Healthcare Services Group Inc Q4 FY2024 Earnings Call

Good day. 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 statement 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 would now like to hand over to Ted Wahl, CEO.

Good morning, everyone, and welcome to HCSG’s Fourth Quarter 2024 Earnings Call. With me today are Matt McKee, our Chief Communications Officer, and Vikas Singh, our Chief Financial Officer. Earlier this morning we released our fourth quarter results and plan on filing our 10-K by the end of the week. Today, in my opening remarks, I will discuss our Q4 highlights, share our perspective on the latest industry trends and developments, and discuss our 2025 outlook. Matt will then provide a more detailed discussion on our Q4 results, and then Vikas will provide an update on our liquidity position and share our 2025 capital allocation priorities. We will then open up the call for Q&A. So with that overview, I’d like now to discuss our Q4 highlights. 2024 was a transitional year for HCSG as it marked a pivotal shift from recovery to renewed growth. This shift was highlighted by Q4 results and positive momentum we are carrying into the new year. For the three months ended December 31, we reported revenue of $437.8 million, net income and diluted EPS of $11.9 and $0.16 inclusive of new business startup costs, and reported cash flow from operations of $36.2 million and actual cash flow from operations excluding the change in payroll accrual of $27.0 million. I'd like to now share our perspective on the latest industry trends and developments. Industry fundamentals continue to gain strength, highlighted by the powerful multi-decade demographic tailwind that is now beginning to work its way into the long-term and post-acute care system. In 2026, the first baby boomers will turn 80 years old, and by the year 2030, all 70 million plus boomers will be over the age of 65, with the oldest being in their mid-80s, the primary age cohort for long-term and post-acute care utilization. We expect that the demand and opportunities for service providers in this space, especially for those with compelling value propositions, durable business models, and market-leading positions, to only increase in the months and years ahead. The industry's most recent operating trends remain positive as well, highlighted by a steady increase in workforce availability, with the industry adding over 100,000 jobs since the beginning of 2023, rising occupancy, which now sits at 80% in line with pre-pandemic levels, and a stable reimbursement environment, which includes October's 4.2% increase in Medicare rates for fiscal year 2025, as well as continued positive reimbursement trends at the state level. On the regulatory front, we continue to believe that CMS's final minimum staffing rule will either undergo significant revision during the extended phase-in period or be eliminated in its entirety, especially given the pending litigation and recent change in administration. Regarding the change in administration, we believe that President Trump's pro-business priorities on taxes, energy, and regulation will be a net benefit to most U.S. domestics, including ours. Specifically, to the industry, the Trump administration was very collaborative and supportive of the provider community during the first term. And while it's still too early to know exactly what, if any, reimbursement, regulatory or administrative changes will be pursued, overall industry sentiment on the new administration remains positive. As far as the outlook for 2025, our top three strategic priorities continue to be as follows: Our first priority is driving 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 expect mid-single-digit revenue growth in the year ahead and estimate a Q1 revenue range of $440 million to $450 million. Our second priority is managing costs. Managing cost of services in line with our target of 86% and managing SG&A into the targeted range of 8.5% to 9.5%. Our key operating trends for customer experience, system adherence, regulatory compliance, and budget discipline continued to trend positively throughout 2024, and our field-based team remained laser focused on exceeding expectations in the year ahead. This operational execution coupled with prudent spend management at the enterprise level positions us very well to deliver on this priority in 2025. Our third priority is optimizing cash flow. Our cash flow continued to gain strength throughout 2024, culminating in an outstanding fourth quarter, largely fueled by our strongest cash collection results in over three years. We estimate 2025 actual cash flow from operations excluding the change in payroll accrual in the range of $45 million to $60 million. Looking ahead, we are confident that focusing on our strategic priorities supported by our strong business fundamentals will enable us to further accelerate growth, enhance profitability, and maximize cash flow through 2025 and beyond. So with those opening comments, I'll turn the call over to Matt for a more detailed discussion on the quarter.

