Healthcare Services Group Inc (HCSG) 2013 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Healthcare Services Group Inc. 2013 first quarter conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time.

(Operator Instructions)

As a reminder, today's conference call 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, 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 other 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 health care 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 6% to our total consolidated revenues in the three months ended March 31, 2013; 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, 2012 in Part I 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 affected 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 Health Care and Education Reconciliation Act of 2010. On July 29, 2011, the United States Center for Medicare Services issued final rulings which, among other things, reduced Medicare payments to nursing centers by 11.1% and changed the reimbursement for the provision of group rehabilitation therapy services to Medicare beneficiaries.

On January 2, 2013, President Obama signed into law the American Taxpayer Relief Act of 2012, which also addressed the provisions of the Budget Control Act of 2011. Under these provisions, the Act reduced federal spending, which began in March 2013. This initiative acts as a means to reduce the national deficit by $1.2 trillion split evenly between domestic and defense spending. 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 threaten 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 impacting future operating results and successfully executing projected growth strategies.

With that I would now like to introduce your host for today's conference, Mr. Dan McCartney, CEO. Please go ahead.

Thank you, Allie, and thank you, everybody for joining us. We released our first quarter results yesterday after the close and we'll be filing our 10-Q during the week of the 23rd, and I guess before we begin, I think anybody whose been on these conference calls before will confirm that Allie just did the best job of reading our cautionary statements in the history of our conference calls. So thank you, Allie.

But as we announced last week with preparation of our proxy statement, we announced the appointment of Jason Bundick, Corporate Counsel, as Chief Compliance Officer due to the retirement of former Chief Financial and Chief Compliance Officer, Rich Hudson. Before we start, with thanks, we only wish Rich the very best in his retirement. We also announced the retirement from the board of directors of Joe McCartney effective after the shareholder meeting in May. Again, after 30 years on the board we thank Joe for all his hard work and contributions to the board of directors during that period of time. If elected, the new slate of board members will be made up of two-thirds outside directors. We also announced the modification of our relationship with two of our corporate clients which impacted revenue growth for the quarter below our historical targets of double digits. Although the two clients remain customers, we reduced the services and therefore, obviously the revenue procured from those clients.

So with that, I'm going to turn it over to Ted Wahl, and Ted is going to talk about the results in a little more detail.

Thank you, Dan. Revenues for the first quarter of 2013 increased over 5% to nearly $274 million which reflects the impact of the relationship modifications we made with the two corporate clients Dan just described. Q1 of '13 also had one less day of leap year revenue when compared to the prior year's corresponding quarter. Housekeeping and laundry revenue for the quarter grew at about 4%. Dining and nutrition was up nearly 9%. Net income for the quarter rose over 74% to $15 million or $0.22 per share, compared to $8.6 million or $0.13 per share in the first quarter of 2012.

The retroactive reauthorization of the work opportunity tax credit for 2012 favorably impacted EPS by about $0.02 per share for the quarter. Both net income and earnings per share were Company records. Direct cost of services for the quarter came in at 85.8% which is slightly below our target of 86%. The districts and regions continue to give proper attention to our existing clients and make progress with the new business we added last year by implementing operational changes and getting the jobs on budget in a timely manner. Going forward, our goal is to manage direct costs of services under 86% on a consistent basis and work our way closer to 85% direct cost of services.

Selling, general, and administrative expense was reported at 7.6% for the quarter. But after removing the impact of the $890,000 gain in the deferred compensation investment accounts held for and by our management people, our actual SG&A was 7.3%. That 7.3% includes about 35 basis points of expense related to the certification of the 2012 WOTC credits. As we discussed in past quarters, SG&A also includes gross receipt taxes paid to states like Ohio, Michigan, and Texas, as well as the additional resources added from when we expanded our human resource and risk management departments. This departmental expansion has allowed us to be more efficient in the employee benefit and insurance areas as well as comply with the new hire and personnel record keeping requirements demanded by the regulatory environment and job tax credit programs like the WOTC. For the balance of the year we would expect our SG&A to continue to be in that 7% to 7.25% range with the ongoing opportunity to garner some modest efficiencies.

