Healthcare Services Group Inc (HCSG) 2013 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Healthcare Services Group Incorporated 2013 third-quarter conference call.

(Operator Instructions)

I would now like to read the 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, and goal, and similar expressions are intended to identify forward-looking statements.

The inclusion of forward-looking statements should not be regarded as representation by us that any of our plans will be achieved. We undertake no obligation to publicly update or refute any forward-looking statements, whether as a result of new information, future events, or otherwise.

Such forward-looking information is also subject to various risk and uncertainties. Such risk and uncertainties include, but are not limited to -- risks arising from our providing services exclusively to the healthcare industry, preliminary providers of long-term care; credit and collection risks associated with this industry; from having several significant clients who each individually contribute at least 3% to 7% of our total consolidated revenue for the three to nine months ended September 30, 2013; risk associated with our acquisition of Platinum Health Services, LLC; our claims experience related to workers' compensation and general liability insurance; the effect 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 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 Act and Affordable Care Act, and the Health Care and Educational 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 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 2013, which delayed automatic spending cuts of $1.2 trillion, including reduced Medicare payments to plans and providers of up to 2%. These discretionary spending caps were originally enacted under provisions in the Budget Control Act of 2011, an 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 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 have affected and could adversely affect the liquidity of our clients, resulting in the inability to make payments to us on agreed-upon payment terms.

These factors, in addition to delays in payments from clients, have resulted in, and could continue to result in, significant additional bad debts in the near future. Additionally, our operating results would be adversely affected if unexpected increases in the cost of labor and labor-related costs materials, supplies, and equipment used 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 services 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, Dan McCartney. Please begin.

Okay, thank you, and thanks, everybody, for joining us this morning. We released our third-quarter results yesterday after the close, and will be filing our 10-Q during the week of the 21st.

As we discussed in the review of the past two quarters, the modification of the relationship with two corporate clients during the first and second quarter impacted our reported revenue growth below our historical targets during the first half of the year. Although the two clients remain customers, we reduced the services we provided and, therefore, the revenue from those clients was reduced.

We continued our facility-expansion plan at a more accelerated pace in the third quarter to utilize the surplus management available due to those changes, especially in the divisions that were most affected.

In addition, we announced and finalized the acquisition of a private service company, which we were familiar with over the years, and closed the acquisition in July. Their clients were spread out through our existing markets and our management structure; we knew the personnel pretty well. And we were familiar with the client base, so we felt that -- and it has been so far a good fit.

Due to our accelerated organic activity and the tuck-in of the acquisition, we were able to get back to our double-digit revenue growth target sooner that we originally expected.

And with that, I'll turn it over to Ted Wahl to go over more specifically the third-quarter results.

Thank you, Dan. And really, it was during the fourth quarter of 2011 through the third quarter of 2012 that we accelerated our expansion, increasing housekeeping and laundry revenues by 15%, and dining and nutrition revenues by over 58%, which makes the Q3-Q3 comparisons more difficult, but our long-term targeted range of 10% to 15% top-line growth remains unchanged.

Revenues for the third quarter of 2013 increased 10% to $298.5 million. For the nine-month period, revenues were up 6% to $846.1 million.

Housekeeping and laundry grew 4% over the prior year's corresponding quarter, and nearly 6% sequentially to $193.5 million. Dining and nutrition was up over 21% to $105 million.

The organic expansion over the past four months, along with the acquisition, will be fully reflected in the Q4 results, and, if we execute properly, our double-digit revenue growth rate should continue for the balance of 2013 into 2014.

Net income for the quarter was up 20% to $13.8 million or $0.20 a share. For the nine-month period, net income increased 33% to $41.7 million, or $0.60 a share.

Direct cost of services for the quarter came in at 85.7%, which is slightly below our target of 86%. The districts and regions have done a good job of implementing our systems and procedures in the new business we brought on over the past four months, which minimized inefficiencies and allowed for favorable operational outcomes. As that new business matures, we would expect ongoing margin improvement, while at the same time continuing to give proper attention and service levels to our existing customers. 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 about 7.5% for the quarter, but after removing the impact of the $1-million gain in deferred compensation investment accounts held for and by our management people, our actual SG&A was 7.25%, which is within our targeted range. 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.

