Healthcare Services Group Inc (HCSG) 2013 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Healthcare Services Group, Inc. 2013 second 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 the 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, goals, 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% to 5% of our total consolidated revenues for the three and six months ended June 30, 2013, risks associated with their acquisition of Platinum Health Services LLC, 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 work force 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 1 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 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. 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. In January 2013, the US Congress enacted the American Taxpayer Relief Act of 2012, which delayed automatic spending cuts of $1.2 trillion, including reduced Medicare payments to plans and providers up to 2%. These discretionary spending caps were originally enacted under provisions in the Budget Control Act of 2011 and the initiative to reduce the federal deficit through the year 2021, also known as sequestration. The sequestration went into effect starting March 2013.

Currently, the US Congress is considering further changes or revising legislation relating to healthcare in the United States which, among other initiatives, may impose cost containment measures impacting our clients. These 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 our 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 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. I would now like to turn the conference over to your host, Mr. Dan McCartney, Chairman and CEO. Sir, you may begin.

Thank you, Ali. Thank you everybody for joining us. I am here with Ted Wahl and Matt McKee. We released our second quarter results yesterday after the close. We will be filing our 10-Q during the week of July 23.

As we have discussed in the first quarter review, the modification of our relationship with two corporate clients altered or phased out and completed during the first quarter impacted our second quarter reported revenue growth below our historical targets. Though the two clients remain customers, we reduced the services we provided and therefore the revenue from those clients during the first quarter, and it did not contribute at all in the second quarter. During this transition, we continued our facility expansion plan at a more accelerated pace to utilize the surplus management people available to those changes with those two clients. In June we added more facilities and revenue than any month since 2011, and we will reflect that expansion fully in the third quarter and obviously the rest of 2013 and beyond.

In addition, we announced the acquisition of a private service company we're familiar with over the years, and we closed the acquisition over the weekend. Their clients are spread out through our existing markets and management structure. We knew the personnel well and felt they were good guys, and we were familiar with their client base, so we felt it would be a good fit. We expect the acquisition to contribute at least $60 million in annualized revenue, predominantly in Housekeeping and Laundry. With our accelerated organic growth efforts and the acquisition, we expect increased revenue with proper execution back to our long-term historical target of double-digit growth in the third quarter and the fiscal year 2013. So with that introductory summary, I'll turn it over to Ted Wahl for a further review of the financial report.

Thank you, Dan. And really it was during the fourth quarter of 2011 through the first half of 2012 that we accelerated our expansion, increasing Housekeeping and Laundry revenues by 16% and Dining and Nutrition revenues by over 58%, which makes the Q2-Q2 comparisons more difficult, but our long-term targeted range of 10% to 15% top line growth remains unchanged. Revenues for the second quarter of 2013 increased 2.5% to $273.6 million. For the six-month period, revenues were up 4% to $547.5 million. Our revenue growth rate for the first six months of the year was impacted by the relationship modifications in Q1 with the two corporate clients Dan described. Housekeeping and Laundry for the quarter grew modestly to $183.7 million; Dining and Nutrition was up over 7% to $89.9 million.

As Dan indicated, in June we added more facilities and revenue than any other month since 2011. This significant organic expansion, along with the acquisition, will be fully reflected in the Q3 results. If we execute properly, our revenue growth rate should return to double digits for the remainder of 2013 and 2014. Net income for the quarter was up over 14% to $12.9 million, or $0.19 a share. For the six-month period, net income increased over 40% to $27.8 million, or $0.41 per share. Direct costs of services for the quarter came in at 85.7%, 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 in June by implementing operational changes and getting the jobs on budget in a timely manner. Going forward, our goal is to manage direct costs 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 7.1% for the quarter with essentially no impact from deferred compensation investment accounts held for and by our management people. 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 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.

Investment income came in at $219,000, again with no impact from the change in the value of the deferred compensation investment accounts. Our tax rate was 35% for the quarter, which is what we expect our tax rate to be for the remainder of the year. We continue to manage the balance sheet conservatively and at the end of the second quarter had over $85 million of cash and marketable securities, 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, even though only one month of the second quarter facility expansion was reflected in Q2 revenues. Finally, the Board of Directors approved an increase to the dividend to $0.16875 per share split adjusted and payable on September 20.

