Healthcare Services Group Inc (HCSG) 2015 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Healthcare Services Group 2015 second-quarter conference call.

(Operator Instructions)

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 risks and uncertainties.

As with any projection or forecast, they are inherently susceptible to uncertainty and changes in circumstances.

Healthcare Services Group's 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 or those projected in forward-looking statements are included in our earnings press release issued prior to this 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 forward-looking statements, whether as a result of such changes, new information, subsequent events or otherwise.

I would now like to turn the call over to Dan McCartney, Chairman.

Sir, please go ahead.

Okay, thank you, Kaylee, and thank you, everybody.

Good morning.

Thank you for joining us.

I am with Ted Wahl and Matt McKee.

And again, we appreciate everybody joining us for this conference call for the second quarter.

We released our second-quarter results last night after the close, and will be filing our 10-Q sometime next week.

And with that, I'd like to introduce Ted for a discussion on the second-quarter results.

Okay, thank you, Dan.

Revenues for the second quarter increased over 11% to $355.4 million.

Year-to-date revenues were up about 13% to $710.6 million.

Housekeeping & Laundry grew at nearly 8% for the quarter.

Dining & Nutrition was up about 19%.

Earnings from operations increased over 22% in Q2 to $26 million, bringing the year-to-date total to $51 million.

Both revenues and earnings from ops for the three- and six-month periods were Company records.

We continue to expect double-digit top-line growth for the year, with Housekeeping & Laundry at the lower end of our targeted range, and Dining & Nutrition likely exceeding that range, as even with the Q4 and Q1 expansion, the Dining segment continues to have an underutilized district and regional management structure, as well as a smaller base from which to grow.

The division successfully transitioned the new business we added over the past nine months, and now have shifted their focus towards managing the departments and servicing the clients.

As that new business matures, we would expect ongoing margin improvement, while at the same time continuing to give proper attention to our legacy customers.

As we discussed on prior calls, we expect to transition our workers' comp, and certain employee health and welfare programs, into the captive insurance subsidiary during the third quarter.

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 the claims, reduce costs, and provide much needed flexibility for our facility-level health and welfare plans to meet the requirements of the Affordable Care Act, which took effect January 1.

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

Thanks, Ted.

Good morning, everyone.

Net income for the quarter increased to $16.3 million or $0.23 per share, compared to $13.9 million or $0.20 per share in second quarter of 2014.

Both net income and earnings per share were Company records.

Direct cost of services came in at 85.6%, so 40 basis points below our target of 86%.

Going forward, our goal is to continue to manage direct costs under 86% on a consistent basis, and obviously work our way closer to 85% direct cost to services.

SG&A was reported at 7.1% for the quarter, with essentially no impact from the deferred compensation investment accounts that are held by and for our management people.

So, we expect normalized SG&A to continue to be in the 7% range going forward, with the ongoing opportunity to garner some additional modest efficiencies there.

Investment income for the quarter was reported at $240,000.

Again, no impact from the change in deferred comp investment accounts.

Our effective tax rate for the quarter was 38%.

Depending on the timing of the WOTC reauthorization in the year ahead, our rate will likely be between 36% and 38% for the remainder of 2015.

Continue to manage the balance sheet conservatively -- at the end of the second quarter had over $97 million of cash and marketable securities, and a current ratio of 3 to 1. Accounts receivable remained in good shape, below our DSO target of 60 days.

And as we announced yesterday in conjunction with our earnings release, the Board has approved an increase in the dividend to $0.17875 per share, split-adjusted and payable on the 25th of September.

Cash flow and cash balances for the quarter 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's going to be the 49th consecutive cash dividend since the program was instituted in 2003 after the change in tax law.

And it's the 48th consecutive quarter we increased the dividend payment over the previous quarter.

And that's a 13-year period that included four 3-for-2 splits.

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

(Operator Instructions)

A.J. Rice, UBS.

Thanks.

Hi, everybody.

