Healthcare Services Group Inc

NASDAQ:HCSG

Earnings Call Transcript 2023-Q1

[Operator]

Good morning, and welcome to Healthcare Service Group Inc.'s First Quarter 2023 Earnings Call. [Operator Instructions] As a reminder, this conference call is being recorded.

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.

I would now like to turn the call over to Ted Wahl, President and CEO. Thank you. Please go ahead, Mr. Wahl.

[Theodore Wahl, executive]

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

For the 3 months ended March 31, 2023, we reported revenues of $417.2 million, GAAP net income of $12.7 million or $0.17 per share, and adjusted EBITDA of $27.5 million, an 18% increase over Q1 of last year. We also repurchased $2.2 million worth of our common stock as an opportunistic and tax-efficient way to return capital to shareholders.

Today, in my opening remarks, I will discuss our Q1 key accomplishments as well as our outlook for the rest of the year. I'll then turn the call over to Matt for a more detailed discussion on the quarter. We delivered strong operating results and service execution during the quarter as our relentless focus on customer experience, systems adherence and regulatory compliance led to high quality and consistent outcomes for our client partners.

The first key accomplishment I'd like to highlight is that for the second consecutive quarter, we achieved our cost of services target of 86%. This achievement underscores the strength of our customer relationships, our commitment to operational excellence and our enhanced value proposition.

The second key accomplishment I'd like to highlight is the marked improvement in Q1 cash collections year-over-year, in what has historically been our most challenging collections quarter. This accomplishment follows our strong Q4 cash collections, further validates our overall collection strategy and provides a strong foundation and positive momentum heading into the rest of the year.

Lastly, I'd like to highlight the successful exit of the final tranche of facilities related to the completion of the contract modification initiative. This accomplishment not only marks the final action of our contract modification initiative, but underscores our disciplined approach to managing the business and our ability to simultaneously deliver in the short term and prepare for the long term.

As far as our outlook for the rest of the year, we expect industry fundamentals to continue to improve, as a stabilizing labor market and stronger reimbursement environment, especially at the state level, contribute to a gradual occupancy recovery. We will continue to closely monitor industry dynamics and remain confident that the industry is on a path towards recovery, albeit a prolonged one. We also expect to continue to build on the significant progress we made over the past 6 months in replenishing our new business pipeline. And although the timing of new business adds remains dynamic, we anticipate a flattish top line in Q2 and a return to growth in the back half of the year. In the months ahead, we shall 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 with those introductory comments, I'll turn the call over to Matt for a more detailed discussion on our Q1 results.

[Matthew McKee, executive]

Thanks, Ted, and good morning, everyone. Revenue for the quarter was reported at $417.2 million, with housekeeping & laundry and dining & nutrition segment revenues of $193.4 (sic) [ 193.5 ] million and $224 (sic) [ 223.7 ] million, respectively. Housekeeping & laundry and dining & nutrition segment margins were 10.4% and 6.6%, respectively. Direct cost of services was reported at $361 million or 86.5%, and direct costs included a $6.9 million increase in our CECL AR reserves.

As Ted highlighted 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%. SG&A was reported at $40 million. After adjusting for the $1.5 million increase in deferred compensation, actual SG&A was $38.5 million or 9.2%, and we expect 2023 SG&A between 8.5% to 9.5%.

The effective tax rate was 27.8%, which included discrete items specific to Q1. The company expects a 2023 tax rate of 24% to 26%.

For those of you who saw the press release this morning, you might have noticed the table introducing non-GAAP financial measure, specifically adjusted EBITDA. The rationale for introducing adjusted EBITDA as a new metric is to enhance transparency, increase period-to-period comparability and more closely align our reporting with how management views the business. Having said that, adjusted EBITDA for Q1 was $27.5 million or 6.6% of revenue. That compares with $23.3 million for the same period in Q1 of 2022, which was 5.5% of revenue. Cash flow used in operations for the quarter was $16.3 million and was impacted by a $21.2 million decrease in accrued payroll and a $20.6 million increase in accounts receivable related to the timing of cash collections. DSO for the quarter was 76 days. Also, we would point out that the Q2 payroll accrual will be 13 days. That compares to the 6 days that we had in Q1 of 2023 and the 12 days that we had in Q2 of 2022. But the payroll accrual only relates to timing, and the impact ultimately washes out through the full year.

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

[Operator]

[Operator Instructions] Our first question comes from A.J. Rice from Credit Suisse.

