Healthcare Services Group Inc Q2 FY2025 Earnings Call

Thank you for joining us today for the Healthcare Services Group, Inc. Second Quarter 2025 Earnings Conference Call. We will discuss forward-looking statements regarding the business prospects of Healthcare Services Group, Inc. For our most recent forward-looking statement notice, please check the press release issued this morning on our website, www.hcsg.com. Actual results may vary significantly from what is communicated due to various risks, uncertainties, and important factors, as outlined in the risk factors, MD&A, and other sections of our annual report on Form 10-K and other SEC filings. Our most recent forward-looking statements notice also contains relevant information. Additionally, management will cover certain non-GAAP financial measures, and a reconciliation to U.S. GAAP is available in this morning's press release. After the initial remarks, we will open the floor for questions. Now, I will hand the call over to Ted Wahl, President and CEO. Please proceed.

Good morning, everyone, and welcome to HCSG's Second Quarter 2025 Earnings Call. I am joined today by Matt McKee, our Chief Communications Officer, and Vikas Singh, our Chief Financial Officer. Earlier today, we released our second quarter results and plan to file our 10-Q by the end of the week. In my opening remarks, I will discuss our Q2 highlights, share our view on the overall business environment, outline our strategic priorities, and provide details on our $50 million share repurchase plan. Matt will follow with a more detailed discussion of our Q2 results, and Vikas will update us on our balance sheet and capital allocation progress. We will then open the call for questions. First, I want to comment on the previously announced restructuring at Genesis HealthCare. Genesis filed for Chapter 11 bankruptcy on July 9. Since the petition date, we have maintained our contractual relationship with the Genesis facilities without disruption in services or payments. While we are disappointed by the impact this event had on our second quarter results, we believe the causes are specific to Genesis and its prior circumstances and decisions, and do not reflect the current state of the industry. Genesis has received significant external attention over the years, and rightly so, as they are an important customer, and we have a long-standing partnership with them. We believe this event will lead to stronger, healthier client facilities, provide clarity for our stakeholders, and remove an overhang that has impacted our stock for years. Now I would like to turn our focus to results that are more reflective of our underlying business fundamentals and the exciting opportunities ahead. Our second quarter growth surpassed expectations and marks our fifth consecutive sequential revenue increase, achieving the highest growth rate since Q1 2018. New client acquisitions and high retention rates fueled our organic growth, which has carried into the latter half of the year. Despite the news surrounding Genesis and its effect on our Q2 reported results, our growth plans and cash flow outlook for 2025 remain strong. We are reiterating our mid-single-digit growth expectations for 2025 and raising our cash flow from operations forecast, excluding the change in payroll accrual, to a range of $70 million to $85 million, up from the previous $60 million to $75 million. Regarding the overall business environment, industry fundamentals continue to strengthen, driven by a multi-decade demographic tailwind in long-term and post-acute care. The latest industry operating trends are positive, characterized by steady occupancy, increasing workforce availability, and a stable reimbursement environment. The One Big Beautiful Bill Act has sparked significant political debate and speculation, as various interest groups seek to shape the narrative. We view this as a predictable reaction to such significant legislation and expect commentary to remain heightened through the midterm elections. Overall, we maintain a positive view of the industry. Beneficial provisions include a 10-year moratorium on the minimum staffing mandate, successful legal actions, industry exemptions from provider tax reductions, and a $50 billion investment in rural markets. In the short term, these measures will enhance the industry’s strength and stability, offsetting any potential long-term concerns regarding other Medicaid provisions that may be phased in later. Looking ahead, we are hopeful that the administration and Congress will continue prioritizing the evolving and expanding needs of our nation's most vulnerable populations and the providers who care for them. As we move into Q3 and beyond, our top three strategic priorities remain: driving growth by developing management candidates, converting sales pipeline opportunities, and retaining existing facility business; managing costs through effective operational execution and prudent expenditure management; and optimizing cash flow through increased customer payment frequency, improved contract terms, and disciplined working capital management. We are confident that by continuing to execute on our strategic priorities, supported by robust business fundamentals, we will accelerate growth, enhance profitability, and maximize cash flow throughout the latter half of 2025 and beyond. Additionally, alongside our earnings release, we announced plans to further accelerate our share buybacks, intending to repurchase $50 million of common stock under our February 2023 authorization. Over the past several years, we have strengthened our balance sheet and expect strong cash flow generation in the coming year. Our approach to capital allocation has been prudent and balanced, focusing on investing in growth initiatives. The current valuation of our stock, in relation to our long-term growth potential, presents a unique opportunity for buybacks to return considerable capital to shareholders. With those introductory comments, I'll now turn the call over to Matt for a detailed discussion on the quarter.

