Healthcare Services Group Inc (HCSG) 2015 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Healthcare Services Group Incorporated 2015 third-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, go, may, intends, assumes or similar expressions. Forward-looking statements reflect management's current expectation as of the date of this conference call and involve certain risk and uncertainties. As with projections or forecasts, they are inherently susceptible to uncertainty 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 different from recent results or those projected in forward-looking statements are included in our earnings and press release issued prior to this call, and 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 would now like to introduce your host for today conference call, Mr. Dan McCartney, Chairman. You may begin.

Thank you, Kevin and good morning everybody. Thanks for joining us. I'm here with Ted Wahl and Matt McKee and we appreciate everybody participating in our conference call. We released our third quarter results yesterday after the close and will be filing the 10-Q during the week of the 19th. With that, I'll turn the call over to Ted for a discussion about our third-quarter results.

Thank you, Dan. Revenues for the third quarter increased nearly 13% to $360.2 million. Housekeeping and Laundry grew at 8%, Dining and Nutrition was up 22% for the quarter. Year-to-date revenues were also up about 13% to $1.1 billion.

Earnings from operations for Q3 came in at $26.6 million, bringing the year-to-date total to $77.6 million. Both revenues and earnings from ops for the three and nine month periods are Company records. As we enter the fourth quarter, we continue to expect double digit top line growth for 2015 as the division successfully transitioned the new business added over the past year and have shifted their focus to managing the departments, servicing the clients and most importantly developing the next wave of management people to support our current and future expansion efforts.

In the year ahead we'll look to manage growth and retention rates within our historical targeted range, while at the same time adhering to our operational systems and budgetary commitments. In September we completed the transition of our workers' comp and employee health and welfare programs into the captive insurance subsidiary, adding to the general liability coverage that's already part of the program.

The captive structure will help contain cost, allow for greater efficiency in the management of claims and provide needed flexibility for our facility level health and welfare plans to meet the requirements of the Affordable Care Act. So with that abbreviated overview, I'll turn the call over to Matt for a more detailed discussion on the quarter.

Thanks, Ted. Net income for the quarter increased to $17.1 million, or $0.24 per share. Year-to-date net income came in at $48.9 million, or $0.68 per share. Both net income and earnings per share for the quarter and year-to-date are Company records.

Direct cost of services came in at 85.7% which is 30 basis points below our target of 86%, and going forward our goal is to continue to manage 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 6.5% for the quarter, but after adjusting for the $1.4 million related to the change in the deferred comp investment accounts, held flat for and by our management people, our actual SG&A was 6.9%. We expect our normalized SG&A to continue to be in the 7% range going forward, with the ongoing opportunity to garner some modest efficiencies.

Investment income for the quarter was reported as a $1.3 million expense. But again, after removing the impact of the change in deferred comp investment accounts, our actual investment income was about $100,000 for the quarter. Depending on the timing of the WOTC reauthorization, we would expect our Q4 effective tax rate to be in the low 30s assuming retroactive credit treatment to the beginning of the year.

As far as the balance sheet, we continue to manage the balance sheet conservatively, and at the end of the third quarter we had over $103 million of cash and marketable securities and a current ratio of 4 to 1. Our accounts receivable remained in good shape, well below our DSO target of 60 days and as announced yesterday in conjunction with our Earnings Release, the Board of Directors approved an increase in the dividend to $0.18 per share, split adjusted and payable on December 18. The cash flow and the cash balances for the quarter more than support it, and with the dividend tax rate in place for the foreseeable future, the dividend program continues to be the most tax efficient way to get the value and free cash flow back to our shareholders.

It will be the 50th consecutive cash dividend payment since the program was instituted in 2003 after the change in tax law, and it's the 49th consecutive quarter that we increased the dividend payment over the previous quarter. So that's a 13 year period now that includes four three for two stock splits.

With those opening remarks, we'd like to now open the call up to questions.

(Operator Instructions)

Our first question comes from AJ Rice with UBS.

Hi, everybody.

Good morning, AJ.

First of all, when you think about being able to recruit both your hourly workers and your management trainees and so forth, have you seen any change in that with the pickup over the last year in the economy, in the employment picture?

Not really, AJ. For us, getting resumes and getting recruits in the door, at least at the management level, has never really been the issue. For us, it's having them go through the 90 day apprenticeship, the MIT program that's been the more challenging part. Again, just because of the hands-on nature of the management training program and what's required from our perspective of learning the business and being able to work your way through the management levels that we have in the organization.

