Healthcare Services Group Inc (HCSG) 2022 Q3 法說會逐字稿

Good morning. My name is Chris, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the HCSG 2022 Third Quarter Earnings Call. (Operator Instructions)

Ted Wahl, President and Chief Executive Officer, you may begin.

Thank you, Chris, and good morning, everyone. Matt McKee and I appreciate you joining us today. We released our third quarter results this morning and plan on filing our 10-Q by the end of the week.

Our third quarter results reflect the ongoing and expected choppiness that we referenced during our second quarter call. And while we have conviction in our ability to manage the controllable components of our business, namely customer satisfaction, systems adherence, regulatory compliance and budget discipline, we are also realistic about the ongoing challenges that remain within our industry and the broader economy.

During the quarter, we successfully executed on our strategy to more favorably position our customer partnerships and agreements. We are confident that this work will yield improved results in the fourth quarter and remain on track to meet our goal of exiting the year with cost of services in line with our historical target of 86%. We will continue to adjust, adapt and aim to deliver optimal results in a way that maintains the quality and integrity of our existing partnerships and opportunistically explores future growth.

So with those introductory comments, I'll turn the call over to Matt for a more detailed discussion on our Q3 results.

Thanks, Ted, and good morning, everyone. Revenue for the quarter was reported at $415.8 million (sic) [$414.5 million], with housekeeping and laundry and dining & nutrition segment revenues of $197.2 million (sic) [$196.9 million] and $218.6 million (sic) [$217.6 million], respectively. As previously disclosed, the third quarter results were impacted by contract modification actions taken by the company, resulting in a onetime reduction of approximately $9 million of revenue, and that's compared to the previously estimated $17 million and also a $9 million in operating income reduction.

Housekeeping & laundry and dining & nutrition segment margins were 8.9% and negative 0.2%, respectively. Segment margins were impacted by the aforementioned contract modification actions. Direct cost of services was reported at $376.9 million or 90.9%, and cost of services was impacted by a $7.6 million increase in AR reserves, primarily related to the $16.2 million increase in aged accounts receivable and the impact that has on the calculation of CECL AR reserves. The majority of the aged AR relates to actions taken as a part of our contract modification work. And as Ted highlighted in his opening remarks, we remain on track to meet our goal of exiting the year with cost of services in line with our historical target of 86%.

SG&A was reported at $37 million. After adjusting for the $1.2 million decrease in deferred compensation, actual SG&A was $35.8 million or 8.6%, and we expect 2022 SG&A between 8.5% to 9.5%.

Cash used in operations for the quarter was $9.9 million and was impacted by a $16.2 million increase in accounts receivable. As I referenced earlier, the majority of this increase in aged accounts receivable relates to actions taken by the company as part of our contract modification work. Cash used in operations was also impacted by a $15.7 million decrease in accrued payroll.

DSO for the quarter was 76 days. And our Q4 cash flow will be impacted by the increase in payroll accrual from 6 days in Q3 to 15 days in Q4, but that will be offset in part by the $24 million second and final installment of the CARES Act deferred payroll tax repayment.

We're pleased with the ongoing strength of our balance sheet and the ability to support the business while continuing to return capital to HCSG shareholders. We announced that the Board of Directors approved an increase in the dividend to $0.215 per share, payable on December 22, 2022. The cash balance is supported, 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 return capital to shareholders. This will mark the 78th consecutive cash dividend payment since the program was instituted in 2003 and the 77th consecutive quarterly increase. That's now a 20-year period that's included 4 3-for-2 stock splits.

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

(Operator Instructions) Our first question is from Andy Wittmann with Baird.

I guess, Ted, I wanted to start with the gross margin comments, and you guys have been resolutes in your commitment to getting to the 86% here exit rate for the year. And it's been a couple of quarters now that you've been doing the contract modifications and having those conversations. And it feels like with -- even if you adjust for the receivable write-off in the quarter, you've got like 300 basis points sequentially. To post that in the fourth quarter, I recognize you're planning to exit the year, so it might not print it exactly 86% here in the fourth quarter, but it seems like a lot of work to do, I guess.

And so my question for you is, can you talk about what gives you confidence in that achievement? And what's going to change here in the next 3 -- 3-plus months here to achieve that goal?

