Daniel P. McCartney - Chairman and Chief Executive Officer Theodore Wahl - President, Chief Operating Officer and Director

Jailendra P. Singh - UBS Investment Bank, Research Division Michael W.

Gallo - CL King & Associates, Inc., Research Division Ryan Daniels - William Blair & Company L.L.C., Research Division Sean Dodge - Jefferies LLC, Research Division Robert M. Mains - Stifel, Nicolaus & Co., Inc., Research Division Toby Wann - Obsidian Research Group, LLC

Okay. Thank you, and thanks, everybody, for joining us this morning.

We released our third quarter results yesterday after the close, and we'll be filing our 10-Q during the week of the 21st. As we discussed in the review of the past 2 quarters, the modification of the relationship with 2 corporate clients during the first and second quarter impacted our reported revenue growth below our historical targets during the first half of the year.

Although the 2 clients remained customers, we reduced the services we provided and, therefore, the revenue from those clients was reduced. We continued our facility expansion plan in a more accelerated pace in the third quarter to utilize the surplus management available due to those changes, especially in the divisions that were most affected.

In addition, we announced and finalized the acquisition of a private service company, which we're familiar with over the years, and closed the acquisition in July. Their clients were spread out through our existing markets and our management structure.

We knew the personnel pretty well and we're familiar with the client base, so we felt that -- and it has been, so far, a good fit. Due to our accelerator organic activity and the tuck-in of the acquisition, we're able to get back to our double-digit revenue growth target sooner than we originally expected.

And with that, I'll turn it over to Ted Wahl to go over more specifically the third quarter results.

Thank you, Dan. And really, it was during the fourth quarter of 2011 through the third quarter of 2012 that we accelerated our expansion, increasing Housekeeping and Laundry revenues by 15% and Dining and Nutrition revenues by over 58%, which makes the Q3-Q3 comparisons more difficult, but our long-term targeted range of 10% to 15% top line growth remains unchanged.

Revenues for the third quarter of 2013 increased to 10% to $298.5 million. For the 9-month period, revenues were up 6% to $846.1 million.

Housekeeping and Laundry grew 4% over the prior year's corresponding quarter and nearly 6% sequentially to $193.5 million. Dining and Nutrition was up over 21% to $105 million.

The organic expansion over the past 4 months, along with the acquisition, will be fully reflected in the Q4 results. And if we execute properly, our double-digit revenue growth rate should continue for the balance of 2013 into 2014.

Net income for the quarter was up 20% to $13.8 million or $0.20 a share. For the 9-month period, net income increased 33% to $41.7 million or $0.60 a 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 have done a good job of implementing our systems and procedures in the new business we brought on over the past 4 months, which minimized inefficiencies and allowed for favorable operational outcomes.

As that new business matures, we would expect ongoing margin improvement while, at the same time, continuing to get proper attention and service levels to our existing customers. 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 about 7.5% for the quarter. But after removing the impact of the $1 million gain in deferred compensation investment accounts held for and by our management people, our actual SG&A was 7.25%, which is within our targeted range.

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. The 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.

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. Investment income was reported at $1.2 million but, again, after removing the impact of the $1 million gain in the deferred compensation investment accounts, our actual investment income was $200,000.

Our tax rate for the quarter was 35%, which is what we expect our tax rate to be for the balance of the year and into 2014. We continue to manage the balance sheet conservatively, and at the end of the third quarter, had over $62 million of cash and marketable securities, no debt and a current ratio of better than 4:1.

Our accounts receivable remained in good shape, below our DSO target of 60 days, even with the accelerated organic growth and the transition of the credit and collection function for the new clients that were part of the acquisition. In conjunction with our earnings release, the Board of Directors approved an increase in the dividend to $0.17 per share, split-adjusted and payable on December 20.

The earnings for the quarter and cash balances 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 42nd consecutive cash dividend payment since the program was instituted in 2003, after the change in tax law.

