Healthcare Services Group Inc (HCSG) 2014 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Healthcare Services Group 2014 fourth 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 follow at that time. (Operator Instructions) As a reminder, this conference call is being recorded.

The matters discussed on today's conference call include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are often preceded by words such as believes, expects, anticipates, plans, will, goal, may, intends, assumes or similar expressions.

Forward-looking statements reflect management's current expectations as of the date of this conference call and involve certain risk and certainties. As with any projection or forecast, they are inherently susceptible to uncertainties and changes in circumstances. Healthcare Services Group actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors.

Some of the factors that could cause future results to materially differ from recent results are those projected in forward-looking are included in our earnings press release issued prior to the call and in our filings with the Securities and Exchange Commission. We are under no obligation and expressly disclaim any obligation to update or alter its forward-looking statements, whether as a result of such changes, new information, subsequent events or otherwise.

I'll now turn the call over to Chairman and CEO, Dan McCartney.

Okay. Good morning, everybody, and thank you for joining us today. I am with Ted Wahl and Matt McKee for the conference call for our fourth quarter. We released our fourth quarter results yesterday after the close and we'll be filing our 10-K during the week of the 16th.

So with that, I'll turn it over to Ted.

Okay. Thank you, Dan. Revenues for the fourth quarter increased over 12% to $341.6 million. Housekeeping and laundry grew at about 13%; dining and nutrition was all up almost 12% in the quarter. For the year, revenues were up about 13% to $1.293 billion. Both quarterly and annual revenues were Company records, as our divisional and regional management teams have more than made up for the 2013 client modifications, which put our growth rate at less than 7% for that year.

Going into 2015, we have good momentum and expect double-digit topline growth, with housekeeping and laundry at the lower end of our targeted range and dining and nutrition likely exceeding that range as the dining segment continues to have an underutilized district and regional management structure as well as a smaller base from which to grow. Overall, the districts and regions really did do an outstanding job transitioning the new business during the fourth quarter, not only in minimizing inefficiencies, but more importantly for the long-term, fostering strong working relationships at the facility level with our new clients. As the 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.

As we announced last quarter, during the second half of this year, we do plan on transitioning our workers' comp and certain employee health and welfare programs into the captive subsidiary that we introduced in 2013. These programs will add to the general liability coverage that's already included as part of the captive as well as allow for greater efficiency in the management of claims, reduce our cost, and provide needed flexibility for our facilities' various health and welfare plans to meet the requirements of the Affordable Care Act, which took effect January 1. Aside from the operational and administrative benefits, the planned insurance-related enhancements will be accretive to earnings.

With that abbreviated overview, I'll turn the call over to Matt for a detailed discussion on the quarter.

Thanks, Ted. Net income for the quarter was $15.4 million or $0.22 per share. Excluding the non-recurring charges that we took in the third quarter of 2014, net income and earnings per share for the year would have approximated $58 million and $0.85 per share, respectively.

Direct cost of services came in at 86.8%, which is 80 basis points above our target of 86% and that was due to start-up related costs for the new business that we started during the quarter. Going forward, our goal continues to be to manage the direct costs under 86% on a consistent basis and work our way closer to 85% direct cost of services.

SG&A expense was reported at 7.1% for the quarter but after adjusting for the $500,000 related to the change in the deferred compensation investment accounts, which are held for and by our management people, our actual SG&A was 6.9%. We would expect normalized SG&A to continue to be in the 7% range, with the ongoing opportunities to garner some modest efficiencies.

Our effective tax rate for the quarter was 29%, which is about 8% below our 37% run rate for the year and that was due to the reauthorization of the Work Opportunity Tax Credit, which occurred during the quarter. So depending on the timing of the WOTC reauthorization for the year ahead, the rate will likely be between 36% and 38% for 2015.

