Earnings Call Transcript - HCSG Q2 2021

Operator, Operator

The matters discussed on today's conference call include forward-looking statements about the business prospects of Healthcare Services Group, Inc. within the meaning of the Private Securities Litigation Reform Act of 1995. 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, including the SEC's ongoing investigation. There can be no assurance that the SEC or another regulatory body will not make further regulatory inquiries or pursue further action that could result in significant costs and expenses, including potential sanctions or penalties, as well as distraction to management. The ongoing SEC investigation and/or any related litigation could adversely affect or cause variability in our financial results. 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. I would now like to turn the call over to Ted Wahl, President and CEO. Sir, you may begin.

Ted Wahl, President and CEO

Okay. Thank you, Phyllis, and good morning, everyone. Matt McKee and I appreciate you joining us today. We released our second quarter results this morning and plan on filing our 10-Q by the end of the week. We remain encouraged by the stabilizing industry landscape, in particular, some of the recent and more positive trends for census and new COVID cases in long-term and post-acute care facilities. Having said that, we're also cognizant of the significant uncertainty related to COVID that remains. We'll continue to closely monitor the various interrelated factors that will play a crucial role in industry recovery, including immunization rates, occupancy trends, staffing levels, and government funding. And although we don't know exactly what the pace and pathway of recovery will be, we've learned an awful lot over the past 18 months and are confident that we are well positioned for long-term growth. Looking ahead, we're incredibly excited about the return to growth in Q3 and expect over $50 million in annualized revenue growth to be reflected in next quarter's results. Our HCSG heroes have continued their tireless efforts to protect those most vulnerable and this significant expansion, primarily with existing customers, not only underscores the strength of our core client partnerships, but also serves as recognition of our team's extraordinary dedication and commitment to going beyond. While Q2 reported results were impacted by several temporary or nonrecurring items, our underlying operational and financial performance was very strong and in line with recent quarters as we continue to execute on our operational imperatives and manage the elements of our business that are within our control. During Q2, we agreed to temporarily modify certain pricing and payment terms of our agreements with Genesis as it continues to work through its restructuring plan. We believe that these temporary adjustments, in conjunction with concessions made by other stakeholders, are in our best interest as Genesis facilities provide a broad platform for strategic opportunities in the future. Additionally, we were pleased with the significant progress made during the quarter towards a resolution in the SEC matter. We also anticipate resolving through mediated settlements California Labor & Employment matters. Together, the temporary or one-time adjustments related to Genesis, the SEC, and California L&E matters accounted for the majority of our sequential decreases in reported revenue, net income, and adjusted cash flow from operations. So with those introductory comments, I'll turn the call over to Matt for a more detailed discussion on the quarter.