Yes. Well, I guess, just -- you referenced Q4, and without having a crystal ball from Q4, it absolutely is not our expectation that it would print at that 86%. I think we've been clear, hopefully clear, Andy, that that's really a Q1 target, which is why we focused and have tried to orient everyone around our goal of exiting the year at that run rate without the impact being reflected in Q4.

The strategy that we've had with a lot of these negotiations for a variety of reasons are really that they're more back-end loaded. And again, we won't begin to realize the benefits of that from a P&L perspective until Q1 of '23. So that, I think, is the first point I'd want to make.

And to your point, we've done an extraordinary amount of work over the past year in modifying our contracts. And it's a goal that we've very aggressively pursued during the third quarter, and we're going to continue to pursue in the fourth quarter. I will say that after Q4, we're confident that the initiative phase of the contract modification work is going to be behind us. But the emphasis on capturing recent and future inflation on a more real-time basis is going to continue to be an area of focus and an opportunity of ours going forward.

But again, based on the work we've either completed, Andy, or expect to complete before the end of the year, we are, as resolute as we possibly could be about meeting our goal of exiting the year with cost of services in line with that target.

Okay. I guess maybe to achieve that, how much more work -- I mean, this quarter, you forecasted that there would be some contracts that you're exiting, you actually didn't exit as many as you thought. Is there more that we should be thinking about in terms of the revenue run rate from the work that is still to be done here before year-end? And maybe did you want to help us like you've helped us last quarter with what that run rate could look like?

Yes. I think from a -- look, there's a lot of moving parts, as you can imagine, between the timing of the contract modification adjustments being reflected, which, as I alluded to earlier, are more back-end loaded. But for Q4, once you adjust for the Q1 onetime revenue reduction. And again, considering the impact of the Q4 potential new business adds factoring in the Q3 business adds and the offsetting exits, our estimated range for Q4 would be between $420 million and $430 million.

Our next question is from Sean Dodge with RBC Capital Markets.

Maybe starting with the contract modifications in the quarter. Matt, you mentioned those being a little bit less than you all had initially anticipated. Can you just give us a little bit more detail on maybe why that was?

Yes. Really, that was just the accounting treatment, Sean. There was that initial assessment where -- in which we thought there would be the $17 million onetime impact on revenue with a corresponding $9 million reduction in operating income. And after several reviews internally and leveraging external partners and consultants, it was determined that the appropriate treatment was the $9 million reduction onetime in nature in both revenue and operating income.

Okay. That's helpful. And then you've been doing a lot of work on the contract modifications. I guess if we set all of that aside and maybe take a step back, what's the backdrop like now for hourly labor? Have things started to ease up there? Or does that still remain challenging?

It's a little bit of both, Sean. It remains a challenge, there's no doubt about that, but we've seen ongoing stabilization with modest improvement. Now bearing in mind, this is very much a market-to-market dynamic. And while wage growth remains high relative -- certainly to historical norms, the pace of that growth has continued to slow since about March or so. And there's been modest incremental increase in the overall nursing home workforce, which is a good thing, but we still remain near a 30-year low. And that's just for the industry in general.

As for HCSG more specifically, we noted on the last call, some of the positive signs in our hiring and retention and we're approaching the point at which we feel comfortable calling them trends. We've seen a nice rise in application rates and a tailing off of the terminations and separations. And most importantly and from our perspective, is a notable decrease in the number of open job posting. So it remains a challenge, but we're definitely starting to see improvement.

The next question is from Ryan Daniels with William Blair.

This is Jack Senft on for Ryan Daniels. Just for a point of clarification, you were expecting a onetime negative revenue impact this quarter of about $17 million, but instead it came in at $9 million, correct?

And then to -- so if I am thinking about this correctly, this is still above your estimated range for last quarter modestly. Can you just comment on what kind of drove this revenue outperformance? Is this more like a factor of price increases? Or just any additional color you have would be appreciated.

Yes. Jack, the majority of the higher-than-expected revenue was related to, I guess, what I would describe as opportunistic new business additions, opportunistic in the sense that we were able to fairly seamlessly reassign our managers from the facilities that we exited in Q2 as part of that contract modification initiative right into new business opportunities, which certainly helped offset the impact of those exits.

So that was really the primary driver of it. More than anything related specifically that the contract modification and the related billing increases, which, as I mentioned earlier, we won't really see until Q1 in earnest -- the impact in Q1.

