Healthcare Services Group, Inc. (NASDAQ:HCSG) Q1 2024 Earnings Call Transcript

Healthcare Services Group, Inc. (NASDAQ:HCSG) Q1 2024 Earnings Call Transcript April 24, 2024

Healthcare Services Group, Inc. beats earnings expectations. Reported EPS is $0.2067, expectations were $0.18. HCSG isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Hello. Welcome to Healthcare Services Group 2024 First Quarter Earnings Conference Call. 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 the Healthcare Services Group Inc. other SEC filings. And as indicated in our most recent forward-looking statement 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’d now like to hand over the conference to the President and CEO, Ted Wahl; and Chief Communication Officer, Matt McKee. Please go ahead.

Ted Wahl: 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. Today, in my opening remarks, I’ll first discuss our Q1 financial highlights and key accomplishments, including the change health care disruption and the temporary impact it had on our customers, cash collections and cash flow. I’ll then share our perspective on the latest industry trends and developments. And then lastly, I’ll provide an update on our Q2 priorities and outlook for the rest of the year. I’ll then turn the call over to Matt for a more detailed discussion on the quarter. So with that overview, I’d like to now discuss our Q1 financial highlights and key accomplishments.

Our team delivered strong first quarter results, building on our positive momentum in 2023. For the 3 months ended March 31, 2024, we reported revenue of $423.4 million in line with expectations. Net income and diluted EPS of $15.3 million and $0.21, adjusted net income and adjusted diluted EPS of $16.5 million and $0.22 and adjusted EBITDA of $28.9 million, a 10.7% increase over Q1 of 2023. During the quarter, we managed adjusted cost of services under 86% and continue to grow our new business and manager and training pipelines. We remain confident that we will deliver on our goal of year-over-year growth in 2024 with the majority of those new business adds expected in the second half of the year. On the cash collections front, Q1 has historically been our most challenging quarter, especially on the heels of Q4 which typically sees our strongest collections.

The first quarter seasonality is anticipated and accounted for in our cash flow forecasting. However, what was unanticipated was the February Change Healthcare cyberattack. The resulting disruption had a far-reaching impact across the healthcare landscape and affected the claim submissions and billing activities of long-term and post-acute care providers, many of whom are HCSG customers. In spite of these first quarter headwinds anticipated or otherwise, we achieved 95% cash collections and would have met our first quarter cash flow estimates, if not for the change healthcare issue. While this event was disruptive during the quarter, we are confident that the impact on our customers is temporary. We expect to make up for any cash collection delays in the months ahead which is why we’re reiterating our previously shared 2024 cash flow range of $40 million to $55 million.

I’d like to now share our perspective on the latest industry trends and developments. Industry fundamentals continue to trend positively, highlighted by a slow but steady increase in workforce availability with the industry adding nearly 100,000 jobs since the beginning of 2023. At the current pace, the sector’s workforce will match the $1.6 million pre-pandemic employee levels by the end of 2025. Rising occupancy which now sits at 79%, 12 points [ph] higher than the January 2021 low and just 1% under pre-pandemic levels and a stable reimbursement environment which includes CMS’ recently proposed 4.1% increase in Medicare rates for fiscal year 2025 as well as continued positive reimbursement trends at the state level. Reimbursement rates are especially important at this stage of the recovery and helping to offset the increased cost of doing business driven by persistent inflation and the higher cost of capital.

On the regulatory front, CMS published its final minimum staffing rule earlier this week. There is a growing list of stakeholders opposed to the rule, including healthcare industry leaders, trade associations like ACA, MedPAC members and a bipartisan group of legislators, including nearly every R and a growing number of these. The reason 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, the rule would lead to facility closures and ultimately reduce access to care, especially in rural areas. We believe it’s highly likely the rule will not be implemented or will undergo significant revision during the extended phase-in period, especially given the inevitability of litigation and potential for legislation or administration change.