At the staff level it's really a localized effort. These jobs aren't very desirable, even for minimum wage type employees, which is why at the facility level most properties are required to hire people at something higher than the minimum wage. You may have some markets that are, depending on the labor market and how tight it is, has to increase their wages to be able to retain and recruit employees. Others that have looser labor markets don't have the same type of labor pressure. It's really, for us at least, a district by district exercise both at the management level and at the facility level a localized effort.

In the Housekeeping business you were a little below your target, I know that you said that will grow at the lower end of the 10% to 15% target for the overall Company. It was a little below that. Is there anything about the timing of when new business came on or anything else that's worth highlighting there?

I guess during the quarter the majority of the business we started in Q3 was in the back half of the quarter. But when we look out over the next 12 to 18 months, growth and expansion opportunities are really the least of our concerns. The demand for the services continues to be as strong as it's ever been which is why our focus and attention needs to be on the quality and the quantity of our management pipeline. And each district and region is at a different stage of development in that process. But ultimately it's that pipeline of management candidates that's going to act as the accelerator, or in some quarters and years the decelerator of that growth rate.

I would just add that beyond the management capacity consideration, there's a lot of other variables that impact the top line as well. The timing of when we add the business, if we add 20 or 30 more facilities, AJ, than what we expect in a given quarter, we may grow the top line at the higher end of our historical range. If we're 20 or 30 facilities lighter than what we anticipate in a quarter, then maybe we grow at the lower end of that range.

Even the geography of where we add the business matters. 100 bed facility in Manhattan with high wage rates and a rich benefit plan may be a seven figure contract. That same size facility in rural Louisiana that's pinned to the minimum wage and has a limited medical plan may be a $200,000 contract. There's similar operational requirements in both properties, but varying price points.

Our retention rate and client satisfaction standards impact how quickly we'll expand. I know 90% client retention has been a foundation of the Company since its inception and it's certainly something we're proud of. We can never take it for granted, the amount of work, really the amount of time and treasure, human capital that goes into maintaining that type of retention rate is substantial. But over the long term, our expansion efforts are ultimately going to be driven by the management development efforts.

Okay. That's great. Maybe one last question. On the captive subsidiary, I faded out there for a minute. Did it have any impact, the insurance captive on the P&L for the quarter, and your long-term thoughts about what the impact of that will be, has there been any update on that?

The reorg was completed during the third quarter and simultaneous to that reorg being completed we did fund the captive with $70 million in transition to workers' comp and some of the voluntary health and welfare programs into the captive. We continue to target $6 million to $8 million of annualized save which we should begin realizing during the first half of next year, although ultimately that number could prove to be conservative, depending on how things evolve.

We also targeted the $20 million cash benefit as a result of the accelerated tax deduction from capitalizing the entity, $15 million of which has already been realized through lower estimated tax payments during the first nine months of the year. And there's going to be another $5 million to $7 million in Q4 of cash benefit as a result of the lower payments.

Okay. Great. Thanks a lot.

Take care, AJ.

Our next question comes from Ryan Daniels with William Blair.

Good morning, guys. Thanks for taking the questions.

Good morning, Ryan.

Let me follow up with AJ's question on the captive. You mentioned that you should start to see the benefit on a run rate in the first half of 2016. Should we be modeling any improvement in Q4, or is it safer at this point just to assume that doesn't really start to hit the P&L until 2016?

During Q4 there's going to be some transitory expense just due to the switch from our third-party insured to the captive and PPA model. That would offset whatever modest savings we would have had for the fourth quarter anyway. So we're really looking towards next year as when the captive savings would take hold.

Okay. That's helpful. Then you, I appreciate the cost savings. I'm curious if it gives you any more opportunities in regards to new business as well? So thinking new ways to structure contracts or move more labor onto your income statement off of clients or drive even better savings at an equal margin, anything like that, that could take place too?

I think Ryan when you think about how we structure the contracts and specifically the pricing of the prospective contracts with our clients, the pricing limitation is really due to the high visibility that there is in our pricing structure because we match the wage rates, mirror the benefits, and recognize the seniority of the employees that we're bringing on. Even without a calculator, the prospective client can have a pretty good idea of how we're staffing pricing and the margins that we're making. So for us, the margin limitation on pricing has really always really been due to the recognition of the wage and benefit structure. So don't anticipate that there would be leverage there.