Good morning, A.J.

First off, just ask -- you had a nice step-up in your cash position from first quarter to second quarter.

You mentioned receivables.

How much of that was working capital to management versus just timing on when the close of the quarter occurred?

It was a combination of both, A.J. You saw we had about a $25 million positive swing in our cash balances.

And about $15 million of that increase, which is the timing of the payroll accrual from one quarter to the next.

And the balance of that was largely driven by the improvement in DSO and better cash management.

Okay.

And as that cash balance builds, you guys have been obviously very steady at increasing dividends for a long time.

Is that cash balance something that you feel like you need to maintain?

Or will you look at perhaps either stepping up the dividend even faster or something else as that continues to build?

I think as far as the dividend, it's something that the Board evaluates on an ongoing basis.

And certainly if earnings and cash flow -- and to your point, cash balances -- continue to grow at a rate faster than the dividend, then increasing the dividend would warrant some serious consideration.

Our plan as it stands today is to finalize the captive-related reorg, which includes capitalizing or funding the subsidiary with $60 million to $70 million during the third quarter.

And then after six months or so of operating the captive will evaluate what makes the most sense in terms of capital allocation for 2016.

Okay.

And then switching gears for a bit, obviously the economy from the employment standpoint seems to be picking up a little traction here for the last year or so.

Have you seen your client long-term care facilities begin to push up a little bit the rate increases, the wage increases, with their hourly workers yet?

Or is that still about the same as it was, say, a year ago?

Yes, A.J., when we look at the industry -- and obviously, I know you raise the question because that's the trigger that increases our contract prices.

But really, the long-term care industry has always had to respond more sensitively to wage increases relative to other blue-collar-type employment companies.

So we haven't really seen any changes.

And it's rare that we would see macro level economic or employment data really have an impact on our clients.

Obviously, an extreme example is, you'll see it.

But over the past year, it's been a pretty steady state for us, seeing the typical increases that our clients are passing along to their blue-collar employees.

Which in turn, causes the path to [repause] in our contract price increases.

Right.

And I just might finally finish up.

You had said that you thought at least the business you brought on by year-end, this bolus of big business by the time you exited second quarter would largely be at your baggage target margin.

Is that what you're seeing?

Or do you still have some margin improvement in front of you from that rollout of new business late last year?

The majority of the business is well within our targeted margin range.

As is always the case, we have some outliers to the positive and to the negative, and they are the ones we're working through.

But overall, I think the business is on-line.

And we think as that business continues to mature, there's some ongoing margin opportunity as well.

All right, thanks a lot.

Okay, thank you, A.J.

Michael Gallo, CL King.

Hi, good morning.

Hi, Mike.

A couple of questions.

With the business now digested that you added to Q4 and Q1 substantially on budget, how should we think about the acceleration starting to really ramp back up on the sequential housekeeping additions?

And then also, I know it's been lumpier with a lot of larger business coming in, in one shot.

I was wondering if you see more potential large lumps coming in here over the next 6 to 12 months?

I think in the near-term, we continue to plan for double-digit revenue growth for the balance of the year.

Our efforts are going to be focused on building the top-line momentum, which, as has always been the case, is fueled by our management development efforts over the next six months as we prepare for 2016.

I think to take a step back, Mike, I would say the demand for the services is as great as it's ever been.

But the rate-limiting factor on our ability to add new facilities -- and this, again, has always been the case -- is developing the next wave of management candidates.

Each district and region is at a different stage in terms of the quality and quantity of their management pipelines.

And it's really that pipeline, if you will, that determines how quickly we can grow.

It acts as the accelerator -- in some quarters and years, the decelerator -- of our growth rate.

So it's driven from the bottom up in the training center by training center-type of way, rather than through some corporate-dictated plan being sent out to the field.

We are comfortable that as the new contracts were initiated over the past nine months, the divisions continued to focus on the management development functions.