Matt McKee, Executive Vice President

Thanks, Ted, and good morning, everyone. Revenue for the quarter was $398.2 million with Housekeeping & Laundry and Dining & Nutrition segment revenues of $202.9 million and $195.3 million, respectively. The majority of the sequential decrease in revenue relates to the temporary Genesis adjustments that Ted described in his opening remarks. The full run rate impact of the temporary adjustments to revenue is reflected in Q2 and expected to remain in place through December of 2021. The remainder of the sequential decrease in revenue relates to the decrease in supplemental billings for COVID-related employee pay premiums, which were initiated by and passed through to customers. These supplemental billings were down $3.1 million quarter-to-quarter from $3.9 million in Q1 to $800,000 in Q2. Direct cost of services was reported at $336.4 million or 84.5%, which is below our historical target of 86%. Housekeeping & Laundry and Dining & Nutrition segment margins were 11.2% and 7%, respectively. SG&A was reported at $50.1 million, but after adjusting for the $2.9 million increase in deferred compensation, actual SG&A was $47.1 million. SG&A was also impacted by the nonrecurring legal-related charges that Ted mentioned earlier, including $6 million related to the potential settlement of the SEC matter, $700,000 of SEC-related legal and professional fees, and $3 million related to the expected mediated settlement of California Labor & Employment matters. Investment and other income for the quarter was reported at $3.4 million, but again, after adjusting for the $2.9 million change in deferred compensation, actual investment income was about $0.5 million. Our Q2 tax rate of 36.5% was impacted by the non-deductibility of the $6 million charge related to the potential settlement of the SEC matter. For Q3 and Q4, we expect our effective tax rate to be in the 24% to 26% range. Net income for the quarter came in at $9.6 million and earnings were $0.13 per share. Together, the temporary or nonrecurring items related to Genesis, the SEC, and the California L&E matters unfavorably impacted reported earnings by $0.15 per share. Cash flow from operations for the quarter was $25.3 million and was impacted by a $20.7 million increase in accrued payroll. DSO for the quarter was 62 days. The majority of the sequential decrease in adjusted cash flow from operations and increase in DSO relates to the temporary Genesis adjustments. The full run rate impact of the temporary adjustments to payment terms is reflected in Q2 and expected to remain in place through December of 2022. We would point out that the 2021 payroll accruals should have a similar cadence to what we saw last year. Q3 will have 5 days and Q4 will have 13 days, which compares to 4 and 12 days that we had in 2020 during those corresponding periods. The payroll accrual relates only to timing, and the impact ultimately washes out through the full year. Q4 will also be impacted by one-half or about $24 million of the CARES Act deferred payroll tax repayment. We're pleased with the ongoing strength of our balance sheet and the ability to support the business while continuing to return capital to HCSG shareholders. We announced that the Board of Directors approved an increase in the dividend to $0.20875 per share payable on September 24. The cash flows and cash balance are supported. 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 return to the shareholders. This will mark the 73rd consecutive cash dividend payment since the program was instituted in 2003 and the 72nd consecutive quarterly increase. That's now an 18-year period that included four 3-for-2 stock splits. We recognize that the dividend is important to our shareholders, and we've increased it in line with our performance track record. Additionally, the company repurchased $1.8 million of its common stock pursuant to its previous authorization during the quarter. The company remains authorized to repurchase 1.6 million shares of our common stock pursuant to the previous Board of Directors authorization. And with those opening remarks, we'd now like to open up the call for questions.

Operator, Operator

Your first question comes from the line of A.J. Rice with Credit Suisse.

Nat Putnam, Analyst

Good morning. This is Nat Putnam on behalf of A.J. Rice. We just had a quick question on the $50 million of annualized revenue that you're expecting from new dining services contracts. We were just wondering how soon you expect these new contracts to be profitable?

Ted Wahl, President and CEO

Yes. Just in line with our typical start-up timeline, we really earmarked EVS openings in that 30- to 60-day window and dining in the 60 to 90. We don't see these dining contracts having any different makeup or composition than ones in the past. So we would expect certainly within ideally the first 2 months, if not by the end of the quarter that they would be within budget.

Operator, Operator

Your next question comes from the line of Sean Dodge with RBC Capital Markets.

Thomas Keller, Analyst

Hey, good morning. This is Thomas Keller on for Sean. Just start off on revenue. This group of clients, you guys have adjusted with service previously. So can you guys give any update on the status of those? Has there been any sort of reopening or restaffing that have taken place there?

Ted Wahl, President and CEO

I'm sorry, there was a bit of a muffle in the connection. Could you please repeat that question?

Thomas Keller, Analyst

Yes, sure. No problem. So you guys talked about adjusting the service levels for some of the clients previously. Just want to see if you can give any update on the status of those. Have there been any sort of reopening or restaffing that have taken place?

Ted Wahl, President and CEO

So I think just to clarify, I suspect you're referring to sort of the impact that census declines have had on our staffing levels and the fact that we've worked arm in arm with our customers that in as much as their census has declined as a result of the events that have unfolded over the course of the past 18 months. We've correspondingly been able to reduce our staffing levels and purchasing, whether that relates to supplies or to food and food-related items. So in as much as census begins to increase in any particular facility in a way that requires sort of an add back, if you will, to staffing levels and/or purchasing, that's something that we'll do with any particular client. So there weren't sort of sweeping adjustments to contractual relationships per se, but really more just that flexibility in working with customers as their census declined and have every expectation that as we've begun to see census, albeit modestly, but as we've begun to see census increase that we would make those corresponding adjustments very much in concert with the customers as well.

