Good day, ladies and gentlemen, and welcome to the Healthcare Services Group's First Quarter 2014 Conference Call. [Operator Instructions] As a reminder, today's 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, goals, 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 obligations 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 turn the call over to Dan McCartney, Chairman and CEO. Sir, you may begin. .

Okay, thank you. And thank you, everybody, for joining Ted Wahl, Matt McKee and I for our First Quarter Conference Call..

We released our first quarter results yesterday after the close, and we'll be filing the 10-Q during the week of the 23rd. But our first quarter results, our revenues increased 14% for the quarter to $312 million, up 14% compared to the same period in 2013, with housekeeping and laundry up more than 9% and food service up over 24%.

Both were new company records.

We ended 2013 with a double-digit growth rate going into 2014, which was an important and significant accomplishment for our divisional and regional management people in the field who have done a real good job, as they more than made up for the first half of 2013 client modifications, which if you guys remember, put our growth rate at less than 2.5% for the first 6 months last year.

More importantly, they've been able to begin the new client startups effectively both operationally and financially so far. But it'll be important for us to sustain those results over the next few months as the start-up challenges wind their way down.

Going into 2014 with very good momentum, we expect to continue to grow at double digits, with housekeeping and laundry likely at the lower end of our growth targets and food service at the higher end, as it still has a surplus of management capacity and a smaller base..

And with that abbreviated summary, I'll turn it over to Ted Wahl for a more detailed review. .

Okay, thank you, Dan..

Revenues for the first quarter increased 14% to $312.2 million compared to the same period last year. Housekeeping and laundry grew over 9% to $204.7 million. Dining and nutrition was up nearly 25% to $107.4 million..

Pretax income increased 22% over the prior year's corresponding quarter to $23.1 million. Net income came in at $14.6 million, or $0.21 per share, compared to $14.9 million, or $0.22 per share, for the first quarter of 2013.

As we discussed previously, Q1 '13 net income was favorably impacted by $0.03 per share due to the enactment of the American Taxpayer Relief Act, which retroactively reinstated certain 2012 job tax credits and lowered our effective tax rate to 21%..

Direct cost of services came in at 85.7%, which is slightly below our target of 86%. The districts and regions did a good job transitioning the new business startups during the first quarter, opening up the facilities, reassigning management people and minimizing inefficiencies.

As that new business matures, we would expect ongoing margin improvement while, at the same time, continuing to give proper attention and service levels to our existing customers. We continue to focus on the development of our dining and nutrition middle-management structure as it progresses towards being more fully utilized.

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, which includes a $277,000 gain in the deferred compensation investment accounts held for and by our management people. We would expect our normalized SG&A to continue to be in that 7% to 7.25% range, with the ongoing opportunity to garner some modest efficiencies.

As we discussed in past quarters, SG&A also includes gross receipt taxes paid to states like Ohio, Michigan and Texas, along with significant investments in our biometric time and attendance system and other electronic record-keeping initiatives..

In December, we announced the expansion of our legal department, which in conjunction with the personnel and technology investments made in our human resource function should allow the divisions to comply with the new hire and personnel-record-keeping requirements demanded by both the regulatory environment and job tax credit programs like WOTC.

We also announced in December the formation of a wholly-owned captive insurance subsidiary as well as enhancements to our credit facility that will provide flexibility in addressing our various insurance needs in the upcoming years..

Investment income for the quarter was reported at $381,000, but, again, after removing the impacts of the $277,000 gain in the deferred compensation investment accounts, our actual investment income was approximately $100,000.

Our effective tax rate for the quarter was 37% and, depending on the timing of the WOTC reauthorization, should be between 35% and 38% for the remainder of the year..

We continue to manage the balance sheet conservatively and, at the end of the first quarter, had over $83 million of cash and marketable securities and a current ratio of better than 3:1.

Our accounts receivable remained in good shape below our DSO target of 60 days, even with the accelerated organic growth during the first quarter and transition of the credit and collection function for the new clients that were part of the acquisition..

As announced yesterday in conjunction with our earnings release, the Board of Directors approved an increase in the dividend to $0.1725 per share split-adjusted and payable on June 27. The earnings, 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 will be the 44th consecutive cash dividend payment since the program was instituted in 2003 after the change in tax law.

It's the 43rd consecutive quarter we increased the dividend payment over the previous quarter. That's an 11-year period that included 4 3-for-2 stock splits..

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

[Operator Instructions] Our first question is from Sean Dodge of Jefferies. .

