Healthcare Services Group Inc Q4 FY2021 Earnings Call

Good morning. My name is Chris, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Healthcare Services Group, Inc. 2021 Fourth Quarter Earnings Call. The matters discussed on today's conference call include forward-looking 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 the circumstances. As with any projection or forecast, they are inherently susceptible to uncertainty and changes in circumstances. Healthcare Services Group Inc.'s 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 performance. 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. Thank you. Ted Wahl, Chief Executive Officer, you may begin.

Great. Thank you, Chris, and good morning, everyone. Matt McKee 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 next week. Our Q4 results reflect continued margin pressures resulting from workforce availability, inflation, and supply chain disruption. While the current operating environment has pressured our profitability, we are taking decisive action to ensure we have a durable, scalable business model that will enable us to deliver sustainable, profitable growth over the long term. To that end, we remain actively engaged with our customers to modify our service agreements to adjust for the extraordinary inflation experienced during the second half of 2021, as well as account for future inflation on a more real-time basis. The goal of this initiative is to: one, get billing increases from our customers to capture past cost increases; and, two, amend our service agreements for both current and prospective customers, so future cost increases are passed through in a way that is automatic and real-time. We expect these service agreement modifications to be completed throughout the first half of 2022, with the goal of exiting the year with cost of services in line with our historical target of 86%. During the quarter, as we were actively engaging with our customers to modify our service agreements, we continued to take a longer-term view in staffing and supplying our client facilities to get the job done, even though in many cases, our service agreements had not yet been modified to adjust for the inflation experienced during the second half of 2021. If that meant incurring overtime hours, introducing special employee bonuses or increasing wage rates and premium pay, that's what we did. We did this while we were actively engaging with our customers to modify our service agreements. We did this to maintain client satisfaction, systems adherence and compliance. We did this because it best positions us to collaborate with our clients and modify our service agreements in a way that is mutually beneficial and durable over the long term. Bottoms-up client-by-client action that will be long-lasting, as opposed to top-down unilateral action that would be short-lived. Although the extraordinary cost that we incurred without a corresponding billing increase had a significant impact on our Q4 financial results, we believe this is a temporary challenge that will be resolved in 2022 by our service agreement modification efforts. We are encouraged that we've seen relative stability in industry census since August as operators have worked through the clinical challenges of both the Delta and Omicron strains. Having managed through those challenges, we are cautiously optimistic that the availability of staff improves, labor market pressure stabilizes, and operators are able to build back their census in the year ahead. We will continue to monitor industry recovery and remain confident that despite these near-term headwinds, the long-term growth outlook for the company remains strong, given our market leadership, efficient operating model and the attractive demographics. So with those introductory comments, I'll turn the call over to Matt for a more detailed discussion on the quarter.

Thanks, Ted. Good morning, everyone. Revenue for the quarter was $420.4 million, with housekeeping & laundry and dining & nutrition segment revenues of $200 million and $220.4 million, respectively. Direct cost of services was reported at $377.2 million or 89.7%, and was impacted by increases in labor and supply costs. Again, we expect the service agreement modifications that Ted described in his opening remarks to be completed throughout the first half of 2022, with the goal of exiting the year with cost of services in line with its historical target of 86%. Housekeeping & Laundry and Dining & Nutrition segment margins were 5.7% and 2.1%, respectively. Selling, general and administrative was reported at $44.3 million. After adjusting for the $2.7 million increase in deferred compensation, the actual SG&A was $41.6 million. SG&A was impacted by $2 million of nonrecurring items. In the year ahead, the company expects SG&A between 8.5% to 9.5%, with the opportunity for ongoing efficiencies. Investment and other income for the quarter was reported at $2.7 million, but after adjusting for the $2.6 million change in deferred compensation, actual investment income was about $100,000. The company reported an effective tax rate of 25.8% for the year. The fourth quarter tax rate was impacted by lower income before taxes and other discrete items, and the company expects a 2022 tax rate of 24% to 26%. Net income for the quarter came in at $2.1 million and earnings were $0.03 per share. Cash flow from operations for the quarter was approximately $31.4 million and was impacted by a $3.9 million increase in the accrued payroll, including the impact of $22.1 million of Cares Act deferred payroll tax repayment. The DSO for the quarter was 64 days. We would also point out that the Q1 payroll accrual is 5 days, and that compares to 13 days in Q4, and 4 days that we had in 2021 during the corresponding period. But the payroll accrual only relates to timing, and the impact ultimately washes out through the full year. We're pleased with the ongoing strength of the balance sheet and the ability to support the business while continuing to return capital to the HCSG shareholders. We announced that the Board of Directors approved an increase in the dividend to $0.21125 per share, payable on March 25, 2022. The cash balance is supported. And with the dividend tax rate in place for the foreseeable future, the cash dividend program continues to be the most tax-efficient way to get free cash flow and ultimately maximize the return to shareholders. This will mark the 75th consecutive cash dividend payment since the program was instituted in 2003, and the 74th consecutive quarterly increase. That's now a 19-year period that's included four 3-for-2 stock splits. Additionally, the company repurchased $16.1 million of its common stock pursuant to its previous authorization during the quarter.