Earnings from operations for the quarter increased 40% to $18.8 million, and investment income came in at $150,000 after removing the impact of the $890,000 gain in the deferred compensation investment accounts. Our tax rate for the quarter was 21% due to the true-up of the 2012 WOTC, and we would expect our tax rate for the balance of the year to approximate 35%. We continue to manage the balance sheet conservatively, and at the end of the first quarter had over $77 million of cash and marketable securities on hand, no debt, and a current ratio of better than 4 to 1. Our accounts receivable remained in good shape, well below our DSO target of 60 days.

Finally, in conjunction with the first quarter earnings release, our board of directors approved an increase in the dividend to $0.1675 per share split adjusted payable on June 14. The cash balances and earnings for the quarter more than support it and with the dividend tax rate increase being less than anticipated and in place for the foreseeable future, the cash dividend program continues to be the most tax efficient way to get the value and free cash flow back to the shareholders. It will be the 40th consecutive cash dividend payment since the program was instituted in 2003 after the change in tax law. It's the 39th consecutive quarter we increased the dividend payment over the previous quarter. That's a 10 year period that included four 3-for-2 stock splits.

And with those opening remarks, Dan and I would like to open up the call for questions.

(Operator Instructions)

Rob Mains, Stifel.

One balance sheet question, notes receivable went up in the quarter. Is that related to the contract restructuring or is that something else?

It's really -- it has nothing to do with the two clients. We've used the promissory notes before if a client got beyond the terms that we boxed them into a promissory note and that's the longer term portion of one of the clients on some of the notes that we entered during the course of the quarter, but it has nothing to do with the two clients that we modified the services with.

Okay, because it was up from where it was at year-end. I assume I shouldn't read into -- (multiple speakers). Pardon me?

It was about $1 million. That's the longer-term portion of the receivable.

Right, but I shouldn't read into that any kind of trends in terms of client credits?

No.

Okay.

Our credit issues are really still client specific, and when we enter into these notes it's just a vehicle to enhance the collection efforts.

Okay, thanks. And then when you look at revenue growth, obviously the two contracts kind of put you a little bit behind the eight ball to start the year, but in the past you've talked about the dietary division might be able to accelerate growth. Are you still thinking the 10% to 15% long-term is the right number or are you thinking that we should be -- might that thinking be changing as the year progresses?

No, I mean internally that's still our growth target, and therefore externally, but the difference is when you have the impact of these changes which is highly unusual for us in a quarter, it's just going to take us a couple of quarters to execute to get back to double digits. But if we execute properly, incrementally the revenue increases should start to bump up, and by the end of the year, we should be back close to double digits. The thing that's constrained our growth mostly has been the development of management people with the skinny down of services in this case, we really now have a surplus of management people which will allow us in certain areas that have been impacted by this to grow at a more rapid rate than they would have, had they not. But it's going to take us a couple of quarters to continue to execute, add the new business in some areas at a more accelerated pace than we would have otherwise because of the management resources available. And by the end of the year, certainly the beginning of 2014, we still expect 10% to 15% to be our target growth rate.

Okay, because in the past, you've talked about looking at the run rate that you've got, particularly in dietary, as something that could potentially positively impact long-term growth rates. Are you still evaluating that I guess?

Yes, Rob, I believe our objectives continue to be on the dining side, the higher end of the 10% to 15%. But as we talked about on some of the prior calls, we've digested successfully the expansion in the second half of 2011 and into the first half of 2012 and over the next few months certainly our target and what we should be able to grow at the higher end of that range, 20%, 25% some quarters but that will depend on the adds and where we decide to geographically layer in the business. I'm not saying it's the easy part, but it's certainly the easier part on the dining and nutrition side, is growing that top line and managing the business given the depth that we have in our management structure today.

Got it. Then one last question. Specifically on the dietary in the quarter, when you look at the new contract adds that you had, roughly what proportion of those are with existing housekeeping clients versus non-housekeeping clients?

It's still the majority continues to be with our existing housekeeping clients. It's almost all of them.

Ryan Daniels, William Blair.

I want to start with a quick follow-up on the revenue outlook given the contract modifications. Curious if you can give a little bit of color when those took place, meaning is that a January 1 type change so that the full impact was seen this quarter? Or did it happen mid quarter such that we'll see a little bit more slowdown when it fully run rates through the numbers in Q2?