Thanks, Ted, and good morning, everyone. Revenue was reported at $437.8 million. Housekeeping and laundry revenue was $192.7 million, and housekeeping margin was 10.2%. Dining and nutrition revenue was $245.1 million, and the margin was 4.7%. Our Q1 revenue estimate is in the range of $440 million to $450 million. Cost of services was reported at $379.2 million, or 86.6%, which includes new business startup costs. Our 2025 goal is to manage cost of services in the 86% range. Reported SG&A was $44.8 million. After adjusting for the $4 million increase in deferred compensation, actual SG&A was $44.4 million, or 10.1%. SG&A is also inclusive of new business startup costs. Our 2025 goal is to manage SG&A into the 8.5% to 9.5% range. Having said that, based on investments that we've made and spoken about in previous quarters, SG&A has been elevated as a percentage of revenue. So realistically, we expect to be tracking in the 9.5% to 10.5% range for the near term, but remain committed to the opportunity for leverage as we continue to grow the top line. Net income and diluted earnings per share were reported at $11.9 million and $0.16 per share, inclusive of an estimated $3 million to $4 million of new business startup costs. We've reported cash flow from operations of $36.2 million. Actual cash flow from operations excluding the change in payroll accrual was $27 million. We expect 2025 actual cash flow from operations excluding the change in payroll accrual in the range of $45 million to $60 million. I'd now like to turn the call over to Vikas for a discussion on our liquidity position and 2025 capital allocation priorities.

Thank you, Matt, and good morning, everyone. I will briefly discuss our liquidity and balance sheet, as well as our capital allocation priorities for the year. Our primary sources of liquidity continue to be our cash flow from operating activities, cash and cash equivalents, and our credit facility. We wrapped up 2024 with cash and marketable securities of $135.8 million and a $500 million credit facility. The credit facility is inclusive of a $200 million accordion. At year end, the credit facility was undrawn and was utilized only for LCs. Turning to our capital allocation, the board regularly reviews our capital allocation strategy to ensure it supports our goal of creating value for shareholders by delivering on our operational objectives and our growth outlook. Our 2025 capital allocation priorities are fully aligned with our strategic plan to direct investments in organic growth drivers, inorganic growth opportunities, and opportunistic share repurchases. First and foremost, internal investments and organic growth will continue to be our highest priority. Recruitment, training, development, and employee engagement, as well as customer and resident experience, are central to our business plans and will be further enhanced in the future. We will also continue to invest behind increasing awareness and brand positioning. Secondly, we will prioritize investments in high quality inorganic growth opportunities to expand our footprint, accelerate growth, and increase earnings. While we have been measured and deliberate in making acquisitions in the past, we want to explore these opportunities with greater intent going forward. In our core market of long-term and post-acute care, we will focus on complementary opportunities from strategic alliances to investments in emerging technology to adjacent service offerings. In our emerging markets, such as education, we will prioritize tuck-in opportunities that complement our premium dining and EVS brands, namely Meriwether Godsey and CSG. And finally, we will continue to prioritize opportunistic share repurchases as a way to return capital to shareholders. Since the February 2023 share repurchase authorization, we have bought back $16 million of our common stock, and we have over 6 million shares remaining under that authorization. Future repurchases will depend upon, among other considerations, alternative uses of capital outlined above, current liquidity, and our share price. With that, we will conclude our opening remarks and open up the call for Q&A.

Your first question comes from Sean Dodge from RBC Capital Markets. Your line is now open.

Yes, thanks. Good morning and congrats on the strong cash flows in the quarter. And I guess maybe more importantly on the Eagles' dominant performance this past year.

Thank you, Sean. Thank you very much for that. Yes, it's been an exciting time. I think on this call, I have to go cash flow first, Sean.

Yes. Ted, you mentioned a shift back to a growth stance. Are gross margins being impacted by the upfront investments needed to drive that? Matt noted that was between $3 million and $4 million in the fourth quarter. How should we view those startup costs for the next few quarters? You have the 86% cost of sales target that you're maintaining. Do you expect to end the year at that level, or do you think you can reach it a bit sooner?