As far as our outlook for Q2 and the second half of 2024, our top 3 priorities continue to be as follows: the first is managing adjusted cost of service is in line with our target of 86%. We do not take operational execution for granted but have full faith in the ability of our operators to deliver the services on budget. It took a considerable amount of work in 2022 to modify our contracts to better capture wage inflation and cost increases in our pricing on a closer to real-time basis. Those contract enhancements along with recent positive trends in customer experience, systems adherence, regulatory compliance and budget discipline provides strong operating momentum heading into the second quarter. We expect Q2 adjusted cost of services to be at or below 86%.

Our second priority is delivering year-over-year growth by executing on our organic growth strategy through hiring, training and developing future management candidates, converting opportunities from our sales pipeline into new business adds and retaining our existing facility business. We estimate a Q2 adjusted revenue range of $420 million to $430 million and remain confident that we will deliver on our goal of year-over-year growth in 2024, with the majority of those new business adds expected in the second half of the year. The third priority is collecting what we bill. We view cash collections as a lagging indicator of industry recovery. While our recent trends have improved compared to 2022 and the first half of 2023 and if not for the change healthcare disruption, we would have met our Q1 cash flow estimates.

This remains an area of opportunity for the company in 2024. We continue to expect some choppiness throughout the year ahead but anticipate our cash collections gaining strength throughout 2024 and further still into 2025. We estimate a Q2 adjusted cash flow range of $5 million to $15 million and reiterate our previously shared 2024 adjusted cash flow range of $40 million to $55 million. As we round the turn of what has been a prolonged recovery for the industry, the company’s underlying fundamentals are stronger than ever and we remain focused on executing on our strategic priorities to drive growth and deliver meaningful shareholder value in the year ahead. So with those introductory comments, I’ll turn the call over to Matt for a more detailed discussion on the quarter.

Matt McKee: Thanks, Ted and good morning, everyone. Revenue was $423.4 million, in line with the company’s expectations of $420 million to $430 million. The company estimates Q2 revenue in the range of $420 million to $430 million. Housekeeping and Laundry and Dining & Nutrition segment revenues were $190.5 million and $232.9 million, respectively. Housekeeping & Laundry and Dining & Nutrition segment margins were 9.7% and 7.6%, respectively. Cost of services was $358.9 million. Adjusted cost of services was $357.3 million or 84.4%. The company’s goal is to continue to manage adjusted cost of services in the 86% range. SG&A was $46.9 million. Adjusted SG&A was $42.8 million or 10.1%. The company’s goal continues to be achieving adjusted SG&A in the 8.5% to 9.5% range.

Net income and diluted earnings per share were $15.3 million and $0.21, respectively. Adjusted net income and adjusted diluted earnings per share were $16.5 million and $0.22, respectively. Adjusted EBITDA was $28.9 million or 6.8%. This is a 10.7% increase over Q1 of 2023. Q1 cash flow and adjusted cash flow used in operations were $26 million and $9.2 million, respectively. DSO for the quarter was 88 days. Also as part of our adjusted results, we adjust for the impact of the change in the payroll accrual but since it will still be included in our reported cash flow from operations, we would point out that the Q2 payroll accrual is 15 days. That compares to the 8 days in the first quarter of 2024 and the 13 days that we had in Q2 of 2023. 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 Bill Sutherland from The Benchmark Company.

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Q&A Session

Bill Sutherland: Nice print. Ted, can you comment on client retention in the quarter? Just curious about if you had to offset the exits and maybe — and in that light, what the new adds were in the quarter?

Ted Wahl: From a retention perspective, Bill, our retention was greater than 90% which is, as you know, our expectation is we’re always aspiring for something greater than that but we were in those levels and expect that to continue to trend along those lines. And from an adds perspective, again, modest adds which offset some of the exits we had. But by and large, again, looking ahead, we expect to have additional facility adds and really begin to ramp up our new business additions in the second half of the year.

Bill Sutherland: So the cadence would add to expect would kind of build in the back half of the year as far as new adds?