The 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. We would expect our normalized SG&A to continue to be in that 7% to 7.25% range, with the ongoing opportunity to garner some modest efficiencies.

Investment income was reported at $1.2 million, but again, after removing the impact of the $1-million gain in the deferred compensation investment accounts, our actual investment income was $200,000. Our tax rate for the quarter was 35%, which is what we expect our tax rate to be for the balance of the year and into 2014.

We continue to manage the balance sheet conservatively and at the end of the third quarter, had over $62 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, below our DSO target of 60 days, even with the accelerated organic growth, and the transition of the credit and collection function for the new clients that were part of the acquisition.

In conjunction with our earnings release, the Board of Directors approved an increase in the dividend to $0.17 per share, split adjusted, and payable on December 20. The earnings for the quarter and cash balances more than support it, and with the dividend tax rate 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 42nd consecutive cash-dividend payment since the program was instituted in 2003 after the change in tax law. It's the 41st 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)

A.J. Rice, UBS.

This is actually Jailendra Singh filling in for A.J, just a few questions -- if I can ask. It looks like your organic revenue growth in housekeeping segment was [apparently] impacted by the two contract reviews and [some] tough comps in the quarter. I was just wondering if you can share your thoughts? Like when do you expect to return back to your double-digit organic revenue growth in that segment?

Well more than half of the growth total Company was organic but where the acquisitions reflected from mid-July forward, the organic adds are layered in over a 3-month period. But really, whether it is organic or acquisition-related, we don't really differentiate internally. The customers require the same level of district and regional support, implementing our systems and procedures, appropriate customer contact, the same management and development requirements, budgetary oversight.

So whether it is organic or acquired, each facility requires the same level of commitment and attention from our Management team. So you have a situation where the areas that were more directly impacted by the acquisition, surplus of Management not withstanding, maybe had opportunities with new facilities that would've otherwise been realized in the second half of 2013, they now become opportunities in the first half of 2014. But certainly, heading into the fourth quarter and next year, know that 10% to 15% target total Company, with housekeeping and laundry fitting into that, remains unchanged.

Okay.

Whether the new business comes from organic efforts or an acquisition, our Management resources are utilized to the same degree. So the areas that are impacted and inherit new clients that were part of an acquisition, just have that many less Management resources to organically grow. Those who were unaffected by the acquisition tuck-in, then organically, they expand at a more rapid rate than they would had they had to inherit some facilities. So after the acquisition is done and the decision is made, we really don't look at those clients any differently than organic growth no matter how we procure them.

Okay, got it. And then my follow-up question, your cash and marketable securities, it seems to decline some $20 million plus from second-quarter. Just wondering if you can provide some color on that? It is all related to the receivables tied to PHS or is something else going on there?

Well over $11 million of it is just related to the timing of the payroll cut-off relative to the second quarter and then you have the cash payment, the cash outlay of over $5 million for PHS, and then inheriting the PHS receivables, which are going to take a few months to really get in line with our credit terms and within our payment expectation. So it is a combination of factors, but going forward, from a cash flow perspective, certainly from a cash balance perspective, we would expected it to be in line with where we've been historically.

But the significant variance is the cut-off of the bi-weekly payroll, which was about a $12 million difference from the second quarter to the third quarter.

So you have payroll cut-off and PHS-related cash payments and AR inheritance.

Got it. And my last question, your tax rate in the quarter was roughly 35% and I was just wondering if we should be modeling similar tax rate for 2014? Do you expect to have another 1-year extension of WOTC program?

Well it is extended through next year. I would model 35%. We will have the benefit of hindsight at the end of the year to do a look back on where the WOTC program came in as far as the job tax credits and some of the other programs we are involved with. But so maybe there is some potential upside next year, but 35% is the number we feel comfortable with.

Okay, perfect. Thank you.

Michael Gallo, CL King.

Good morning. Just a couple of questions.

Dan, how much was the contribution from Platinum in the quarter? Was it $12 million, $13 million roughly?

About that. Yes. Maybe a little less because we started it in the end of July.

Okay, so might have been $11 million, something like that?