Where there will be an opportunity though is in the flexibility that the captive offers us to ultimately move the health and welfare in the major medical, specifically into the captive vehicle. So as we're looking to put together new proposals for prospective clients, because mirroring the benefits has always been a key of our structure, due to the captive we'll now have better -- greater flexibility to put together a program that better mirrors the structure that they have in place now, while serving as a benefit to the Company, because we won't have to farm that out to an Aetna or to a Blue Cross and Blue Shield type program.

That makes good sense. That's good color. Last one, I'll hop off. Just on the -- Ted, you managed, or you mentioned management capacity considerations. How are you looking on the food services side? I know that's been underutilized historically but you've been seeing some really good growth there the last few years. Could you maybe give us an update on the regional infrastructure and where you stand there? Thanks.

No problem, Ryan. We're right around -- if you look at it from an average perspective, we're around eight facilities per district and about four facilities per region, which when you compare that to four or five years ago is substantial improvement. I would say we're another two to three years away from being -- the Dining and Nutrition segment managing a similar complement of facilities to what Housekeeping and Laundry typically manages. Which is 10 to 12 facility districts and 4 to 6 district regions.

And even with the growth, it's not an excel spreadsheet exercise where we layer a certain amount of growth on and the districts and regions are fully utilized, because it's really driven by where we're adding the business. If we're adding new Dining business in the Northeast or Mid-Atlantic where we have more mature districts and regions, similar to Housekeeping, we're promoting district managers from within as we add that business. Versus areas that are less penetrated like the Southwest, Southeast, far west, we still have five facility districts and three district regions that are -- if we add business in those areas, we'd get that disproportionate jump in earnings in that particular division.

Okay. Great. Thanks for all the color, guys.

Absolutely, Ryan. Take care.

Our next question comes from Michael Gallo with CLK.

Hi, good morning.

Mike, how are you?

Good. Two questions. I was wondering, Ted, as you look at each of the regions in terms of food service additions, where do you feel like there's the most room or they're really ready to add facilities and where is it still going a little bit slower? And then I have a follow-up question.

In Dining it's really, the capacity is throughout the country. It's just the growth in the Northeast and the Mid-Atlantic would just be more traditional within our historical targeted range that we've had. Whereas in some of the areas where we have disproportionately underutilized middle management structures, we are able to grow at an accelerated rate. The same opportunity exists from a cross-sell perspective throughout the country.

Okay, great. And then a question, Ted, the cash balance is obviously going to be building up here. You're certainly out-earning the dividend now by a decent amount. So how should we think about the dividend as we go into 2016? I know you've been bumping it up at a relatively modest rate more recently, but it seems like that the cash flows and the cash balances support that may be moving a little bit faster. Is that something we should think about for 2016?

We thought since this was such a significant milestone quarter for us, being the 50th anniversary of our dividend inception, 50 consecutive quarters, we wouldn't have to address this. But really it's something the Board evaluates on an ongoing basis. And to your point, Mike, if earnings and cash flow continue to accelerate at a rate faster than the dividend, which we would anticipate, then bumping up the dividend would warrant some serious consideration.

And our plan, as we talked about last quarter, was to complete the captive reorg because it is a different capital structure than what we've operated under historically. So we've completed that during the third quarter. And then over the next six to nine months of operating the captive, determine what makes the most sense in terms of capital allocation going forward. But it is something that we're seriously considering going forward and depending on the balance sheet and how it continues to evolve over the next six to nine months, that's when we'll make the decision.

Thank you.

Thank you, Mike.

Our next question comes from Chad Vanacore with Stifel.

Good morning.

Chad, good morning.

Since all the other guys asked such great questions I've just got a few clean-up ones. On the captive, how much impact should we expect in the fourth quarter? I know you said $6 million to $8 million in 2016, but it should be fully funded now. Should we get a pro rata share of that in the fourth quarter?

Yes, I mentioned that earlier, Chad, but nothing in the fourth quarter just because it's really a transition quarter for us. From switching from our third party insurer to the captive PPA model that's going to be managing the P&C programs and really the voluntary health and welfare programs out of the subsidiary.

All right. Thanks. What can you tell us about the pace of new contract adds, are you seeing any pressure on SNF operators that may lead to them outsourcing more business at a faster rate?

Chad, look, we've talked about previously the demand for the services remains far greater than what we're able to service at present. So for us, it really gets down to growth being tied to our ability to develop the management personnel to be able to put new managers into the new facilities that we'll be bringing on-board.