It's the 41st consecutive quarter we increased the dividend payment over the previous quarter, that's a 10-year period that included 4 3-for-2 stock splits. And with those opening remarks, Dan and I would like to open up the call for questions.

This is actually Jailendra Singh filling in for AJ. Just a few questions, if I can ask.

It looks like your organic revenue growth in Housekeeping segment was firmly impacted by 2 contract revisions and tough comps in the quarter. I was just wondering if you can share your thoughts like when do you expect to return back to your double-digit organic revenue growth in that segment.

I think more than half of the growth total company was organic, but where the acquisition's reflected from mid-July forward, the organic adds are layered in over a 3-month period. But really, whether it's organic or acquisition-related, we don't really differentiate internally.

I mean, the customers require the same level of district and regional support, implementing our systems and procedures, appropriate customer contact, the same management and development requirements, budgetary oversight. So whether it's organic or acquired, each facility requires the same level of commitment and attention from our management team.

So you have a situation where the areas that were more directly impacted by the acquisition, surplus of management notwithstanding, maybe had opportunities with new facilities that would've otherwise been realized in the second half of 2013, they now become opportunities in the first half of 2014. But certainly, heading into the fourth quarter and next year, know that 10% to 15% target total company, with Housekeeping and Laundry fitting into that, remains unchanged.

Whether the new business comes from organic efforts or an acquisition, our management resources were utilized at the same degree. So the areas that are impacted and inherit new clients that were part of an acquisition just have that many less management resources to organically grow.

Those who are unaffected by the acquisition tuck-in, then organically, they expand in a more rapid rate than they would had they had to inherit some facility. So after the acquisition is done and the decision is made, we really don't look at those clients any differently than organic growth, no matter how we procure them.

Okay, got it. And then my follow-up question.

Your cash and marketable securities, it seems to decline some $20-plus million from second quarter. Just wondering if you can provide some color on that.

Is it all related to the receivables tied to PHS or is something else going on there?

Well, over $11 million of it is just related to the timing of the payroll cutoff relative to the second quarter, and then you have the cash payment, the cash outlay of over $5 million for PHS. And then inheriting the PHS receivables, which we're going to take a few months to really get in line with our credit terms and within our payment expectations.

So it's a combination of factors. But going forward, from a cash flow perspective, certainly, from a cash balance perspective, we would expect it to be in line with where we've been historically.

But the significant variance is the cutoff of the biweekly payroll, which is about a $12 million difference from the second quarter to the third quarter.

So you have payroll cutoff and PHS-related cash payments and AR inheritance.

Got it. And my last question, your tax within the quarter was roughly 35%, and I was just wondering if we should be modeling similar tax rate for 2013.

I mean do you expect to have another one year extension of WOTC program?

Well, it is extended through next year. I would model 35%.

We'll have -- we'll be -- have the benefit of hindsight at the end of the year to do a look-back on where the WOTC program came in, as far as the job tax credits and some of the other programs we're involved with. But -- so maybe there's some potential upside next year, but 35% is the number we feel comfortable with.

Just a couple of questions. Dan, how much was the contribution from Platinum in the quarter?

Was it $12 million, $13 million, roughly?

About that, yes. Maybe a little less, because we started it at the end of July.

Okay. So it might have been like $11 million, something like that?

Yes, in that [indiscernible].

And what was the split there with Housekeeping? Is it pretty much all Housekeeping?

Almost all Housekeeping. [indiscernible]

Okay. And as you kind of have some time to digest it, have you started to think about the cross-sell of Food Service, or is that still a quarter out?

Well, there's still so much pent-up demand with the existing client base. We don't feel compelled to have to address it right away.

But there's certainly an opportunity in almost all of their clients to add the Food Service to the menu, but that's still the case in our existing client base as far as the expansion of the Food Service as well. So it's not like we are coming close to saturating the availability of the existing clients and this opened up a new avenue.