We continue to manage the balance sheet conservatively. And at the end of the fourth quarter, at $87 million of cash and marketable securities and a current ratio of three to one. Accounts receivable remained in good shape, below our DSO target of 60 days. As we also announced yesterday in conjunction with the earnings release, the Board of Directors approved an increase in the dividend to $0.17625 per share split-adjusted and that will be payable on March 27.

The cash flow, cash balances and the net income for the quarter more than supported and with the dividend tax rate in place for the foreseeable future, cash dividend program continues to be the most tax-efficient way to get the value and free cash flow back to the shareholders. It'll be our 47th consecutive dividend payment since the program was instituted in 2003 and the 46th consecutive quarter in which we increased the dividend payment over the previous quarter. That's a 12-year period that included four, three for two stock splits.

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

Thank you. (Operator Instructions) Michael Gallo, C.L. King.

Hi, good morning.

Good morning.

Good morning, Mike.

A question I have is on the receivables. It was nice to see them come down, DSOs came down nicely. Was that just some of the legacy platinum businesses that have been acquired finally getting down to your contract terms or just better collections overall and do you think you can maintain the receivables at that somewhat lower level in terms of DSOs?

I think it was a combination of both. First, our guys have done a very good job in managing the existing clients and the new clients and getting them more in line to the credit terms that corporately we set out for our objectives. But chipping away some of the older part of the acquisition of platinum clients a couple of days or a little improvement quarter-to-quarter, they've done a very good job in that area as well. So, our internal target is still to try to improve it a day a quarter in the receivables, but frankly where they are, the guys have done a real good job, both in the field, the district and regional participation and financial departments and credit collection guys in the corporate office. So, we're very happy with that.

And Mike, just to add a little more color specifically on the PHS receivables that Dan referenced, of that $5 million to $6 million that we identified 18 months or so ago after the acquisition, the majority of that opportunity really is now included as part of our normal payment schedules and conforms more to our standard receivables. So that certainly has been part, as Dan said, of the progress that we've made.

Hey, great. And second part of that question, cash is obviously starting to build back up as a result, you had $87 million, I think you still have most or all of the $20 million from the captive coming in which would take the balances, add north of $100 million. You're getting to the point now where I guess use of cash certainly will be a good problem to have. So, either you've increased the dividend modestly over the last several quarters, certainly outearning it. The cash is starting to build up on the balance sheet. Should we start to think about maybe faster increases later in the year or are there other things of uses of cash that you see coming down the pike?

The other uses, we're looking at big management bonuses, that's the best use of cash. Right now, I mean, it's something that the Board in all seriousness evaluates every quarter and I think certainly the increase in the dividend being steady was important to us as we established it and it's getting to the point where we think down the road, we'll certainly consider being a little bit more ambitious with the increases.

Okay, great. And then, Dan, could you give us an update on the captive. Now, you're set up and going, you've been doing the general liability. How's it going, how's the experience been? And would you still expect it to be incremental the way you thought when you kind of put it in? Thanks.

We do. I think that it's going to be incrementally put into effect during the course of the year, but all projections and the start-up cost have come in as good or better than we expected. We've just got some additions for additional coverage and approval, which is only going to enhance it. The captive was attractive to us, not only because of the coordination with the change in the medical environment, with the Affordable Care Act, but we had enough administrative support to really pursue it, not only financially short-term for this year, but it's going to give us a platform administratively to give us the flexibility with all of our clients to really put the program in place that mirrors that client rather than taking standard Blue Cross and Blue Shield or medical policies, for example, and have them earmarked for particular facilities with modest adjustments.

Now, we can have them conform to exactly what the customer has been doing to a greater degree and the real payoff is putting the third largest cost component, our workmen's compensation, into the program to where the real benefits are going to be. We've managed the claims more aggressively the last six or seven years. Now being able to do it for ourselves with a profit motive even makes it more attractive for us. So, it's given us a good platform, not just for the short-term, but for the years to come.

Thank you.

Thank you. A.J. Rice, UBS.

Hello, everybody.

Good morning, A.J.