Yes. To some degree, Sean, that will vary depending on when the new business is added. If it's more disproportionate in a specific quarter, that's when you'll see greater pressure, margin pressure as well as startup cost investments, whether it be period costs or some balance sheet investments vis-a-vis working capital. So it really depends on whether the timing of the adds is spread evenly throughout the quarter in which that would result in one, say quarter-to-quarter impact as opposed to disproportionate in a given period. But you bring up cost of services. Again, we're highly confident in our ability to execute and manage cost of services within the targeted range. And I think the primary driver of that is really service execution, even removing some of the other considerations. So I know we mentioned some of those trends at the outset in customer experience, system adherence, reg compliance, and budget discipline. They're really the nearest of near-term margin drivers, and they're going to carry into Q1 and 2025, which again is why we remain confident in our ability to manage the business in that 86% cost range. But to your point, when you think about, geez, what could drive the month-to-month or quarter-to-quarter movement, it's certainly startup related costs. And I would also expand that out to not just the fact that we're inheriting the existing facility budgets, whether it be payroll and or non-payroll related, but also the management development investments that we're making in the lead up to and for the execution of that new business adds. And then depending on the quarter, there may be some modest seasonality factors in the business, which really offset each other in the main, but could impact the margins in any given quarter. But again, they're far outweighed by operational execution and some of the other factors I mentioned. So with that as the backdrop, again, feel confident in that 86% range, would be reluctant to point to a specific number that startup cost would pressure a given quarter or even the year. But you have our word, we'll call it out and provide that clarity once the quarter has passed and we're able to have this discussion.

And I think, Sean, just as a bit of a reminder to put a finer point on some of the timing considerations, just a reminder that generally speaking, when we are starting a new piece of business and as Ted noted, inheriting the budgets, the existing conditions, and the inefficiencies that are currently in place at that facility, the guidepost for us is generally about 90 days to get a new housekeeping and laundry account on budget. And for dining, it stretches out a bit longer just with some of the considerations relative to the provision of food and the implementation of some of the menu management programs, etc. Whereas those starts can generally take about one 120 days to get on budget. So again, relative to the timing of those new business starts, that's one way to think about the pressure that it could have on margin.

Okay. That's good context, Matt. And maybe just on the cash from operations on an adjusted basis, Q4 was up a lot from Q3, but you did kind of slightly miss the full year target. Is that just related to the startup costs too? And then maybe just any thoughts on how you're kind of bridging your 2024 performance to your 2025 guidance now?

Yes, that's right. We would have reported stronger cash flow, Sean, in the quarter, even stronger cash flow if not for what really were higher than expected number of new business adds. We were able to pull in some opportunities that we had previously thought were going to be more first half of 2025. So that puts some additional pressure on the near-term cash flows. And I think specifically to bridge that to 2025, I think similar just from a cadence perspective and timing of how we think of cash flow in a mid-single-digit world, we would expect the second half of the year to be stronger than the first half of the year, which is again consistent with what we've seen historically and have confidence in that $45 million to $60 million cash flow range, but aren't going to provide for all the reasons we just discussed specific quarter-to-quarter cash flow ranges, specifically because of the considerations related to new business adds and some of the other factors. And I think to really illustrate that point further, that $45 million to $60 million range assumes mid-single digit growth. If new business adds are disproportionate to one specific quarter, in a mid-single digit world that would have an effect on that quarter, but not our full year range. But if we're in a situation where we're further ramping up or accelerating our top line growth into say the high single-digit or low double digits, that would require additional startup cost and related cost in a quarter or in a period of time. And then depending on the nature of timing of that new business, may require us to revise that forecast. So again, we have a high degree of confidence in that $45 million to $60 million range in a mid-single-digit growth world without getting into the quarter-to-quarter estimates because of the considerations we spoke about, primarily new business ad timing.