The cash flow, cash balances and earnings for the quarter are more than supported. 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 41st consecutive quarter that cash dividend payment was paid out since the program was instituted in 2003 after the change in tax law. It's the 40th consecutive quarter we increased the dividend payment over the previous quarter. That's a ten-year period that included four three-for-two stock splits. With those opening remarks, Dan and I would like to open up the call for questions.

(Operator Instructions)

Ryan Daniels, William Blair. Please go ahead.

Good morning, guys. Thanks for taking the question. I wanted to ask on the Platinum acquisition, obviously they did not have any food services capability. So maybe talk a little bit about the possibility of offering that into their client base. How long will you typically wait before you offer that type of service? Is that something you got right away or kind of digest the acquisition and let the clients get to know you before you sell that?

I think there will be some time in the relationship and the offering. And I think, like our existing client base, there will be different interests depending on the clients. But even within our existing client base, Platinum aside, there is still more cross-selling opportunities for food service than our management structure can support. But Platinum and their client base certainly fall into that category. So on the upside, it created the potential for those kinds of opportunities. But our existing clients, we haven't come close to maximizing the cross-selling opportunity with the base business as well.

Okay. That's helpful. If we think about the acquisition coming on here in early July and the fact that you have a ton of new client adds in June, does that do anything to your sales strategy in the third quarter, meaning do you step off the gas pedal a little bit in July to let the team digest all the new business and the new acquisition, or is it kind of full bore ahead?

I think the divisions that are most affected by it will certainly be less aggressive than they would have been otherwise as they try to digest this and make sure we don't stub our toe with the new business added in June organically and then the acquisition clients as we get to know them and make our contribution and get the help a little bit. But a lot of the divisions aren't as affected, and their growth opportunities and their growth targets are going to remain the same. So I think the divisions, it will be more division and geographically specific. The areas that are impacted will grow less than they would have otherwise, and the divisions that aren't impacted by it are not the beneficiary of this influx of new clients, will still continue to expand organically.

Perfect. One more quick one, just accounts receivable balance up a little bit. Is that just a manifestation of the big new business in June and not collecting on that yet because it's only been a month in the books?

That's exactly right, Ryan. Since the expansion was concentrated in June, we had one month of billing in accounts receivable but only one month of revenue. Next quarter, we will still have one month of billing in AR, but we'll have the three months of revenue. So our average day sales won't be understated for the quarter.

The impact was about three days.

Perfect. Thanks so much, guys. Appreciate it.

Michael Gallo, C.L. King. Please go ahead.

A couple questions if I may on the business edge in June. Dan, was that split between the Housekeeping and Food Service in terms of the additions, or how many facilities did you add on Housekeeping, or how should we think about that?

It was both, a combination of both, but more Food Service than Housekeeping and Laundry. But it was about $10 million in quarterly sales and about the amount of facilities we typically add in a quarter that we added in June. And that's why even though we don't usually do that, we wanted to differentiate the progress we are making organically in this quarterly report because it was an unusual amount of new adds that we worked on, and the guys in the field did a real good job procuring to try to make up for the two client adjustments that we were dealing with and to utilize the surplus management people it made available to us.

And then just, second question on that, at times when you have had that accelerated addition in a given month, it's taken a little while to kind of digest and get it on budget. Obviously, in this case you had some underutilization from the issue described previously in the first quarter. So is the business on budget now? Do you expect any material margin impact? Were you able to kind of digest it?

I don't think it's -- some of them, but not all of them are not on budget yet. Even with surplus management people, it's still a transitional period to get the job on budget. Our target is still only start a new property to get it on budget within 60 days, 90 days at the outset. Certainly putting more seasoned management people into start up the account can reassure us that we have a more likely shot of doing that timely than we would have otherwise if they were newer management people. But there is still that risk. We fully expect them to adhere to the schedule, the guys in the field, and get the jobs running on budget within that 60-day threshold though.