And then just as a quick follow-up. So I know AR is up again this quarter on a sequential basis, but obviously, impacted by the onetime impacts you mentioned before. And then DSO is up even more by about like 5 days or so. And I know that you previously stated that you were in a position to collect on what you build and then also possibly looking to make up a portion of cash collections in the second half.

So just trying to understand, do you expect the cash collections impact to be seen more in the fourth quarter? And then in first quarter 2023, where it's more just a function of timing that is just getting pushed back? Or I guess how should we be thinking about this going forward?

Yes. And just maybe to back up and to your point, last quarter, we talked about how the majority of the shortfall more than half of the shortfall year-to-date, and that trend continued into Q3 was really was driven through more intentional negotiation as part of these contract modifications, so in working with our customers to come up with a win-win kind of situation on how we move forward.

Last quarter, our stated goal was to make up a portion of that shortfall during Q3 and Q4. That timing has shifted now and we're thinking of that more as a 2023 dynamic as we recalibrated some of the repayment plans or the timing of when some of those repayment plans begin. And specifically on those repayment plans, Jack, a good number of them have ended up in promissory notes, which I just want to emphasize again, it's been a while since we've talked about the value of promissory notes for the company, but it's always been a critical tactic in our overall collection strategy.

It's an instrument where we're able to memorialize the indebtedness that's outstanding in a formal document. It's interest-bearing and oftentimes, it comes with a security interest, which even if it's junior to a senior secured lender, it still gives us a seed at that secured lending -- secured interest table.

So I think it's for all of those reasons, the promissory notes have a strong payment track record for the company historically. But just for perspective, year-to-date and a lot of the -- in conjunction with that contract modification work, we've originated over 20 million promissory notes, nearly all of them in Q2 and Q3. And I would anticipate that number to grow in Q4 as well.

So again, we'll make every effort to recoup what we can between now and the end of the year. But 2023 is really when some of the more recent promissory notes and the repayment agreements are scheduled to kick in.

The next question is from Mitra Ramgopal with Sidoti.

First, I was just curious, as you bring on new business, if you already have personnel waiting to be deployed? Or are you running the business in, sort of, at a lean state right now that you'd have to go to higher managers, et cetera?

No. The good spot that we're in, Mitra, relative to new business and onboarding new facilities is we're back into that very localized effort in the sense that just as our management development efforts have always taken place locally, we want that to run in concert with our business development efforts. So there are certain geographies, of course, because the recruiting, training, development and ultimately, retention of management candidates happens locally. There are some geographies that are further along that continuum right now than others.

But generally speaking, we are equipped to opportunistically look out for growth opportunities. So management development, the availability of managers won't be a drag on that really from our perspective when we think about growth, it remains that opportunistic selective assessment of the new business opportunities, given where we are with the industry landscape and some of the challenges that continue namely with respect to the availability of labor and the impact that, that's had on census for clients and prospective clients.

Okay. And speaking of census, if you could just touch on the occupancy you're seeing amongst your clients? And increasingly, we're hearing talk about potential COVID surge in fourth quarter, new strains, et cetera, how do you see yourself positioned to deal with that, especially the nursing home industry?

Yes. Well, I'd say the most recent occupancy data are somewhat encouraging just industry-wide, Mitra, and that census is slowly but steadily moving higher. The national occupancy currently sits at about 75.2%. As a company, we're slightly above that by a couple of points. But again, that 75.2% industry-wide indicator is about 1.2% higher than what we reported in Q2. So that's about a 10 basis or so increase per week during the quarter.

And if the industry experienced that type of improvement going forward, that would put the industry on a pace to reach 80%, which is not a magic number, but it's at least a frame of reference for where the industry sat pre-pandemic, but we'd reach that as an industry by the end of 2023. That doesn't factor in any sort of COVID surge or anything like that in Q4. And we haven't heard any of our clients talk about that as they're always planning and preparing for not just COVID but flu and other infectious diseases, but nothing specifically COVID-related that we've heard that the industry is highlighting.

But that said, the key to occupancy, longer term, even getting out of the month-to-month or quarter-to-quarter dynamics over the next 12 to 18 months in terms of the industry recovery, it's going to be around staffing. Labor availability and staffing continues to be the key. Occupancy is the key to industry recovery and labor availability is the key to occupancy recovery.

Okay. That's great. And then you might have mentioned this earlier, but if you could remind us in terms of the contract modifications. Has it been completed? Or you expect that to get done by year-end?