Yes, in that (multiple speakers) --

And what was the split there with housekeeping? Was it pretty much all housekeeping?

Almost all housekeeping.

Okay. And as you've had some time to digest it, have you started to think about the cross-sell of food service or is that still a quarter out?

There is still so much pent-up demand with the existing client base, we don't feel compelled to have to address it right away, but there's certainly an opportunity in almost all of their clients to add the food service to the menu. But that's still the case in our existing client base, as far as the expansion of the food services, as well.

So it's not like we are coming to saturating the availability of the existing clients and this opened up a new avenue. We really have the opportunity for both and it gets back to the consistent development of the Management structure to execute properly, to take full advantage of that, which we've been doing and continue to do over the next few years.

Okay great, and then final question, Dan. When I look at the gross margins, you were able to hold it flat sequentially at 14.3% despite having the surplus Management people, as well as absorbing Platinum. I was wondering, as you start to get the districts and the regions better utilized, and as you have that integrated, should we start to think about that you can work the direct cost down to 85% or is there anything unusual in the quarter--?

We think over a period of time, a couple of basis point improvement quarter-to-quarter is reasonable and, really our internal targets, as well. But, frankly, with the -- when we made the changes with those corporate clients we talked about in the first half of the year, all our Management people had jobs with us. We were going to reassign them and just had to recharge our marketing and growth rates to assign them to new positions.

The guys did a much better job than I expected absorbing those costs and building them into the operation to keep the direct costs below 86%. And with the new business that we really added towards the end of the second quarter and work to get them on budget during the third quarter, that's when we are the most inefficient until we make the staffing cuts and adjustments. So the guys in the field really did a very good job in controlling the cost, both with the surplus Management people and getting the new business on budget. And we think as they become more and more mature, as Ted described, that we should be able to keep improving it quarter-to-quarter, and if we execute properly, get ourselves closer to 85%. And there is still substantial upside improvement available as we get better and broaden the base of clients in the food service area.

That's right because the primary driver of the margin expansion is going to still come from the districts in the regions being fully utilized. So in housekeeping and laundry, if a typical district is overseeing 10 to 12 facilities; in dining, we are still averaging 7 to 8 facilities. In housekeeping, a typical region oversees four to six districts; in dining, we are still averaging three to four districts per region.

So again, that's going to be the primary driver of the margin expansion opportunity in dining over the next 2 to 3 years. I'm not saying adding the new business is easy but it is certainly the easier part in what we are trying to accomplish from a margin expansion perspective.

Okay and then final question, how much SG&A did you absorb with Platinum?

A very modest amount.

Okay, but we should -- my point is--?

Nothing noteworthy, Mike.

Okay. Okay, thanks very much.

Ryan Daniels, William Blair.

Thanks for taking my question. Let me start just with Platinum. It sounds like from all your commentary that the integration efforts are pretty much on track, but any color there as it relates to Management or employee retention and client retention, anything noticeable that has been outside the band of your expectations so far?

No, and I think it gets back to what Dan and I just touched on earlier in that, we really -- once the acquisition, once the administrative part of the acquisition is completed, it is really treated and tucked in no different than a start-up business, housekeeping, laundry, or dining would be from an organic growth perspective. So we have the same challenges that we would with organic growth, but also it's not like it's treated as an appendage or an albatross to how we would normally operate business that we grow through our normal regional director network.

And then their Management people that we inherit, we knew some of them before and, as we've gotten to know them better, it's been a better fit, although we are always concerned with the dual philosophies or different approaches. But there's been very little of that, in fact less than some of the other smaller acquisitions that we made, to where we think their Management people are fitting in better than at least I had anticipated. So it's gone pretty well.

Okay, great. And then, Ted, you made some comments about some of the impacted regions slowing down what would have been the organic growth you would have pursued otherwise. What's the typical time frame for that integration to take place? Is it something where maybe first quarter of 2014, you will start to unleash those regions for the organic sales or new client adds more actively?

It is a 90- to 180-day process, so certainly by the end of the year, Ryan, whatever acquisition-related slowdown from a growth perspective we had in the areas that were most impacted would be behind us and then it would be growth in the Business as usual type fashion.

