Healthcare Services Group, Inc.
Q2 2013 Earnings Call Transcript

Published: 17 Jul 2013

[Operator:]

Good day, ladies and gentlemen, and welcome to the Healthcare Services Group Inc. 2013 Second Quarter Conference Call. [Operator Instructions] As a reminder, today's conference call is being recorded. The discussion to be held and any schedules incorporated by reference into it will contain forward-looking statements within the meaning of the Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are not historical facts, but rather, are based on current expectations, estimates and projections about our business and industry, our beliefs and assumptions. Words such as believes, anticipates, plans, expects, will, goal and similar expressions are intended to identify forward-looking statements. The inclusion of forward-looking statements should not be regarded as a representation by us that any of our plans will be achieved. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Such forward-looking information is also subject to various risks and uncertainties. Such risks and uncertainties include, but are not limited to

[Daniel P. McCartney:]

Okay. Thank you, Allie, and thank you, everybody, for joining us. I'm here with Ted Wahl and Matt McKee. We released our second quarter results yesterday after the close, and we'll be filing our 10-Q during the week of July 23. As we have discussed in the first quarter review, the modification of our relationship with 2 corporate clients, altered or phased out and completed during the first quarter, impacted our second quarter reported revenue growth below our historical targets. Although the 2 clients remained customers, we reduced the services we provided, and therefore, the revenue from those clients during the first quarter and it did not contribute at all in the second quarter. During this transition, we continued our facility expansion plan in a more accelerated pace to utilize the surplus management people available to those changes with those 2 clients. In June, we added more facilities and revenue in any month since 2011 and we'll reflect that expansion fully in the third quarter, and obviously, the rest of 2013 and beyond. In addition, we announced the acquisition of a private service company we're familiar with over the years, and we closed the acquisition over the weekend. Their clients are spread out through our existing markets and management structure. We knew the personnel well and felt they were good guys, and we were familiar with their client base, so we felt it would be a good fit. We expect the acquisition to contribute at least $60 million in annualized revenue predominantly in housekeeping and laundry. With our accelerated organic growth efforts and the acquisition, we expect to increase the revenue, with proper execution, back to our long-term historical target of double-digit growth in the third quarter and the fiscal year 2013. So with that introductory summary, I'll turn it over to Ted Wahl for a further review of the financial report.

[Theodore Wahl:]

Thank you, Dan. And really, it was during the fourth quarter 2011 through the first half of 2012 that we accelerated our expansion, increasing housekeeping and laundry revenues by 16%, and dining and nutrition revenues by over 58%, which makes the Q2-Q2 comparisons more difficult, but our long-term targeted range of 10% to 15% topline growth remains unchanged. Revenues for the second quarter of 2013 increased 2.5% to $273.6 million. For the 6-month period, revenues were up 4% to $547.5 million. Our revenue growth rate for the first 6 months of the year was impacted by the relationship modifications in Q1 with the 2 corporate clients Dan described. Housekeeping and laundry for the quarter grew modestly to $183.7 million, dining and nutrition was up over 7% to $89.9 million. As Dan indicated, in June, we added more facilities and revenue than any other months since 2011. This significant organic expansion, along with the acquisition, will be fully reflected in the Q3 results. And if we execute properly, our revenue growth rate should return to double digits for the remainder of 2013 and 2014. Net income for the quarter was up over 14% to $12.9 million, or $0.19 a share. For the 6-month period, net income increased over 40% to $27.8 million, or $0.41 per 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 continue to give proper attention to our existing clients and made progress with the new business we added in June by implementing operational changes and getting the jobs on budget in a timely manner. Going forward, our goal is to manage direct cost under 86%, on a consistent basis, and work our way closer to 85% direct cost of services. Selling, general and administrative expense was reported at 7.1% for the quarter, with essentially no impact from deferred compensation investment accounts held for and by our management people. As we discussed in past quarters, SG&A also includes gross receipt taxes paid to states like Ohio, Michigan and Texas, as well as the additional resources added from when we expanded our human resource and risk management departments. This departmental expansion has allowed us to be more efficient in the employee benefit and insurance areas, as well as comply with the new hire and personnel-recordkeeping requirements demanded by the regulatory environment and job tax credit programs like WOTC. For the balance of year, we would expect our SG&A to continue to be in that 7% to 7.25% range with the ongoing opportunity to garner some modest efficiencies. Investment income came in at $219,000, again with no impact from the change in the value of the deferred compensation investment accounts. Our tax rate was 35% for the quarter, which is what we expect our tax rate to be for the remainder of the year. We continue to manage the balance sheet conservatively, and at the end of the second quarter, had over $85 million of cash and marketable securities, no debt and a current ratio better than 4

[Operator:]

[Operator Instructions] Our first question comes from Ryan Daniels of William Blair.

