and us as a Company specifically, but so was services locally property by property. And because they're at-will contracts, we are only there because that particular operational person or administrator sees us in their best interest. And no matter what the corporate structure may or may not be, it almost all the cases, the decision is left up to the local provider.

And now that we have become more well-known and all the large national chains where almost all of them are clients, we are not doing anywhere near all of some of the business, but we are doing more every year. And some of them, we are doing a significant part of their business. But it has been, in Golden Living's case, for example, a 28-year relationship that we've sold property by property to where now you, are doing 90% of the facilities. So the consolidation and ebbs and flows we have really experienced for the 35 years, seeing the trends go back and forth. As long as we execute at the property level, our client retention has remained pretty solid no matter what the corporate structure changes will be.

We'll take our final question from James Terwilliger with Benchmark.

Nice and numbers here in the quarter. Most of my questions have been answered. But in your opening remarks I'm very familiar with the dividend program and your desire to give shareholders back some funds. But you also mentioned the stock buyback program. Are you doing anything with the stock buyback program?

We have always had an authorization and NOI different times that create some liquidity issues. But I would say since the program was instituted maybe more than 10 years ago, we have bought about $45 million was our stock 'we still have 100,000 shares on the last authorization, because we like having it available if the opportunity is there. We would be able to go back and utilize it. But in 2003 or since then, it has really been significant that the cash flow has gone back to the shareholders in the form of a dividend rather than as aggressive a buyback as we had prior to 2003.

Thank you for updating me on that. When you look at the pipeline of the new business, I know you have had a great revenue growth year of 26%, extremely strong. What does the pipeline of the new business look like in terms of the bids and the RFPs that are sitting on your desk? Is that --

Very few are RFPs, except for the hospitals. But the pipeline and the regional directors and regional management people through the 10 divisions, have always enough activity, anticipating that we're going to execute the new business properly, and then anticipating the next quarter's growth. And frankly, the new opportunities have been as a significant as they have ever been in the 35 years we have been doing this, but as I said, probably too many times for you guys to hear, that has never been our problem. There is more opportunities for us to pursue, and as long as we don't ahead of ourselves, execute the existing properties and get the new business on budget properly, we will be able to, in a controlled way, continue to expand quarter to quarter because there is no lack of opportunity for us to chase.

Okay, and my last question is when I look at the -- and I know this has been talked about at length, but when I look at the gross margin improvement from the first quarter to the second quarter, maybe 110 basis points off the top of my head, what were the drivers if you could drill down a little bit, what were the drivers of the gross margin improvement from Q1 to Q2?

As we talked in the fourth quarter more specifically when the margins, when the direct costs were over 87% in the first quarter, when we start that much new business, that is where the most significant investment is. It is usually to get the inventory levels or housekeeping and laundry and linen, but primarily in food service, to the levels we feel we need to operate. So that was an anticipated investment we had to make. What we didn't do as well as we should have. We also absorb all of the employees on our payroll when we start. And that usually takes us 30 to 60 days to make the staffing adjustments and cuts to get the jobs running on budget. And it just took us longer than it should have when we started that much new business in the first quarter. And I mentioned in the first quarter call that in March, it demonstrated we were making good progress; it just took us longer than it should But we were able to sustain that and improve upon it and get more of the accounts on budget. So it came from just getting the new business more where it was bid, where it took us a little longer than it should have in the first quarter. And that is where the direct cost margin improvement came from.

We have no further questions at this time. I'll turn the conference back over to Mr. McCartney.

Okay. Again, thanks everybody for joining us today. Going into the third quarter and really for the remainder of the year, we continue to -- we expect to continue to expand our client base in housekeeping and laundry in a very controlled way. Probably at the top end of our growth targets typically. In this environment, the demand for the service is still as great as it has ever been. We will continue to control our growth rate, attempt to balance the expansion with new clients without taking our eye off the ball with the existing clients. It remains important for us to balance the client satisfaction measurements, and our client retention has been much better than 90% that we typically historically have targeted. And we want to get the new business on budget maybe more timely than we did the first quarter as we expand, without taking the older clients for granted. So it is a balancing act.

The guys have done a very good job in the second quarter executing from the facility manager, the district manager, and the regional management level. And we expect to be able to do the blocking and tackling every day to be able to execute properly. We're more confident in the consistency of the new district and regional managers and housekeeping and laundry and food service, really in all 10 of the divisions. And as we more fully utilize the management people, our expectations are that the margins continue to improve and we look to get the direct costs below 86%.

We think that the SG&A will stay in the 7%, 7.25% range, excluding any deferred comp impact one way or the other. We think our tax provision is going to remain at 38%. Depending on what Congress does, we could be the beneficiary down the road, but we are not planning on that. It will be a nice outcome of it comes in. But in our business, there is still strong demand for the services, housekeeping and laundry and dining. Our management people in all divisions, and especially in food service, continue to develop and get better. We believe the recent growth will continue to operate on budget, and consistently going forward, we will do what is required to make sure we execute as well as we can. So overall, these are pretty good times for us. Thanks again for everybody joining us. Have a good summer and onward and upward.

Thank you, ladies and gentlemen, that does conclude today's conference call. We'd like to thank you all for your participation.