Healthcare Services Group Inc (HCSG) 2023 Q2 法說會逐字稿

Hello. My name is Chris, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the HCSG 2023 Second Quarter Earnings Call. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions).

The matters discussed on today's conference call include forward-looking statements about the business prospects of Healthcare Services Group Inc. For Healthcare Services Group, Inc.'s most recent forward-looking statement notice, please refer to the press release issued this morning, which can be found on our website, www.hcsg.com.

Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the risk factors, MD&A and other sections of the annual report on Form 10-K and Healthcare Services Group, Inc.'s other SEC filings. And as indicated in our most recent forward-looking statements notice.

Additionally, management will be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in this morning's press release.

Thank you Ted Wahl, Chief Executive Officer. You may begin.

Thank you, and good morning, everyone. Matt McKee and I appreciate you joining us today. We released our second quarter results this morning and plan on filing our 10-Q by the end of the week. For the 3 months ended June 30, 2023, we reported revenue of $418.9 million net income of $8.6 million or $0.12 per share and adjusted EBITDA of $26.3 million.

Today, in my opening remarks, I'll discuss our second quarter key accomplishments as well as our outlook for the back half of the year. I'll then turn the call over to Matt for a more detailed discussion on the quarter.

Overall, we delivered strong service execution during the quarter. Our KPIs related to customer experience, systems adherence and regulatory compliance all trended positively in Q2, leading to high-quality and consistent outcomes for our client partners.

I'd now like to highlight our second quarter key accomplishments. The first accomplishment I'd like to highlight is our strong core earnings. For the third consecutive quarter, we achieved our direct cost target of 86%, excluding CECL. We managed SG&A within our targeted range and we delivered adjusted EBITDA of $26.3 million.

The second key accomplishment I'd like to highlight is collecting what we billed in May and June. This achievement came on the heels of falling short of our April cash collections target as our clients brace for the May 11 expiration of the public health emergency. And although we did not meet our quarterly cash collection objectives, the results we delivered in May and June provides us with positive momentum heading into Q3 and positions us well for a strong back half of the year.

Lastly, I'd like to highlight the continued progress we made in replenishing our new business pipeline during the first half of the year. As we continue to have a growing pipeline of future client partners heading into the back half of 2023 and 2024. And while the timing of new business adds remains dynamic, we are planning for sequential top line growth in the second half of the year compared to the first half of the year and estimate a Q3 revenue range of $420 million to $430 million.

Looking ahead, industry fundamentals continue to improve and a stabilizing labor market and select state-based reimbursement increases have contributed to the gradual but steady occupancy recovery. And while there remains uncertainty as to what a minimum staffing requirement might look like for the industry, we remain hopeful that CMS will fully consider the impact on operators before finalizing a rule and have confidence in our customers' ability to manage any such rule.

We enter the second half of the year with 3 clear priorities: the first is continuing to manage direct costs at 86%, excluding CECL. The second is collecting what we bill, building on the strong momentum gained in May and June. The third and perhaps the most impactful is the realization of our business development efforts yielding new facility starts.

There is a high level of internal enthusiasm as we pivot the growth mode through the back half of 2023 and into 2024. So with those introductory comments, I'll turn the call over to Matt for a more detailed discussion on our Q2 results.

Thanks, Ted. Good morning, everyone. Revenue for the quarter was reported at $418.9 million with Housekeeping & Laundry and Dining & Nutrition Segment revenues of $190.8 million and $228.1 million, respectively. Housekeeping & Laundry and Dining & Nutrition segment margins were 8.7% and 5.5%, respectively.

Direct cost of services was reported at $367.7 million or 87.8%. Direct costs included an $11.3 million increase in our CECL AR reserves. As Ted mentioned in his opening remarks, we again met our goal of managing the business with cost of services in line with our historical target of 86%, excluding CECL.

SG&A was reported at $41.4 million -- after adjusting for the $2.3 million increase in deferred compensation, actual SG&A was $39.1 million or 9.3%. We expect 2023 SG&A between 8.5% to 9.5%. The effective tax rate was 24.6% and the company expects a 2023 tax rate of 24% to 26%.