It's really a phase-in. One of the clients was at the beginning of the quarter and the other client was kind of incrementally adjusted during the course of the quarter, but I'd say the lion's share of the impact is reflected in the first quarter revenue numbers.

Okay, that's helpful. And then in the past, you've talked a little bit, another follow-up question here to Rob, about the food services infrastructure and kind of given us updates at the start of the year on the development and ability to ramp that as an initial sale. Can you just give us the latest state of the union on the food services group and how the capacity looks there?

Yes, it's similar to kind of where we were over the last couple quarters. We continue to have an underutilized dining and nutrition infrastructure at the district and regional level compared to the model that we've successfully implemented in housekeeping and laundry as well as certain areas in dining and nutrition. So if we're averaging 10 to 12 facilities per district in housekeeping, we're still at that seven to eight facilities per district in dining and nutrition, and at the regional level, 3 to 6 districts per region in housekeeping, we're averaging 3 to 4 districts per region in dining and nutrition. So obviously that's what is allowing us to try to accelerate the growth in dining and nutrition and grow at a faster pace relative to what we've done historically, this underutilized management infrastructure. But it will also benefit the margins going forward. It won't happen in one quarter or over a 12 month period, but if we execute properly by layering in the new dining and nutrition business into this existing infrastructure, we'll see over the next two to three years the margins continue to take up and ultimately near those of housekeeping and laundry. That's our goal.

Okay, that's helpful. And then either Dan or Ted, maybe one final one. Maybe I'm looking at your website too much, but it seems like you've got more material up of late on the hospital markets, talking on the dining about your Personal Select and your Classics Cafe and then a little bit more focus there on the IntelliClean for the hospital services as well. So I'm curious if -- is that something you've always had? I know you've had a little bit of focus on the hospital market and had some contracts there. Are you pushing that as more of a novel growth opportunity or is that just a little bit more marketing focus or description on the website?

You know what it is, Ryan? We've been invited to more RFP situations than we have in the past. So what we've concentrated on doing over the past 12 months was really amalgamating best practices from throughout the country and making sure we have a consistent effort when we are -- when we do have that opportunity to propose on a hospital. But it still continues to be a situation that we're invited to propose rather than us pursuing a hospital in a given market. And we've always done about 100 or so hospitals, and we've just tried to maybe have more resources available for people in the field that will be able to demonstrate we have that expertise too. So we're not pigeonholed into only doing the long-term care segment of the health care industry, but certainly have the ability and resources and the track record to where we can successfully convert our services to hospitals. The difference is somebody else is marketing them the idea and we're invited into bid when we're in those marketplaces as opposed to long-term care where we're starting from scratch.

Right, and has that become a bigger portion of your growth then over the last 12 months or has that not yet really manifested with seeing more, I assume quite larger hospital clients coming in the revenue mix? I think it has been proportionate to what it has historically been. I think the bigger difference is we've added food service in some of the larger community hospitals and governmentally run hospitals that warrant housekeeping and laundry clients, and that's been different. We've been invited in the RFP process to bid for the food service and have been pretty successful where there are not housekeeping and laundry clients and they don't have the interest for the time being in that. And that's been a little differentiation from our normal approach.

(Operator Instructions)

A.J. Rice, UBS.

Couple questions. I got on a couple minutes late so I may have missed this if you gave it in your prepared remarks. Has the reworking of the two contracts that you guys have been highlighting for the last few weeks lead to any other clients coming forward and asking for a change in terms?

No, because really the modifications were in some cases mutually dictated depending on the customer and the geography that we transition. So this has -- each client we look at on an individual basis and really on a facility by facility basis, so there was no impact with any of our other customers.

Okay, and then I know long term the discussion has been around getting the dietary margins up to the level of the housekeeping. You've put that out as a long-term goal. Can you comment about what you're seeing in terms of opportunities to get margin leverage on the dietary side and how that will play out over this year and into next?