[Albert Rice, analyst]

Maybe I'll just ask a couple of quick ones here, hopefully. So when we think about the margins you're posting this quarter, the 10.4% for housekeeping and 6.6% for dining, your modifications are done. Are these sort of normalized? And do you think margins in this range for the rest of the year are going to be achievable? Or any reasons to think they would either trend a little better or a little worse as we progress through the rest of the year?

[Theodore Wahl, executive]

Yes, A.J., it's a great question. I think specifically from a segment perspective, you're always going to see some movement month-to-month, quarter-to-quarter, largely due to execution, new business adds and other considerations that are happening each and every day out in our field-based operations. I think maybe to bring it back to our reported number, we're proud that our margins for the second quarter in a row, the second consecutive quarter, came out in that 86% target range, and we expect those positive trends to continue into Q2 of 2023 and feel confident in our ability to manage at those levels for the rest of the year.

I alluded to it in my initial response, but there's always going to be execution risk. We don't talk about that enough, but managing this business is difficult. There's a lot that goes into it. The client experience, budget versus actual, regulatory and compliance reporting, so for us, execution is always the key to the business. We've talked about CECL in the past, which introduces a degree of variability as well. One of the reasons, it wasn't the catalyst for us, but I think now providing that adjusted EBITDA table will at least provide a bit of context to any sort of CECL adjustment quarter-to-quarter.

The only other variable to our ability to deliver on those margins as we see it would be growth, which would be a good thing. And as you know, that's always a factor because when we're starting new business and inheriting the existing payrolls and supply budgets, there's typically some initial margin compression as we work to implement our systems and staffing patterns. Typically, that lasts anywhere from 60 to 90 days, but that could be a temporary drag as well. I think overall, though, we feel very good about the underlying business and the KPIs and trends related to experience, systems adherence, regulatory compliance and budget discipline, all of which are factors in margin consistency.

[Albert Rice, analyst]

Okay. That's great. I know the CECL accrual gets volatile quarter-to-quarter. And I think you had an increase of 6.9% you're calling out this quarter. Anything about that, that says, hey, this is going to -- we're going to have an ongoing accrual of bad debts at a higher rate? Or is that sort of a onetime adjustment? Or how should we think about that? I know it's sort of formulaic, but any thought on that going forward?

[Theodore Wahl, executive]

Yes. I think we introduced adjusted EBITDA for a few reasons, primarily to really increase transparency and increase the comparability quarter to quarter, period to period. But more importantly, it's more closely aligned with how management views the business, including bad debt expense. CECL, as you alluded to, is very formulaic. In our adjusted EBITDA table, we show the difference between the CECL bad debt reserve and what our actual write-offs have been using the same look-back period. So that's another indicator, another way to look at, if past its prologue, what we could expect moving forward.

[Albert Rice, analyst]

Okay. One last question. You had a $16 million use of cash this quarter. It looks like that was primarily driven by the volatility in the accrued payroll and so forth. And you said -- you pointed out how that's going to swing around in the second quarter. Can you just give us a sense of where you think a normalized cash flow run rate is for you? Do you have a target for the year or a range that you think is the right way to think about cash flow normalizing for the volatility in the payables?

[Theodore Wahl, executive]

Yes, I'd say for any given year, the best proxy for free cash flow continues to be net income. Having said that, we are in a period where, as the industry is recovering, there's a bit more fits and starts with cash collections in any given quarter, specifically as we called out our expectations around the first half of the year.

But to your question, based on the timing and the impact of the Q2 payroll accrual, we would project a free cash flow range in that $15 million to $25 million territory. And then for the second half of the year, A.J., $20 million to $30 million. So net-net for the year, that gets you to about a $30 million free cash flow number, which will likely prove to be conservative, but it gives you at least a flavor for how we're thinking about the cadence for the balance of the year.

[Operator]

Our next question comes from Andy Wittmann from Baird.

[Andrew J. Wittmann, analyst]

Sorry, I just wanted to make sure that I -- and maybe everybody else is on the same page -- about the AR definitions here in your adjusted EBITDA. So let me try to articulate it a different way and see if I've understood this correctly. So you took a total CECL AR reserve against bad debt of $6.9 million. That was -- the way you're thinking about that is that's actually just $4 million, I guess, higher than the way you think about it. And I guess the way you think about it is kind of the old methodology before CECL became the standard. Is that the right way of kind of thinking about what you're doing there with that reconciliation?