Cash flow from operations for the quarter was $7.4 million and was impacted by an $18.8 million increase in accrued payroll and the $39 million increase in accounts receivable related to the timing of cash collections.

DSO for the quarter was 83 days. Also, we would point out that the Q3 payroll accrual will be 7 days. That compares to the 13 days that we had in the second quarter of 2023 and the 6 days that we had in the third quarter of 2022. But the payroll accrual only relates to timing and the impact ultimately washes out through the full year. And with those opening remarks, we'd now like to open up the call for questions.

(Operator Instructions) Our first question is from Sean Dodge with RBC Capital Markets.

Yes. Ted, I just want to start with your comments around collections tough in April, but sounds like improved in May and June. I guess, post the close of the quarter, are there any big outstanding balances you've now collected that kind of helped through some of this up? Maybe just kind of give us a sense of DSOs for 83 in the second quarter. Are those going to be able to come down as we go through the balance of the year?

Yes. It's a great question, Sean. And we've talked about DSO before in this forum and other forums. DSO for us, we view more as a by-product of executing our collection strategies than an indicator as to our success. Obviously, it's something we consider and we focus on, but we do view each and every account holistically in terms of our assessments.

I think to your question, specifically if we're going to be recapturing some of the -- specifically the April delayed payments. And I can tell you, we are actively working with our customers on finalizing plans, including in the form of promissory notes to make up some of that April shortfall in the coming months. The timing is TBD on that, but we are actively engaged on repayment plans, which could be a nice cash flow tailwind for the back half of the year.

Beyond that, our goal remains to be -- to collect what we bill in the quarter ahead, and we're going to continue to focus on increasing payment frequency proactively using and utilizing promissory notes and then remaining disciplined in our decision-making for both new customers as well as existing business.

So again, it's a -- it's -- we did not meet our objective in April, but the momentum we gained in May and June and what we've seen July to date has really been positive, and we feel good about the back half of the year from a collection standpoint.

Okay. Great. And then if we look across the sales and adjust out the CECL reserves through the first 2 quarters, you've actually been able to manage that closer to 85% with your comments that you're continuing to target 86% for the full year, is that just a function of the investments you're making around kind of staffing up and positioning now for growth? Or is there something else that's happening there that we should expect kind of the core cost of sales again, excluding CECL to kind of increase over the course of the year?

Yes, at or below 86%, Sean, to your point, is the target. We exited the year with the 86% run rate, third consecutive quarter now that we've been able to ex-CECL, deliver on that target. And to your point, it's accounting for, of course, execution risk, which is always a consideration, but growth. When we factor in growth the back half of the year, that's always going to be a temporary -- have a negative temporary impact on cost of sales as well as anyone, when we started a new piece of business, we're inheriting the existing payrolls, we're inheriting the supply budgets. Typically, there's a degree of margin compression as we work to implement our systems and staffing patterns over the first 60 to 90 days. But I think that all will be viewed and should be viewed as a positive as we head into the second half of the year because we are expecting and have pivoted already to growth mode going into the second half of 2023.

The next question is from Andy Wittmann with Baird.

I guess, Ted, I wanted to ask about the new business pipeline here, somewhat. Over the years, the challenge for you has been keeping facility managers in your training program and having those people ready to go when you're ready to launch new facilities. I guess in the last couple of years, I haven't been asking about the strength in the performance and the amount of people you've got in this training program. But given that you're talking more confidently about growth now, I thought it would be worth talking to you and having you talk about how you hire for those positions, the fullness of that training pipeline and if you're ready to go, should some of your customers decide to turn on the switch for Healthcare Services Group.

Yes, Andy, I'll address that. This is Matt. I'm glad you asked about this, and I think we touched on this component of our growth trajectory a bit last quarter. But to dive in a little bit deeper, you're exactly right. One of the major contingencies of our ability to grow historically has always been overall, our management capacity, but more specifically, having the appropriate number of managers working through the queue in our management training program and our compelling pitch, if you will, or the employee-based value proposition historically has been that one is able to grow one's career with Health Care Services Group that as the company grows, one has the opportunity to develop one's own career and promotional trajectory in light of not having put up much top line growth over the course of the past few years, that's created a different challenge for the organization.