Yes. And Sean, what I would add there is the cornerstone of our Q4 cash generation was the fact that our cash collection for the quarter was in excess of 100%. And if you look at the back half of last year, Q3 and Q4, our collection rate was in excess of 99.5%. So I think the emphasis on cash collections has been the driver of your initial observation around cash flows.

Okay, perfect. And then just to make sure we can calibrate our models here. Matt, do you have the payroll accrual days in the fourth quarter and then maybe just what they should be for the next few quarters?

Yes, Sean. So in Q1, the change in payroll accrual will have an $8 million negative effect on cash flow. So that's a three-day decrease from the 12 days of payroll that was accrued in the fourth quarter to then nine days in the first quarter. And then looking out over the balance of the year, we'll have a seven-day increase from nine days in Q1 to 16 days in Q2. So that'll have a $20 million positive effect on reported cash flow in Q2. Q3 will have a six-day decrease from 16 days in Q2 to 10 days in Q3. So that will result in a $17 million negative effect on reported cash flow. And then in the fourth quarter, it'll be another six days decrease from 10 days in Q3 to four days in the fourth quarter. So, the change in payroll accrual will have a $17 million negative effect on reported cash flow in the fourth quarter as well.

Okay, perfect. Thanks, and congratulations again.

Thank you, Sean. Thanks, Sean.

Your next question comes from Andy Wittmann from Baird. Your line is now open.

All right. And then just to finish up on the last one, it looks like so the $45 million then, Ted, is that staying basically new businesses at the high end of your expectations, and then the $60 million would be the low end. Are there any other factors, credit issues or other investments in the P&L that we should be thinking about? Or is it really just $45 million to $60 million is the range of your startup costs and the working capital injection that's required?

In a mid-single-digit world, that's exactly right.

Okay. And then just to keep going on that a little bit further, just anything that you'd say on overall credit quality in the quarter? We didn't see a call out anything large here in the quarter, but just was there any impact that we should know of? What can you tell us about some of the numbers that we're going to see later in the queue? Maybe those are some of the questions that are worth investigating here.

Yes. Look, I think, Andy, on the collection front, credit quality front, what we would say is we saw some positive trends over there, specifically with respect to DSOs. We brought that DSO number down. And I think that is a result of a few factors at play, right? We had a strong collection in the back half of the year, as I just mentioned. That allowed us to bring down our aggregate AR and NR balance. There was a mix shift from AR to note receivables. And finally, you are doing the calculation of your DSOs based off a stronger sales number for the quarter. So the combination of those three factors drove down our DSOs, which is a positive. We did have a CECL expense, the bad debt expense of close to $10 million which again, if you look at the average for the back half of the year, turns out to be about 1.2% of revenue, which is where you would expect it to be if you look at the historical trends. I would say between the momentum on collections and revenue growth, we continue to see favorable trends in our overall credit quality at the portfolio of our collectibles.

Okay, great. I see. And then I'm just kind of curious, maybe I missed this, but did you guys say where the $3 million to $4 million of startup costs hit versus the segments that you report or could you?

The majority of it was cost of services, Andy, and there was a portion of it that was SG&A related, but more 75% of it would have run through cost of services.

Was that dining?

Largely dining. That's exactly right. Yes.

Okay. Just last question for me then is, with the federal bureaucracy being addressed, and I know this is very real time here, but are your customers seeing an impact to the way they're getting paid or the timeliness from which they're getting unpaid or responses to their questions? I was just wondering if there's any impact that's flowing through to them to you that we should be aware of in these very early days, and obviously this is rapidly changing, but I just thought I'd check in on this one specifically.

Yes, there’s nothing to report on that matter. We wanted to highlight in our opening comments that while it's still early, there is an awareness that changes are likely to occur. Historically, and based on the latest interactions between the administration and the associations and provider community, any changes would be made collaboratively, particularly concerning entitlement programs like Medicaid. The President has consistently voiced his views on Medicare, Social Security, and more recently, Medicaid. Although we do not foresee any immediate changes, the expectation is that any alterations would be made through collaboration. This contributes to the overall positive sentiment within the provider community regarding the new administration.