We really have the opportunity for both and it gets back to the consistent development of the management structure to execute properly to take full advantage of that, which we've been doing and continue to do over the next few years.

Okay, great. And then final question, Dan.

When I look at the gross margins, you were able to hold it flat sequentially at 14.3% despite having the surplus management people as well as absorbing Platinum. I was wondering, as you start to get the districts and the regions that are utilized and as you have that integrated, should we start to think about -- that you can work the direct cost down to 85%, or is there anything unusual in the quarter...

We think, over a period of time, a couple of basis point improvement quarter-to-quarter is reasonable and, really, our internal targets as well. But frankly, with the -- when we made the changes with those corporate clients we talked about in the first half of the year, all our management people had jobs with us.

We're going to reassign them and just had to recharge our marketing and growth rates to assign them to new positions. The guys did a much better job than I expected, absorbing those costs and building them into the operation to keep the direct cost below 86%.

And with the new business that we really added towards the end of the second quarter and worked to get them on budget during the third quarter, that's when we're the most inefficient until we made the staffing cuts and adjustments. So the guys in the field really did a very good job in controlling the costs, both with the surplus management people and getting the new business on budget.

And we think, as they become more and more mature, as Ted described, that we should be able to keep improving it quarter-to-quarter and, if we execute properly, get ourselves closer to 85%. And there's still substantial upside improvement available as we get better and broaden the base of clients in the Food Service area.

That's right because the primary driver of the margin expansion is going to still come from the districts and the regions being fully utilized. So Housekeeping and Laundry with a typical district is overseeing 10 to 12 facilities.

In Dining, we're still averaging 7 to 8 facilities. In Housekeeping, a typical region overseas 4 to 6 districts.

In Dining, we're still averaging 3 to 4 districts per region. So again, that's going to be the primary driver of the margin expansion opportunity in Dining over the next 2 to 3 years.

I'm not saying adding the new business is easy, but it's certainly the easier part in what we're trying to accomplish from a margin expansion perspective.

Okay. And then final question, how much SG&A did you absorb with Platinum?

Very modest amount.

Okay. But which is -- I guess, my point is...

Nothing noteworthy, Mike.

Let me start just with Platinum, it sounds like, from all your commentary, that the integration efforts are pretty much on track. But any color there as it relates to management, your employee retention, client retention, anything noticeable that's been outside of the band of your expectation so far?

No. And I think it gets back to what Dan and I just touched on earlier in that we really -- once the acquisition -- once the administrative part of the acquisition is completed, it's really treated and tucked in no different than a startup business, Housekeeping, Laundry or Dining would be from an organic growth perspective.

So we have the same challenges that we would with organic growth, but also, it's not like it's treated as an appendage or an albatross to how we would normally operate business that we grow through our normal regional director network.

And then their management people that we inherit, we knew some of them before. And as we've gotten to know them better, it's been a better fit, although we're always concerned with the dual philosophies or different approaches.

But there's been very little of that, in fact, less than some of the other smaller acquisitions that we made to where we think their management people are fitting in better than, at least, I had anticipated. So it's gone pretty well.

Okay, great. And then Ted, you made some comments about some of the impacted regions slowing down, what would've been the organic growth you would've pursued otherwise.

What's a typical timeframe for that integration to take place? Is it something where maybe first quarter of 2014, you'll start to unleash those regions for the organic sales or kind of new client adds more actively?

Yes. It's a 90- to 180-day process.

So certainly, by the end of the year, Ryan, whatever acquisition-related slowdown from a growth perspective we had in the areas that we're most impacted would be behind us, and then it would be growth in a business-as-usual type fashion.

Okay, got it. And then last question, I know you talked a little bit about the DSOs and moving them on to your accounts receivable teams.

Is there any difference in their contract terms with payments or anything sustainable that their DSOs will be higher? Do you anticipate, once it gets on your team's platform, that that should gravitate towards the corporate average?