Thanks, Ted. And good morning, everyone. Revenue was reported at $458.5 million, an increase of 7.6% over the prior year. Segment revenues for Environmental and Dietary Services were reported at $205.8 million and $252.7 million, respectively. We estimate Q3 revenue in the range of $455 million to $465 million and reiterate our 2025 mid-single-digit growth expectations. Cost of services was reported at $455.5 million or 99.4% and includes the impact of the $61.2 million or 13.4% noncash charge related to the previously announced Genesis restructuring. Our goal is to manage the second half of 2025 cost of services in the 86% range. Reported SG&A was $49.2 million. But after adjusting for the $4.7 million decrease in deferred compensation, actual SG&A was $44.5 million or 9.7%. The company expects to manage SG&A in the 9.5% to 10.5% range in the near term, based on investments that we've made and spoken about in previous quarters, with the longer-term goal of managing those costs into the 8.5% to 9.5% range. Segment margins for Environmental Services were reported at 0.8% and include the impact of a $20.3 million or 9.9% noncash charge related to the previously announced Genesis restructuring. Segment margins for Dietary Services were reported at negative 10.1% and include the impact of a $40.9 million or 16.2% noncash charge related to the previously announced Genesis restructuring. Net loss and diluted loss per share were reported at $32.4 million and $0.44 per share. This includes the impact of a $0.65 noncash charge or $61.2 million pretax, tax affected at 22.7% related to the previously announced Genesis restructuring. As previously announced, we estimate a third quarter $0.04 per share noncash charge related to the Genesis restructuring. Cash flow from operations was reported at $28.8 million. After adjusting for the $20.3 million increase in the payroll accrual, cash flow from operations was $8.5 million. We're raising our 2025 cash flow from operations forecast, excluding the change in payroll accrual, from $60 million to $75 million to $70 million to $85 million. I'd now like to turn the call over to Vikas for a discussion on our liquidity, balance sheet and capital allocation progression.

Thank you, Matt. And good morning, everyone. Our balance sheet strength and liquidity position have been driven by sustained collection trends and results in the current quarter as well as the last few quarters. We ended the second quarter with cash and marketable securities of $164.1 million. This includes $7.9 million of ERC receipts in the second quarter. At the present time, there is no income statement impact from ERC as these credits are being recorded on our balance sheet only. Our credit facility was undrawn at quarter end, with utilization limited to LCs only. On the capital allocation front, our priorities are to direct investments towards organic growth, acquisitions and opportunistic share repurchases. Overall, our balance sheet and liquidity are well positioned to facilitate and support our growth journey through organic and inorganic initiatives. As for activity during the second quarter, we repurchased $7.6 million of our common stock this quarter. This takes our year-to-date buybacks to $14.6 million. And while there were no completed acquisitions in the quarter, we continue to actively evaluate opportunities. Finally, as Ted highlighted in his remarks, in conjunction with our earnings release, we announced plans to further accelerate the pace of our share buybacks. And over the next 12 months, we intend to repurchase $50 million of our common stock under our February 2023 share repurchase authorization. We expect these repurchases to be made on the open market, which may include a 10b5-1 plan as well as through privately negotiated transactions. With that, we will conclude our opening remarks and open up the call for Q&A.