But a substantial amount -- really a year's worth of managerial resources -- have been assigned to the new business that we've added over the past few quarters.

Which is why, again, the back-half of 2015 is going to be focused on digesting that bolus of new business and replenishing the management pipelines.

It sounds like it will still probably be a little bit before you get back to the historical sequential?

Or is it starting to get (multiple speakers) --

No, I think sequentially, quarter to quarter, you will see a build-up.

But it will be incremental, as it has been historically.

Okay, great.

And then just a follow-up question on the captive.

Can you just walk us through what still needs to happen from a reorg and regulatory?

What are some of the hoops left that you still have to jump through before we get funded and before you start to see the benefits?

The captive is on track.

We will have it completed by the end of the third quarter.

There's really no additional regulatory hoops for us to jump through.

So it will be completed, again, by the end of the third quarter.

It's just a matter now of administratively and from a back-office perspective transferring the employees to their designated entities, funding the captive -- funding, really, the subsidiaries, and then ultimately funding the captive, is the order of events.

But we're still expecting $6 million to $8 million of annualized savings.

And that could prove to be conservative, depending on how things evolve.

As well as a $20 million or so cash benefit as a result of the accelerated tax deduction from capitalizing the entity.

Right.

And in terms of the -- will you get to that full run rate by the fourth quarter or --?

We should be trending towards that run rate by the end of the year, Mike.

And then I would expect in 2016, that's when you'll really see the full benefit.

But there's going to be a transitory period during Q3.

During Q4, we would expect the pro rata share of that benefit to drop to the bottom line.

And then heading into 2016, our expectation is, we're going to realize the full benefit of what we expected.

Right, okay.

And you see that really start to show up in the gross margin line.

That's exactly right.

So walking through the numbers, the 14.4, assuming that you could hold that, you talked about some opportunities to improve that a little bit on the new business.

That would move your direct costs closer to 85, once we get the full funding of the captive.

Is that reasonable?

I think the two drivers of our margin improvement over the next couple of years, as we've said for quite some time, are going to be the Dining & Nutrition districts and regions, managing the right complement of facilities.

Because even after the Q4 and Q1 expansion, we still have an underutilized district and regional network in Dining, relative to Housekeeping & Laundry, as well as the tailwind that the captive insurance vehicle is going to provide.

So working our way closer to 85%, and consistently managing it towards that number is what our objectives are.

If you look back historically, over the past at least 6 to 12 months, that is exactly what we've done.

Okay, great.

And then just final question.

I know we saw the G&A come down nicely sequentially.

I know you've talked in the past about a lot of the things you have done to really enhance your ability to take on a lot of additional business, in terms of the G&A structure.

Is there any reason as we can go forward and you start to layer in -- continue to layer in that double-digit top-line growth, why you shouldn't be able to keep SG&A in the $25 million, $26 million, even $27 million range?

Which should actually bring the level as a percentage of sales down below 7%, if we assume double-digit growth continues.

There's nothing specific that I could identify as to why we couldn't continue to manage it in that 7% range going forward.

I think if you look over the next year -- you mentioned $25 million to $27 million.

I think that's a fair modeling assumption.

If you're using that and calculate the percentage, that gets you to 7% or so, which is where we've ran SG&A the past six quarters.

If your question, Mike, is, do we have scale going forward, I think the answer would be that we do.

But until we demonstrate that we're going to run it consistently under 7%, I wouldn't model it like that.

My question was more about, is there anything additional you need to add that you can foresee above and beyond, that you'd need to bring on the next wave of growth?

Do you feel like you have what you need in place for the next 12, 18, 24 months from a G&A perspective?

We do, yes.

Okay, thank you.

Thank you, Mike.

Ryan Daniels, William Blair.

Good morning, guys.

Thanks for taking the questions.

Let me start with another quick follow-up on the captive.

Ted, you mentioned you'll fund that with $60 million to $70 million.