Maybe just starting with an update on the new or the large client you signed in the latter part of 2013.

Have they pretty much been rolled out entirely at this point? And what kind of follow-through impact do you expect on revenue in the second quarter?.

So even before we talk about the progress of the new business we signed, all our corporate clients, we really view as separate clients, separate service agreements and separate facilities, so in the aggregate, the negotiations were done for on a broader base than individual.

But we've rolled them in at a different schedule during the course of the first quarter, with about 1/3 in January, 1/3 in February, 1/3 in March and still a trailer of properties that were -- we began or expect to begin in April.

So by the end of April, we'll fully have implemented the new business that we added, both corporately as well as the individual momentum we got in the fourth quarter last year, and that'll be fully impacted in the revenue growth for the second quarter. .

Okay, helpful. And then on the dining side, you seem to be able to sell those services pretty much at will.

So the better utilizing the management infrastructure there, is that kind of the singular goal when you decide which new facilities you want to cross-sell to first? Or are there other factors that are playing a role there in those decisions?.

We just try to make it look easy. It's not as easy as we pretend.

But there's still enough pent-up demand in the existing client base, so it does give us the flexibility to more pick and choose not only the clients that we want to use but -- or begin the services with, but to be able to pick and choose the areas that we feel our management people is strong enough to expand in those divisions, and the ones that aren't quite there consistently, to be able to delay the startups, because our growth and expansion has always been and still remains dependent on the quality and the performance and the depth of our management people in those areas.

And because the pent-up demand is what it is, it allows us to modify our expansion ideas and growth rates in the areas that we feel are best able to digest it. .

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

I know you're basically at the point where the 2 big restructured deals last year you now are anniversarying. I know, sometimes -- in the past, people that have had walked away or tried alternatives sometimes come back to you.

Have you seen any of those facilities at this point express any interest in coming back? And -- well, I guess I'll leave it at that. .

I think, for us, A.J., anytime we leave a facility, they become a target. So certainly, there has been opportunity with some of the contract restructurings.

And we said, specifically with the dining and nutrition contract restructurings that happened during the first quarter of last year, that we're more a pare-down of the -- and a give-back of the labor and food purchasing component, that they would be an option going forward because we continue to have a relationship both on the housekeeping and laundry side, as well as continue to provide services, albeit modified services, in dining and nutrition.

So they continue to be an ongoing opportunity. And with the housekeeping customer we referenced, they are an ongoing opportunity for us to have expansion with. And we really -- we'll market them and continue to focus on them no different than we do any other greenfield opportunity.

It's done locally, as Dan alluded to, with the expansion we had in the first quarter and it's done on a area-by-area basis. .

Okay. I know, last quarter, [indiscernible] opportunity potentially to manage those more on a revenue cycle turnover, like your core business.

Where are you at on that? Is there still further opportunity to go?.

A.J., would you repeat that? You broke up a little bit. .

Sorry. On the PHS receivables, I know last quarter you talked about an opportunity to perhaps manage those a little more tightly and similar to the way you do your own business.

Is there any update on where you're at there? And is there further opportunities to go that aren't yet reflected in the current results?.

Yes, we made some modest progress over the past 3 months with respect to the PHS receivables. That $5 million opportunity, for the most part, still exists. I think the foundation of the relationships we have in place are strengthening and continue -- will continue to be stronger as the year goes on.

It's just going to take some time to work the legacy clients back onto our payment schedules and credit terms, but that remains a cash flow opportunity for the balance of the year. .

And maybe just one last question, if I could slip it in there. I know, when you did the legal settlement in California, some of that money got put into a pool where people had to come forward and actually ask for their pro rata share of it, I guess, for a lack of a better way to describe it.

Have -- what's the time frame on that? And do you have any visibility on how many people are coming forward or whether some of that money may come back to you at some point in the future?.

Yes, we have no update at this time on it, but that'll happen over the next few months. .

Our next question is from Sean Kim of RBC Capital Markets. .

Just one question regarding the growth in dining. You've seen some -- you've seen over 20% growth in dining services revenue over the past 3 quarters. And I know -- I understand there's -- you're still in the early stages of cross-selling those services to your existing facilities, but I think the comps get tougher towards the second half.

Just wondering, the -- if you look at over the next few quarters, what the pipeline for new facility additions is like for the dining segment and what the visibility is like. .