Your first question comes from the line of A.J. Rice from UBS.

Maybe just a few quick ones here. Just to make sure I understand on the Genesis situation between the big charge you took this quarter and the little follow-on you're pointing to for the third quarter, will you have effectively written off all of your exposure to Genesis at that point? And I assume your positioning is pretty strong within the capital structure there. Do you have any sense about recoveries or where the process is and how quick there might be resolution on the outstanding receivables?

Yes, regarding your first question, after the third quarter, which will include some prepetition amounts, it will be fully reserved. As for the process and potential recoveries, it's still very early, so we don’t have much to report about developments aside from the usual affidavits and motions typically seen at this stage. I want to emphasize that we are experienced in navigating this process, and our partnership with the client communities we serve with Genesis is stronger than ever. Chapter 11 recoveries vary from case to case, and we will leverage our strong position to prioritize recovery. However, it's still too soon to speculate on what that may look like.

Okay. And then I just wanted to think about where you're at with respect to growth. You've got, on the one hand, retention and attrition that you have to deal with every year, albeit modest, hopefully. Are you back to sort of a normalized rate there? Can you just comment on that and comment on how much new business adds you've had and maybe sort of how that stays as you look at the back half of the year?

Sure. I mentioned this earlier, but for Q2, we achieved our fifth consecutive increase in revenue, marking our highest growth rate since the first quarter of 2018. This was primarily due to successfully implementing our organic growth strategy, developing management candidates, converting sales pipeline opportunities, and retaining existing business. The majority of the increase from Q1 to Q2 came from new business wins, which were predominantly concentrated at the beginning of Q2, along with retention rates exceeding 90%, which we are optimistic about maintaining. For everyone on this call, a 90% client retention rate has been fundamental to the company since we started. There have been some fluctuations over the past few years related to post-COVID restructuring and an unusual spike in ownership changes, some of which we were not comfortable partnering with. This led to a higher number of exits than we traditionally see. However, looking ahead to the second half of the year and beyond, we expect to maintain retention rates above 90%. Specifically, for the latter half of the year, we forecast revenues between $455 million and $465 million, with sequential growth expected compared to the first half of the year.

Okay. Lastly, do you have any updates on food inflation? I know there’s a lot of discussion about tariffs and other factors. What are you observing? I assume you're managing this through your contract structure. Any insights on that?

Yes, that's correct, A.J. I'm glad you pointed that out because even in a volatile market, we have the ability to pass along those increases to our clients. We're always aiming to mitigate specific menu items or food line items that are showing significant inflation. We have the flexibility to do this with our network of clinical dieticians collaborating with food service directors at the facilities for menu management. We can manage this from both operational and financial perspectives. To give you a broader view, the consumer price index for all items in the quarter was 60 basis points, the same as in Q1. Specifically, food at home inflation has varied month-to-month, decreasing quarter-to-quarter. Q2 showed 20 basis points of inflation compared to 1% inflation in Q1 and 50 basis points in Q4. Interestingly, April had 40 basis points of deflation, while May and June both had about 30 basis points of inflation for food at home. This is something we will continue to monitor. We will manage and mitigate those cost increases as best as we can for the benefit of our clients at the facility level. Ultimately, as we see cost increases, we have the contractual rights to pass those increases through.

Your next question comes from the line of Tao Qiu from Macquarie.

The first question I want to ask about guidance. So for the first half, you achieved 6.6% revenue growth. And based on the Q3 revenue guidance, it seems that the momentum will continue north of 7% at the midpoint. Any reason you reiterated that mid-single-digit guidance, which is clearly below the current trend line? Any downside risk we should contemplate in our estimates?