Is that cash, just from an accounting standpoint, that will sit on your balance sheet still in a restricted cash account?

Or how will that work?

Yes, it will be a mix of cash debt that we draw down from our extended line of credit, and then letters of credit.

Okay.

That's part of what's being finalized over the next 60 days.

Okay.

And then, you discussed this briefly, but any final reorg costs?

I know you had some one-time expenses earlier, so maybe that's all accrued.

But anything we should be aware of in Q3 as you actually go through the launch?

Nothing.

No additional costs related to the captive that we anticipate, Ryan.

Okay, perfect.

And then, I don't know if this is in your savings, but I'm curious, with the novel entities you've structured for captive, are there any potential tax benefits that you could see manifest from that -- state-level taxes?

Or is that in your estimate at this point?

It's not included in our estimates, but there is an opportunity for us -- and this is more of a 2016-2017 opportunity -- to more efficiently determine and allocate our state income taxes.

From some of the preliminary modeling we've done, we think there's about a 100-basis point to 200-basis point opportunity, just on a state income tax side.

And again, that's not baked into our assumptions, but that's something we see as an opportunity over the next couple years.

Okay, perfect, that's helpful.

And then just --

And that's really why -- I know we've emphasized the near-term financial opportunities.

But I think the more compelling and longer-term benefit of the captive is that it establishes a platform for what is our third largest spend.

And provides us with significant operational and administrative flexibility, not just for the program design of our property and casualty and health and welfare programs, but for a variety of other initiatives that we're going to be able to take advantage of for years to come.

It's really the flexibility that I think is the long-term play.

Yes, that makes sense.

Okay then, final one for you guys.

From a macro standpoint, obviously a lot of changes going on in the reimbursement, with bundling hips and knees, and value-based purchasing, and things that probably could trickle down into the client base that you serve.

And I'm curious if you're hearing any discussions in the field about that accelerating demand to outsource, so these entities can focus more on core competencies and patient care.

Is that still not resonating enough in the market to show up in your income statement yet?

I think for us, Ryan, it's really, again, the macro-level uncertainty as it relates to reimbursement has always been a benefit to outsourcing services of all kinds, including ours.

So we've certainly, I think -- we see more general uncertainty than stalwart planning, moving forward with a firm plan to definitively outsource service X, Y and Z and focus on certain core functions.

So for us, I think the trends to outsourcing continue to be in our favor, and certainly work to the benefit of all outsourcing companies.

But I think your premise is spot-on, in that the operators want to focus on their core competencies and continue to look to outsource any function that makes sense from a financial and operational perspective.

That trend, I think, continues.

I don't know that there's any increased urgency as it relates to reimbursement uncertainty.

But we certainly continue to be the beneficiaries of that trend, in general.

Okay.

Thanks a lot guys, I appreciate it.

Take care, Ryan.

Toby Wann, Obsidian Research Group.

Good morning, guys.

Congratulations on the quarter.

Just quickly, one housekeeping item.

Number of Housekeeping and also Dining & Nutrition facilities under management at the end of the quarter?

It's pretty consistent with where it was the past 90 days, Toby.

We're at around 3,800 Housekeeping and about 1,000 Dining & Nutrition facilities.

Okay.

And I know you spoke to it a little bit earlier in the call about the capacity.

Just refresh us where you stand capacity-wise on Dining & Nutrition, in terms of number of facilities per district, region, that sort of thing, if you would?

Toby, when you look at it on a rolled-up basis, it's still fairly comparable, in that the district managers who should be overseeing 10 to 12 facilities are still in the 8 or 9 range, on average.

And the regional managers who should be overseeing four to six districts are still typically overseeing maybe four.

It was three to four, now probably closer to four, on average.

The good news -- and just to reiterate -- is that when you look at the maturation of the Dining Services division, starting in the mid-Atlantic, working our way to the Northeast, then to the Southeast, Midwest and then the Far West.