[Theodore Wahl, executive]

Let me play it back a different way for you, Andy. I'd say CECL, and you're right, has showed $6.9 million this quarter. What we did is we used that same 7-year look-back period and compared actual write-offs against actual revenue in that 7-year look-back period. And then that was -- and then the resulting difference was the adjustment in the adjusted EBITDA table.

Said another way, the $6.9 million -- the $6.9 million CECL reserve was about 1.6%, 1.7% of revenue. The write-off reserve would have been 70 basis points of revenue. So the difference of that is the adjustment in the table. It's just presenting what we actually wrote off over that 7-year period versus what is being reserved for, because write-off -- what we're reserving for within CECL is not necessarily indicative of what's going to be written off, because a lot of it just relates to timing, not necessarily risk profile.

[Andrew J. Wittmann, analyst]

And is it also -- is the adjustment here, I guess, conceptually reflective of the last 7 years, which is required under the GAAP, were obviously a tough 7 years in terms of the write-offs. But with the improvements that you've made over the last -- actually, more than just 1 year, 1.5 years, 2 years in this, the thought is that you'll be in a better position, and that those 7 past years are not indicative of the first of the coming years in the future? Is that part of the thought process in doing what you're doing here as well?

[Theodore Wahl, executive]

Well, it's just showing what we actually wrote off, right? I mean not what we're -- not as being -- not what necessarily what's being reserved, but what's being written off. But to your point, Andy, I mean, whether the past is necessarily indicative of the future, we're not willing to accept a single write-off. For us, any write-off is disappointing. We work hard for every single dollar we're able to earn as a company and which is why you highlighted it, I guess, in concept. But we've spent a lot of time, whether it's increasing payment frequency and the strategy that we've had around that, today still greater than 60% of our customers are paying us at a frequency of greater than monthly. In most cases, it's weekly. In some cases, it's biweekly. But we were sitting here a couple of years ago, we would have been able to count on one hand the number of customers that were paying us at a frequency greater than monthly.

We are more proactively than ever utilizing promissory notes as a critical tactic in our overall collection strategy, and we've been successful in that endeavor. And perhaps most importantly, remaining disciplined in our decision-making, not just for existing business but also for new business. So all of that are going to be focal points for us moving forward, and we believe will bear fruit in '23, but certainly in the years ahead.

[Andrew J. Wittmann, analyst]

Got it. Okay. So just a couple more questions along that line then. Can you talk -- maybe Matt, you've got the number handy. What was -- how much was converted into promissory notes in the quarter? And is the bad debt -- can you just remind me, is that reflected in your COGS? Or is that in your SG&A line? I think it's in COGS, but I just wanted to verify.

[Matthew McKee, executive]

Yes, Andy, it was about $14 million that was converted to promissory notes in the quarter, and that was both a combination of the final sort of cleanup and conclusion of the contract modification initiatives, and then just normal course, because as we've discussed previously, we increasingly view the promissory note as not simply a workout tool but really a favorable proactive tool by which we can really capture and secure receivable balances with our clients.

[Andrew J. Wittmann, analyst]

Got it. Okay. On the COGS question?

[Matthew McKee, executive]

Sorry, could you repeat that one, Andy?

[Andrew J. Wittmann, analyst]

The second half of my question was the bad debt. Is that reported in the gross margins or in the SG&A?

[Matthew McKee, executive]

Yes, that's in gross margin and cost of services.

[Andrew J. Wittmann, analyst]

Okay. And then sorry, last question here. Just more fundamentally, I guess Ted, now that the contract review process is done, I guess, how much of a benefit could that be to your top line, presuming that you'll have to walk away from fewer contracts here in '23 than you did in '22? In other words, your customer retention, I suspect, will be better this year than it was last year. How much help do you think that offers you to your top line growth rate this year?

[Theodore Wahl, executive]

Yes, Andy, I wouldn't be able to quantify the -- necessarily the puts and takes around your question other than to say we feel very confident in how solid our core customer base is today. I mean one of the benefits of the contract modification initiative, Andy, beyond making sure we were rightsizing the increases in a way where they could keep up with the significant inflation we've experienced, is the connectivity and the contact we had with our customers. I mean we've described it before, but it was bottoms up, all hands on deck. It wasn't done out of a home office with maps and pushpins. It was our field-based operators, our field-based leaders working with their counterparts, aligning on a future, what it could look like from a contract perspective, what some of the operational adjustments, maybe that we're aligning the operations more with their preferences. So it was very collaborative.