It's a great question, Tao. Our goal is to provide accurate ranges given the variables, particularly the timing of new business additions, which can change from quarter to quarter. There will always be some opportunities within a quarter that might be delayed or expedited. For example, in Q3, starting an opportunity on September 1 instead of October 1 might not show much difference on a year-over-year basis but can significantly impact a specific quarter based on the size of the new business opportunity. This is why we're maintaining the mid-single-digit guidance. The range of $455 million to $465 million reflects our management's visibility and expectations for that quarter. To address your question directly, we understand our trends and have no reason to believe we won't continue that direction. Currently, we evaluate our performance in 12-month increments rather than just quarterly, so we're sticking with the mid-single digits for now. However, your point is valid, and we are certainly trending towards higher digits and possibly even beyond that.

Understood. And the second question is about Genesis and more broadly, your collection strategy. I think one of the reasons you cited for leveraging those receivables is better recovery expectation in a situation like this. So could you help us understand whether you expect any difference in the recovery through this process? And how does this process inform your future collection strategies that you guys have?

Yes. Our collection strategy continues to focus on increasing payment frequency. We are actively using promissory notes as they document indebtedness, carry interest, and come with personal or corporate guarantees. Occasionally, we are able to secure an interest, even if it's junior to a senior secured lender, which still allows us some level of involvement with that secured lender. Remaining disciplined in our decision-making is crucial for the overall strategy. Regarding Genesis, as I mentioned in response to A.J.'s question, it's still too early to determine potential recoveries since Chapter 11 cases can vary significantly. We are hopeful and plan to leverage our position in the process as a key stakeholder and priority vendor. We anticipate a long-term partnership with the client facilities after the reorganization, but at this point, it's too early to provide meaningful insights on recovery expectations.

We'll await the update there. Just curious, lastly, on the macro front, I think, Ted, you mentioned a lot of the positive discussions coming out of the budget bill and the policies from Washington. Just curious, I think the states are setting health care budget for 2026 and beyond. We have seen some cuts or at least moderated growth going forward. I know that it's still early, but any particular geographies that worries you longer term?

No. We are certainly monitoring the reporting you provide. Our regulatory and reimbursement experts are actively analyzing and assessing this on a weekly basis. They collaborate with customers, third-party experts, and industry lobbyists. We are observing similar trends. Overall, there appears to be a moderation in Medicaid growth. However, from our perspective, the underlying fundamentals continue to strengthen. I mentioned the demographic tailwind, which is starting to influence the long-term and post-acute care system. The ongoing interaction between staffing availability and patient census remains crucial for any facility's success. Labor availability is the most significant factor in driving occupancy growth, and we consider occupancy growth in Medicare or Medicaid settings essential for achieving consistent financial results. Recent occupancy data is very encouraging, with trends exceeding 80% across all settings, including urban, suburban, rural, long-term, and short-stay facilities. This perspective remains unchanged. Additionally, we have a more optimistic outlook on ABA, especially concerning the near-term provisions. While some states may experience pressures at the margins, we still see increases at the state level. This encapsulates our viewpoint.

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

To follow up on the previous discussion, many of the offsets in the Beautiful Bill relate to states that expanded Medicaid under the Affordable Care Act. These states may face a decrease in their capacity to impose health care taxes as a means to finance Medicaid. Furthermore, during the COVID pandemic, there was a greater incentive for more states to expand Medicaid, but that incentive may now be diminished. While the implementation timeline for these changes won't happen all at once, I thought it would be useful to discuss how the passage of this legislation could affect states with expanded Medicaid and how it may influence your customers in the future.

We believe the key factors that will positively influence us in the near term include the 10-year moratorium on minimum staffing, the exemption from provider tax reductions, and the $50 billion investment in rural markets. These three elements are foundational for enhancing strength and stability. Some other provisions will require thorough evaluations to determine their impact on providers, and we need to see if they have been implemented. Our regulatory and reimbursement experts conducted a comprehensive assessment of the 21 Medicaid subchapters to analyze their potential impact, effective dates, and implementation guidance. They validated this work with our customers, industry experts, and lobbyists, which shapes our optimistic perspective on the legislation as it pertains to the industry. However, we understand that Medicare and Medicaid remain politically sensitive issues, and we will stay adaptable to respond as necessary.