In the mid-Atlantic and the Northeast, we have fully functioning and fully utilized district managers and regional managers in the Dining segment.

So we know the model works, and we know we can get there.

Now, is it a nice, clean, quarter-over-quarter, linear, Excel spreadsheet exercise?

No, it is not.

We wish it was.

But we fully expect that, that model that is in place in the mid-Atlantic and Northeast divisions will continue to grow and expand to the other divisions that I mentioned.

And that's just going to be a gradual step-wise approach.

But certainly the opportunity to more fully utilize those folks remains.

And that is, as Ted alluded to earlier, the greatest margin opportunity for the Company.

Okay.

I appreciate that, and I especially appreciate the commentary about linear growth.

(laughter)

Sean Dodge, Jefferies.

Thanks, good morning.

Good morning.

You guys had previously mentioned potentially adding major medical into the captive.

What are your thoughts on the timing of that?

And would that require a material amount of incremental funding?

It wouldn't.

And that's why that's not part of the initial phase-in.

That would be more of a 2016 consideration as well.

But that would be more of a fund-as-you-go process, rather than an initial funding requirement.

Okay.

What percent of your client base, roughly, is made up of not-for-profit operators?

It really mirrors the market, and it's more driven by a state-by-state.

You have some states like Minnesota that have a higher percentage of non-for-profits.

And as a result, a higher percentage of our customer base in Minnesota is non-for-profit.

So it really mirrors that of the market, and it's just driven by what the state allocation is.

Okay.

If you look across the entire United States then, is the entire not-for profit SNF market addressable for you?

What I'm getting at is, are there any structural or behavioral differences unique to not-for-profit guys they keep you from fully penetrating that side of the market like you would the for-profit guys?

Not any longer, Sean.

If you go back 10 or even 15 years ago, the non-for-profits really operated in a vacuum and had no real concern for financial efficiencies within the management of their facilities.

With changing reimbursement, and reimbursement uncertainty, that paradigm has completely shifted.

So that now even the most well-funded non-for-profits are typically concerned not only with managing overall in an efficient way financially, but also -- to Ryan Daniels' question and comment earlier -- to really focusing on their core competencies.

So just as we've seen with the for-profit sector, the non-for profits -- it may be a little bit of a slower evolution toward demanding outsourced services.

And certainly, demanding the management of housekeeping and dining services in an outsourced fashion has certainly accelerated over the past few years.

But to your basic question, there's really nothing fundamentally that differs among the management of for-profit or non-for-profit facilities.

From our perspective, really what defines a proper target for us from a housekeeping and laundry perspective, remains the size and scope of the facility being sufficient to bear the cost of having a full-time, on-site manager to manage the housekeeping and laundry department.

So there's not typically a for-profit/non-for-profit threshold -- even necessarily a bed size threshold.

But it's really this facilities being able to bear the cost of having a full-time, on-site dedicated housekeeping manager.

Okay, very good.

Thanks again.

Thanks, Sean.

Chad Vanacore, Stifel.

Good morning, all.

Good morning, Chad.

All right.

Can you give us an update on your promissory note receivable balance?

And then tell us a little bit about your collection experience throughout the quarter?

The details around the promissory notes will be in the Q. But it's going to be consistent with or better than where we were last quarter.

But again, from a promissory note perspective, we've always looked at that is a tactic in an overall collection strategy.

And without sounding glib, if we could have all of our receivables in the form of a promissory note, we would.

Because a typical accounts receivable for us is an unsecured amount that's due from a client.

Versus a promissory note, which typically comes with a security interest, which is in a legally binding document.

So our preference would be to have as much -- and we're more proactive in approaching our clients today and engaging them in promissory note discussions than we have been in the past.

I think from a promissory note perspective, it should be in-line with last quarter, as far as the absolute amounts that we have.

But that's really been our focus and our approach that we've taken historically.

All right, thank you.

And it looks like in your new credit line, you borrowed $85 million to fund the [captive insurance company].