Thomas Keller, Analyst

Okay. And you're starting to see that a little bit already?

Ted Wahl, President and CEO

Very modestly. The census has started to rebound, and it's been somewhat consistent, modest but consistent. However, we haven't noticed any significant increase in our staffing levels compared to the low point we mentioned at the end of Q1.

Thomas Keller, Analyst

Thank you for your insights. Can you provide any updates regarding the SEC matter, considering the nearly $60 million you mentioned? Do you believe you have enough clarity about this situation, or is there more to come?

Ted Wahl, President and CEO

Well, I think we continue to be limited in what we can share, and I think out of respect for the process, we're not going to be commenting further, especially while the discussions are ongoing. But what I can tell you is that we continue to cooperate as we have throughout the process. And as we indicated earlier, we're pleased with the dialogue and hopeful that we're going to be able to reach a final resolution sooner rather than later.

Thomas Keller, Analyst

Understood. You mentioned working on some pilots related to school campuses being a longer-term opportunity. Can you provide any updates or progress on that?

Ted Wahl, President and CEO

Nothing substantive. As you can imagine, over the course of the last 18 months or so, we've sort of been up to our eyeballs in trying to effectively manage the operations within our core segment that, of course, being long term in post-acute care, which really since the early stages of the pandemic have been in the eye of the storm. So I would say, our primary operational focus and likewise, from a business development perspective, the conversations that we're having that have led to the new business that we're talking about onboarding to be effectively impacting the top line in Q3 and other opportunities reside more within that core niche market, that long-term and post-acute care end market. Having said that, obviously, the value proposition that we bring by way of our environmental services offering continues to resonate in a variety of adjacent end markets, not the least of which is the private and independent schools. So we continue to view that in sort of the very early embryonic stages. I'd hesitate to even call it a pilot at this point, but there remains a significant opportunity there. We're having conversations, we're pursuing and exploring the opportunities, but doing so in a very sort of methodical, mindful and strategic manner. So nothing noteworthy as yet other than it continues to be of interest to us. And we'll continue to explore and pursue that as appropriate, but very much mindful in a way so as not to detract or distract from that core end market that obviously has significant runway of opportunity yet ahead for us.

Thomas Keller, Analyst

All right. Appreciate it. Thanks for the comments.

Operator, Operator

Your next question comes from the line of Andrew Wittmann with Baird.

Andrew Wittmann, Analyst

Good morning, everyone. Thank you for taking my questions. I'm looking to gain a better understanding of the quarter, particularly the $0.03 mentioned in relation to Genesis. When adjustments to contracts are made, or when there are one-time items that arise in accounting or other aspects during the quarter, I'm curious if the $0.03 impact includes any one-time items. Did the actual run rate differ from the $0.03? Essentially, should we expect similar $0.03 impacts in the third and fourth quarters, or might they be less?

Ted Wahl, President and CEO

No, you're thinking about it and described it the right way.

Andrew Wittmann, Analyst

Okay. And then just in terms of your commentary, Ted, on the December 31, 2021, is kind of, I guess, what you've agreed to in terms of the modification. Do you have an agreement in place for January 1 that tells you that it's something other than that? Or are you just basically giving them this temporary relief and planning to get back at the table sometime in late '21 to talk about what the '22 rate is? I just want to try to understand what's kind of been agreed to between you and Genesis and a little bit more than that?

Ted Wahl, President and CEO

No. We've reached an agreement in principle, and we called out December of 2021 for the pricing-related modifications and then December '22 for the 2022 for the payment modifications because that's consistent with the agreement in principle we reached.

Andrew Wittmann, Analyst

Okay. Great. I have a broader question that might be useful to address. Looking at the competitive landscape and your customer base, there have been many facilities changing ownership recently, including Genesis and other franchises, regionals, and local entities. I would like to know how many of your facilities are being operated or owned by those that are changing hands. What has your experience been so far in retaining those customers? Additionally, what is your outlook on any ongoing discussions with your new or existing customers regarding these transitions?