We really base the growth, specifically in dining, more around the strength and the capacity with the district and regional organization, as well as the particular customer that we're going to expand with, so when you think of it on a quarter-to-quarter basis, that's not really the way we look at it.

Year-over-year, as we said earlier, we expect to be 10% to 15%, with dining and nutrition at the higher end of that range and housekeeping and laundry at the lower end. There is going to be quarters where maybe it's a little lumpier and it's towards 15% to 20%.

Maybe there's a quarter, depending on the comp, where it dips under that, but 10% to 15% continues to be the blended target. Dining and nutrition year-over-year should be at the higher end of that range. .

And I think another variable on why there's such a wide range is because it's so wage driven.

If we add the new business, whether it's housekeeping and laundry or food service, in the Northeast, for example, where the wage rates are higher, the contract value is substantially greater and obviously has a stronger, more dramatic impact on the revenue growth.

The same-size properties in the more rural areas where they have a lower $8.00-an-hour wage rate, for example, the guys are working just as hard as the guys in the urban areas in the Northeast but the wage rate difference makes the contract value and revenue contribution about half.

So that's why our range is so high depending on where the growth is and the expansion is, whether it's food service or housekeeping and laundry. .

Just one more question.

Can you give us an update on facility count for housekeeping and dining, please?.

It'll be over 3,700 in housekeeping and over 800 in dining. .

Our next question is from Toby Wann of Obsidian. [Operator Instructions] Our next question is from Michael Gallo of CL King. .

Dan, can you give us an update on the captive, what you've kind of put in there, what you're seeing so far? And how do you think that'll evolve over the next 2 or 3 years? I know you go at it gradually, but it seems like there are some significant savings to direct cost to be had, assuming you like what you see and you kind of evolve it over time.

So give us an update there. .

I think, in general, with the captive, we are going to move very slow.

All our research projections and ideas seem like, over the next few years, it will not only give us flexibility to address the insurance markets more effectively than we have in the past but, frankly, save us a lot of money, but we want to make sure step by step we do the right things.

Right now, it's just a voluntary insurance, and maybe we'll cherry pick some states that we'll put it, but the voluntary medical insurance options that we provide some of the management people are being put in there.

And we'll keep everybody informed as it evolves, but it's going to move very methodically and we'll try to update everybody quarter-to-quarter. We think, and the reason we went to the efforts to establish it is it is going to pay dividends, but we're going to make sure we do it step by step as opposed to having any dramatic changes. .

And as Dan said, I think the near-term opportunity, along with the voluntary health and welfare and general liability options, is really to gain experience. That's what's going to be critical for us over the next 12 to 18 months, to develop experience and a track record within the captive.

And then the longer-term payoff will be the balance of the property and casualty programs, including workers' compensation, which is a longer-term phase-in but that's the longer-term opportunity. .

Great.

And then just a housekeeping question, what drove the increase in payables quarter-to-quarter?.

Really, payables are more driven depending on the quarter and the cutoff of the food purchases, Mike. So if you look back historically, they -- payables typically grow in line with housekeeping and dining top line growth, but they're more driven by dining growth and the cutoff of the food purchases in any given month. .

Our next question is from Ryan Daniels of William Blair. .

Dan, maybe a quick one for you.

You've often talked about the demand from clients has been there and your growth constraint is more on the management talent you have or the hiring outlook there, so maybe the better question is talk a little bit about what you're seeing on the hiring front, developing and obtaining your managers, given somewhat of an improved employment picture in the U.S.

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I think, for us, Ryan, that we've never had better management people in the history of the company. And internally, we go back and forth whether that's due to the macro employment environment in the country or not.

I believe, as we've become more and more established, we truly have tried to live up to the promotion-from-within concept for the divisional, regional and certainly district management people. So the new candidates we get at the trainee level, which is still where we do our hiring, can project out where they envision their career evolution.

And because we've grown consecutively for 37 years, we've never been in the position where we held anybody's career back. It's more likely they're going to get promoted before they're ready, as opposed to having the expansion stall out and not create the opportunities we committed to the management people.

And I believe, as we become a more legitimate career choice for the young candidates that enter the training program, they have more staying power and we don't have the same kind of turnover at the entry level in the first stages of the training that we did before.

Now I'm sure the macro employment sense impacted a little bit, but I think it's more, as we've evolved and expanded consistently as a company over the years, has given us a better group of management people at each stage, but I'm not certain of that. .

Okay, no that's helpful color. And then maybe a related one. I know a lot of your existing contracts allow you to pass-through price increases if the end market client increases wages for their other employees.