Should we be expecting you to carry that balance for a while?

Or is that in terms of letter of credit?

We don't have any draw-downs on the credit line as of the balance sheet date, Chad.

Okay, all right.

And then one last question.

You mentioned taxes for the year, you expect 36% to 38%.

Is that ex the WOTC credit?

The most recent indication from the House Ways and Means Committee suggests that the tax extenders legislation is an early fall priority, which would be a significant improvement over the past two years.

I don't know what early fall priority means in Washington DC parlance, but we'll see how that plays out.

Our tax rate would be 36% to 38%, depending on the timing of the extenders legislation.

36% being if the WOTC, on an annualized basis, is in fact re-authorized before the end of the year.

And I think 38% if it's not re-authorized until 2016.

Right.

Early fall probably means early spring retroactive.

Although it's Paul Ryan's debt, so it may be a little more reliable than others.

We'll see.

All right, gentlemen, thanks for your time today.

Thanks again, Chad.

Thank you.

And I'm showing no further questions at this time.

I would like to turn the call over to Ted Wahl, President and CEO, for closing remarks.

Thank you.

And before we wrap it up, I know Matt wanted to review our conference schedule for the next few months.

Matt?

Yes, we will be participating in several conferences upcoming, including the CL King 13th Annual Best Ideas Conference.

That will be on the 10th of September at the Omni Berkshire Place in New York City.

And then also the 6th Annual Credit Suisse SMID Conference, which will be on the 16th of September.

And that's at the Waldorf-Astoria, also in New York City.

So we look forward to seeing some of you folks at those conferences.

Ted?

Thanks, Matt.

As we look towards the next 12 months, we expect to continue to expand our client base -- both in Housekeeping & Laundry and Dining & Nutrition -- within our historical targets.

The Q4 and Q1 expansion efforts do provide us with a good platform for the back half of the year, to not only maintain our growth rate, but also the margin improvement that we've demonstrated during the first half of 2015.

The demand for our services has never been greater, as our customer base, and really the provider community at-large, continues to face significant uncertainty in both the regulatory and reimbursement environments.

Even with this stepped-up demand, we remain committed to controlled expansion.

The rate-limiting factor on our growth continues to be the pace at which we're able to develop field-based management personnel, particularly at the MIT, account and district manager levels.

The focus on teaching and training our management people, from orientation through maturation, will be our highest priority over the next 12 to 24 months.

Using all available forms and mediums, including on-the-job training, classroom settings and leveraging technology to its fullest extent.

We'll look to keep direct costs below 86%, and work our way closer to 85% direct cost of services.

The primary drivers of that margin improvement will be the Dining & Nutrition districts and regions managing the right complement of facilities.

And the transition of our workers comp and employee health and welfare programs into the captive insurance subsidiary during the third quarter.

Again, the captive vehicle will provide significant flexibility -- financially, operationally and administratively -- in the near-term and for years to come.

We expect our normalized SG&A to be about 7% or so, excluding any deferred comp impact, but remain committed to ongoing investment in our HR and legal functions.

With the adversarial regulatory environment emanating from DC, our subject-matter experts have been valuable resources for our management team in the field, and allow us to more proactively navigate the highly regulated litigious industry in which we operate.

Our effective tax rate should continue to be in the 36% to 38% range for the balance of 2015, as I just talked about, depending on the timing of the tax extenders reauthorization.

Overall, we continue to operate in an unprecedented cost-containment environment, and that's increased the demand for outsourcing services of all kinds.

We have the most talented management team that we've had in the history of the organization.

And we have the financial wherewithal to grow the business as fast as our ability to manage it.

Ours is an execution business, and our ability to execute is what will drive our success in the months and years ahead.

So on behalf of Dan, Matt, and really all of us at Healthcare Services Group, I again wanted to thank Kaylee for hosting the call today, and thank you to everyone for participating.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude the program, and you may all disconnect.

Everyone have a wonderful day.