We would now like to open up the call for questions. Our first question is from Andy Wittmann with Baird.

I guess, Ted, I wanted to start with just trying to understand the status of the discussions with your clients regarding these renegotiations. I think historically, you guys have always tried to get reasonable prices that were in the terms of how you've always done things. But this idea of amending the contract or really the business model to automatically pass through these inflationary items is clearly different from the past. Is it your expectation that effectively all of your customers will move to this? And what do your early discussions regarding terms like that today indicate to you about your success in achieving that?

The early indicators are positive, and we expect to see some progress in the first quarter. Our expectations are that our value proposition remains strong. The costs we are incurring are consistent with what clients are experiencing with their own workforce, and they clearly understand our position. The challenge with the fixed price model in this environment is not that we can’t achieve increases. Even if we manage to secure increases for past wage inflation, it doesn’t fully account for the potential for future inflation in a timely manner, given the current uncertainty. Therefore, our expectation is that, in many cases, it will involve sitting down with the customer to agree on the past inflation and then establishing quarterly triggers, similar to what we have in food, which has benefited the company for years. This approach is not unfamiliar to clients. There are others with whom we can have a more comprehensive discussion that may include a cost transparency model, leading to a more open and collaborative relationship, whether that's cost plus or something similar. There isn't a one-size-fits-all solution; this issue does not impact all our customers, but many are affected. Our goal is to achieve a very high success rate, and it requires effort. As you can understand, there are various strategies to consider, whether a top-down approach or a bottoms-up approach. We chose to take a bottoms-up approach during the fourth quarter, acknowledging the unique circumstances of each client, which aligns with our historical strategy. While this may demand more patience and investment from us in the current environment, we believe it will yield significant positive outcomes in the long run. And really set us up well going forward because aside from our existing business, this also relates to new business prospective customers that we're going to be engaging with. This resonates very well in the current environment. The same pressures we're experiencing in our business are all the more reasons why the demand for the services is increasing and is as strong as they've ever been. So I think we will continue to prioritize this exercise that we're going through with our customers. And again, expect that to be completed mid-year and exit the year with a direct cost of services line consistent with our 86% historical target.

Matt, just maybe a follow-up for you regarding the staffing levels that you're currently seeing in the facilities where you are involved. Can you just give us some context maybe about the progression of the number of open positions you have today versus maybe normal staffing, which would have probably been a few years ago now, versus six months? Is it getting better? Is it getting worse? Where are you on the open positions curve today?

Yes, I would say we're seeing modest improvement, Andy. Some of our data are actually encouraging. They're not yet kind of bearing out in the form of actual hires or replacement per se. But when we look at some of our data with respect to the inbound applications that we're receiving and then our new hires relative to terminations, a bucket that for us constitutes either somebody voluntarily exiting or us terminating their employment, but just any separation from the company, it's maybe a bit too early to call them trends, but I would say that the recent data are certainly encouraging. It really sort of relates to the fact that we've been consistent throughout in innovating and developing recruiting and retention strategies to better attract and retain employees at all levels. That, of course, applies to our management development program. But likewise, felt more acutely in recent months for sure at the line staff level, and that's encompassed promoting our purpose, vision, and values through every level of the organization, but leveraging our existing recruiting platforms, streamlining our onboarding process. We've talked about previously repurposing and deploying some resources to high-need facilities, and to other geographies, and developing employee engagement initiatives, and then ultimately as a component of that, introducing employee incentive and referral programs. Again, without speaking specifically to a trend per se, we've seen that the number of employees who are being infected, and the impact of the Omicron variant, has decreased significantly over the past couple of weeks. And that's certainly indicative of a more favorable environment to be able to get bodies in to fill positions at the facility level.

