Healthcare Services Group, Inc. (NASDAQ:HCSG) Q4 2022 Earnings Call Transcript

Healthcare Services Group, Inc. (NASDAQ:HCSG) Q4 2022 Earnings Call Transcript February 15, 2023

Operator: Good morning, and welcome to the Healthcare Services Group 2022 Annual Earnings Call. . The matters discussed on today’s conference call include forward statements about the business prospects of Healthcare Services Group, Inc. Forward-looking statements are often preceded by words such as believes, expects, anticipates, plans, will, goal, may, intends, assumes or similar expressions. Forward-looking statements reflect management’s current expectations as of the date of this conference call and involve certain risks and uncertainties. The forward-looking statements are based on assumptions that we have made in light of our industry experience and our perceptions of historical trends, current conditions, expected future developments, and other factors that we believe are appropriate under these circumstances.

As with any projection or forecast, they are inherently susceptible to uncertainty and changes in circumstances. Healthcare Services Group, Inc. actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors and the forward-looking statements are not guarantees of performances. Some of the factors that could cause future results to materially differ from recent results or those projected in forward-looking statements are included in our earnings press release issued prior to this call and in our filings with the Securities and Exchange Commission. We are under no obligation and expressly disclaim any obligation to update or alter the forward-looking statements, whether as a result of such changes, new information, subsequent events or otherwise.

Now I would like to turn the call over to Ted Wahl, President and CEO.

Ted Wahl: Thank you, and good morning, everyone. Matt and I appreciate you joining us today. We released our fourth quarter results this morning and plan on filing our 10-K by the end of the week. We reported for the three months ended December 31, 2022, revenue of $424 million, net income of $16.2 million or $0.22 per share and cash flow provided by operations of $22.9 million. We also announced as part of our disciplined and balanced approach to managing capital, a rebalancing of our capital allocation strategy. To enhance financial flexibility, invest in organic and inorganic opportunities and to accelerate value creation. As such, the Board of Directors has suspended the quarterly cash dividend and authorized the repurchase of up to 7.5 million shares of our common stock.

Today, in our opening remarks, I will discuss our Q4 accomplishments, our rebalanced capital allocation strategy and our 2023 outlook. I’ll then turn the call over to Matt for a more detailed discussion on our Q4 results, after which time will be available for Q&A. I’m pleased with our Q4 results, which underscore the resilience of our business model and continued passion and perseverance of our people in a challenging operating environment. We achieved our 2022 goal of exiting the year with cost of services in line with our historical target of 86% then our Q4 goal of collecting what we bill and have a growing pipeline of future client partners as we head in 2023. Although each of these achievements relate to different aspects of our business, together they underscore our business resilience, the strength of our client relationships and our enhanced value proposition, which is why I put the highway in each stock and each of these accomplishments.

The first accomplishment I’d like to highlight is the completion of our 2022 service agreement modification initiative. This was a massive company-wide achievement, the outcome of which is foundational to the scalability of our business model and durability of our client partnerships. As many of you would recall, the purpose of this initiative was to adjust for the extraordinary labor inflation experienced during the second half of 2021, as well as contractually account for the future inflation of labor on a more real-time basis. This was the very definition of all hands on deck bottoms up client by client effort that required significant levels of internal and customer-related relation and collaboration. Today, I am pleased to report that initiatives taken for the contract modification work is complete, and we achieved our goal of exiting the year with cost of services in line with our historical target of 86%.

The second accomplishment I’d like to highlight is that we met our Q4 goal of collecting what we bill and what was our strongest cash collection quarter of the year. And although one quarter does not translate, this was a significant accomplishment in further validating our overall collection strategy in the state of what continues to be a challenge industry landscape, as well as providing a strong foundation and positive momentum heading into 2023. Lastly, I’d like to highlight the significant progress we made in replenishing our new business pipeline during the second half of 2022 but mostly notably during Q4. As we once again but for the first time , as many of you would recall, the interest levels and overall demand for our services remain high throughout the pandemic and through the first half of 2022.