We could have taken a different approach and sent Dear valued customer letters, that would have failed on day 1. So we were very pleased, aside from the financial outcome and maybe more importantly, the durability that it provides to these client partnerships, was the enhanced customer relationships we had moving forward. So I think that, although it doesn't necessarily answer your question quantitatively, I think will inure to the company's benefit for months and years to come.

[Operator]

Our next question comes from Sean Dodge from RBC Capital Markets.

[Sean Dodge, analyst]

Just to start, I have one more on CECL and the reserving process just to make sure I'm clear there. If we kind of roll forward in your collections performance, if that stabilizes or improves, would there be additional CECL reserves in each quarter? Or is this kind of -- are you reserving kind of above or below some type of like baseline?

[Theodore Wahl, executive]

It's not a baseline. It's the CECL calculation essentially looking back over 7 years and assigning percentages to each aging bucket. And then that produces the reserve, and the difference quarter-to-quarter reserve, the resulting difference quarter-to-quarter is the bad debt expense. But to your point, Sean, as we -- depending on cash collections and the timing of cash collections, the way the formula has worked historically, the stronger the cash collections in any given quarter, the lower the CECL reserve. So we could end up at some point in the future, which we've had in the past, where we actually have a credit balance resulting in bad expense. If we have a couple of strong cash collection quarters depending on how that's applied to the reserve buckets and the clients within those buckets, we could have a pickup within bad debt expense, which I'll be honest with you, I don't believe that's appropriate either. So that's why we're anchoring it back to what have we historically written off. So in some quarters, as our cash collections improve and become stronger in the months and years ahead, as CECL becomes lower, we're still going to, in our adjusted EBITDA table, show what the actual write-offs have been. It's just to present a different context, and really more aligned with the way management views the result of the work that we do in our financial services department.

[Sean Dodge, analyst]

Okay. So there will likely always be some type of reserve in the quarter, but that reserve will get smaller as your performance improves?

[Theodore Wahl, executive]

I think that as our cash collections improve, I think that's a fair -- it's not a guarantee because, again, it depends on the aging of the buckets and the customers within those buckets. But yes, I think directionally, that is a fair statement.

[Sean Dodge, analyst]

Okay. Okay. Good. And then you said the plan is still to return to growth in the back half of the year. Should we think about the kind of the first motion there being the dining cross-sell, so targeting existing housekeeping customers and adding in the dining services? And then I guess, maybe give us an update on where you are as far as reramping all of the manager recruiting and training efforts needed to feed that? Is that kind of all getting underway now?

[Matthew McKee, executive]

Yes. Absolutely, Sean. We've talked for quite some time, and with conviction, about the lowest-hanging fruit for us as an organization with respect to growth being that cross-sell opportunity, given that as we sit here, if we look at our existing customers from a housekeeping & laundry perspective, we're still with less than 50% penetration in also providing dining services.

Now in this environment, obviously, we can make a more accurate and a higher level of conviction assessment of the financial help of that existing housekeeping and laundry customer, to determine if it's appropriate to then add dining services to the mix of services provided. That's compared to making that assessment with the greenfield opportunity for a prospective customer off the street. So without a doubt, that remains an appealing and attractive growth opportunity for us, is that cross-sell of dining services. Keeping in mind that we continue to view environmental services, housekeeping & laundry services as the greenfield sales lead opportunity, and then would view the cross-sell as secondary from there.

There are instances in which we do initiate a relationship with a new customer and provide both services, but that's far less frequent than offering housekeeping & laundry services as the lead. Just to sort of digress and think about the bigger picture as to the growth prospects, we've certainly spoken previously about restocking our prospect pipeline, and we continue to see that pipeline grow. We're obviously focusing on growth, especially as we look to the back half of the year.

And some of the other factors that contribute to that view, Sean, in addition to the cross-sell of dining services that you alluded to, would be, of course, the ongoing industry recovery, which puts both customers and prospects on firmer financial footing. And that's bolstered by some of the census recovery that we're seeing out there and some of the reimbursement wins that we're seeing really not only at the federal Medicare level, but state by state, some of the Medicaid improvements that we're seeing.