I think the best indicator of what we're going to do in the months and years ahead is just what we've done over the past two years subsequent to making the investment in the infrastructure and the consistent margin improvement that we've demonstrated. But we'll be filing the Q in a couple weeks and it will be there for everybody to see, but the margins we will expect to continue to move in a positive direction. And again, ebb and flows quarter to quarter aside, we're looking at it more from a year to year basis if we continue to execute and continue to layer in the business successfully into the existing infrastructure then the margin improvement -- the margin expansion both in dining and nutrition and really the Company as a whole will continue to benefit. But really the last year and a half, every quarter the food service margins have continued to improve from the previous year. So we've been on track to a couple basis points a quarter, look to improve them until we work our way closer to housekeeping and laundry's margins.

Okay, and then maybe just lastly, I know a lot of the details in the 10-Q, but on the cash flow in the quarter, any comments there, usual items? I saw current liabilities was down a little bit year to year or at least versus the year-end. Anything interesting to highlight on the cash flow statement?

Yes, I think current liabilities specifically is impacted by the cutoff of and the timing of our accrued payroll so that's really the biggest difference quarter to quarter depending on when the cutoff is. But no, other than that, there was really nothing specific.

James Terwilliger, Benchmark.

A couple quick questions, and I've been jumping from some different calls so I apologize if this was asked previously. On the accounts receivable --.

No more important call than ours.

(Laughter). I'm just going to grill you guys. On the accounts receivable it's trended up for the quarter and it's trended up in terms of actual dollars, I know your revenue is growing, but in terms of actual dollars its trended up the last, say, since really last four or five quarters. Do you have a DSO for the quarter and can you remind me of your target DSO range that you like to run the Company at?

Our target DSO rate was always 60 days but the guys have done a much better job recently and frankly we've managed the credit more rigidly than we had the last five years than we had the previous 30 years of the Company's existence, and frankly left more buildings for credit issues. They've been able to keep the receivables below 50 days, which if I had a lie detector test 10 years ago, I would have said we would never get there. So 60 days is our aggregate target but certainly managing the credit the way we have before has put us in the cash position that we've enjoyed the last 10 years and enabled us to either through the buyback or more recently to dividend increases be able to fund it. But 60 days is our general target, but our receivables have been below 50 days for the last few quarters including this quarter.

Okay, great. Next question, very quickly as it relates to in terms of customer demand out in the industry. It seems like there's a lot of cross-currents, a lot headwinds. We had a fiscal cliff people were worried about. We've got sequester out of DC. We've got Obamacare which people are talking about. Can you talk at all in terms of the core customer demand, how is your customers' tone with all these headwinds and crosswinds?

As far as new opportunities, it's always been that no matter what the buzzwords or the overall environment and publicity had been, the operators have never been reimbursed generously enough to where they didn't have to be cost efficient. And it was a lot easier for them to outsource in a cost efficient way to support service areas rather than the direct patient care areas, our type of services. That's the case today even more so. The tighter they get squeezed, the more they look for outsourcing options of all kinds including our type of services to be the beneficiary. As far as the impact on the existing clients, it really manifests itself in the credit and we've always said that we have to manage the credit client by client that good customers in more difficult times still pay their bills and bad operators even in good times have some issues. So we have to manage the credit the same way we have before no matter what the environment is. But certainly, if we're going to write a scenario for ourselves the demand for the services has still never been greater.

And really just to add to what Dan mentioned, the biggest, the most significant constraint in our growth continues to be our ability to develop the management team that's capable of delivering the services. So all the rhetoric around the operators getting squeezed and tighter Medicare/Medicaid reimbursement considerations, we need to continue to develop the management people and make sure obviously the activity is there on the housekeeping and laundry side and we have the management depth on the dining and nutrition side to turnkey that housekeeping and laundry business.

Thank you. I'll move to my next question. When you talk about your field employees, are you seeing type of wage pressure from your field employees at the facility level or would you define the wage pressure or any type of wage trends as stable as it relates to your employees at the facility level?

I think its been stable, but really it's been dictated by what the client does with its blue collar workers and our participation and matching of their conditions of employment. So its never done unilaterally. If the client is in a position where they can't be as generous as they would have otherwise with wage increases for example, then we're with them shoulder to shoulder. On the other end, if they determine that to be more generous with a bump up to get the kind of staff that they're looking for, then it triggers our pass-through clause and we give the same increase to our employees but pass the appropriate billing adjustment to the client because that's what we agreed to when we began servicing them.