And it's 1 that we were certainly mindful of, if not outright concerned about. What that required of us was to sort of be overly communicative and transparent with our managers, both our existing managers who've committed at least a significant portion of their careers to the organization and folks to whom we were having -- with whom we were having discussions from a recruiting perspective.

And we've been very transparent about the rationale as to why it didn't make sense for us to be onboarding new business and in growth mode over the course of the past few years. That's enabled us, quite honestly, Andy, to be a bit more selective and judicious not only in our hiring, but in replacing managers who perhaps were underperforming and what have clearly been significantly challenging operational times and an overall challenging operating environment. You think back to the clinical challenges and limitations that COVID presented on the heels of that, the labor challenges and the overall struggles that we faced with respect to the availability of labor and managing our payroll-related costs.

So we needed top-notch managers through all of those conditions. So that's been a bit of a carrot that we've been able to hold out for folks to keep them motivated and engaged within the organization. Ted alluded to in his opening remarks, the sort of palpable enthusiasm that's running through the organization as we pivot to growth mode. And that has massive effects and reverberations in that not only is everyone excited to see our results in putting up top line growth. But from a more personal career developmental perspective, what does that mean by way of growth opportunities.

So long end around and answer to your question, I would remind you that the recruiting efforts and the management training program is executed locally. So of course, as is always the case, we're going to have variability as to some districts and regions being far ahead of the curve and really being prepared for specific onboarding opportunities as to new business in the third and fourth quarters here whereas other geographies may still be struggling with labor market implications and staffing challenges.

So perhaps they're not quite as far along that continuum. But as an organization in total, Andy, very much having been focused on the back half of the year as the inflection point towards growth.

We have been building and managing our management capacity toward that, and we feel extremely confident that our management capacity aligns very well with the geographic opportunities that we've indicated as most likely to come on board here in the back half of the year.

Great. That's helpful. I guess just as a follow-up to that. I guess I just wanted to understand a little bit more on the confidence level of the second half revenue growth rate. You gave this $420 million to $430 million, obviously, that suggests a sequential growth, which is good. I guess maybe the first question would be, does that $420 million to $430 million range -- is that already -- is that business that's already been started as we sit here today? Or are there other facilities that still need to transition here during the rest of the quarter and able to hit that target?

And then I guess maybe just more broadly, Ted, maybe if you could just comment on, it sounds like the pipeline is there. You made a comment that if and when the -- I think you said this, if and when the customers decide to go, what needs to happen, do you think, for those customers to really pull the trigger that you've been having dialogue with that you feel like you could add to the top line. But what needs to happen to get them over the hump?

Yes. I think in terms of the confidence or conviction around the $420 million to $430 million, it's a mix, Andy. We -- obviously, we wouldn't have provided that range if we didn't have a high degree of conviction that we were going to be able to deliver in that range. So it's a combination of business that we've already have in hand that we started towards the end of Q2 and new business adds that we'll have throughout the quarter.

I guess the bigger question you had about the pipeline and what's the gating factor to a customer pulling the trigger. It's a collaboration the pipeline is robust. Every customer group, every prospective customer has a different set of circumstances to it. In many cases, it's just a piggyback off of Matt's commentary of management development -- it's a function of where do we have the depth, where do we have the bench strength to be able to take on new business.

We've always talked about the single greatest gating factor on growth. Is it the demand for the services or the amount of opportunities that are out there. It's our own ability to hire, develop, train and then successfully deploy management candidates. That remains as true as ever today. I know we haven't talked about it in recent quarters and years as much as we had historically, but pivoting to growth mode here that will be front and center in our own internal assessment and analysis and focus. And I'd imagine it will be a conversation we have quarter-to-quarter in this forum.

So nothing necessarily as -- generally speaking, as a catalyst to put a specific customer group over the hump. It's just a cost prospective client-by-client assessment and where our management development efforts and capacity match up with the demand, that's where we're able to execute on the growth strategy.

The next question is from Brian Tanquilut with Jefferies.