Our next question is from Tao Qiu with Stifel.

Ted and Matt. Just a quick question on the margin. If you look at incremental margin this quarter in terms of expense increases sequentially, certainly the growth has been slowing from the last quarter. Just wondering what's your margin outlook for the next few quarters, understanding that you're going through these contract negotiations?

We expect to see some progress beginning next quarter. Ideally, it would be a stair-step, Tao, throughout the year, right, where we're exiting the year back at that 86% or better. There's probably going to be some fits and starts along the way. I think part of our strategy here is to allow enough time and space to not get the quickest deal done, to get the right deal done for the long-term relationship.

Is it fair to say that the inflationary environment in the fourth quarter is slightly better sequentially than the third quarter? Or do you think that it's still pretty acute right now?

Yes. I'd say Q4 relative to Q3 was similar, meaning a similar type of intensification, specifically on the labor side. We did see some of the food inflationary pressures stabilize a bit between Q3 and Q4, but we saw the labor inflationary pressures further intensify. It's too early to tell year-to-date where we are. But that's again why with this modification of our service agreements, we're not only going to make sure we secure increases for our past cost increases to get the billing rate correct at that moment in time, but it's also equally as important to make sure the go-forward is taken care of and that the adjustments are done on a more real-time basis, whether that's tying it to a third-party index, or if it's using our own data that we have internally or the client's data for their similarly situated employees. So that hopefully adds a little color to the types of conversations and engagement we're having.

Got you. I appreciate that. Any update on the Genesis contract? I know that you talked about the pricing coming back first quarter 2022 and the terms will probably reverse at the end of the year. Any update there?

No, other than, as we previously called out, the pricing modification sunsetted at the end of 2021. So that returns back to its historical rate heading into the year effective January. As you highlighted, the AR modifications will begin to reduce throughout the year, and that will sunset at the end of 2022.

Okay. Got you. Maybe one last one. I missed this: when you talk about it, what's the operating cash flow for this quarter?

From a cash flow perspective, we were north of $30 million.

It was 31.4 million.

Our next question is from Sean Dodge with RBC Capital.

Maybe, Ted, going back to one of your earlier comments. On the labor challenges, is there a seasonal pressure that hit you in the fourth quarter too, with the hourly workforce? I'd imagine you're all probably competing with Amazon and UPS and all the retail that are staffing up and operating premiums around the holidays. Now that we're through that, does that help things get sequentially better in the first quarter?

I'd say it should, like in a theoretical sense, Sean, that would be the case. I think you have to look at it. One is Matt pointed to some of the January data that are suggesting some stabilization and some actual improvement on our front. So that would add some credibility to your question and your thinking on it. I think the one thing that is yet to bear out is the niche within the niche, right? The healthcare labor market is, kind of has its own pressures outside of, say, the non-health care-related labor. Even within long-term on post-acute care, I think it's seeing a different type of impact than the broader healthcare market. That's why I'm a little reluctant to latch onto your silver lining there to some of the labor pressures that we saw in Q4. There are so many moving parts between Delta, Omicron. While the clinical impact may have been less on the industry, it had a significant impact on staffing with quarantining requirements.

Sure. Okay. Fair enough. And I guess now with the plan for getting cost of sales back in order. Where are you now on new manager development? Are you back out recruiting and training again? What are your thoughts around when you might start adding new facilities?

Yes, absolutely, Sean. I would say, not dissimilar to our typical strategy. That's really the managerial needs assessment occurs at the local levels, primarily to ensure that we have the management capacity to effectively manage the existing portfolio. But just as importantly, in this environment, given the increasing demand for the services that Ted noted, to ensure that we've got the requisite managerial wherewithal to be able to think about onboarding new business opportunities. So there are, as is always the case, some geographies that are further ahead in that exercise than others. Without a doubt, this is a conversation that's happening throughout the company, to stabilize the operating environment in the face of some of the remaining challenges that are presenting as a result of COVID. But the optimistic view is certainly that we continue to drive recruiting efforts and managerial development efforts with an eye toward future growth opportunities. For all the reasons that we talked about previously, suggestive of modest but suggestive of industry recovery, we're definitely beginning to think about getting back into growth mode. Obviously, the management development is a significant component of that.

Our next question is from Ryan Daniels with William Blair.