Matt McKee, Executive Vice President

Yes. Regarding the quantification, I don’t have specific data available, but anecdotally, we are indeed witnessing the dynamics of transactions occurring within our customer base. I believe these transactions reflect broader trends in the industry. We anticipate retaining over 90% of new business opportunities in facilities that change ownership or operator control. This serves as our benchmark. We view these transitions as new business opportunities, which can allow us to reassess pricing or service levels based on the new customer's preferences. The familiarity we have with the facility and its employees, including those in other departments, enhances our working relationships during these transitions since many department heads usually remain in their positions. New owners or operators typically prioritize smooth operations rather than significantly disrupting existing services. Therefore, we expect to maintain a strong presence and know that our value proposition resonates with all customers, whether they are new prospects or long-standing clients. While 90% is our expectation, we believe we can exceed that as we approach upcoming transactions.

Ted Wahl, President and CEO

Yes. I want to emphasize that when we mention customer, we are referring primarily to the resident, while the decision-maker is usually the administrator. This relationship is not only our main source of future growth through references and networking, but as transitions occur, we can maintain our retention rate of over 90% and leverage any new owner-operator platform for additional growth opportunities. High customer turnover is not ideal because it leads to excessive time spent on contractual negotiations and resets. However, we believe the current turnover levels are healthy, and we prefer to view the situation positively rather than negatively.

Andrew Wittmann, Analyst

I found that helpful. I have one final question about the current labor market. It appears to be quite different now compared to a few years ago, before COVID, when we experienced some labor shortages. Ted, could you elaborate on whether your customers are willing to pay competitive or market rates to secure the necessary labor? It's important to note that your contracts allow customers to set their own labor rates. Are you successfully finding enough workers to meet your needs and managing your workforce effectively based on the rates your customers are prepared to pay in today's labor market?

Ted Wahl, President and CEO

Yes. I understand we've discussed this before and recognize that the current labor market is more challenging than it has been for Matt and me during our time leading the company. However, there aren't many universal answers; there's variability from market to market. The headlines we read don't always align with what we're observing in individual markets daily. The contract structure continues to place the responsibility for creating favorable employment conditions to attract and retain employees on the client. We do communicate the challenges we're facing in various labor markets and offer recommendations. For many clients, we've been successful in securing those passthroughs, though sometimes it requires ongoing effort to find the right balance between service management, maintaining appropriate wage rates, and delivering quality service. From our perspective at HCSG, we may be doing a slightly better job than our competition, whether it's the in-house model or our clients' competitors. However, this remains a continuous challenge. We're closely evaluating the situation, but ultimately, we seek solutions tailored to each market rather than a one-size-fits-all approach.

Andrew Wittmann, Analyst

Thanks for that, Ted. I appreciate, and have a great day, guys.

Operator, Operator

Your next question comes from the line of Ryan Daniels with William Blair.

Nick Spiekhout, Analyst

Hey, guys. Nick Spiekhout in for Ryan. Just a quick clarification. That $50 million in incremental revenue, and I guess, of that 12.5 per quarter, what's the base that you guys are considering for that growth?

Ted Wahl, President and CEO

The current quarter's base.

Nicholas Spiekhout, Analyst

Okay. Got you. So from Q2 '21?

Ted Wahl, President and CEO

That's exactly right.

Operator, Operator

Your next question comes from the line of Brian Tanquilut with Jefferies.

Jack Slevin, Analyst

It's Jack Slevin on for Brian. I wanted to ask about the margin trends moving forward. It seems like we noticed some normalization, especially in the gross margin figures compared to our expectations. Could you share your thoughts on how we should view margin normalization as occupancy trends stabilize with your client base?

Matt McKee, Executive Vice President

Yes. We’ve discussed the importance of managing our services and costs effectively, particularly regarding the challenges our clients are experiencing with census pressure. We will continue to oversee staffing, purchasing, and production in relation to census changes, keeping a close eye on our operations as census numbers improve. However, as we anticipate top-line growth in Q3 and beyond, we should expect some inefficiencies as different districts and regions enhance their management, recruiting, and training processes to support this growth. Additionally, when we integrate new facilities, it takes time to establish our systems and align new accounts with our budget, which can create some margin pressure. Currently, we are targeting a cost of services at 86%, and we remain dedicated to managing our labor and supply costs. We may share a new cost of services target in the near future, but we’re not at that point yet. Our goal is to return to growth while keeping the cost of services at or below 86%.