[Ryan Daniels:]

I wanted to ask on the Platinum acquisition. Obviously, they did not have any food services capability. So maybe talk a little bit about the possibility of offering that into their client base. And then, how long will you typically wait before you offer that type of service? Is that something you go out right away, or kind of digest the acquisition and let the clients get to know you before you sell that?

[Daniel P. McCartney:]

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

[Ryan Daniels:]

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

[Daniel P. McCartney:]

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

[Ryan Daniels:]

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

[Daniel P. McCartney:]

Yes, that's exactly right, Ryan. Since the expansion was concentrated in June, we had 1 month of billing and accounts receivable, but only 1 month of revenue. So next quarter, we'll still have 1 month of billing and AR, but we'll have the 3 months of revenue. So our average day sales won't be understated for the quarter.

[Theodore Wahl:]

The impact was about 3 days.

[Operator:]

Our next question comes from Michael Gallo of CL King.

[Michael W. Gallo:]

Just a couple of questions, if I may. On the business adds in June. Dan, was that split between the housekeeping and food service in terms of the additions? Or how many facilities did you add on housekeeping? Or how should we think about that?

[Daniel P. McCartney:]

I -- it was both -- a combination of both, but more food service than housekeeping and laundry. But it was about $10 million in quarterly sales and about the amount of facilities we typically add in a quarter that we added in June. And that's why even though we don't usually do that, we wanted to differentiate the progress we were making organically in this quarter maybe. But because it was an unusual amount of new adds that we worked on. And the guys in the field did a real good job procuring to try to make up for the 2 client adjustments that we were dealing with and to utilize the surplus management people it made available to us.

[Michael W. Gallo:]

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

[Daniel P. McCartney:]

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

[Michael W. Gallo:]

Right. But overall, there was nothing really too specific about it in terms if it should come on budget in the normal course of business.

[Daniel P. McCartney:]

Yes, yes.

[Operator:]

Our next question comes from A.J. Rice of UBS.

[Albert J. Rice:]

A couple of different questions. First of all, on the new kind of -- just to follow on with the other questions. On the new accounts side of June, is that going to be concentrated either geographically or under 1 ownership structure? And then -- well, I guess, we'll start with that.

[Daniel P. McCartney:]

Yes. It was primarily spread across 3 ownership groups, and in the Southeast and Southwest, A.J., which is, quite frankly, where we were prepared and had some underutilized infrastructure. So it will be folded in nicely given our management team down there.

[Albert J. Rice:]

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

[Daniel P. McCartney:]

I mean, really, the introduction was made over 1 year ago. And over the past year, we've met at different times. But as far as whether this bodes for significant acquisitions or other opportunities in the future, there's just not a lot of candidates out there. So this -- again, it met our criteria, certainly the financial evaluation was critical, and we concluded that Platinum would complement our margin profile and be accretive to earnings. But they had a strong management team, they have an entrepreneurial-minded customer base that's looking to grow. And then, knows some attractive cross-sell opportunities in dining and nutrition, so we're able to meet the retention and expansion goals. It certainly has upside potential. But there's just not a lot of candidates out there for what Platinum presented as the opportunity. That's why we have always been relatively conservative as far as looking at acquisitions. Because as Ted said, there aren't really many opportunities that fit our niche, and there was enough opportunity organically to continue to expand as well. We really have to assess that, financially, it makes sense. And just as much, relationship-wise, these are guys that we knew for a long time. They seem like good guys. The ones that we knew more intimately would fit in well. And that's why we thought it was a good fit, financial factors aside.

[Albert J. Rice:]

Okay. Then thinking about -- you had the 2 big contract restructures in the first quarter, which impacts yourselves. Have you seen any other move by other clients who have come in and asked for restructuring? Has there been any change in the attrition rate on your contracts? Just update us on that maybe.

[Daniel P. McCartney:]

No, there's no updates. I mean, our retention rates are as strong as they've ever been, even with the contract restructurings. And remember, the client -- the customer that was southwest-based and on the dining and nutrition side continues to be a customer, as does the housekeeping and laundry customer that we restructured some contracts with. So both are customers heading into the second half the year, and we haven't seen anything along what we saw in the first half of the year going forward.

[Albert J. Rice:]

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

[Daniel P. McCartney:]

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

[Albert J. Rice:]

Okay.