Nick Spiekhout on for Ryan. To start, just a clarifying one on those new contract structures. Would those be eliminating the current, I think you said, 90-day lag that most of your contracts have, such that it would be much more immediate to where increases in input costs would be mitigated within the quarter?

The reason for that 90-day lag, if you're speaking specifically to the food component of our dietary contracts is really just a function of when the data are published by the requisite government agencies. That's just a simple matter of when it's published. As soon as it's published, it's provided to the client and then we're adjusting the following quarter. That’s not where the impact is being felt most acutely. If we had a similar, and again, there is no one size fits all, but if we had a similar type of adjustment even with the 90-day lag on the wage piece, we'd still be in a much better spot. Now, there are different variations to that. If we were to try to implement a monthly adjustment, and the customer is open to that, that's something we would consider as well. Again, we want this to be long-lasting and durable. So we're not in a race to get kind of the quickest deal done. We're building this for the next four to five decades, quite frankly.

Okay. Great. And then, I guess, so you're planning on kind of second half being through most of that. When did these kind of negotiations start? How far along are you in that rollout between your total facility base?

Yes, they've been ongoing really throughout beginning as early as kind of the beginning of Q4 and have been ongoing since then, with the continued inflation. It's not a matter of inflation happened and it's over. It continues to evolve. So those conversations have continued to evolve as well. As you highlighted, we should expect all of the agreements and conclusions with our clients to be reached by midyear. Our goal is to exit the year with a run rate of 86% or better cost of services, which would be in line with our historical target.

Just to sort of put a finer point on that, we've had initial meetings with every one of our client groups at this point. As Ted mentioned, there's not a unilateral approach. It’s client by client, the efforts that are undertaken. It's not a one-size-fits-all solution per se, but all of the conversations have been initiated. It's just going to take some time to come to agreement. Of course, that will be a moving target to a degree as to the timing of the closure of these, but we're confident that by midyear, we'll have some clarity and conclusion, and be able to move forward and ultimately see the effects run through the results of the business.

Great, thanks for the color. On the labor side of things, is this more of an issue on recruiting new employees or more on maintaining your current workforce such that you’re making it more enticing for them to stay on versus go somewhere else?

It's more the former than the latter. I wouldn't be dismissive to suggest that we assume all of our employees will want to stay with us. We've talked about some of the employee engagement initiatives we've initiated over the past few years. There is an element of emotional connection that employees establish with the facility. Now that doesn't run in perpetuity when it's substantially challenged, and there have been challenges, but we're finding that the availability of labor on the new hire front has been far greater a challenge than retaining our longer-established employees.

Our next question is from Brian Tanquilut with Jefferies.

Jack Slevin on for Brian. I want to start and just make sure I understand sort of the puts and takes as we bridge to year-end and sort of what's happening in the industry versus the outlook with these contracts. If you're looking to adjust the contracts, we're sort of looking at industry data, occupancy has flattened off in the fourth quarter and is still sort of 10% below pre-COVID levels. You've got clinical staffing shortages that are at their highest levels we've seen, and significant wage inflation and wage pressure there for your clients. So piecing those two things together with the step-up that you're expecting to get adjusted into your contracts, I guess I'm just wondering, is there a risk or how you're thinking about what needs to happen from an occupancy standpoint to stave off risk that you'll need to do more on the price concession side as we move through 2021?

Yes, Jack, I would say, clearly, census is not a panacea, but it is a significant component if you think about the financial makeup for any one of our particular customers at the facility level. The fact that you noted that census has plateaued a bit is a major win. Since about the second week of August, we've been above 72% occupancy on an average national level throughout the industry, and to have maintained that to this point is a big win from a clinical perspective. That's likewise in the face of the clinical staffing shortages that you noted, and the forced quarantines that have been required for infected individuals down to the frontline staff level. So that, in our view, is a fairly significant accomplishment. We are starting at a level that's significantly more favorable than where we stood at this point last year with respect to expectation for ongoing census improvement. You're correct in noting that clinical staffing shortages will have an impact on census. But again, there are some data that are encouraging, not only internal health care services group data, but some of the external anecdotes we're beginning to hear from customers and industry groups. So there is an expectation that even if it's modest, we do begin to see that uptick in census and that bodes well from a financial perspective for our industry end market.