And I'm curious if you're seeing more of that as we enter into 2014, if that might give you a little bit more of a same-store growth boost, if you will, versus the past couple of years.

Any color there?.

It will, and that's still how our service agreements are structured, but I'd say the average increase has still remained to the 2%, 2.5% range. It's not been significantly different for the last 5 or 10 years.

They don't have the flexibility in this reimbursement environment to be more generous even if they chose to, but the jobs are not that great to where they can just have a wage freeze. So it has been and we still expect it to be in that 2.5%, maybe 3% at the outset, accelerator wage-driven. But I don't think it'll change very much. .

And as you know, Ryan, the increases and the pass-throughs with the customers, they're really margin-preservation increases, not margin-expansion increases. .

Right, great, understood. And then last one, Dan, I guess, back to you, just on the dividend. Obviously, it continues to grow nicely, but the growth rate year-over-year has slowed down a bit versus your growth in cash flows.

Is there any thought of maybe amping that up a little more? Has the board debated that at all?.

I think every quarter we really go through the increase. First, I mean, in a general way, we thought it was most important to be consistent that people could hang their hat on, anticipating an increase each quarter even though it's more modest. But it's not as modest after the 4 3-for-2 stock splits, but it still is more modest than we have.

And I think, when we get the cash levels maybe a little bit higher, we review that every quarter at every board meeting, and I think it's reasonable to expect us to not only continue the increase but maybe to accelerate the increase down the road. .

Our next question is from Rob Mains of Stifel. .

Just a couple of questions left.

Ted, of the $204.7 million housekeeping revenues, about how much of that is Platinum versus organic?.

Well, sequentially, all of it's organic, when you look at Q4 to Q1.

And we would expect Platinum -- legacy Platinum facilities -- although as we have talked about on prior calls, we don't differentiate between acquired growth and organic growth because both require the same level of management, infrastructure and attention by our management team, but we would expect the legacy Platinum business to continue to contribute $14 million to $15 million a quarter.

.

The target of 86%, you were able to get below that in a quarter where, given all the new business that you added, it had been reasonable to expect you might be a little bit above that, you were able to come in below.

I know we're talking about 30 basis points difference, but what would you see that would get the margin if you had your direct costs back up to the 86% level as opposed to a sustaining level a little below that?.

The way and the segment information for the quarter will be in the Q, which we expect to file in the week of the 21st. I would expect the dining margins, Rob, to continue to show improvement, albeit incrementally, with the districts and regions being more fully utilized.

The housekeeping and laundry margins would likely show some compression as a result of the new business being layered in over the past 4 months but overall in line with our historical performance.

So when you think about what the expectations would be going forward in terms of drivers of the margin, it's really going to be our ability to continue to quarter-to-quarter increase the dining and nutrition margins, which is more a function of where we're adding the business and how our districts and regions are being utilized, as well as during the start-up phases of not just the new business we've ramped up the past 4 months but, going forward, opening up the business and getting it within budget over a 60-day period.

They're really the 2 most significant variables to our margins in any given quarter or year, for that matter. .

I was frankly surprised that we did as well with the new startups because, you're right, Rob, that is where we're the most inefficient. When we start the new properties, it usually takes us 60 days, 90 at the outset, to get the jobs on budget.

The guys have done a very good job getting out of the starting blocks and making the adjustments, the job description changes and the things that are required with any of our startups to get them on-budget, but the -- we're still on the honeymoon stages and we have to be able to sustain that for the next few months with the clients.

But the guys have done a real good job in doing that quicker than, frankly, I expected. .

Our next question is from Toby Wann of Obsidian. .

Quickly, with the SNF readmission program being mandated by the temporary doc fix, kind of how do you guys think about how that impacts you-all's boons? I know it's not for a couple of years before that goes into place, but with the continued assault on margins at -- across-the board at all these different operators, kind of how does that play into you-all's hands from attracting new business?.

Typically, I mean the tighter the operators, the provider community gets squeezed, the more demand there's going to be for the services. Having said that, our growth rate is really dependent on the depth of the management team we have in any particular district or region.

So that won't change our 10% to 15% top line target on a blended basis because, again, our growth rate is more dependent on our ability to manage the business than it is any change in demand. .

Our next question is from Mitra Ramgopal of Sidoti. .

Dan, I believe you mentioned you have excess management capacity on the food services side.

