Healthcare Services Group Inc

NASDAQ:HCSG

Earnings Call Analysis

Upbeat Q3 Performance; Enhanced Q4 Outlook

In Q3 2023, the company posted $411.4 million in revenue, a 13.9% uptick from the prior year, with adjusted EBITDA growing 10.2% to $23.3 million. Adjusted cash flow from operations soared by 208.9% to $18 million. Key priorities like managing adjusted cost of services at 86% were met, and cash collections exceeded expectations at 98% of billed amounts. New contracts with facility operators anticipate a stable or better future financial outcome. The company raised its H2 2023 cash flow projection from $20-30 million to $35-45 million, with Q4 adjusted revenue expected between $420-430 million. Segment margins for Housekeeping & Laundry and Dining & Nutrition were adjusted to 7.2% and 4.7% respectively. Riding on these results, the company anticipates strong year-end performance and continued positive trends into 2024.

Resilience in Financials Amid Challenges

Healthcare Services Group reported its Q3 2023 financials with resilience, achieving $411.4 million in revenue and $424 million in adjusted revenue, aligning with their forecasted range of $420 million to $430 million. Although the company faced a net loss of $5.5 million and a diluted loss per share of $0.07, it made headway with a 13.9% and 13.3% increase in adjusted net income and adjusted diluted earnings per share over the last year.

Substantial Growth in Cash Flow and EBITDA

Cash flow from operations skyrocketed to 208.9% compared to Q3 2022, and adjusted cash flow from operations surged to $18 million. Moreover, adjusted EBITDA experienced a healthy 10.2% increase year-over-year. The company capitalizes on such achievements by upping their expectations for H2 2023 cash flow from operations to $35 million to $45 million from the previously expected $20 million to $30 million.

Segment Performance and Cost Maintenance

Segment-wise, Adjusted Housekeeping & Laundry and Dining & Nutrition revenues were $194.6 million and $229.4 million, respectively. The strategic management of cost services remained robust at 86.4%, mirroring their established goal of 86%. Moreover, segment margins adjusted nicely, with Housekeeping & Laundry at 7.2% and Dining & Nutrition at 4.7%.

Solid Debt Collection and Improvement in Days Sales Outstanding

The company strengthened its debt collection efforts, with days sales outstanding (DSO) falling to 82 days from 86, indicating a more efficient collection strategy. The refined adjusted DSO stood at 79 days, which is a notable 4-day improvement from the previous quarter.

Navigating Industry Dynamics and Regulation

Healthcare Services Group is navigating industry restructurings, entering new agreements to retain business affected by changes in client operations. The company is adapting to the shift from large multistate operators to regional ones, reducing the risk in accounts receivables. Despite regulatory uncertainties such as the minimum staffing rule proposed by CMS, the firm’s prudent outlook is geared toward continued improvement amidst industry turbulence.

Earnings Call Transcript 2023-Q3

[Operator]

Good morning. My name is Ralph, and I will be your conference operator today. At this time, I would like to welcome everyone to the Healthcare Services Group Third Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. 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 at 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, President and CEO, you may begin your conference.

[Theodore Wahl, executive]

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

Today, in my opening remarks, I will first discuss our third quarter financial highlights and key accomplishments. Next, I will provide an update on recent client restructuring actions. I'll then share our perspective on the latest industry trends and developments. And then finally, I'll share our fourth quarter and 2024 outlook. I'll then turn the call over to Matt to provide a more detailed discussion on the quarter, including our basis for GAAP to non-GAAP reporting. So with that overview, I'd like to now discuss our third quarter financial highlights and key accomplishments.

For the 3 months ended September 30, 2023, we reported revenue of $411.4 million and adjusted revenue of $424 million, in line with our expectations of $420 million to $430 million. We reported net loss and diluted loss per share of $5.5 million and $0.07 per share, and adjusted net income and adjusted diluted earnings per share of $12.5 million and $0.17 per share, a 13.9% and 13.3% increase, respectively, over Q3 2022.

We reported adjusted EBITDA of $23.3 million, a 10.2% increase over Q3 2022. And we reported cash flow from operations of $2.9 million and adjusted cash flow from operations of $18 million, a 208.9% increase over Q3 2022.

We entered the second half of the year with 3 clear priorities and made substantial progress on all 3 during the quarter. The first was continuing to manage adjusted cost of services at 86%, which we did. The second was collecting what we bill, building on the strong momentum that we gained in May and June.