A couple of questions, if I could ask. First, on the start-up costs that you've incurred with the new business, the $120 million or so of new business that came on in the fourth quarter, I believe. Obviously, there were a magnitude of that is large just because of the nature of the business. But in terms of the start-up cost associated with that versus start-up cost associated with normal business you bring online in the normal course of business, would you say that there's been more start-up cost, less start-up cost associated with this new business and is it trending in terms of a time to get it to your target margin about as expected or is there much variance there?

A.J., I would say that of the $120 million of new business we phased in during the quarter, so beginning in October through December, the business that we started the first half of Q4 is online, the business in the normal start up and efficiencies for the facilities we started mid-November through December will certainly have some carryover into Q1. So you could see some modest margin pressure in Q1, but we would expect that given the volume of the business that we added.

I would say that there is nothing unusual or out of the ordinary that would impact our ability to get these facilities on budget and certainly at the lower end of our 30-day to 90-day window and I think the fact that the new business touches all 10 of our operating divisions and is split pretty evenly between the housekeeping and dining segment allows us to digest it in a more business as usual fashion. So it should be normal course of business given the fact that it's spread across the various divisions and regions in the Company. So there is nothing specific to this group of new business relative to any other groups that we've started.

I think the districts that are impacted with the new business will get them on budget as we've historically done in this 60-day, 90-day at the outset time frame, but it has a bigger impact because there was more volume, more business, so it impacted the margins a little bit more. But, we would expect within a 90-day framework, each of the districts will be able to get their new business on budget, just as they historically have over the last 30 some years.

Okay. And then, thinking about obviously your focus has been on these big blocks of businesses, in the last year, you've had a couple ways of that. If you move into a mode of more your traditional blocking and tackling approach to new business development, it's sort of the pipeline's moderated and therefore you guys, it will take awhile in 2015 for that pipeline to rebuild or do you turn on the switch, off the switch of the big boluses of business and have the one-off adds just kick in right away? I guess how do you transition back to more of your traditional growth?

Well, I think in many respects, other than the timing of some of the business that we otherwise would have started during the second quarter into the third quarter that for a variety of reasons was pushed back into the fourth quarter, this really was growth in a more typical fashion. Some of it was centered around large chains. There were state-based operators and there was local growth that was included in that $120 million as well and as you know, we're not managing the growth on a month-to-month or quarter-to-quarter basis.

Our growth targets, certainly when you look at next quarter for the balance of the year and beyond, continue to be in that 10% to 15% targeted range, with housekeeping and laundry at the lower end and dining and nutrition on a longer-term basis at the higher end of that 10% to 15% range and even to go a little more granular as far as the two different segments, the demand for dining and nutrition services is really no different than that of housekeeping and laundry in that there's more demand, really pent-up demand in both segments and we're capable of managing. And over the past 24 months, that demand has really only increased alongside the reimbursement pressures and the regulatory uncertainty that the providers feel. So, the tighter they are getting squeezed, real or perceived, the more opportunity that opens up for us.

Having said that, the rate-limiting factor on our growth as it always has been continues to be our ability to hire and successfully develop the management people and not just the facility level, but also the district and regional levels of the organization. As a company, we're more committed than ever to the idea of promotion from within. So regardless of the reimbursement environment or the pent-up demand, we can only grow as fast as our ability to manage it.

But I think that's an important challenge for us going forward too. I mean, one of the balancing acts that we have to continuously address is you get seduced by the corporate chains and it's nice to get that business and the planning from an operational standpoint is very similar as if they were individual clients with individual properties, operationally as far as the management resources and drain that go along with it.

The temptation is you start chasing the great white whale or you want the big fish and you forget the nuts and bolts and the local operators as well, because the payoff is so much greater when you close and we've been fortunate the past few years to grow in that arena more quickly than any of the other client breakdowns. But our regional directors and regional managers know they have to do the grassroots to sustain our growth rate on a continuous basis as well and making sure that we pay attention to both, that's really been critical for us.