All right, guys. Thanks a lot for your time. Have a good day.

Great. Thank you. And

Next question comes from A.J. Rice from UBS. Your line is now open.

Hi, everybody. Just to think about the movement in revenues from Q4 to Q1, I think at the midpoint you're stepping on, if I got the math right, about $7 million. Is that all new business? And how much of the new business, whatever it was, was reflected in the fourth quarter? Or was that something that would carry over, that really is largely going to be reflected in Q1? And then I would also ask along the new business lines, when you get back in that mode, does there tend to be a seasonal pattern to new business wins? Do they tend to happen towards the beginning of the year or later in the year? Any thoughts on that?

I would address the second part of your question first. Historically, there hasn't been a distinct seasonal pattern; it's more about client-specific opportunities. Over the past three to four years, we've mostly been in a holding pattern from a growth perspective, so we see opportunities being spread evenly throughout the year. However, if we onboard a larger opportunity at a particular time, it will attract more attention and impact a specific quarter more significantly. This trend is driven more by dynamic circumstances than seasonality. Regarding revenue growth in Q4 and its carryover into Q1, I want to recognize our field-based leadership and specifically highlight the efforts of our district managers, training managers, and PDMs in managing our training program. Their commitment to the candidates and the integrity of the overall program over the past year has been exceptional, especially as we transition into growth mode, which has resulted in positive outcomes for our management trainees. The quality and quantity of candidates, coupled with strong demand for services and high client retention rates, give us confidence in our expectations for 2025. In Q4, the new business we acquired was fairly evenly distributed throughout the quarter, and we maintained over 90% retention rates with our existing clients, indicating no significant facility exits. This performance is what fueled the increase from Q3 to Q4, and we are carrying that positive momentum into Q1. Some of the business we secured in Q4 will impact Q1, alongside new activities and ongoing prospect discussions that have yet to come to fruition. Overall, demand remains strong, and we are well-positioned to capitalize on these opportunities in the coming year.

Okay. That's great. And then maybe just to ask as a follow-up on the expectations around labor inflation and food inflation embedded in your thinking about 2025 outlook?

Yes. Obviously, something that we continue to monitor, A.J. Looking at the fourth quarter, CPU for all items was 90 basis points compared to 60 basis points in the third quarter. Food at home inflation continued to increase sequentially, showing 90 bps of inflation, which compared to 50 bps we saw in Q3, and actually 10 basis point deflation that we saw in the second quarter. So, this is now the highest level that we've seen since the fourth quarter of 2022. So, notably, the month of November was 50 basis points in and of itself, which is the highest monthly inflation we've seen since October of 2022. So certainly, to your point, something that we'll continue to be mindful of and monitor. On the wage side, we did see specifically in the nursing and residential care facilities across the U.S., 70 basis points of inflation continuing the sequential declines that we saw throughout 2024. So declining from 1.2% in Q1 to 0.9% in Q2 and 0.8% in Q3 and then, as I mentioned, 0.7% in the fourth quarter. So, we've seen substantial increases since the introduction of the massive wage inflation that came on the heels of COVID. But since then, it's definitely moderated in 2023 and 2024. So, favorable trends there. And as that relates to the labor market in general, labor market remains relatively steady. The most recent data show job postings are stable and November and December both saw reasonably strong job growth. And wage growth, like I said, has stabilized. So, the unemployment rate remains only moderately elevated from historic lows. And to the nursing care industry, which is how the data are reported, still close to 100,000 about 95,000 jobs short relative to pre-pandemic levels, but improved from an overall loss of nearly a quarter of a million at its peak. So, in 2024, the industry jobs recovery averaged about 3,400 per month compared to 2023, where we saw about 5,600 jobs recovered per month. So, a little bit of a slowdown. But what does that mean for Healthcare Services Group? Ultimately, we're in a good spot, A.J., as we head into 2025 here. Wage growth for us specifically has remained stable. Our job applications are high nearly across the board relative to both line staff employment opportunities and those management opportunities that Ted just discussed in his recent comments. So, there are some markets with ongoing challenges, but we're able to allocate resources to focus and address those situations as they arise. And the final bow that I would put on this whole conversation is the fact that having gone through the bottoms-up, laborious exercise of the contract modification initiative, we now have rights to pass through not only food-related inflation, chemical and supply-related inflation, but also the wage inflation that we're experiencing something closer to real-time. So, with respect to the durability of our contract structure, as it relates to managing the business, of course, we'll be mindful of inflationary factors on both food, supply, purchases, and wages specific to any given market. But we do have that confidence in the durability of the contract model to be able to recapture any and all such increases.