The increased resonance of our value proposition, which affects not only our new business pipeline, but also our ability to retain the existing business, the continued build-out of our management capacity, as you noted, through recruiting efforts, hiring and training, and all of that being executed locally at our facilities, just as it always has been. And then another element that we've maybe not talked as much about previously is the fact that we're in an increasingly transactional environment as far as facility ownership changes.

There are survey data, and our experience certainly mirrors this, that saw 2022 as a record year for deals within the skilled nursing space. The frequency of SNF deals accelerated in the last 4 months of 2022, and in a separate study, nearly 3/4 of owners, executive and administrators, predicted that their organization would likely be engaged in an acquisition, sale or merger in 2023. So in those instances, we continue to assess the new operating ownership and determine the course of action that's best for the company, specifically whether it makes sense to continue providing services or to exit the business.

And on a net basis, Sean, we expect that this transactional environment should allow us to expand our partnerships with the strong acquiring operators. Now as always, we'll guard against engaging with distressed or unproven players, but overall, we're definitely building toward growth. And of course, we'll manage growth in a measured way so as to ensure that we're appropriately assessing new prospects and ensuring that we have the managerial wherewithal to deliver operationally. But I can tell you that there's a palpable enthusiasm within the organization for getting back into that growth cycle.

[Operator]

Our next question comes from Tao Qiu from Stifel.

[Tao Qiu, analyst]

We're seeing consistent market improvement in dining margin over the past 2 quarters, which has been a major contributor to the bottom line. I think the 6.6% margin number is higher than the averages pre-pandemic. And I believe some of that is the catch-up on food cost from contract modification, which ties your rate to some type of cost index. Is there any reason you think you can or can't be sustained at that level in the context of moderating CPI numbers? And second to that, I think in the past, you have been at a higher single-digit level of margin for that business. Is that still the case?

[Matthew McKee, executive]

Yes. To speak specifically to your point about the food inflation, Tao, you're exactly right in that in the quarter, food at home inflation was 0.4%, and that was a sequential improvement from Q4, which was 1.1%. And then with respect to the pass-through mechanism, you're exactly right that the inflation that we experienced in the third quarter of 2022 would have been passed through in this first quarter. And the third quarter inflation was 2.7%. So you're exactly right in that we're getting a 2.7% increase, inflationary increase in Q1, and that compared to the actual inflation that we saw in the quarter of 0.4%.

So definitely, if inflation continues to move in a favorable direction, that will be beneficial. As a matter of fact, it's worth noting that in March, we actually showed 30 basis points of deflation in that CPI food at home data. So definitely something to keep an eye on there, and that could be a favorable benefit if we continue to see food deflation.

And with respect to the dining margin, Tao, the target, as Ted alluded to in his opening remarks, is a little bit of a moving target with respect to not only operational execution, but new business adds as well. So for the time being, we continue to view an appropriate segment-level margin for dining in that sort of mid-single digit, mid- to high single digit.

[Tao Qiu, analyst]

Got you. I don't think we have talked about labor so far. I think a few health care services providers that have reported continue to see sequential improvement on labor conditions. Could you maybe shed more light on your experience this quarter in terms of hiring, open positions, turnovers, et cetera?

[Matthew McKee, executive]

Yes, Tao, I mean, broadly speaking, on a national level, the labor force participation rate continues to trend positive and has picked up 10 bps each of the past 3 months. Job openings and wage growth are all trending downward. I would probably use the word stabilization to describe our overall experience relative to the labor market.

However, one of the themes that we mentioned on our last call, as far as kind of the haves and have-nots, continues to bear out. And generally speaking, we've seen greater improvement in suburban and urban markets as compared to the rural markets. And there are definitely some markets that remain more challenging than others, but that offers HCSG really an opportunity to demonstrate one of the key components of our value prop, and that's the fact that we have more resources and are better equipped to manage through these challenges that an in-house managed operation or a would-be competitor. So overall, Tao, I would characterize our general environment as stable, with market improvement in certain markets.

[Tao Qiu, analyst]

Okay. Last question for me. I think the nursing home industry is anxiously waiting for the announcement of the federal minimum staffing to understanding that the regulation is focused on the clinical side of the labor force. I'm curious what is your perspective on how that might affect your business? Does it make it more likely or less likely that potential clients will be interested in outsourcing [ HSG's ] services?