That would gravitate towards the corporate average and be in line with what the rest of our business is. That was, obviously, part of the discussions we had with the acquisition and with the customer base.

So it's all -- they're all part and parcel with one another. But over the next 3 months, they should be in line with the rest of our portfolio from an AR perspective.

But you can only imagine, it's a delicate -- if they had different kind of credit terms and different anticipation, taking over the responsibility and now having more rigid control has to be done more diplomatically than we would if we sold the services initially and laid out the expectations, as far as payment terms with an organic client.

Dan, you guys are coming off a pretty strong second quarter in terms of new client contracts signed. I was just curious how the third quarter fared relative to second in terms of maybe new client wins and then the mix of business that was added?

I think in the districts and regions that were impacted by the acquisition, they obviously took a less aggressive posture as far as the organic expansion they could experience because they were using their management resources to digest and inherit the new properties that were part of the acquisition. But the other divisions that were unaffected continued to grow at a more accelerated pace, as they did at the end of the second quarter, or else we wouldn't have been able to achieve in the aggregate the double-digit expansion.

So I think that will just sustain itself in the fourth quarter where, obviously, the bulk of the growth and expansion is going to be all organically driven for the next few quarters. We don't anticipate any acquisition activity for the next year.

Okay. And then when you look into the Platinum, the existing client base, how efficiently were they staffing their facilities?

Have you found any surprises or maybe opportunities to make those clients that were added to the acquisition a bit more profitable than they've been historically?

In some of them. It's really across-the-board.

There are some -- it's more client-specific than a trend in the aggregate. But that's, frankly, no different than organic growth.

When we surveyed the buildings, even part of corporate chains, there's so many variances to how each property kind of operates. We really have to survey each building individually and then determine where our efficiencies are going to come from and what our ultimate profit -- profitability targets can be.

And when we do an acquisition, we really take the same approach. The only exception is we know what the price is.

We're not negotiating the contract price that's in place. So I'd say it's kind of been very proportionate with our organic expansion and observations.

Some of them, we think, we can bring efficiencies and make some cuts. Others, frankly, with management salaries and benefits are going to change, so it may add some expense in those other properties to have their management structure more conformed to ours.

So it's a lot of moving pieces, but we've been there before.

Yes. It's a partnership approach, no different than an existing customer, and you have to look at it holistically.

I mean, part of the -- whatever staffing patterns they have may be reflected in the pricing. There's operational outcome considerations.

There's the accounts receivable piece we talked about. So it really is a client-by-client, area-by-area evaluation.

The same as with an organic [indiscernible] customer.

Right.

Just so I'm straight on this organic versus acquired growth. You said that there's, let's say, $11 million of Platinum revenues, which is about equal to the sequential increase in Housekeeping, which sounds -- and from your commentary, it sounds like you still did the acquisition growth in lieu of organic growth in the markets where you were affected by the acquisition.

It also sounds like you didn't do a whole lot of organic growth in the quarter. Is that a fair characterization?

I'm talking just the Housekeeping side.

Well, I think the -- yes, the majority of the Housekeeping growth was reflected through the acquisition. But I think, again, the acquisition went online in the second half of July, whereas the organic adds that we had during the quarter was layered in, in July, August and September.

So the full run rate of the organic growth won't be reflected until Q4 and then into 2014.

But I'd say, organically, there's about $3 million or $4 million sequential Housekeeping and Laundry growth, excluding the acquisition.

You have the gross net dynamic as well, Rob. The gross adds versus whatever ownership changes or attrition we had in a quarter.

Got it. But your comments also would seem to suggest that you have the -- whatever kind of increase in revenues we saw from Q2 to Q3, whether organic or acquired, that's the type of level of increase we can expect at minimum going forward?

Yes. I think maybe on the high side, organically, because we had a surplus of management people that the more business-as-usual fashion wouldn't afford us the ability to added $25 million sequentially of new business.

Right. And then pointing to -- turning to the food side of the business, obviously, a pretty nice increase in revenues there.