Okay, great. Thanks a lot.

Great. Take care, A.J.

Chad Vanacore, Stifel.

Hey, good morning.

Hey, Chad.

Hey, continuing the discussion on the new contract adds, can you remind us what the mix of new clients versus existing clients are?

Yes, Chad. So, for us, that was part of the attractiveness of the fourth quarter adds, not only the dollar amount and total revenue anticipated, but for us, it was really a nice [wins]. Kind of looking across the board at the various factors that make up our client base, you had a 50:50 split roughly between the dining segment and housekeeping and laundry segment and geographically touched all 10 of our operating divisions.

So, that coupled with the fact that about half of the new opportunities were really an additional cross-sell with existing clients; another probably quarter or so were greenfield opportunities in housekeeping with new clients and then an additional quarter, we're actually rather unique for us in that it was a greenfield opportunity to combine both housekeeping and dining services, which as you all know is atypical for us in that we've thus far been really for the most part only cross-selling dining new opportunities within our existing housekeeping base. But for us, it was a new client that we had had extensive discussions with and their preference was far and away to add both dining and housekeeping services in lockstep fashion. So again, that was a unique offering for us, but really if you look again across the whole offering of new facilities, it was a great blend of business and geography and segments.

And Chad, just as far as the breakdown, you'll see in the fourth quarter results, it looks like it's more disproportionately tilted towards dining and nutrition, two-thirds of the new business as opposed to housekeeping and laundry one-third; and that's really just due to the timing of the starts, the majority of the dining business was started during the first half of the quarter with the housekeeping and laundry business being way more towards the back half of the quarter. So that should even out more in Q1 once the full run rate is reflective and that will get you closer to Matt's suggestive 50:50 breakdown.

Alright. And so with all the new dining adds, should we expect some kind of margin improvement in food services as you ramp that up or is it going to be something that's still more gradual, evolutionary?

I think it's going to be more gradual though. We continue to have the underutilized, middle management structure in dining relative to housekeeping even with the Q4 expansion. If a typical housekeeping and laundry district oversees 10 to 12 facilities in dining, we're averaging right around 8 facilities per district. If a typical housekeeping and laundry region oversees four to six districts, in dining, we're averaging four districts per region, which is why we're able to grow dining at an accelerated rate relative to housekeeping, because we have that capacity that's available within the middle management network. But as you saw it over the next two years or so, the margins should continue to tick up just as they have the past three or four years, up almost 2% in the segment. So that's what we expect going forward. But that will happen incrementally not in one fell swoop in the first half of this year.

Alright. Thanks for your time.

Excellent. Thanks, Chad.

Thank you. Ryan Daniels, William Blair.

Hi, this is Nick in for Ryan Daniels. Thanks for taking my questions.

Good morning, Nick.

I was just wondering, how has client retention been trending relative to historical averages?

Yes, Nick, we've been able to maintain above the 90% target that we've had since the existence of the Company and over the past few quarters, we've actually kept it closer to 95%. So we're very pleased with the efforts that [were] in the field organization has made to maintain that client base, which is so crucial for us as we look for future growth opportunities. More than 9 out of 10 of our new business opportunities can be traced in one way or another back to that existing client base. So, maintaining that retention level is key for our model.

And that doesn't happen by accident. I mean, certainly the work and the significant effort put forth by the district and the regional team, but we do a better job today than probably we've ever done at the transitory stages of facilities where we are most at risk. When an administrator or Director of Nursing changes jobs, we would better be selling that individual when they come in and they don't have the benefit of the before and after picture. So, typically, if an administrator leaves one facility and moves into another, they may have a preference to bring in their own Director of Nursing, their own Activities Director, perhaps their own [Culinary] Director or Director of Environmental Services. Again, we've done a better job over the last three years of being able to get a trial with that individual and that's why you've seen the retention rates tick up, because that's where we are most at risk.