[Theodore Wahl, executive]

Yes. I'd say overall, we're going to continue to monitor the industry recovery along with the reimbursement and regulatory dynamics, probably the most awaited one, Tao, you pointed out, very closely so we can make informed decisions along the way. I think just generally inclusive of the minimum staffing, the fact that there's uncertainty or when there is uncertainty, whether it's around the timing of recovery, reimbursement or any sort of regulation, it almost forces providers to find ways to create more certainty in their business. And when you think about it, the central theme of our value proposition is providing peace of mind, operational and financial peace of mind. So still too early to tell generally what impact, if any, that would have. You think if the mandate is -- has an appropriate pilot, it has a phase-in period, along with it a recognition of labor availability constraints. And -- and this is the big one -- and it's fully funded, I think the industry would lean into that type of framework. But an unfunded mandate obviously, not recognizing the realities on the ground, would not be well received. So stay tuned, all of us, right? We'll be able to react and adapt to whatever happens. But generally speaking, I think given our value proposition, if anything, it would only increase the demand for our services.

[Operator]

Our next question comes from Ryan Daniels from William Blair.

[Jack Melick, analyst]

Yes. This is Jack Melick on for Ryan. Quick question. With Q1 in the books, any update you'd like to give on the share repurchase program and maybe any highlights to a change in strategy on that front?

[Theodore Wahl, executive]

No change in strategy. We did purchase about $2.2 million worth of shares during the quarter, and we really view the buyback as opportunistic and as a tax-efficient way to return capital. Again, we'll be very opportunistic with respect to timing, and that timing will depend on a variety of factors, whether it's liquidity, expected cash flow, of course, our share price. We'll look at annual dilution rates and always alternative use analysis, where can we deliver the highest returns. But that was the quarterly activity, and we'll continue to evaluate it each and every week and each and every quarter.

[Jack Melick, analyst]

Okay. And if you could also provide a bit more color into what drove weaker top line performance this quarter, maybe a bit of detail on the mix between contract modification, price increases versus facility exits. I guess if I'm thinking about this correctly, was it more end market driven? Or is there something else to call out?

[Matthew McKee, executive]

No, Jack, last quarter, we obviously estimated Q1 revenue would be in the $420 million to $425 million range, and we reported $417 million, just outside that estimated range, largely due to the fact that we pulled forward the final tranche of the contract modification-related exits, meaning we exited some of that business earlier than we had originally anticipated.

So looking ahead, we'll continue to build on our work over the last 6 months in replenishing that business pipeline, as I alluded to earlier. Although the timing of some of the new business adds does remain dynamic, we anticipate flattish top line into Q2, with the contract modification work behind us and a return to growth in the back half of the year.

[Operator]

Our next question comes from Bill Sutherland from Benchmark.

[William Sutherland, analyst]

Good to see all the progress. I was curious, Ted, does the Medicaid redetermination issue have -- what are you hearing on that as far as any impact on the clients?

[Theodore Wahl, executive]

What was that, Bill? I'm not sure I heard you.

[William Sutherland, analyst]

This is not in the current period, but looking at what Medicaid -- what's being proposed -- or not proposed, but the redetermination process that's going on with the Medicaid beneficiaries?

[Theodore Wahl, executive]

Yes, I think I would include that as part of the overall environment, Bill. Going line by line for each and every one of these items, it's all dependent on the market and the specific management companies and/or clients that any one piece of regulation or reimbursement impacts. When you think about -- a lot of these calls, we find ourself speaking at a higher level, kind of rolled up type reports and numbers. But to really think about the business and evaluate the business in a meaningful way, which is what we're doing each and every day, you really have to look not just within the state, but also within a local market and how the facts and circumstances, or again, any piece of reimbursement or regulatory pressure, may impact a given operator. So I would include that or any other executive order, regulation, reimbursement as part of our collective that we're evaluating in our assessment of the business and certainly informs -- could inform a decision that we may make.

[William Sutherland, analyst]

Okay. I was noticing that absent the CECL reserve, your core cost of goods was actually closer to 85%. So when you guys talk core, you're assuming a certain level of reserving, right?

[Theodore Wahl, executive]

That's right.

[William Sutherland, analyst]

Okay. I just wanted to clarify that. And then education, can you give us any color on how that did in the quarter or how that's looking?

[Theodore Wahl, executive]

Yes. We've been at it for less than 2 years, and it's beyond the pilot stage at this point, Bill. And I would say it's formally into the start-up phase. The early returns have been remarkably positive, but it is still somewhat nascent. And to your question, it still makes up less than 5% of our revenues. That said, it's an opportunity that we're deeply committed to further exploring in 2023. There's many similarities between our core market and the education space, just the most similar being that they're both highly fragmented, largely in-sourced and vast.