And now that you're managing over 800 facilities, how much more room you -- would you say you have in terms of before you need to bring on more management on the food services side?.

In different divisions, it's a little bit less, but in general, where a few years ago, in our model, a district should oversee 10 to 12 properties in food service, years ago, they were averaging 6 to 7. I'd say, right now, the average across the division is 8 or 9, although some of the divisions are closer to the ideal model of 10 to 12.

Some of the others are still substantially underutilized because they're at a different stage of developing their district and regional network. So I'd say food service is still in the 8- or 9-facility average per district, where 10 to 12 is our model, so they have a 20%, 25% capacity to expand without an additional district expense.

And a region, in our model, typically should oversee 4 to 6 districts. And in food service, they're still averaging 3 to 4 districts per region in food service, so there's still room for them to grow there, too, since we're eating that district and regional expense right now.

So even though we've been doing it at 800, they technically or reasonably have the capacity to do 1,000 facilities without any additional district and regional expense. Now we're never going to get there.

We're always anticipating the next year's growth, so each area makes the decision on when to split the districts, when to promote from within and create new regions to stay within that cookie-cutter model that we've used for 30 years or so. .

And then, Mitra, that's -- really just to add to what Dan had said, that underutilized management structure is really the reason why we're able to grow dining and nutrition at a faster rate relative to housekeeping and laundry, not any change in demand. It's all about the management depth that we have in place.

It's also the margin-expansion opportunity for the company. And that'll be over the next 2, 2.5 years, but as we layer in the new business, which I'm not saying is easy but it's the easier part, the margin should continue to tick up, and the goal is to have them ultimately mirror those of housekeeping and laundry. .

And again, the capacity is really only on the food services side, not on the housekeeping?.

That's exactly right. .

I'm showing no further questions at this time. I would like to turn the call back over to Dan McCartney for closing remarks. .

our conference schedule for the next few months. .

Thanks, Dan. Good morning, everybody. Since we shortened our cautionary statement at the beginning of the call this quarter, I figured we'd have some leeway to spend a minute or 2 to share some information about upcoming Q2 conferences where we'll be presenting..

So the first is the Mizuho Securities Healthcare Conference. We'll be attending this for the first time. And that conference will take place on the 6th of May at the Omni Berkshire Place in New York.

We also plan on attending and presenting at the UBS Global Healthcare Conference on the 19th of May, and that's at the Sheraton New York Times Square Hotel. And then finally, we'll be presenting at the Jefferies Global Healthcare Conference on June 4, and that's at the Grand Hyatt, also in New York City..

So we look forward to seeing some of you at those conferences. And now here is Dan for his concluding comments. .

Okay, thanks, Matt..

I guess, just to wrap it up, going into 2014, we expect to continue to expand our client base in housekeeping and laundry as well as food service within our historical targets. We should increase our expansion each quarter and, if we execute properly, maintain our double-digit growth rate.

The environment and the demand for the services is still as great as it's ever been. And our growth is still solely dependent on our ability to have a pipeline of capable management people, and that's going to be the determining factor on how quickly we expand. It's a nice position to be in, but not dependent.

There's more demand for the services that we can really do..

We've gotten off to a good start, but keep the new business running properly operationally as well as on budget, especially at the early stages of the transition. All our divisions continue to perform better, but with any expansion, we need to assure consistency.

With the attention on the new business startups, it's also critical for us to make sure there's no disruption of service in the existing client base, so it's a real balancing act..

We look forward to keeping our direct cost below 86% and work our way down to 85%. With the changes in the state tax policies and the staff increases we made in the legal departments and human resources over the past 6 months or so, we expect our SG&A to remain in the 7%, 7.25% range without any deferred comp investment impact.

We believe the recent expansion of the legal and personnel department will be a helpful and valuable resource for our management people in the field..

Our tax provision was 37% for the quarter, but with the reenactment and extension of these certain tax credits, which we believe should be concluded quickly but it's not done yet, it could be back to 35%. The Senate Finance Committee has approved the bill extending the credits, including the WOTC tax credit.

And we believe the House Ways and Means Committee is taking it up this week, so we expect it to be, hopefully, resolved soon. That aside, in our business, there is still strong demand for the services for housekeeping and laundry as well as food service.

Our management people in all divisions, especially in food service, continue to develop and get better. We believe we will continue to operate on budget consistently going forward as we expand. So overall, these are pretty good times for us..

Thanks, everybody, for joining us, and onward and upward. .

Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. .

Thank you..