And I think that's been the critical part to our consistent growth rate that you have a founding block and the region, even though we've beat it to death sometimes, the client retention has been critical for us away from the marketing opportunities and the expansion opportunities when clients grow, acquire new facilities, administrators, Directors of Nursing change jobs that the client retention opens the door for us for those new opportunities. But it doesn't happen by accident. In many cases, it's taken for granted that we're going to have a 90% client retention rate so the growth rate of 10% to 15% just becomes a new business model, which is far from the case (inaudible) in the field. The existing clients, with their at-will contracts, we are only there every day, because we're in the clients' best interest. When they think we're not, they can cancel at any time.

So our management people have really done a very good job and sometimes it's not as acknowledged externally as it should be to keep the existing clients happy. I mean most of you guys on the call are in the service business. So keeping 95% of your clients relatively happy and we don't bat a thousand every day is no small task. So, customer is always right, but they also always want more.

Okay. Great, thanks. That's really helpful. And then, just on the corporate reorganization, does that help you save in taxes at all after 2015?

It does. We would expect and it's really part and parcel with the captive in terms of the corporate reorganization. I mean, it's done for a variety of different reasons. But the IRS has certain Safe Harbor guidelines that require appropriate risk distribution between captive and short subsidiaries. So, by reorganizing the organization into a variety of different subsidiaries, not only are we able to enjoy the benefits of potential tax planning and efficiencies as related to the captive but we're able to accelerate what would be $60 million or so of future claims payments made for insurance programs into 2015. So if you think about that $60 million at a 35% effective tax rate, that's where -- I think it was Mike Gallo that referenced earlier the potential to pick up another $20 million or so of balance sheet benefit as a result of the corporate reorg.

Okay, great. Thank you.

Sean Dodge, Jefferies.

Yes. Good morning, thanks for taking the questions.

[Hey], Sean.

Taking a little bit different push to A.J.'s earlier question and clarifying a comment that Matt had made, did I hear correctly the implementation had an 80 basis point drag on fourth quarter gross margin? And then, can you put some bookends around how much of that you expect to carry into the first quarter?

Yes. I think Matt was referring to that our direct cost of services was about 80 basis points or so, our historical target of 86%. And the majority of that [over jaw] was related to the new business inefficiencies by carrying the payrolls for the first 30 to 60, 90 days that we're inheriting as of the transition date, as well as the supply budgets and consumables, that's when we're at our most inefficient.

So, once that 60-day process winds down and the facilities are on budget, then we don't have that overbudget spending that results in the higher direct cost of services. So, you think about the majority of the business that was opened up during the first half of the quarter is on budget going into Q1, there will be some December starts that still the net 30 to 60-day window that could put some pressure on the margins in Q1, but it will be modest relative to what we saw in the fourth quarter.

Understood, okay. And then, Dan, on the last call, you had mentioned a greater amount of corporate involvement in the decision-making process than you've typically experienced. What has changed the causes? Is the bigger chains attempting to aggregate their buying power and effort to more closely control their costs? Or is it just you guys doing more whale hunting like you talked about before?

I think it feels like (multiple speakers) they have. But, frankly, I think over the last 10 years, if you broke up our client base, 10, 15 years ago, I would have said 50% or 60% were individual mom-and-pop operators or even if they were part of a chain, the negotiation and the marketing effort and sales effort were done with the individual property.

Our strategy with the corporate chains has been to neutralize the corporate people, get them to feel comfortable with outsourcing our services in general, both us as a company specifically, but sell the services locally property by property; and if they needed some kind of corporate approval or blessing, they would go back to the administrator or decision maker, will go back to the corporate people and say, oh! yes, I know those guys; if you want to use them, go ahead.

Over the last 10 years, as we've maybe had built inroads to a lot of these corporate chains, we become more visible and probably more attractive to the corporate decision makers than we were 10 years ago, that we've been making contributions to the organization that they've recognized as beneficial in a lot of cases and then have been more proactive in the decision-making and giving us a license to hunt and then coordinating the decision from a corporate level, which wasn't the case 10 or so years ago. So I think when we get these big chunks of new business, the decision had been -- the last prior to 10 years ago, have been made individually property by property, that's changed over the last 10 years much more so corporately driven.