Okay, got it. And then last question, I know you talked a little bit about the DSOs and moving them onto your accounts receivable teams. Is there any difference in their contract terms with payments or anything sustainable that their DSOs would be higher or do you anticipate once it gets on your team's platform that that should gravitate toward the Corporate average?

That would gravitate towards the Corporate average and be in line with what the rest of our Business is. That was obviously part of the discussions we had with the acquisition and with the customer base -- it is all -- they are all part and parcel with one another. But over the next 3 months, they should be in line with the rest of our portfolio from an AR perspective.

But you can only imagine, it's a delicate -- if they had different kind of credit terms and different anticipation taking over the responsibility and now having more rigid control has to be done more diplomatically than we would if we sold the services initially and laid out the expectations as far as payment terms with an organic client.

Yes. All right. Thanks for all the color, guys.

Sean Dodge, Jefferies.

Dan, you guys are coming off a pretty strong second quarter in terms of new client contracts signed. I was just curious how the third quarter fared relative to second in terms of maybe new client wins and then the mix of business that was added?

In the districts and regions that were impacted by the acquisition, they obviously took a less aggressive posture as far as the organic expansion they could experience because they were using their Management resources to digest and inherit the new properties that were part of the acquisition. But the other divisions that were unaffected continued to grow at a more accelerated pace, as they did in the end of the second quarter, or else we would not have been able to achieve in the aggregate the double-digit expansion. So, I think that will just sustain itself in the fourth quarter, where obviously the bulk of the growth and expansion is going to be all organically driven for the next few quarters. We don't anticipate any acquisition activity for the next year.

Okay, and then when you look into the Platinum, the existing client base, how efficiently were they staffing their facilities? And have you found any surprises or maybe opportunities to make those clients that were added to the acquisition a bit more profitable than they've been historically?

In some of them. It is really across the board. There are some -- it's more client specific than a trend in the aggregate. But that's frankly no different then our organic growth. When we survey the buildings, even part of Corporate chains, there is so many variances to how each property operates, we really have to survey each building individually and then determine where our efficiencies are going to come from and what our ultimate profitability targets can be. And when we do an acquisition, we really take the same approach, the only exception is we know what the price is. We are not negotiating; the contract price is in place.

So, I would say it has been very proportionate with our organic expansion and observations. Some of them, we think we can bring efficiencies and make some cuts. Others, frankly, with Management salaries and benefits are going to change so it may add some expense in those other properties to have their Management structure more conform to ours. So, it's a lot of moving pieces, but we've been there before.

Yes, it's a partnership approach, no different than an existing customer and you have to look at it holistically. Part of the -- whatever staffing patterns they have may be reflected in the pricing. There is operational outcomes considerations; there is the account receivables piece we talked about. So it really is a client-by-client, area-by-area evaluation.

Same as with an organic new customer.

All right. Thank you. Thanks for the questions.

Rob Mains, Stifel.

Just so I'm straight on this organic versus acquired growth, you said that there is, let's say, $11 million of Platinum revenues, which is about equal to the sequential increase in housekeeping. What sounds to -- and from your commentary, it sounds like you did the acquisition growth in lieu of organic growth in the markets where you were affected by the acquisition but it also sounds like you didn't do a whole lot of organic of the quarter. Is that a fair characterization -- I'm talking just the housekeeping side?

Yes, the majority of the housekeeping growth was reflected through the acquisition, but again, the acquisition went online in the second half of July, whereas the organic adds that we had during the quarter was layered in, in July, August, and September. So the full run rate of the organic growth won't be reflected until Q4 and then into 2014.

But I would say, organically, there's about $3 million or $4 million sequential housekeeping and laundry growth, excluding the acquisition.

Okay.

You have the gross-net dynamic as well, Rob. The gross adds versus whatever ownership changes or attrition we had in the quarter.

Got it. But your comments also seem to suggest that whatever increase in revenues we saw from Q2 to Q3, whether organic or acquired, that's the type of level of increase we can expect at minimum, going forward?

Yes.

Okay.

I think it may be on the high side organically because we had a surplus of Management people that, in a more business-as-usual fashion, would not afford us the ability to add $25 million sequentially of new business.

