Q3 2022 Healthcare Services Group Inc Earnings Call

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're 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 exploring future growth.

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

Thanks, Ed and good morning, everyone revenue for the quarter was reported at $415 $8 million with housekeeping and laundry and dining and nutrition segment revenues of $197 2 million and $218 6 million respectively.

As previously disclosed the third quarter results were impacted by contract modification actions taken by the company, resulting in a one time reduction of approximately $9 million of revenue and that's it.

It compares to the previously estimated $17 million and also a $9 million.

In operating income reduction.

Housekeeping and laundry and dining <unk> nutrition segment margins were eight 9% and negative two 2% respectively.

Segment margins were impacted by the aforementioned contract modification actions.

Direct cost of services was reported at $376 9 million or 99%.

Cost of services was impacted by a $7 $6 million increase in our reserves primarily related to the $16 2 million increase in aged accounts receivable and the impact that has on the calculation of seasonal reserves. The majority of the aged AR relates to actions taken as a part of our contract modification work and.

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 eight 6% and we expect 2022 SG&A between eight five to nine 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 and 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.

So for the quarter was 76 days now.

In our Q4 cash flow will be impacted by the increase in payroll accrual from 60 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 <unk> shareholders, We announced that the board of directors approved an increase in the dividend to $21 five per share payable on December 22022.

The cash balances 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 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 is <unk>.

<unk> 43 for two stock splits so with those opening remarks, we'd now like to open up the call for questions.

Thank you.

Reminder, if you'd like to ask a question. Please press Star then one on your telephone handset.

First question is from Andy Wittmann with Baird. Your line is open.

Okay.

Yes. Good morning, guys. Thanks for taking my question. This morning, I guess I wanted to start with the gross margin comments and you guys have been resolute and your commitment to getting to the 86%.

Exit rate for the year and.

A couple of quarters now that you've been doing a 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.

Posted in the fourth quarter I recognize youre planning to exit the year. So it might not printed exactly 86 here in the fourth quarter, but it seems like a lot of work to do I guess 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 three to three plus months here to achieve that goal.

Yes, well I guess, just you referenced Q4 and without having a crystal ball for 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 great one target, which is why we focused and I've tried to orient everyone around our goals.

Existing 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 theyre more back end loaded and again, we won't begin to realize the benefits of that from a P&L perspective until Q1 of 'twenty. Three so that that I think is the first point I'd want to make and to your point, we've done an extraordinary amount of work.

Work.

And over the past year and modifying our contracts and it's a goal that we've been 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 initiatives phase of the contract modification work's going to be behind us, but the emphasis on capturing <unk>.

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.

There'll be some contracts youre exiting he actually didnt 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 have helped us last quarter with what that run rate could look like.

Yes, I think from a look theres 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 backend loaded but for Q4. Once you adjust for the Q1, one time revenue reduction and again considering the.

<unk> of the Q4 potential new business adds factoring into Q3 business adds and the offsetting exits our estimated range for Q4 would be between $424 30.

Great guys.

<unk> the floor. Thanks a lot.

Great. Thanks, Andy.

Our next question is from Sean Dodge with RBC capital markets. Your line is open.

Thanks.

<unk>.

Maybe starting with the contract modifications in the quarter Matt.

Matt You mentioned, there has been a little bit less than you all.

We had initially anticipated can you just give us a little bit more detail on maybe why that was.

Yes, it really that was just the accounting treatment Shaun.

There was that initial assessment, where in which we thought there would be the $17 million one time impact on revenue with a corresponding $9 million reduction in operating income and after.

After several reviews internally and leveraging external partners and consultants. It was determined that the appropriate treatment was $9 million reduction onetime in nature in both revenue and operating income.

Okay.

That's helpful. Thank you and then.

<unk> been doing a lot of work on the contract modifications.

If we said all of that aside and maybe take a step back.

What's the backdrop light now for hourly.

Labor 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 is no doubt about that but we have 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 now theres 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 Thats just for the industry in general less for <unk> 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.

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.

Okay, great. Thanks again.

The next question is from Ryan Daniels with William Blair. Your line is open.

Hey, guys. This is Jack on for Ryan Daniels just for a point of clarification, you were expecting one time negative revenue impact this quarter of about $17 million, but instead it came in at 9 million correct.

And then two so if I am thinking about this correctly is still above your estimated range for the last quarter modestly can you just comment on what kind of drove this revenue outperformance was this more like a factor of price increases or just any additional color you have would be appreciated.

Yeah, 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 wont really see until.

Until Q1 in earnest the impact in Q1.

Great. Thank you and then just as a quick follow up so I know <unk> is up again this quarter on a sequential basis, but obviously impacted by the onetime impacts mentioned before and then dsos up even more by about like five days or so.

And I know that you previously stated that you were in a position to collect on what your Bill 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 can be seen more in the fourth quarter and then in first quarter of 2023, where it's more just a function of timing that it's just getting pushed back or I guess how.

Should we be thinking about this going forward. Thanks.