In Q3, we delivered our strongest cash collections of the year, collecting over 98% of what we billed, with the modest shortfall primarily related to the timing of new business adds during the quarter.

The third priority was executing on our organic growth strategy. Adjusted revenue for the quarter was up sequentially. Our sales pipeline is growing. And our recruiting and management development efforts are ramping up as we ready ourselves for growth.

Now moving on to some of the recent client restructuring actions. We had 2 long-term clients initiate restructurings during the quarter. As part of their restructuring actions, these customer groups divested facilities to new operators. We're pleased to report that we've entered into new agreements with those new operators to retain the business and ensure many more years of partnership. As a result, we expect a neutral to positive effect on future revenue and earnings related to these facilities.

These client downsizing actions are in line with the ongoing shift in the sector, from large multistate operators to smaller regional operators. This shift is a very good thing for us for many reasons, not the least of which is diversity of AR risk. I would also add that, notably, Genesis is not one of the restructurings. We continue to be very encouraged by the positive direction of their organization as they work towards their goal of having a leaner, healthier regional footprint, and with our most recent conversations regarding our partnership going forward, both operationally and financially.

I'd like to now share our perspective on the latest industry trends and developments. As we look towards 2024, 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. On the regulatory front, on September 1, CMS proposed the minimum staffing rule, which triggered a 60-day comment period that will remain open until November 6, 2023. A final rule is expected mid-2024.

There is a growing list of stakeholders opposed to the rule, including health care industry leaders, trade associations like ACA, MedPAC members, and a bipartisan group of legislators, including 28 senators and counting. The reasons for their opposition include the unfunded nature of the mandate, the one-size-fits-all approach, the apparent disregard for the realities of present and future nursing availability, and the near certainty that, if implemented as proposed, the rule would lead to facility closures and ultimately reduce access to care, particularly in rural areas.

In addition to the public comment period, any rule would have to survive an onslaught of litigation, political changes in administration, and at least on some level, be funded. From our perspective, there remains great uncertainty as to whether any final rule would ultimately be implemented, at least a rule that resembles the current proposal.

As far as our outlook for the fourth quarter in 2024, we enter Q4 with 3 clear priorities. The first is continuing to manage adjusted cost of services in line with our target of 86%. The second is collecting what we bill, building on the strong momentum gained in May, June and Q3. We're raising our expectations for second half of 2023 cash flow from operations from $20 million to $30 million to what is now $35 million to $45 million.

The third priority is continuing to execute on our organic growth strategy. Our Q4 adjusted revenue estimated range is $420 million to $430 million. We look forward to ending the year on a strong note and expect our positive operating cash collection and new business trends to continue into 2024.

So with those introductory comments, I'll turn the call over to Matt for a more detailed discussion on the quarter, including our basis for GAAP to non-GAAP reporting.

[Matthew McKee, executive]

Thank you, Ted, and good morning, everyone. For those of you who saw the press release this morning, you might have noticed that we introduced supplemental non-GAAP financial tables. The rationale for the supplemental schedules is to enhance transparency by providing even greater visibility into current business trends to increase period-to-period comparability and will closely align our reporting with how management views the business.

So with that context, I'd like to now move on to a more detailed discussion of the quarter. Revenue was $411.4 million. Adjusted revenue was $424 million, Housekeeping & Laundry and Dining & Nutrition segment revenues were $190.9 million and $220.5 million, respectively. Adjusted Housekeeping & Laundry and Dining & Nutrition segment revenues were $194.6 million and $229.4 million, respectively. Housekeeping & Laundry and Dining & Nutrition segment margins were 5.4% and 0.9%, respectively. Adjusted Housekeeping & Laundry and Dining & Nutrition segment margins were 7.2% and 4.7%, respectively.

Cost of services was $377.6 million. Adjusted cost of services was $366.2 million or 86.4%, in line with our target of 86%. And our goal is to continue to manage adjusted cost of services in the 86% range. SG&A was $39.0 million. Adjusted SG&A was $40.3 million or 9.5%, within the company's targeted range of 8.5% to 9.5%. And we expect to continue to manage adjusted SG&A within that targeted range.

Third quarter cash flow and adjusted cash flow from operations were $2.9 million and $18.0 million, respectively. As Ted mentioned in his opening remarks, we raised our expectations for second half 2023 cash flow from operations from $20 million to $30 million to $35 million to $45 million. DSO for the quarter was 82 days. Adjusted DSO was 79 days, a 4-day improvement over last quarter.