Right. But overall there was nothing too specific about it in terms of -- and it should come on budget in the normal course of business?

Yes.

Thanks very much.

A.J. Rice, UBS. Please go ahead.

Thanks. A couple different questions. First of all, on the new -- and just a follow on to the other questions, on the new accounts in June, did that tend to be concentrated geographically or under one ownership structure? I will start with that.

It was primarily spread across three ownership groups and in the southeast and Southwest, A.J., which is quite frankly where we were prepared and had some underutilized infrastructure. It will be folded in nicely given our management team down there.

Okay. On the Platinum acquisition, can you give us a little bit of background about how long you were in discussions with them? Sort of how the deal came to fruition, as well as does this portend other deals out there? Any commentary about a potential pipeline of any sort?

I mean, really the introduction was made over a year ago. Over the past year, we have met at different times. But as far as whether this bodes for significant acquisitions or other opportunities in the future, there is just not a lot of candidates out there. So it met our criteria. Certainly the financial evaluation was critical.

We concluded that Platinum would complement our margin profile and be accretive it to earnings. But they have a strong management team. They have an entrepreneurial-minded customer base that is looking to grow and then some attractive cross-sell opportunities in Dining and Nutrition. If we are able to meet the retention and expansion goals, it certainly has upside potential. There is not a lot of candidates out there for what Platinum presented as the opportunity.

That's why we've always been relatively conservative as far as looking at acquisitions. As Ted said, there aren't really many opportunities that fit our niche. There was enough opportunity organically to continue to expand as well. We really have to assess that financially it makes sense and just as much relationship-wise. These are guys we knew for a long time. They seemed like good guys. The ones we knew more intimately would fit in well. That's why we thought it was a good fit, the financial factors aside.

Okay. Thinking about -- you had the two big contract restructures in the first quarter which impacted your results. Have you seen any other move by other clients to come in and ask for restructuring? Has there been any change in the attrition rate on your contracts? Just update us on that maybe.

No, there has been no updates. Our retention rates are as strong as they have ever been, even with the contract restructurings. And remember the client -- the customer that was Southwest-based and on the Dining and Nutrition side continues to be a customer, as does the Housekeeping and Laundry customer that we restructured some contracts with. Both are customers heading into the second half of the year, and we haven't seen anything along what we saw in the first half of the year going forward.

Okay. And then how about on repricing of contracts? Any update there? Are you seeing the underlying nursing home change start to raise rates a little more with their own employees, which would flow-through to you, or still sort of steady state?

It's really client-specific. Most of them. I think the average has still been, in spite of the rhetoric and the cost pressures some operators are feeling and their rhetoric about what they think they have to do to contain their labor costs aside from outsourcing as an option, but internally, they still have been giving an average of 2% to 2.5% increases to their majority of their blue-collar workers, and that obviously impacts our pass-through clause to give the same benefit to our employees, as well.

Okay.

They really have frozen the wage rates and increases going forward. But I think I could count on one hand the clients that actually followed through with that.

Right. Okay. And then the last question on your balance sheet. You are now up to $85 million in cash. I understand that, obviously, you increased the dividend again this quarter. Is there a point at which you say, well, we actually are at a -- we can do a little more with the cash because we don't need this much cash to run the business and sort of excess?

I think we have said before we're looking at big management bonuses. (laughter) Frankly, the Board does assess this every quarter, and I think as the earnings per share continue at a more rapid pace, we'll certainly review increasing the dividend maybe at a more rapid rate proportionate with the earnings per share growth, as well. Something we kick around every quarter. So it's certain reasonable to expect that.

Okay. Thanks a lot.

Rob Mains, Stifel. Please go ahead.

Yes, thanks. Good morning. Was there any Platinum impact on the second quarter? Obviously, if the deal closed in July, you knew it was coming in June.

Yes. I mean, really, there was stop and starts along the way as we were negotiating with Platinum and kind of confirming what the structure and the timing of the deal was going to be. But I would say the last two months in the lead up to it in the markets that were going to be most impacted by the acquisition where the customer base was -- there was a slowdown as we prepared for the acquisition and the support that would be needed by the operational team to assist the Platinum team in integrating and supporting the customer base.