Ted Wahl: Yes, we would expect the top line to look and feel similar to what it has been — what it was in Q1 into Q2 and then again, expect some step-ups in the back half of the year which we’ll be able to share in more detail on our next call.

Bill Sutherland: Okay. And you adjusted SG&A at 10.1%, it’s outside the range. Is there anything in particular there?

Ted Wahl: Well, when we made our — when we balanced our capital allocation strategy, we talked about making new and sustained investments along the lines that are organic growth drivers and certainly highlighted that as part of our shift in strategy. I think specifically, in Q1 and these have been in process now for well over a year but we continue to have investments in employee engagement and experience which we’re in the midst of a company-wide initiative to drive retention and satisfaction among our employees. So we’ve increased marketing and branding positioning investments which we view critical for the future for both external as well as internal stakeholders and our goal is to move this from a neutral to a strength and then ongoing tech investments.

I think most recently, this past quarter, we had facility level investments in Chromebook and tablets, specifically in our dining department. So we’re going to continue to make those investments. Again, they’re central to our organic growth strategy as well as our retention and customer satisfaction and employee retention drivers. And then we’ve also seen some increases in T&E expense like a lot of businesses just with overall activity and inflation. But longer term, as we lever that top line, Bill, we expect to see the SG&A as a percentage of growth — as a percentage of revenue, rather come back in line with our target. So we’re committed to maintaining our target. It’s just more of a timing issue than anything else.

Operator: Next question comes from Sean Dodge from RBC Capital Markets.

Sean Dodge: Ted, you said cash collections in Q1, typically seasonally weak but certainly impacted by the change outage. How much of a drag do you think change was in the quarter? Are there any bookends you can give us around some quantification there?

Ted Wahl: Yes. The change disruption, Sean, affected about half of our customers in some form or fashion. And then obviously, depending on the scale of the relationship that our client had with change as well as their claims and billing volumes and even alternative capabilities with — of certain of those customers, some were affected more than others. Some that were the larger groups, especially that were equipped with greater back-office support, we’re able to offset at least in part the impact by processing manual claims. Many of our customers — actually, the majority of the affected customers did apply for CMS’ accelerated and advanced payments program but we’re not expecting that supplemental funding to really hit in the main until late April, early May.

I think overall, when you think about the difference from forecasted cash flow to adjusted cash flow, we estimate anywhere from $12 million to $15 million being directly related to the change impact. And we were able to get different levels of granularity and validation from some customers more so than others but that’s what we estimate that impact to be.

Sean Dodge: Okay. And then you said it should only be temporary in some of the supplemental help impacting kind of hitting later in April. Are you seeing any signs of collections elsewhere? I guess so far to date in April.

Ted Wahl: In April, we’re pacing right on with what our forecast was for the month. So we’re, again, confident that the impact, as you mentioned, as we touched on in our opening remarks is temporary and expect to make up for any delays in the months ahead which, again, is why we reiterated that ’24 adjusted cash flow range of $40 million to $55 million.

Sean Dodge: Okay, great. And then on cost of sales, so adjusted was 84.4% so you continue to manage that very well. Is there anything else to call out there that’s onetime or more transient than helping right now? Or do you think you can kind of continue to operate well within this 86% range?

Ted Wahl: Yes. I know I touched on it in my opening remarks but the contract enhancements from 2022 certainly are a key factor in providing the durability and as we see it, the sustainability of our cost of services line but most importantly, really, Sean, it’s the positive trends we see in customer experience, system adherence, regulatory compliance and budget discipline which all the credit goes to our teammates that are leading the business in the field and their relationships with our customers and the impact they’re able to have within the communities they’re servicing. And that’s really more than anything central to driving consistency of cost of services and ultimately, margins. So yes, we are very confident in our ability to continue to manage adjusted cost of services at or below 86%.

You’ve seen before, Sean, there’s always going to be some month-to-month and quarter-to-quarter movement depending on the timing of new business adds or even exits occasionally, management development investments can impact that even the business mix. But by and large, it’s about execution and the consistency of that execution.