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However, our ability to consistently prospect and further develop opportunities, let a little open new business at any type of scale was extremely limited use of facility asset issues, challenges and accurately accessing the financial health of potential partners and overall clinical considerations. Over the six months, those limiting factors has meaningfully diminished, and we once again have a growing pipeline of qualified opportunities heading into 2023. And although the timing of new business has remained dynamic, the ongoing replenishment of our pipeline is highly encouraging. Now I’d like to move on to a discussion on our comprehensive rebalanced capital allocation strategy. The Board regularly reviews the company’s capital location strategy to ensure support to creating value for shareholders by delivering on our near-term operational objectives, and on our growth outlook.

And dividend has been an important part of our capital allocation strategy for many years and the Board recognizes the dividends positive impact on total shareholder returns over that time period. But as we work through a strategic planning process and look into the future, it was clear especially given the prolonged industry recovery, ongoing macroeconomic challenges and our strong liquidity position as they are more proactive, impactful and lasting ways to maximize shareholder value in the coming years. Now our rebalanced capital allocation strategy is designed to enhance financial flexibility to support future growth opportunities and accelerate value creation. The new framework is to spent the quarterly cash dividend and prioritize its investments in organic growth drivers, inorganic growth opportunities and opportunistic share repurchases.

I’d like to describe in more detail each of these capital allocation priorities. First and foremost, internal investment and organic growth will continue to be at the highest priority in terms of capital allocation. Sustained investments in organic growth drivers by talent development and employee engagement, customer investment and experience, land positioning and R&D are residual to our business and will be further enhanced in the future. Secondly, our rebounded capital allocation framework prioritizes investment in high-quality inorganic growth opportunities to increase earnings capacity and accelerate growth. As many of you would recall, we have done a smaller but very successful tuck-in acquisitions over the past decade within our core market.

And more recently, in further exploration of the education sector on market extension acquisition of a premium plan to complement our organically developed EBS print. If early returns of our work in the education pace over the past 18 months continue to be positive, as our value proposition is resonating and more with similar product, margin and working capital profiles. We remain active in developing a pipeline of organic and inorganic opportunities within this fast and highly fragmented market. We will also prioritize exploring complementary inorganic opportunities within our core market from strategic alliances to investments in emerging technology to adjacent service offerings. Finally, in keeping with the shipment of overall capital allocation strategy, we prioritize more proactive, impactful and enduring ways to create shareholder value.

The Board of Directors suspended a dividend and authorized the repurchase of up to 7.5 million shares of our common stock as an opportunistic and tax-efficient way to return capital to shareholders. Opportunism will depend upon among other considerations, our liquidity position, share price and alternative use now. Before I turn the call over to Matt, I’d like to make a few remarks on our outlook for 2023. While the industry continues to take headwinds related to workforce availability, inflation and supply chain constraints, we are encouraged by the gradual but steadily improving facilities and labor market trends. We will continue to closely monitor the industry dynamic and we are confident that the industry remains on a clear path towards recovery, not being a prolonged one.

We entered this year with positive momentum and a strong foundation to which moving this business forward as our underlying fundamentals remain as strong as ever. Our leadership and management team, our business model and the visibility we have into our business execution, our KPIs have translated to customer experience, systems adherence, regulatory compliance and project discipline, our learning platforms for training and development and employee engagement, our strong liquidity position with a nearly over $120 million of cash and marketable securities and a recently reduced $500 million credit facility and the growth opportunity that lies ahead. So in closing, for 2023, we are confident in our ability to control the controllables, realistic about the ongoing challenges that remain within our industry and owner economy and optimistic about creating 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 our Q4 results.