Okay, great. Thanks so much.

Your next question comes from Ryan Daniels from William Blair. Your line is now open.

Good morning, everyone. This is Jack Senft for Ryan Daniels. Thanks for taking the questions. First, this is similar to the last line of questions. But now with the mid-single digit guidance you provided for the full year, and maybe I missed this too, but how should we think about the different pieces to the growth? It sounds like maybe the majority is coming from new business and manager, the manager training program, but is environmental services and education anything to speak to? Or I guess maybe how should we think about that going forward? Thanks.

Yes. We continue to see a nice growth opportunity in education, Jack, for sure. But the primary driver of our 2025 top line growth will be in the Healthcare segment, the core niche traditional end market for us. And when you drill down within the Healthcare opportunities, our pipeline reflects a nice split between the segments. So we expect to pull through new business fairly evenly between environmental services and dining. Now of course, dining new business adds have a greater revenue contribution on a per facility basis. So even if we're onboarding a comparable number of accounts, the dining revenue will increase proportionally, given that the value of a dining contract is typically 2x that of an environmental services contract on a same-store basis. So just to level set and as a reminder, Jack, we've barely reached 50% penetration in providing Dining and Nutrition services within our environmental services customer base. So the cross-sell opportunity remains the ultimate low-hanging fruit for us as a company from a growth perspective. And that's a scenario in which clearly the prospect is already a customer. They're committed to the partnership. And then it also offers us the opportunity to further leverage the underutilized district and regional management structure that exists in Dining and Nutrition. So healthcare will be the primary driver, hopefully looking at a nice split between both environmental services opportunities and dining supplemented by the ongoing growth in the education end market.

Perfect. Makes a lot of sense. Just as a follow-up then off of that. Just given that you do have so much opportunity with what you're just speaking to, as we kind of look into the next few years, and I understand you're not guiding to anything long term, but maybe directionally, is kind of like the mid-single-digit growth rate kind of like a baseline we should be looking at? Just kind of want to get your thoughts on that.

That's exactly how we're thinking about it mid-single digits when we look out over the last next three to five years. That's what our strategic plan and capital allocation priorities are aligned around. So there will be and should be years or quarters where we're pushing higher than that depending on again timing considerations and management development efforts and ultimately management development capacity. But it's that mid-single digit that we see this company moving over the next three to five years at the top line and with some additional benefit from an earnings perspective because we'll be leveraging SG&A along the way.

Okay. Understood. And then just one final question for me. What did client retention look like during this quarter? And then was that pretty steady during the course of 2024?

Greater than 90% for the year and trending higher than that in the back half of the year.

For the quarter, I think you're getting a good year.

Yes. Thank you, Jack.

I'd now like to hand back the call over to Ted Wahl for final remarks.

Thank you, Ellie. It's an incredibly exciting time for the company. The innovations of the past few years have further solidified our value proposition, the durability of our business model, and our market-leading position. The underlying fundamentals are stronger than ever. And with the industry at the beginning of a multi-decade demographic tailwind, we are very favorably positioned to capitalize on the opportunities ahead and deliver meaningful long-term shareholder value. So on behalf of Matt, Vikas and all of us at Healthcare Services Group, Ellie, I wanted to thank you for hosting the call today and thank you so much to everyone for joining.

Thank you for hosting the call today, and we appreciate everyone for joining us.