Okay. That makes sense. And then, Matt, just a clarification here. I guess in your announcements with Genesis recently, you thought it was going to be a $0.62 charge, came in at $0.65 for the quarter. It sounds like the $0.04 that was mentioned then is still coming in 3Q. So a little bit higher here. Was that just an increase in the assessment of the Genesis? Or was there something else in there, different customer that affected here the quarter with coming in a little bit bigger charge than was initially expected?

Yes. Really, Andy, that was just tax rate related for Q2. And then just from a timing with respect to prepetition monies, there was a drag between second quarter and ultimately third quarter, which is why you'll see that modest estimated $0.04 per charge that will impact Q3.

Your next question comes from the line of Matthew Mardula from William Blair.

This is Matthew Mardula on for Ryan Daniels. And I'm curious on how has the cross-selling of dining services into Environmental Services been? And can you provide maybe an update on your outlook for it in the second half? And just any insight into a long term would be great.

Yes. Matthew, as far as the segment breakdown, our new business pipeline is split fairly evenly between EVS and Dietary. And that's a good thing from our perspective because our general preference is still to initiate services with Environmental Services and then to view dining as a cross-sell opportunity. It allows us to have a front-row seat in the facility to really observe and make an expert assessment in their current dining operations such that the point in time when we determine it makes sense to then provide a proposal and initiate discussions about converting dining services, we can really come with that much of a better informed proposal and recommendation to really enhance the value proposition that we're providing for that particular client. So from a top line perspective, obviously, on a same-store basis, that dine-in contract typically has about a 2x impact on revenue. So we want to be able to continue to grow the pipeline of new business opportunities in EVS to be able to ultimately continue that cross-sell. But as we sit here, we're still barely 50% penetrated in providing dining services within the existing Environmental Services customer base. So the demand is unbelievably high. So plenty of opportunities for us to continue to pull through that dining cross-sell, but likewise, have an eye out towards the future and recognizing greenfield sales pipeline opportunities for EVS as well.

Great. And then regarding the Educational segment, I know it is still a small percentage of revenue, but with school starting again, how are you viewing it for the second half of the year?

Yes. It's amazing. We've been at it for over 3 years now. And the ongoing returns have been remarkably positive. There are many similarities, as we've discussed previously between our core market and this still emerging market, in that they're both highly fragmented, largely in-sourced, and our value proposition very much resonates. So we talked about previously some of the seasonality that exists both operationally and from a sales perspective in the Education space. And we're coming to what is the end of what's generally considered the sales season right now for obvious reasons in anticipation of the upcoming academic year. And we've had some really nice wins and continue to put up some nice growth rates. So from a revenue perspective, it's still less than 5% of total company revenues, but certainly an opportunity that we remain committed to, moving forward. So positive early returns, strong commitment to the opportunity moving forward and really a nice complement to the 2025 growth strategy and perhaps something more meaningful beyond that.

And we have reached the end of our question-and-answer session. I will now turn the call back over to Ted Wahl for closing remarks.

Okay. Great. Thank you, Rob. As we enter the second half of 2025, the company's underlying fundamentals are stronger than ever, our leadership and management team, our enhanced value proposition, our business model and the visibility we have into that model, our training and learning platforms, our KPIs and key business trends and our strong balance sheet. And with the industry at the beginning of a multi-decade demographic tailwind, we are incredibly well positioned to capitalize on the abundance of opportunities that lie ahead and deliver meaningful long-term shareholder value. So on behalf of Matt, Vikas and all of us at Healthcare Services Group, thank you, Rob, for hosting the call today, and thank you again to everyone for joining.

This concludes today's conference call. You may now disconnect.