That's helpful. Just looking at the cash flow from operations number, it's really strong in the quarter relative to a pressured P&L. Can you walk through in a little more detail what's going on there or what's driving that? And then talk about how we should be thinking about cash flow as we move into 2022.

Our goal always is to collect what we bill. In the fourth quarter, we had strong cash collections. I think we were $6 million or $7 million to the positive of what we billed. So that was a strong year. When you look at cash, the outlook for the year, taking a look at Q1, we do have the change in the payroll accrual to 8 days. We would expect that alone to result in cash outflow for Q1. Without going through a cash flow model for the year, I think what we can confidently say is our goal remains to collect what we bill. There will be quarter-to-quarter timing differences, depending on the payroll accrual, which is the biggest driver of fluctuations between any one given quarter. Again, our goal is to collect what we bill.

Our next question is from Mitra Ramgopal with Sidoti.

First, just on the top line. Last year, you had announced a pretty nice business addition on the food services side. I know you mentioned you're in talks to bring on new business. Just curious in terms of how optimistic you are, given the environment right now, that we might be getting some positive announcements on that front in 2022.

I would say with all the unknowns and ongoing uncertainty, and the variables we've spoken about in the current environment, we'd be reluctant to project or forecast too specifically on growth opportunities. But that doesn't mean there are not opportunities for growth or that we won't grow. We don't have necessarily specific visibility to next quarter or the quarter beyond that. So we wouldn't really guide on expectations per se, but we continue to be confident around our capabilities to deliver long-term growth. We are increasingly optimistic about pulling forward some of these growth opportunities that have presented themselves, in light of increased access now to facilities, the pent-up demand that's been in our pipeline. It would be more imminent to expand partnerships with existing customers to include dining services, all of this layered against an assessment of the financial health of any prospect. That remains a bit tricky with the state of the industry recovery we've talked about. This all brings us back to why the changes to our service agreement structure are so important to create the most durable value proposition and model going forward.

Okay. On the SG&A side, I believe you're anticipating 8.5% to 9.5% this year. Before COVID, SG&A typically ranged from 7.5% to 8% at most. Should we consider this the new normal for SG&A?

Yes. I think certainly with where revenue sits today. There's a fixed and variable portion of SG&A. The majority of SG&A is payroll related. We expect that range to continue until we ramp up revenue over the next 12, 18, 24 months in a way that Matt kind of just highlighted, but that will be scalable to a degree, but there will be some incremental costs as we grow the top line as well.

Okay. And then finally, about $2 million of nonrecurring costs in the quarter. If you can provide some color on that, and going forward, if there are any more one-time items in 1Q.

Yes, one was about $1 million, which was just an adjustment to one of our amortization schedules that we had, like a catch-up adjustment. The other $1 million was related to a state tax-related education credit, the other side of which you see in the tax rate. So that's an annual program that we participate in, where you see the expense in SG&A, and then the corresponding 90% credit in taxes.

Our next question is from Andy Wittmann with Baird.

There are two from accounting. I noticed that your goodwill and your intangibles are up a decent amount in the fourth quarter over the third quarter level. Matt, is that the amortization schedule that Ted just mentioned, or is there something else that went into your intangibles?

No. That's unrelated to the adjustment that Ted just referred to. During Q4, we acquired a small food service company focused in the education space. They do about $30 million or so annualized in sales. What we liked about them is they've got really a great product and, in our view, a scalable model. So obviously, a small acquisition, but we view that along with our environmental services opportunity and that education niche as a nice complement to our longer-term growth strategy as a company.

That makes sense. Glad I asked. Okay. So then, Ted, just I want to ask on the balance sheets of your customers. There's been plenty of federal money over the last couple of years through various programs. You and your customers had to pay back the payroll tax deferral, that's kind of a knock against everyone's balance sheet, including yours a little bit. I was wondering, I mean you guys haven't seen any material DSO write-offs here. We'll look at the Q and get a little more detail. You've changed your processes a lot over the last several years even before COVID. But I wanted to check in about the credit quality of where your customers sit today? Anything you can tell us about the level of federal funding that is helping or maybe not helping enough from your seat?