And I would say our value proposition very much resonates in this market where we're providing a similar product offering, and it has similar margin profiles and working capital profiles. So the early returns continue to be positive, and we have a strong commitment to exploring the opportunity further in the year ahead, more as a complement to our 2023 growth strategy. But beyond that, perhaps something more meaningful.

[Operator]

Our last question will come from Brian Tanquilut from Jefferies.

[Brian Tanquilut, analyst]

Congrats on the quarter. I guess my question, as you mentioned improving occupancy trends for your end clients being a factor in the improvement of the business, how are the conversations changing? I mean in terms of inbound and how your clients are thinking about their business today that gives us maybe visibility into future growth or your ability to accelerate growth, let's just say beginning in the back half of this year?

[Matthew McKee, executive]

Yes. I think you touched on the biggest factor that relates to our assessment of prospective clients, and quite honestly, Brian, their willingness to engage an outsourcing partner from an operational capacity and availability perspective, in that occupancy, while not a panacea, is certainly a significant contributor to the overall financial health of a client. And that is, as we've discussed in a very much a cause and effect way, tied to the availability of professional nursing staff.

And not to sort of beat the dead horse here on this theme of haves and have-nots, but that continues to bear out. I talked about the impact of, the sort of geographic impact of suburban and urban labor market as compared to rural labor market, and that has a direct effect on the ability to drive census. We're looking at, of course, national occupancy data. But when we look at our own internal data with respect to our clients' occupancy, there's a fairly significant delta between occupancy as a percentage of capacity in the urban and suburban facilities as compared to rural.

So without a doubt, occupancy does have an impact. We are seeing this thematic have and have-not really kind of continues to bear out. So all of that is definitely something that we keep in mind and keep top of mind. It certainly flavors our view of not only the health of our existing customer base, but how we assess and consider prospective customer partners. But much more than any national level data or even our own existing sort of customer base data in assessing new prospects, is really to dig in and do that full financial assessment, not only of their current state as it relates to their financial wherewithal and well-being, but just as importantly, if not more so, is their go-forward prospects. And that's an assessment, not only of kind of their geographical positioning, what state they're operating in, what other states they may have exposure to in their portfolio and really the specific conditions within the 4 walls of that facility, in making our assessment as to determining a healthy prospect or a target that we would perhaps put on the shelf and reconsider when they find themselves in a more favorable financial position. So definitely, as I noted, not the panacea, occupancy, but certainly a significant driver of that assessment.

[Brian Tanquilut, analyst]

Got you. No, that makes sense. And then I guess, as I think about DSOs, any thoughts that we need to be considering in our models for like seasonality of DSOs going forward?

[Theodore Wahl, executive]

Not beyond, I'd say, the cash collection or cash flow estimates, Brian, I provided to A.J. earlier in the call. Meaning as we're -- our goal each and every quarter is to collect what we bill. And if we achieve that goal, when we achieve that goal, DSO is going to remain flattish with a downward trajectory in a quarter like Q1, which is traditionally our weakest quarter of the year, you typically would see a DSO uptick. And then if we're successful in executing on our strategy for the remainder of the year, you'd see a downtick. And that's what our goal would be. So it's a good indicator. It's not the only indicator when you think about underlying customer health and future prospects of collection, but it's an indicator and something we should all continue to monitor, and we certainly do going forward. But again, as our cash collections improve throughout the rest of the year, I would expect DSO to trend downward.

[Operator]

We have no further questions in queue. I'd like to turn the call back over to Ted Wahl for closing remarks.

[Theodore Wahl, executive]

Okay. Great. Thank you, Julianne. And in the months ahead, we remain committed to executing on our 2023 priorities. Operational excellence, with the goal of delivering on our operational imperative of customer experience, systems adherence, regulatory compliance and budget discipline, cash collections with the goal of collecting what we bill, and growth with the goal of opportunistically adding new business from our growing pipeline of future client partners.

Longer term, we remain excited about our rebalanced capital allocation strategy which prioritizes more proactive, impactful and enduring ways to create shareholder value. Our future investments in organic growth drivers, inorganic growth opportunities and opportunistic share repurchases will not only accelerate value creation, but more importantly, best position the company to deliver sustainable, profitable growth over the long term.

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

[Operator]

This concludes today's conference call. Thank you for your participation. You may now disconnect.