Also, as part of our adjusted results, we adjust for the impact of the change in payroll accrual. But since it will still be included in our reported cash flow from operations, we would point out that the Q4 payroll accrual is 15 days. That compares to the 7 days that we had in the third quarter of 2023 and 14 days that we had in the fourth quarter of 2022. But again, the payroll accrual only relates to quarter-to-quarter timing.

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

[Operator]

[Operator Instructions] Our first question comes from the line of Sean Dodge from RBC Capital Markets.

[Sean Dodge, analyst]

Maybe just starting with the impact of the 2 restructurings. Ted, you said some of the facilities were divested but you signed contracts with the new operators. Did either of those new agreements contribute any revenue in the quarter? I guess I'm just looking for a little bit of help squaring, that was the revenue and the adjusted revenue you reported. Should we think about the $424 million of adjusted revenue numbers, is that kind of the jumping-off point into Q4?

[Theodore Wahl, executive]

It is, Sean. And really that -- in terms of the impact on restructuring, there was no -- other than the way it was accounted for as a temporary onetime step down in revenue. In terms of the go-forward, we believe that there's going to be more opportunity because divestiture of facilities was a large part of the restructuring activities of both of these groups. So they provide us new operators and smaller, nimbler organizations to grow within the future. And that's why we expect, going forward, from a revenue and earnings perspective, it to be a neutral to positive event.

[Sean Dodge, analyst]

Okay. Great. And then, on the guidance for the cash from operations for the second half of the year, the $35 million to $45 million, is that an adjusted number? Or will that be GAAP? And then maybe if you could just walk us through the visibility you have into that, what gives you the confidence to raise that range by, the $15 million...

[Theodore Wahl, executive]

To be consistent with how we presented it last quarter and the quarter before in terms of our second half of the year expectations, we're just presenting and sharing a GAAP number. So that's -- our revised range has moved from $20 million to $30 million to $35 million to $45 million.

And in terms of our conviction around that number, I think it's a function of what we've talked about before. While the industry is still recovering, it hasn't fully recovered. We talked about, coming into the year, even on the heels of a strong Q4 last year, we expected some fits and starts on the collections front, especially in the beginning of the year, which is why we provided more modest cash flow estimates for the first half of the year.

But during the third quarter, and really starting in the second quarter with May and June, we continued that strong momentum, and this quarter collected over 98% of what we billed. And I mentioned it in the opening remarks, but the modest shortfall was really related to some of the startups we had intra-quarter.

So we have positive momentum heading into Q4, and visibility, Sean. Visibility is a big thing in any business, including ours. So I think the signals that Matt and I are trying to send to our investors and all of our stakeholders is we're continuing to gain visibility into our future performance, and that's what gives us conviction.

[Sean Dodge, analyst]

Okay. Great. And congratulations on the progress in the quarter.

[Theodore Wahl, executive]

No, I appreciate it, Sean.

[Operator]

Your next question comes from the line of Andy Wittmann from Baird.

[Andrew J. Wittmann, analyst]

Gentlemen, I appreciate you taking the time for my question here. And I guess, Matt, maybe I wanted to just dig into the $21.3 million, the item here in the reconciliation, just to get a little bit more color. It seems like there's 2 factors here. It looks like there's some of the revenue recognition that you talked to in the prior question, but it's also a component that's just, I guess, I'd just call it kind of bad debt write-downs judging from the footnote. Can you just tell me how much of the $ 21.7 million was what would be, I guess, considered a bad debt write-down?

[Theodore Wahl, executive]

Sean, I think -- and this is Ted speaking. About $12.5 million would have impacted the top line with the balance impacting bad debt. And that's just a function of the way the accounting guidance works. There's still -- there was still a partial ongoing relationship with the smaller much leaner operation that the existing customer is organized. So because they're still an existing customer, that's accounted for as a onetime revenue step down in the quarter.

And then conversely, the other restructuring has been divested in full to 2 separate operators. And because that's a former customer, that's accounted for as bad debt. So it's just geography in terms of the P&L, but the same impact, noncash, onetime from our perspective. Legacy issue.

[Andrew J. Wittmann, analyst]

Got it. So then I guess the question is from a process point of view, given that you've got about $9 million of kind of bad debt, is this idea of adjusted revenue that's going to add back some of the bad debt unique to the circumstance of this quarter? Or should we expect that this is a metric that you're going to report on an ongoing basis?