Could you review how much of the new business you're doing is still with existing clients versus new clients?

All of it was with existing.

Where -- any thoughts about when you might open up the spigot to nonexisting clients?

I think selectively, if there's a unique opportunity in a particular area, it's something we'd consider. But really, the opportunities, the low-hanging fruit, the customer demand, with clients that have been with us, in some cases, for decades, continued to be a priority for us as far as the expansion.

As a policy, we really, last year, told the guys in the field they could sell it to anybody. But it's like Ted described the low-hanging fruit, if I was in the marketing and sales effort within a division, there's enough pent-up demand with the existing client base, it's a much quicker and easier sale.

So it's not like they are prohibited from selling to outside, in some areas where they particularly get momentum or the right introduction, they pursue that. But primarily, the Food Service growth has been from the existing clients.

Got it. And then my last question, turning back to Housekeeping again.

Is there any shift that you're seeing in the market or sort of in the -- your potential clients that give you the confidence that, that growth can reenergize the levels we've seen from prior to this year?

Yes. I mean, I don't think it's any different than it has been for 30 years.

The tighter the Medicare or Medicaid environment put pressure on the customers, the more they look for outsourcing options of all kinds. And Housekeeping and Laundry and Food Service are easier decisions, in many ways, to make them the direct patient care areas to outsource.

And even though there's been plenty of room for competition, we've had relatively none. I think the Housekeeping and Laundry attention or non-attention is more geared towards where our guys put their resources as far as new business.

And Food Service becomes easier, so some of the divisions disproportionately focus on that. Housekeeping and Laundry demand is still as great as it's ever been.

It just needs us to cultivate it and pursue it.

Just a couple of housekeeping items. Could you give us the number of facilities there that you guys are in, in Housekeeping as well as Dining now?

I think we're over 3,700 in Housekeeping and 800 in Dining.

Okay. Those are pretty good guidance, congratulations.

And then, DSOs in the quarter, you might have driven that, but I might have missed it.

Yes, they came in right around 56 days. And again, that was with the PHS receivables included as part of the total company DSO.

Okay, so in line -- still below the goal and in line with historical trends. And then, the only other housekeeping item, just what was the depreciation and amortization in the quarter?

D&A came in at around $1.8 million for the quarter and then stock-based comp would have been $600,000 or $650,000.

Okay. Again, thanks again for joining us, everybody.

But working towards the end of our fiscal year in 2013, we expect to continue to expand our client base within our historical growth targets. And now, with our third quarter activity, we've worked our way back to double-digit growth, which will be fully reflected in the fourth quarter.

The overall environment demand for our services is still as great as it's ever been. We'll continue to control our growth rate and balance the expansion with our ability to manage it.

The management capacity, we're able to accelerate our expansion with the acquisition and, organically, remain vital to us. It allows us to balance our client satisfaction measurements.

The client retention was good for the quarter as well as we digest the increased amount of new business. We look to make certain the current expansion operates consistently, look to improve the Food Service margins while growing the Food Service client base at a controlled but more accelerated pace than Housekeeping and Laundry.

All the divisions continue to perform better. But as with any expansion, we need to assure execution and consistency.

We have to keep the attention on the new business, getting -- operate on budget timely while managing the existing client base, so there's no disruption in their services. We look to get the direct cost consistently below 86% and work our way, over the next year, 1.5 years, closer to 85%.

With the changes in some state tax policies and the staff changes we made in the human resource functions, we expect our SG&A to stay in that 7% to 7.25% range, excluding any deferred compensation investment impact. Our tax provision should stay at about 35% for the next year.

But in our business, there's still strong demand for the services, for Housekeeping and Laundry and Food. Our management people in all divisions and especially Food, continue to develop and get better.

We believe and we will continue to operate on budget. But consistently going forward, as we expand, make sure we take care of the existing client base.

So in general, overall, these are pretty good times for us. Thanks for joining us and onward and upward.