It's -- they're still -- as I referenced earlier, Mitra, there's still a few loose ends in groups that we're working with. But after Q4, that initiative phase, we've kind of designated this as an initiative within the company. But we'll be -- that will be behind us. And the emphasis on capturing recent and future inflation, which is really the driving force behind the initiative will continue to be an area of focus and of opportunity.

But as far as the initiative and us highlighting the progress and the timing of that progress on this call, that will be something that will be behind us.

And then finally, I know the dividend obviously is a priority. Given where the stock is trading, should we be looking also in terms of capital being used for share buybacks?

So look, the buyback has always been something that's been considered by the Board. I think in terms of capital allocation strategy, the dividend remains of the highest priority and an important part of that strategy, second only to organic growth and internal investment. So that along -- the dividend, along with just capital allocation in general, something the Board will continue to evaluate quarter-to-quarter.

But -- so obviously, that could be an option if the situation presented itself or the opportunity presented itself in a different type of way. But for now, I think organic growth, internal investment and the dividend continue to be the priorities from a Board perspective with respect to capital allocation.

The next question is from Brian Tanquilut with Jefferies.

I guess my question is, as we think about these contract modifications, right, it's clear that you're focused on putting inflation adjusters in there, which we appreciate. But as we think about the health of the industry right now, how are you -- or how should we be thinking about potential client turnover or increases in bad debt as you roll out these new contract structures?

Yes. Brian, as Ted alluded to, we're through the majority of the work, not that the work will ever cease, right? It may shift from an initiative phase, but then it evolves very much into business as usual. And we think about the main levers in our contracts being pricing, contract structure and payment terms, right, all of which are essentially open for negotiation at any point between the customers and ourselves.

So we feel fairly confident in that -- clearly, we called out some facility exits in Q2 as a result of the directional result of negotiations with certain clients in the final stages here, there's not to say that we wouldn't potentially exit additional facilities. But as we sit here, we're not anticipating that to be anything significant or meaningful.

And I would say that the experience that we had in Q3 that we talked about and very seamlessly replacing the business that we exited from Q2 into Q3, that we have a high level of confidence that should we need to exit facilities, we'd be able to very seamlessly repurpose those managers into new business opportunities as well.

So not in any way, looking to negate the possibility, but confident in the fact that directionally, we're feeling very positive about retaining the business partnerships. And if there are instances as a result of these negotiations or for any other reason that we're exiting business, it's not something that we do cavalierly, but we do retain that confidence that we would be able to replace that business.

That makes sense. And then I guess my second question, as I think about a potential economic slowdown here as we look at 2023, I mean, maybe if you can remind us how the business fared during the last recession? And how you're preparing for kind of like a potential recession here as we enter 2023?

Yes. I think in terms of the general economy, it's something we're always monitoring and keeping a watchful eye on. Quite frankly, when you think about the industry, and the industry has been somewhat of an outlier in terms of the overall post pandemic recovery in terms of it never has reached pre-pandemic levels in terms of workforce and occupancy, as I highlighted earlier.

So there's kind of a counterview industry-specific that perhaps some -- a slack labor environment could be a nice boost in the event of a recession, could be a nice boost to workforce availability considerations, so which could have a somewhat of a benefit to occupancy because as I mentioned earlier, the key to occupancy is really having the appropriate staffing in place to take on that pent-up demand.

So it's a difficult question to really answer because there's -- in recessions in the past, the industry has always been, generally speaking, recession proof, and I think our performance has mirrored that because we're in a post-pandemic state and the impact that, that had on the industry as we approach the recession, it's somewhat of an unknown. But again, I think from a workforce availability perspective, I would think a recessionary environment or even an economic slowdown would only facilitate the additional workers for the industry.

We have no further questions at this time. I'll turn it over to Mr. Wahl for any closing remarks.

Great. Well, thank you, Chris. In the quarter ahead, we will continue to prioritize contract modifications to capture both recent and future inflation on a more real-time basis with the goal of exiting the year with cost of services in line with our historical target of 86%. We will prioritize cash collections with the goal of collecting what we bill, and we will prioritize operational execution with the goal of delivering on our operational imperative of client satisfaction, systems adherence, regulatory compliance and budget discipline. Above all, we remain committed to making decisions that best position us to deliver long-term shareholder value.

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

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.