It's Taji on for Brian. So my first question has to do with margins in both segments, right? You had housekeeping at 8.7%, dining at 5.5%. And as we think about your pivot in to growth mode for the second half of the year, just curious what particularly needs to happen in order for you to see alleviation in margins, especially throughout the year in both segments and for you to see that translation to the bottom line?

Yes, Tali -- Taji. It's a great question. I think specifically from a segment perspective, there's always going to be some movement, whether it be month-to-month or quarter-to-quarter. Largely due to execution and you alluded to it, new business adds and there's other considerations that are happening each and every day in our field-based operations. Just as an add-on to that, there's -- we don't talk about it because it's not really material, but around the edges, there's even some seasonality, whether it's the number of holidays in a quarter, sometimes the timing of supplemental billings. We have union buyouts at different times during the year.

I would say just for some additional context from a margin perspective, if you look back pre-COVID, our segment margins, we're in that 9% to 10% range for EVS and 5% to 6% range for dining. We would expect to track and trend in and around those levels for 2023, even with the expectations we have around growth and the margin compression that could create, again, with the degree of quarter-to-quarter variability.

That's really helpful. And then just last question for me. Just curious, as we think about CECL AR, our reserves and other adjustments -- can you maybe talk about sustainability of these adjustments? I think you had talked about how, but CECL is pretty formulaic and at times volatile. But any thoughts around where this could settle out when you expect to, I guess, see adjustments kind of taper out in your P&L?

Yes. And I know we've discussed it at previous times on this call, just to maybe take a step back to your question, Taji. But the industry it's still recovering. It has not yet recovered, and that's the primary reason why coming into the year, even on the heels of a very strong Q4 cash collections quarter, we expected some fits and starts on the collections front, especially in the first half of the year. That's why we provided coming into the year more modest cash flow estimates, and that's why we highlighted our expectation for volatility around CECL. We don't expect that to be the new norm in the quarters and years ahead. But in this current environment, it's -- it was expected that we would see some CECL volatility.

I think that said, and specifically to this quarter, it was a difficult environment. We expected that, especially with the May 11 expiration of the public health emergency. We saw clients really looking to maximize their own liquidity and flexibility and impacted our April efforts. But overall, any negative impact on our customer base specific to the public health emergency was really less than feared and we were successful in executing on our strategies in May and June, which is why we highlighted that strong momentum heading into the back half of the year.

So getting back to your question around CECL specifically, as we're consistently collecting what we bill, we would absolutely expect CECL to moderate and to become more normalized. We'll continue to make the adjustment in the adjusted EBITDA table irrespective of whether it's an upward adjustment or a downward adjustment because we do believe longer term, write-offs -- actual write-offs is a more effective way and probably more indicative of what would actually be P&L charge for HCSG, but again, in terms of the actual business side of it as cash flow and cash -- as cash collections improved, which we expect them to do in the back half of the year, we would expect CECL to moderate.

The next question is from Jack Melick with William Blair.

Jack on for Ryan this morning. Any additional insight into how you're getting comfort over any potential exposure to the finalized rule that might increase staffing requirements. Now is the comfort coming from client conversations or you doing more site-specific analysis to gauge risk? Just kind of curious how you're thinking about this potential headwind?

Yes, Jack, it's a good question. And it's certainly -- as you've alluded to, it's certainly a talk within the industry right now. And I think the latest is that the proposed plan is expected soon, although we've heard that for months at this point, but all industry stakeholders remain on high (inaudible) I'd say the industry view/perspective is around minimum staffing is that if there were an appropriate pilot and appropriate phase-in periods and with it a recognition of the labor constraints and it was fully funded than the industry would and really has leaned into that type of framework. But if it's an unfunded mandate without recognizing the realities on the ground. I do not believe that would be well received.

From our perspective, assuming there is a minimum staffing requirement announced later this year, our assessment of it is it would likely be very narrow meaning it would be related to patient care staff only. It would likely have a phase-in period of up to 5 years, probably in the 3- to 5-year range. There would likely be a robust waiver product, especially for rural facilities. And it would have to service political changes in administration and all the inevitable litigation that would come with it.