And lastly, Dan, what -- I know every quarter you add new customers and to some degree you might lose a customer, you might pull the plug on a customer for a payment issue. What is a historical range of say customer losses on a quarterly basis? And could you give anymore color to these two clients where we've reworked the contracts? I know you gave a timing issue. Can you tell us maybe the number of facilities that were involved even though you maintain this as a customer, was the revenue shortfall, was it split between food services and housekeeping, laundry, and linen or was one larger than the other?

I think first, we've always used 90% as the threshold for acceptable client retention internally and I'm sure we voiced that in our discussions with the outside world as well. But, when you have a base of 3,500 facilities, that means you're going to lose 350 during the course of the year. Primarily, it's not credit that creates our issues. Where we're most at risk is when there's a change in the decision maker who engaged us in the first place. Administrators and directors of nursing change jobs often. If the new administrator comes in and weren't part of bringing us in the first place, wanting to put their own imprint on the property, we have to resell them. They don't have the before and after to compare it to, and that's where we're a little bit vulnerable.

If one of the clients to an acquisition, a new owner-operator comes in that didn't historically outsource or wasn't familiar with us and we're unable to resell them, we're at risk there as well. So the bulk of our losses are typically in that scenario. Although, the only reason I mentioned the credit issues is because it's different than how we operated 25 years from the Company's beginning that we've left where I think I could count on one hand customers we left the first 25 years. The last 10 years, we've managed the credit much more rigidly with less flexibility for the client.

And these particular clients wanted the change, they're both still clients and that's what made the issue a little more complicated than it would have been otherwise. One of the clients was predominantly food service where we're still doing all their housekeeping and laundry and skinny down the food service that we provided. That impacted the revenue in the dietary end, and the other client was primarily housekeeping and laundry with a little bit of food service that we skinnied down, and we're still doing about 150 of their properties, So we don't like losing one piece of business. So we're not nonchalant about this, but put us in a position and now we have to grow faster to get back to our target of 10% to 15%.

I'm showing no further questions at this time. I would like to turn the conference back over to Mr. Dan McCartney, CEO, for any closing remarks.

Okay, thank you, and thanks everybody for joining us today. But now we're well into 2013. We expect to continue to expand our client base, both in housekeeping and laundry and food service within our historical targets. Food service will be on the higher end because of the capacity of middle management people that still have a ways to go before they're up to the levels our model calls for. And housekeeping and laundry, there's still enough pent-up opportunity and demand for our services even though it's the bigger piece of our business that we expect to grow. Housekeeping and laundry may be at the lower end of the rate and food service at the higher end, but quarter to quarter that could fluctuate depending on our adds for that period of time. The demand for the services is still as great in both areas as it's ever been, but we have to control our growth and balance the expansion with our ability to manage it.

The client satisfaction levels for us still are a critical component on how we measure our success rather than trying to outsell our mistakes. The recent expansion in food the last 12 months have gone well, and we've demonstrated that our model not only works but our guys are executing better quarter to quarter and that will be reflected in the improved food service margins when the Q comes out like it has been for the past year. The attention on the new business while keeping track of the old business is still a balancing act. We'll look to get and keep our direct costs below 86%. And over the next few quarters, if we execute properly, work our way closer to 85%. The changes in the tax policies and some of the states that Ted mentioned as well as being the beneficiary of the various job tax programs that bumped up our SG&A expense a little bit, but we're more than offset by the tax benefits. We think the SG&A is going to stay in a 7% and 7.25% range and without any deferred comp impact. Our tax provision is in the 35% range, give or take a couple basis points quarter to quarter depending on the hiring impact.

In general, our business is still as strong as ever. The demand for both services is greater than we can really do. The constraint is really our ability to continue to have a pipeline and develop management people. We believe we're going to continue to operate on budget, consistently going forward as we expand. So overall these are still very good times for us. Thanks, everybody for joining us and onward and upward.

Ladies and gentlemen, this does conclude today's conference. You may all disconnect and have a wonderful day.