Certainly our intention, Rob, in negotiating it, it took some time that we would have been spending doing other things while we were trying to make sure it fit the way we wanted it to. So it was a modest drain on resources in one way, but not too bad I don't think.

Okay. Then, Ted, if you kind of held back a little bit in the regions where you are going to have a lot of contract, would that imply any kind of margin differential between Platinum and HCSG are going to raise pretty quickly now that the deal is done?

Yes.

Great. That's all I had. Thank you.

[Nicha Randopal], Sidoti and Company.

Just a quick question. As you look to grow the business and bring on more management, are you affected at all with the type of labor market given the stronger economy?

Not really. I mean, I'm sure our macro labor environment is more facility specific. I am sure some of our guys in certain areas have a more difficult time in the recruitment and getting warm bodies in than others with a greater capacity in urban areas, for example. But I think we've not had any real complaints bubble up like they had in the past. Not recently, but certainly 20 years ago where some of our management people needed transportation support where they didn't have public transportation, for example, to some outlier type of facilities.

I think the recruitment and getting the staff at each of the properties is a little bit different. But I think they're all -- all our guys are doing a good job keeping the property staffed and having a pipeline of employees available when that comes up. And I think the labor market conditions in those particular areas are really reflected in the personnel policies of the client. If they determine they have to give a 3% increase to be more attractive, it will trigger our pass-through clause and they will do that. I don't see anything really dramatic impacting the labor force for us across the board.

Okay. Thanks.

Toby Wann, Obsidian Research Group. Please go ahead.

I wanted to talk quickly about the accretion from Platinum. I know you teased out that it was going to be accretive to earnings, but I don't know that we have actually kind of quantified the impact. Could you kind of give us a little bit more details about that?

I think at the moment in time assessment would be -- should be about $0.01 a quarter. But, as I said before, there is significant potential upside to it as the retention goals are met, as the growth opportunity or cross-selling opportunity with the customer base is met. But I would say about $0.01 a quarter in the near term.

Okay. Thank you. That's helpful.

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

Okay. Thank you, Ali. Thanks again, everybody, for joining us today. We are well into 2013 now. The business model, to a great degree, hasn't changed very much. We expect to continue to expand our client base within our historical double-digit targets, and with our second quarter activity, we worked our way back to double digits, which will be fully reflected in the third quarter and the remainder of the year.

The overall environment and demand for our services are still as great as it's ever been. We continue to try to balance controlling our growth rate and the expansion with our ability to manage it, but with the first quarter modifications with the two corporate clients we mentioned, we did have more management capacity than we typically have, and we're able to accelerate the growth in the affected divisions as well as pursue this acquisition opportunity that we became aware of. It remains important for us to balance the client satisfaction measurements as we digest the increased amount of new business and continue to operate on budget. We'll look to make certain that the current expansion operates consistently. We continue to improve the Food Service margins while growing the client base at a controlled pace.

All of the divisions continue to perform, better but with any expansion, we need to make sure we're consistent. We have to keep our attention on the new business and getting and keeping them on budget while effectively managing the existing client base so there is no disruption of their services. We look to keep and get the cost, direct costs below 86% consistently and work our way back to 85%. With some of the state tax policies and the staff changes we made, our SG&A will stay in the 7% to 7.25% range, excluding any deferred comp impact. Our tax provision should remain about 35%, but overall in our business, there is still strong demand for the services with Housekeeping and Laundry and Food Service.

Our management people in all divisions, especially in Food Service, continue to get better. And I'd be remiss if I didn't mention with all of the moving parts we had in the second quarter between the customer transitions in the first quarter, the acquisition, the amount of new business we added in June, with so many moving parts, our guys in the field did a great job in maintaining the costs and continuing to improve the direct cost margins. We believe we'll continue to operate on budget consistently as we expand. So, overall, in this environment, these are pretty good times for us. Thanks again, 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.