To start with your last point, there isn’t much happening at the federal level right now. However, there are some positive developments at the state level. Our focus is on state opportunities rather than federal ones. In response to your comment about changes in our processes, I want to highlight the weekly payment initiative we introduced a couple of years ago. This has been beneficial in managing not only through the COVID situation but also in the post-COVID landscape. A couple of years back, we would have mentioned that very few, if any, of our clients were paying us more frequently than monthly. Today, over 60% of our customers are making payments more frequently than monthly, with most of them doing so weekly. That, along with all the additional quantitative data we can gather from our clients, whether related to census or not, enables us to stay closer to our customers, observe their behaviors, and respond more swiftly. While there are no guarantees, I believe we are in a strong position. If we face challenges in the coming year as federal funding diminishes and census data continues to recover, we will be able to remain disciplined in our decision-making. This is something we will keep a close watch on.

Our next question is from A.J. Rice with Credit Suisse.

Can you provide more details on the expectation for margin improvement in the first quarter? It seems that some of it is related to changes in the agreement terms. How much of the margin improvement you've seen, while keeping operating income constant, is due to needing fewer workers because of the decrease in census? How does that compare to other concessions that could offer longer-term benefits? Could you elaborate on your plans for achieving margin improvement in the first quarter?

Yes, I believe we are expecting improvements. While it's challenging to quantify the impact for the first quarter, we anticipate that these enhancements will come from significant and lasting changes to the contract structure, specifically the service agreements, rather than fluctuations in staffing in relation to the number of patients within the facility.

Last quarter, there was the discussion that nursing homes were choosing not to raise rates to cover their hourly workers, meaning you had to unilaterally do that because your pass-through requires them to raise rates for their existing hourly. How is that now trending as you go into the first quarter? Is that getting better, worse, or is it about the same as you saw in the fourth and third quarters?

I would say relatively comparable, A.J., Q4 to Q3. The reality is given the dynamics of the labor environment, we have been making those adjustments in real time. That's been the challenge: the disconnect between when the customer would make an adjustment to the wage scale at the facility. That would have historically triggered the adjustment that we would then pass through. That's not been the case. We've had to be much more nimble in adjusting in real-time to adequately staff the facility. I would say that the environment, generally speaking, in that regard is comparable from Q3 into Q4, if not a bit worse in Q4.

There have been several high-profile renegotiations with some skilled nursing operators. I don't know whether any of those are your customers, but when that type of activity happens, are vendors encouraged to join these discussions?

In just about every situation, we are familiar with some of the groups you referred to, but it's typically directly between REIT and their tenant rather than anything that filters through to the rest of the vendor community.

The 72% occupancy rate you mentioned is steady. Is that good enough for the majority of your underlying customers to operate at that? What's the occupancy rebound needed to sustain operating cash flow?

Ultimately, A.J., I think the general consensus is occupancy needs to be in and around 80% for the industry. There is significant variability between, say, New York, what New York needs versus Texas. It's all state-by-state, area-by-area. Overall, that 80% is really the touchstone. If you look at what happened between January and June of 2021, the industry was recovering slowly but about 0.2% per week once they bottomed out at 67% in January, through June, and that was the pathway to 72%. With the impact of Delta and Omicron, the industry maintained its clinical stance, which is a positive outcome. We're cautiously optimistic that staffing stabilizes and adequate nursing staff returns, which will lead to demand for provider services. We believe a target of 80% by the end of the year could be achievable based on our expectations.

I have one final question. A big part of Healthcare Service Group's story for years has been the dividend and its gradual increase. If you view this as short-term, you could theoretically borrow to cover the dividend for even a year. What's the thinking about that dividend relative to the current run rate of earnings?

The cash balances and cash flow certainly support the dividend. Organic growth and internal investment remain the #1 priority in terms of capital allocation for the Board, followed by the dividend. There is no payout ratio per se. We've talked about consistency and sustainability as the guidepost more than a payout ratio. We'll continue to evaluate quarter-to-quarter just like we always have. The dividend remains of the highest priority right after organic growth and internal investment.

We have no further questions at this time. I'll turn the call back to the presenters.

Great. Thank you. In the quarter ahead, we will continue to prioritize engaging with our customers to modify our service agreements to adjust for the extraordinary inflation experienced during the second half of 2021, as well as to account for future inflation on a more real-time basis. We expect these service agreement modifications to be completed throughout the first half of 2022 with the goal of exiting the year with cost of services in line with our historical target of 86%. We will also continue to execute operationally with an eye towards opportunistic growth. Above all, we remain committed to making decisions that best position us to deliver long-term shareholder value. So on behalf of Matt and all of us at Healthcare Services Group, I wanted to thank Chris for hosting the call today, and thank you again to everyone for joining.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.