So there's a lot of road to hoe here, Jack, but I would say stay tuned. There's going to be more to come from a minimum staffing perspective, but -- in the meantime, we'll wait and see. I think just to bring it back to us for a moment, the fact that, that uncertainty is out there around not just the regulatory environment, but also the recovery of the industry, the reimbursement environment does force to a degree providers to look for ways to create more certainty in their business.

And we've talked about this before, but the central theme and our value proposition is providing operational and financial peace of mind. So not just with the minimum staffing requirement but all of the other variables within the industry, some of which are not necessarily new, creates that demand for the types of services that we're able to provide.

Okay. That's super insightful. I appreciate that. And I guess just switching gears a little bit. Any update on your capital allocation strategy?

No. From our perspective, it continues to go down the path we expected it to our #1 capital allocation priority continues to be internal investment and investment in organic growth drivers. We remain active on the inorganic front and exploring activities, looking to build selectively inorganic opportunities that we can fold in strategically within the company. There's nothing to announce, but that's something we remain active in. And we continue to keep an eye open for buyback opportunities. We did not have any buybacks in Q2, but that will continue to be a very selective, very opportunistic approach that we take towards buybacks.

The next question is from Bill Sutherland with The Benchmark Company.

The state-based reimbursement that you called out in the PR this morning, -- can you give us a little color on the states where you have a higher number of contracts? Just kind of curious the benefit that those facilities are starting to see at a state level.

Yes. Bill, over the past 12 months, really, there's been a number of state-based wins, and some of those states are high-density states for us with respect to our client facilities. If you think about Florida, Illinois, Pennsylvania, more recently, Texas and Ohio, and there's variability there, right? I mean although one may classify a reimbursement increase in a particular state as a win. -- there's degrees, right?

For instance, the state of Ohio just had a pretty substantial dollar PPD increase that was above what was expected. Ohio historically has not been the best state from an operating perspective. You contrast that with Texas that did in fact get an increase, but it was, I'll say, less than what operators were hoping for. It's been quite some time since the state of Texas did in fact get an increase. So you could put that on the board technically as a win in that it was an increase that providers were able to secure, but still deemed insufficient.

Another state would be New York, which was a bit mixed, where there was a 6.5% reimbursement rate increase that was a bit higher than what was initially proposed, but certainly sub what the industry was looking for in light of massively increasing costs for operators in that state. And really quite a lag in time from the prior reimbursement rate increase.

So it's a mixed bag and certainly something that we pay attention to, Bill, at the state-based levels and from an overall regulatory and reimbursement based perspective. But much more important for us, obviously, is how that trickles down and impacts the facility and the operator. So it's 1 component of that overall financial assessment, inclusive of occupancy payer mix and how they're able to staff and manage their nursing departments as well and the effect that, that has overall in occupancy.

I noticed Housekeeping revenue was down just a bit quarter-on-quarter. Is that a couple more exits involved there? I'm just curious about the renewal rate.

Yes, that's right, Bill. We did exit some business. We would classify that as more normal course exits. So nothing substantial, the full run rate of which was reflected in the quarter. While we're talking about the segment level revenue, I would note that Dining, we saw a bit of a step-up there. And that was just a couple of new business adds. Again, nothing substantial. So both the Housekeeping exit and the Dining adds really were fully reflected in the run rate revenue for the quarter.

Okay. And are your contract -- the expansions that you're getting in education, you're reflecting in the overall numbers. Is that right?

That's correct, Bill. They're reflected respectively, in Housekeeping and Laundry and then also Dining segment as well.

Okay. And there -- is that part of the back half uplift?

It is. That's correct.

Okay. And then last one, you mentioned doing at least $30 million free cash for the full year, does that still look like the right way to think about it?

Yes. I think looking to the back half of the year specifically, we're still targeting that $25 million to $30 million range. So depending on where we fall in that range or if we exceed that range, that could obviously, have an impact on the number you just shared, but $20 million to $30 million is our back half of the year target for free cash flow.

We have no further questions at this time. I'll turn it back to the presenters for any closing remarks.

Great. Thank you, Chris. In the months ahead, we remain confident in our ability to control the controllables, realistic about the ongoing challenges that remain within our industry and broader economy and focused on executing on our strategic priorities to drive growth and deliver long-term value to our shareholders.

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 to everyone for joining.

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