Matt McKee: Good morning, everyone. Thanks, Ted. Revenue for the quarter was reported at $424 million on housekeeping & laundry and dining & nutrition segment revenues of $198 million and $226 million, respectively. Housekeeping & laundry and dining & nutrition segment margins were 8.7% and 4.3%, respectively. Direct cost of services was reported at $366.8 million or 86.5%. Direct cost included a $9.8 million benefit related to favorable workers’ compensation loss development trends offset, in part, by an $8.6 million increase in AR reserves. As Ted highlighted in his opening remarks, we met our goal of facing the year with positive services in line with our historical target of 86%. SG&A was reported at $39.5 million; after adjusting for the $2.1 million increase in deferred compensation, actual SG&A was $37.4 million, or 8.8%.

We expect 2023 SG&A between 8.5% to 9.5%. The effective tax rate was 19.4% for the fourth quarter and 23.2% for the full year of 2022. The company expects a 2023 tax rate of 24% to 26%. Cash flow from operations for the quarter was $22.9 million and was impacted by a $3.1 million decrease in accrued payroll, including the impact of the second half, or $24.4 million, of the deferred FICA payment. DSO for the quarter was 72 days. Also we would point out that the Q1 payroll accrual is six days that compares to the 14 days in Q4 and the 5 days we had in 2022 during the corresponding period, but the payroll 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.

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Q&A Session

Operator: Your first question comes from the line of Sean Dodge with RBC Capital Markets.

Sean Dodge: Thanks and good morning and congratulations on the strong fourth quarter – strong year and strong fourth quarter. So Ted, on the rebalanced capital allocation strategy, you mentioned potentially pursuing some inorganic opportunities, and it sounds like specifically in education. I know it’s still early – I think – like you said, you’re only 18 months and exploring that market. Can you give us a sense of how much revenue education contributing now? And maybe how big you think it could be in the next couple of years for you? And then maybe compare and contrast education that end market versus it seems like education is probably less structurally challenged over the long-term. And then where do you think the margins could be in that market versus what you’ve generated historically in the SNFs?

Ted Wahl: I think in terms of your first question, Sean, and you highlighted, we’re still less than 18 months in, but clearly, for us, it’s beyond the pilot stage, and we really believe it’s an opportunity that warrants further exploration, and we’re willing to further commit to that. Currently, it’s less than 5% of revenue. Certainly, when it makes sense to share more of the specifics around that, we’ll do so. But the returns continue to be really positive. And again, the 24/7 mindset, our purpose vision values, kind of the niche when you think about the big players and where we’re really concentrating our efforts within more of the private and independent school space. It – really provides a lot of possibility and we’re very optimistic about that in future.

So I think from a possibility perspective, just to address that question, I think it’s as great, if not greater than what we have in our core market. When you look at the number of candidates for the types of services we would be offering. The other attractive part of it is our – the margin profile, certainly the working capital profile as well as other components of the business, similar product offerings in terms of facility management, i.e., custodial and janitorial type work as well as dining. So we really view it as an opportunity and are excited about those possibilities in the future.

Sean Dodge: Okay great. And then the share repurchase authorization, can you give us just a little bit of a sense on how you expect that to unfold? Is the plan to do something accelerated there or is this going to be more of just kind of a gradual or opportunistic buyback?

Ted Wahl: Yes, we’re thinking of it in terms of opportunism. And I mentioned it in my opening remarks it’s really going to be determine – going to be determined by a variety of different factors – not the least of which is our liquidity position and expected free cash flow, clearly our share price. We’ll look at items like our dilution rates via share creep in any given year. And of course, what’s the highest and best use of capital vis-a-vis alternate use analysis. So we’re going to look at it holistically, but we’re committed to being opportunistic – with that going forward.

Sean Dodge: Okay, thanks again.

Ted Wahl: Thank you, Sean.

Operator: Your next question comes from the line of Tao Qiu with Stifel.

Tao Qiu: Hi, good morning, guys. So you talk about the growth – platform of future client partners heading into 2023. I’d like to focus on the nursing home side. It sounds like you think some of the constraints are dissipating. Could you give us an idea in terms of how large the opportunity set is? I didn’t hear any comments around the leadership pipeline. Could you provide any color on kind of recent pipeline and what’s the development there? Thank you.