Right. And then turning to the food side of the Business, obviously pretty nice increase in revenues there. Could you review how much of the new business you are doing is still with existing clients versus new clients?

All of it was with existing.

Any thoughts about when you might open up the spigot to non-existing client?

Selectively, if there is a unique opportunity in a particular area, it's something we consider. But really the opportunities, the low hanging fruit, the customer demand, with clients that have been with us in some cases for decades, continue to be the priority for us as far as the expansion.

As a policy, we really, the last year told the guys in the field they could sell it to anybody, but it's like Ted described, the low hanging fruit. If I was in the marketing and sales effort within a division, there's enough pent-up [demand] at the existing client base, it is a much quicker and easier sale, so it is not like they are prohibited from selling to outside, in some areas where they particularly get momentum or the right introduction, they pursue that, but primarily the food service growth has been from the existing clients.

Got it. And then my last question, turning back to housekeeping again, is there any shift that you are seeing in the market or in the -- your potential clients that gives you the confidence that, that growth can re-energize the levels we seen from prior to this year?

Yes, I don't think it's any different than it has been for 30 years. The tighter -- the Medicare/Medicaid environment -- put pressure on the customers, the more they look for outsourcing options of all kinds and housekeeping and laundry and food service are easier decisions in many ways to make than the direct patient care areas to outsource. And even though there's been plenty of room for competition, we have had relatively none.

I think the housekeeping and laundry attention or not attention is more geared towards where our guys put their resources as far as new business. And food services become easier, so some of the divisions disproportionately focus on that. Housekeeping and laundry demand is still as great as it has ever been, it just needs us to cultivate it and pursue it.

Okay. Fair enough, thank you.

Toby Wann, Obsidian Research.

Congratulations on the quarter. Just a couple of housekeeping items. Could you give us the number of--?

That was unintended, right (laughter)?

Could you give us the number of facilities there that you guys are in, in housekeeping, as well as dining now?

We are over 3,700 in housekeeping and 800 in dining.

Okay, those are pretty good gains so congratulations. And then DSOs in the quarter? You might have given that but I might have missed it?

Yes. They came in right around 56 days.

Okay, so about--

And again, that was with the PHS receivables included as part of the total Company DSO.

Okay, so in line with -- still below the goal and in line with historical trends. And then the only other housekeeping item, just what was depreciation/amortization in the quarter?

D&A came in at around $1.8 million for the quarter and then stock-based comp would have been $600,000 or $650,000.

Okay. That was all I had. Congratulations on the quarter.

And I'm not showing any further questions. At this time, I'd like to turn the conference back over to Dan McCartney for closing remarks.

Okay. Again, thanks again for joining us everybody, but working towards the end of our fiscal year in 2013, we expect to continue to expand our client base within our historical growth targets. And now, with our third-quarter activity, we have worked our way back to double-digit growth, which will be fully reflected in the fourth quarter. The overall environment and demand for our services is still as great as it has ever been. We will continue to control our growth rate and balance the expansion with our ability to manage it -- the Management capacity, we are able to accelerate our expansion with the acquisition and organically remain vital to us. It allows us to balance a client's satisfaction measurements; the client retention was good for the quarter, as well.

As we digest the increased amount of new business, we will look to make certain the current expansion operates consistently, look to improve the food service margins while growing the food service client base at a controlled but more accelerated pace than housekeeping and laundry. All the divisions continue to perform better, but as with any expansion we need to assure execution and consistency. We have to keep the attention on the new business, getting operated on budget timely while managing the existing client base so there is no disruption in their services.

We look to get the direct cost consistently below 86% and work our way over the next year, year and a half, closer to 85%. With the changes in some state tax policies and the staff changes we made in the human resource functions, we expect our SG&A to stay in that 7% to 7.25% range, excluding any deferred compensation investment impact. Our tax provision should stay at about 35% for the next year. But in our Business, there is still strong demand for the services for housekeeping and laundry and food. Our Management people in all divisions and, especially food, continue to develop and get better. We believe and we will continue to operate on budget, but consistently going forward as we expand, make sure we take care of the existing client base.

So, in general, overall, these are pretty good times for us. Thanks for joining us and onward and upward.

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