Now, we operate them the same, we survey every one of the buildings the same, it's not a topside down proposal. We have to propose and develop the work plan for each of the properties as if they were an individual operator, but the decision-making in the past few years has been more corporately driven than it ever has in the 38 years we've been doing this.

Okay. And so from the facilities standpoint or point of view, nothing's really changed, it's just who's --?

Who's given us the go ahead.

Got him. Okay. Great, thanks.

Yes.

Thank you. Toby Wann, Obsidian Research Group.

Yes. Hey, good morning, guys, and congratulations on the quarter. Quickly, a little bit of a slight housekeeping [part in] the pun item. Could you guys give us the split between housekeeping and food services in revenues and margins?

Toby, you mean for the quarter as far as dollar amount?

Yes, just for the fourth quarter, yes, dollar amount.

For the quarter, for the dollar amounts for housekeeping, we were at $218.9 million; and for dining, we were at $122.7 million.

So it's still about two-thirds, one-third.

Okay. And then, any margin commentary on any of that?

No, that will be in the K, but it should be in line with our historical margins.

But food service is still not at the margins that housekeeping and laundry are and that's still our objective, to utilize the district and regional structure spread out over the right complement of properties, the margins should continue to improve in food service as they have the past three, four years. And ultimately, when we execute properly and ramp up at the level of housekeeping and laundry. And that's going to be reflected in the direct cost improvement that Matt described.

Okay. Perfect. Thank you.

Excellent. Thanks, Toby.

Thank you. There are no further questions in queue at this time. I'll turn the call back over to Dan for closing remarks.

Okay, thanks. Matt just wanted to update you guys on the conferences that we're going to be attending over the next few weeks.

Yes, thanks, Dan. Just wanted to note that we will be attending and presenting at three upcoming conferences, all of which are in New York City. The first is on February 24, that's the RBC Capital Markets Global Healthcare Conference. That'll be at the New York Palace Hotel. On March 16, we will be at Sidoti & Company's Annual Small Cap Equity Conference, that's at the Grand Hyatt Hotel. And on May 19, UBS Global Healthcare Conference is at the Sheraton New York Times Square Hotel. So, hopefully, we'll see some of you at those events. Thanks, Dan.

Okay. Well, thanks, everybody, again for joining us. Ending 2014 and going into 2015, we expect to continue to expand our client base in housekeeping and laundry within our historical targets and food service. With the new business we started in the fourth quarter getting on budget with proper execution, we will not only maintain our double-digit growth rate but have the margin improvement and get the direct cost closer to 86%. The demand for the services in this environment is as great as it's ever been since we've been doing this. All our divisions continue to perform better, but with any expansion, we have to make sure we keep our eye on the ball with the existing clients and not just focus on the new business.

We want to get our direct costs closer to 85% over the next year, year-and-a-half with incremental improvement quarter-to-quarter. With the changes in some of the state tax policies and the investment we made in our legal and personnel departments, not only for the captive, but in this litigious environment that we find ourselves in. We've expanded the legal and personnel departments to be a more value than more detailed resource for our management people in the field. We expect our SG&A to be in the 7% range, with no deferred comp impact. We expect the captive insurance subsidiary to give us an improved platform financially, administratively and more flexibility operationally for 2015 but more importantly benefit us for the years to come.

Our business still benefits from strong demand. Our management people in all divisions, especially in foodservice, continue to get better. We've never had better management people in the history of the Company. So we believe that we'll continue to operate on budget going forward. As we expand in 2015, we anticipate it to be our 39th consecutive record year. So these are still pretty good times for us. Thanks again for joining us onward and upward.

Thank you. Ladies and gentlemen, this concludes today's program. You may now disconnect. Good day.