[Daniel P. McCartney:]

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

[Albert J. Rice:]

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

[John Christopher Shea:]

I think we've said before, we're looking at big management bonuses. Frankly, the board does assess this every quarter and I think as the earnings per share continue with a more rapid pace, we'll certainly review increasing the dividend, maybe to a more rapid-rate proportion at -- with the earnings per share growth as well. Something we kick around every quarter, so it's certainly reasonable to expect that.

[Operator:]

Our next question comes from Rob Mains of Stifel.

[Robert M. Mains:]

Platinum. Was there any Platinum impact on the second quarter? Because obviously, if the deal closed in July, you knew it was coming in June.

[Daniel P. McCartney:]

Yes. I mean, really there were stop and starts along the way, and we were negotiating with Platinum and kind of confirming what the structure and the timing of the deal was going to be. But I would say, the last 2 months in the lead up to it, in the markets that were going to be most impacted by the acquisition where the customer base was. And there was a slowdown as we prepared for the acquisition. And the support that would be needed by the operational team to assist the Platinum team in integrating and supporting the customer base.

[Theodore Wahl:]

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

[Robert M. Mains:]

Okay. And if you kind of held back a little bit in the regions where you're going to have a lot of contracts, would that imply that any kind of margin differential between Platinum and HCSG will be erased pretty quickly now that the deal is done?

[Daniel P. McCartney:]

Yes.

[Operator:]

Our next question comes from Mitra Ramgopal of Sidoti & Company.

[L. Mitra Ramgopal:]

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

[Daniel P. McCartney:]

I mean, not really. I mean, I'm sure our macro labor environment is more facility specific. I'm sure some of our guys in certain areas have a more difficult time in the recruitment and getting warm bodies in than others with a greater capacity in urban areas, for example. But I think we've not had any real complaints bubble up. Like they had in the past, not recently, but certainly 20 years ago, where some of our management people needed transportation support where they didn't have public transportation, for example, to some outlier type of facilities. So I think the recruitment and getting the staff at each of the properties is a little bit different, but I think they're all -- all our guys are doing a good job keeping the property staffed and having a pipeline of employees available when that comes up. And I think the labor market conditions in those particular areas are really reflected in the personnel policies of the client. If they determine they have to give a 3% increase to be more attractive, it'll trigger our pass-through clause, then they'll do that. But I don't see anything really dramatic impacting the labor force for us across the board.

[Operator:]

Our next question comes from Toby Wann of Obsidian Research Group.

[Toby Wann:]

I'm wondering, just talk quickly about the accretion from Platinum. I know you guys kind of teased out that it was going to be accretive to earnings, but I don't that we have actually kind of quantified the impact. Can you kind of maybe give us a little more detail about that?

[Daniel P. McCartney:]

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

[Operator:]

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

[Daniel P. McCartney:]

Okay. Thank you, Allie. Thanks again, everybody, for joining us today. But we're well into 2013 now. The business model, to a great degree, hasn't changed very much. We expect to continue to expand our client base within our historical double-digit targets. And with our second quarter activity, we worked our way back to double digits, which will be fully reflected in the third quarter and the remainder of the year. The overall environment and demand for our services is still as great as it's ever been. We continue to try to balance, controlling our growth rate and the expansion with our ability to manage it. But with the first quarter modifications with the 2 corporate clients we mentioned, we did have more management capacity than we typically have, and we're able to accelerate the growth in the affected divisions, as well as pursue this acquisition opportunity that we became aware of. It remains important for us to balance the client satisfaction measurements as we digest the increased amount of new business and continue to operate on budget. We'll look to make certain that the current expansion operates consistently. We continue to improve the food service margins while growing the client base in a controlled pace. All divisions continue to perform better. But with any expansion, we need to make sure we're consistent. We have to keep our attention on the new business and getting and keeping them on budget, while affectively managing the existing client base, so there's no disruption of their services. We'll look to keep and get the cost -- direct cost below 86% consistently, and work our way back to 85%. With some of the state tax policies and the staff changes we made, our SG&A will stay in the 7%, 7.25% range, excluding any deferred comp impact. Our tax provision should remain about 35%. But overall, in our business, there's still strong demand for the services, both housekeeping and laundry and food service. Our management people in all divisions, especially in food service, continue to get better. And I'd be remiss if I didn't mention, with all the moving parts we had in the second quarter between the customer transitions in the first quarter, the acquisition, the amount of new business we added in June, with so many moving parts, our guys in the field did a great job in maintaining the cost and continuing to improve the direct cost margins. We believe we'll continue to operate on budget consistently as we expand. So overall -- in this environment, these are pretty good times for us. Thanks again, everybody, for joining us. And onward and upward.

[Operator:]

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