Yeah, and just maybe to back up and to your point last quarter, we talked about how the majority of the shortfall of more than half of the shortfall year to date and that trend continued into Q3 was really.

That was driven through more intentional negotiation as part of these contract modifications so in working with our customers to come up with.

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 were thinking of that more of that 2023 dynamic.

As we Recalibrated some of the repayment plans, where 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.

A 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 often times. It comes with a security interest, which even if it is junior to our senior secured lender. It still gives us a seat at that secured lending secured interest table. So I think it's for all of those res.

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 will 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.

<unk> and the repayment agreements are scheduled to kick in.

Awesome. Thank you guys.

Okay. Thanks Jack.

The next question is from Mitra <unk> with Sidoti Your line is open.

Yes, good morning, and thanks for taking the questions first I was just curious as you bring on new business.

If you already have personnel wait.

Waiting to be deployed or are you running the business and sort of lean.

Say it right now that you'd have to go to.

Hi, Matt.

Managers et cetera.

No. The good spot that we're in midst 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 develop.

<unk> 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 opportunity.

<unk> management development, the availability of managers will be a drag on that really from our perspective, when we think about growth 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. Thanks, and speaking of senses, if you could just touch on the occupancy.

You're seeing amongst your clients.

And increasingly we're hearing talk about potential COVID-19 surge in <unk>.

Fourth quarter, new strains et cetera, how do you see yourself positioned to deal with that especially the nursing home industry.

Yes, well I would say the most recent occupancy data.

<unk> somewhat encouraging just industry wide metra in 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 one 2% higher than what we reported in Q2. So that's about a 10 basis point 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 its at least.

As 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-19 surge or anything like that in Q4, and we havent heard any of our clients talk about that is is there are always planning and preparing for not just COVID-19.

Flew in.

Other infectious diseases, but nothing specifically COVID-19 related that we've heard.

That the industry's 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 months to 18 months in terms of the industry recovery, it's going to be around staffing and labor availability and staffing continues to be the K occupancy is the key to IND.

History 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 do you expect that ticket.

Done by year end.

Yes.

They are still.

As I referenced earlier Mitra Theres still a few.

Loose ends and groups that we're working with but after Q4.

That initiative phase.

Kind of designated this is an initiative within the company, but will be that will be behind us.

And the emphasis on capturing recent and future inflation, which was really the driving force behind the initiative.

We will continue to be an area of focus and opportunity, but as far as the initiative in us highlighting.

The progress and the timing of that progress on this call that will that will be something that will be behind us.

And then finally I know the dividend, obviously is a priority with given where the stocks trading.

Should we be looking also in terms of capital being used for share buybacks.

Yeah look.

The buyback is always been something thats been considered by the board I think in terms of capital allocation strategy. The dividend remains the highest priority and an important part of that strategy second only to organic growth and internal investment.

So that along with the dividend along with just capital allocation in general is something the board will continue to evaluate quarter to quarter, but.

So obviously that could be an option if the situation presented itself for the opportunity presented itself in a different type of way, but for now I think organic growth internal investment and the dividend continues to be the priorities from a board perspective with respect to capital allocation.

Okay. Thanks, again for taking the questions.

Great.

The next question is from Brian <unk> with Jefferies. Your line is open.

Hey, good morning, guys.

My question is as we think about these contract modifications right. It's clear that you are focused on putting inflation adjusters in there.

But as we think about the health of the industry right now how are we or how should we be thinking about potential.

Clients are over or increases in bad debt.

As you rollout these new contract structures.

Yes, Brian as Ted alluded to we are.

We're through the majority of the work not that the work will ever six 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 opened for negotiation at any.

Between the customers and ourselves so we.

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 theres not to say that we wouldnt 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 Q.

III that 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 too.

The gate 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 its not something that we do cavalierly, but we do retain that confidence that we would be able to.

Replace that business.

Yes that makes sense and then I guess my second question is I think about a potential economic slowdown here as we look at 2023, I mean, maybe if you could remind us how the business fared during the last recession and how you are preparing for.

Kelly potential recession here as we exit 2023.

Yes, I think in terms of the.

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 the overall post pandemic recovery in terms of it never has reached pre pandemic levels in terms of.

In terms of workforce.

Occupancy as I highlighted earlier, so there is a kind of a counter view.

Industry specific that perhaps some of us.

Slack labor environment could be a nice boost in the event of a recession could be a nice boost to workforce availability consideration, so which could 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.

And so.

It's a difficult question to really answer because there is in recessions in the past the industry has always been generally speaking recession proof and I think our performance mirrored that because we're in a post pandemic state and the impact that that had on the industry as we approached the recession, it's somewhat of an.

Unknown, but again I think from a workforce availability perspective, I would think a recessionary environment, where even in economic slowdown would only.

Facilitate.

Additional workers for the industry.

Alright got it thanks guys.

Great. Thanks.

We have no further questions at this time I'll turn it over to Mr. <unk> 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.

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.

Yes.