[Theodore Wahl, executive]

We would believe it's going to be circumstance-driven. I would expect in most, if not just about -- in most quarters, it would be a 0 in terms of the adjusted revenue. But we at least wanted to introduce that possibility because, again, the accounting rules for revenue are pretty clear. I believe it's ASC 606, that if you're in a negotiation and you're accepting getting paid less than what you had previously billed, and that's with an existing customer that you continue to provide some level of services to, then you're expected to record that adjustment as a reduction to revenue rather than bad debt expense.

So to the extent an incident like that or an action like that happens in the future, we would account for in accordance with the guidance. But otherwise, we wouldn't expect it to be a recurring theme moving forward.

[Andrew J. Wittmann, analyst]

Okay. That makes sense. And then maybe, Ted, just one other one here, just on the increased cash flow guidance here. Was there -- I mean, we heard your answer before to the prior question about the visibility and the confidence since May, and that all makes sense. Was there an item here collecting on the past maybe bad debt that happened in the quarter or that's expected to happen in the balance of the year that gives you some of this confidence for this increase?

[Theodore Wahl, executive]

No. It's really the intra-quarter collections and billings that gives us the confidence. And with that said, we continue to work on our -- with our customers on plans, whether they're in hand, and promissory notes we talked about before as an important tactic in our overall collection strategy, which can add a degree of tailwind to it. But there was nothing specific to this quarter or notable that would have been unusual.

It was really large -- it was largely intra-quarter collecting what we bill, and again, a function of our strategy working, the increased payment frequency, the proactive use of promissory notes, and then disciplined in our decision-making, coupled with, and perhaps even more importantly, Andy, the recovering environment.

Every quarter that goes by, census, occupancy continues to recover and the state-based reimbursement benefits are starting to take hold. October is the first month that the 4% CMS increase would be realized. So you have a confluence of events that I think environmentally make for a stronger -- a strengthening industry.

[Operator]

Your next question comes from the line of Ryan Daniels from William Blair.

[Jack Senft, analyst]

This is Jack Senft on for Ryan Daniel. In terms of margins, it looks like both the Housekeeping & Laundry and then Dining & Nutrition segment decreased from last quarter on an adjusted basis. Is there anything to call out here that caused this decrease? Was it anything to do with the restructurings or possibly just even attributed to seasonality? Just curious if you can kind of double click on that.

[Matthew McKee, executive]

Yes, more the latter than the former, Jack. There's always going to be some movement month-to-month, quarter-to-quarter, depending on timing of new business adds or exit, management development ramp-ups, operational execution and other considerations that are happening really each and every day as a part of our business within our field-based operations.

Year-to-date, our adjusted segment margins are 8.8% and 5.6%. And we'd expect to track in at around those levels for 2024, again, with a degree of that quarter-to-quarter variability. So overall, we continue to have positive operational trends related to customer experience, system adherence, regulatory compliance and budget discipline, all of which are near-term margin drivers, which is why we remain confident in our overall ability to continue to manage adjusted cost of services in that 86% range that we've targeted.

[Jack Senft, analyst]

Okay. Perfect. And then just a quick follow-up, too. In your prepared remarks, I think you noted that the sales pipeline was ramping up nicely, which obviously correlates really well with you guys entering this growth mode phase. Just curious if you can dive a bit deeper on the sales pipeline, and if you can kind of touch in -- touch on and just like in terms of what you're seeing in terms of demand and as you kind of head into 2024.

[Matthew McKee, executive]

Yes. We appreciate that question because, as we've discussed previously, our value proposition continues to resonate more strongly than it ever has even historically. So the demand for the services is absolutely there. And not to suggest that increased demand necessarily yields an increased growth rate, but certainly to have greater demand allows us to be that much more selective in determining with whom we would like to establish new partnerships and in many instances, expand our existing relationships.

So the demand for the services is certainly strong. We've built an organization on both the sales side of our field-based organization and also within our operations to develop the management pipeline such that we have the management capacity to be able to onboard new facilities, all of which are operating at full capacity right now.

So we -- the demand we do anticipate will turn into new business growth and new business opportunities. So given that, we did talk about our expectation for the second half of the year to demonstrate top line growth sequential relative to the first half of the year, and expect that growth trajectory to continue into 2024 such that we have every expectation that we see year-over-year growth 2024 compared to this year.

[Operator]

Your next question comes from the line of Brian Tanquilut from Jefferies. Brian, your line is open.

And there are no further questions at this time. I will turn the call back over to Ted Wahl for some final closing remarks.

[Theodore Wahl, executive]

Okay. Great. Thank you, Rob. As we look ahead, we remain confident in our ability to control the controllables, realistic about the 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 shareholders.

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

[Operator]

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