For us, the demand has never been greater, specifically though as Ted alluded to, we did see nice growth in the latter portion of Q3 and we'll continue to build that momentum on a go forward basis. And that's driven large largely by the management capacity that we've been working to develop and build up since the first half of this year. So external factors related to demand aside, reimbursement uncertainty aside, for us we continue to develop the management personnel to be able to grow within our historical target ranges.

All right. That's it for me. Thank you.

Thanks, Chad.

Take care, Chad.

Our next question comes from Toby Wann with Obsidian Research.

Hey, good morning, guys. Quickly on the SG&A line, Matt, if I heard you correctly and I want to make sure that I did, I know if we back out the deferred comp component this time, 6.9%, and if I recall correctly I thought you said you're going to continue to try to manage to that 7% number, but, so I guess my question really is, is that a little bit of a revision from previous guidance which was you're going to manage to 7% to 7.25%?

Yes, it is, Toby. If you look back over the past seven quarters with some one-time exceptions aside, we've pretty consistently managed it in now that 7% range. Over the past couple of quarters we have become more confident to say that 7% should be the new target as opposed to, you're correct, historically it had been the 7% to 7.25% range. For us 7% is the target range going forward and we'll continue to manage that aggressively and look for ongoing opportunities to garner additional efficiencies.

Okay. No, that's great color. Thanks. And then just more from a macro perspective, and I think maybe Chad kind of hit on this a little bit, are you guys -- I know you -- it's dependent upon management infrastructure to be able to service new clients, but are you seeing -- are you guys seeing any increased demand as we're kind of seeing -- as operators are seeing more pressure on the -- in the post acute world from whether it's reimbursement, implementation of [stars] ratings or bundled payments? Just, if you could kind of characterize any -- the demand side of that?

I think that's a fair statement, Toby. We've continued to see increase in demand for outsourced services of all kinds. Now certainly the focus for the operator's perspective is to manage in the most financially efficient manner and really to kind of refocus on their core competencies in direct patient care, so outsourcing of secondary functions of all kinds has certainly continued to increase.

Specific to our types of services, we have seen increase in demand for the services which maybe allows us to be a bit more selective in both the clients with whom we continue to expand, the timing of those expansions and the geographies in which we'd like to expand. But it doesn't change the overall opportunity from a top line perspective in that, again, we're really dependent upon our ability to develop the managers and we've demonstrated that historically we've not been able to develop managers at a clip greater than 10% to 15% per year. That's what we expect -- regardless, rather, of the external demand for the services, that's the rate that we're comfortable to grow within.

Okay. Thanks for the color.

I'm not showing any further questions at this time. I'd like to turn the call back over to Ted Wahl for closing remarks.

Thanks, Kevin. Before we wrap up, Matt wanted to review our conference schedule for the next few months, so Matt?

Just wanted to let everyone know we will be participating in several conferences in the fourth quarter. We'll be at the Stifel healthcare conference on November 17 at the New York Palace Hotel in New York City. And then the Oppenheimer 26th annual healthcare conference which will be December 8 and 9 at the Westin New York Grand Central, also in New York City. We'll look forward to seeing some of you there. Turn it back over to Ted now to wrap up.

Thank you, Matt. Overall, the demand for our services continues to be greater than what we're capable of managing and with the uncertain regulatory and reimbursement environment facing the provider community, we would expect that demand to only increase in the years ahead. Over the next 12 months we'll look to selectively expand our customer base, controlling our growth to ensure that facility execution and financial performance are in line with what we committed to both our clients and one another.

The rate limiting factor on our growth continues to be the pace at which we're able to develop and promote from within management candidates, which is why people development really at all levels of the organization remains our highest priority. We'll look to keep direct costs below 86% and work our way closer to 85% direct cost of services, with the primary drivers of that margin improvement being the Dining and Nutrition districts and regions managing the right complement of facilities, as well as our property and casualty and employee health and welfare programs being managed out of the captive.

We expect our normalized SG&A to be about 7%, excluding any deferred comp impact, but remain committed to ongoing investment in our clinical, HR and legal functions. These subject matter experts are valuable resources for the field and allow us to more proactively navigate the highly regulated litigious industry in which we operate. We would expect our Q4 effective tax rate to be in the low 30s, assuming WOTC reauthorization is retroactive to the beginning of the year.

As we look to 2016, and what will be our 40th year of business, we continue to operate in a recession proof market niche. The demographic trends have been and continue to be in our favor. We're in an unprecedented cost containment environment that's really increased the demand for outsourcing services of all kinds, including ours. 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 to come.

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

Ladies and gentlemen, that concludes today's presentation. You may now disconnect and have a wonderful day.