Jack Slevin, Analyst

Got it. That's helpful. And then a good segue there getting back into growth mode. As you think about ongoing conversations with new prospective clients, I think the COVID environment is waning a little bit, right? We're seeing some concerns around the Delta variant, but case facility ratios are down significantly based on the data we have from abroad right now. What are those conversations like? And can you just give us an update on what the progress is in terms of getting to the table and having discussions around bringing on new facilities and bringing on new clients?

Matt McKee, Executive Vice President

Yes. I would say that there remains a focus from a clinical perspective among our customer base, right? I mean they're ensuring that they have measures in place to withstand the perhaps pending pressure that continues to come from the Delta variant. They're focused on staffing, right? I mean arm-and-arm with census is staffing, the facilities need to be able to appropriately staff the building to be able to bring new residents in and build back occupancy to the levels from pre-pandemic and beyond. So there's definitely an interplay there, and there's a focus among our customer base, not only in driving census recovery, but likewise, ensuring that they have the caregiving staff in the facilities able to support that census build back. So that's an important area of focus for them all the while very much a continued and kind of renewed focus on infection prevention and infection control. There will be, I think, at least forever in the near term, an ongoing focus on infection prevention and infection control practices not only within the four walls of the facility but not likelihood from a reporting perspective and from a reputational and a marketing perspective. So there's a lot that these operators are focusing on. Certainly, the Healthcare Services Group value proposition resonates and continues to grow in importance as those other factors become more of a focus. The last thing that any operator wants to do is have to focus on some of these secondary services, non-generating services. So in as much as Healthcare Services Group is able to deliver better outcomes, and that's sort of a broad category of improved outcomes related not only financially but of course, from a regulatory perspective and a compliance perspective, operationally, that's definitely an enticing proposition for a would-be customer. So I'd say from our perspective, the easiest conversations from an access perspective continue to be advancing the conversation with existing customers, specifically environmental service customers about onboarding dining and nutrition services. But as access to facilities continues to expand, we are able to have to advance conversations more thoroughly as to true greenfield opportunities, perhaps utilizing environmental services as that initial service offering with prospective customers. So we don't have the exact clarity and visibility as yet beyond, let's say, the third quarter. Directionally, we think things are moving where we'd like for them to move as far as industry recovery and the impact that that has on our ability to continue to add new facilities and grow the top line. But a cautious attitude, I would say, remains. So opening access opportunities await certainly in the mid-to longer term. But as to the nearest of near term, we'll continue to take that cautious view.

Jack Slevin, Analyst

Got it. That's helpful. And then last one for me, just a quick one on any call-outs for the quarter on workers' comp accrual or any kind of one-timer shifting numbers we should be thinking about?

Ted Wahl, President and CEO

No, other than what we've identified. Nothing related to workers' comp. The only one-time type items were the ones that we've identified.

Operator, Operator

Your next question comes from the line of Mitra Ramgopal with Sidoti.

Mitra Ramgopal, Analyst

Just wanted to follow up a little on the labor side, especially as we talk about growth mode and bringing up new business. One thing we've been hearing in some sectors of the economy in terms of demand being there, but just the labor supply unable to cope with that. I'm curious in terms of how you feel that you will be able to have the staff necessary to meet the additional demand, whether it's in food nutrition or housekeeping only?

Ted Wahl, President and CEO

Yes. Following up on my response to Andy Whitman's question, it's always been a challenge to some extent. Mitra, you are correct that it is more difficult today than it has been in recent history. However, if we look back over the years, it's tough to find a labor environment as challenging as the one we're experiencing now. That said, I want to reiterate what I mentioned to Andy; we are still finding success. Compared to what competitors or in-house operators might face, we benefit from our subject-matter experts and our focus at the home office. We employ various tools, from meta data to recruitment and development programs, as well as our extensive network of grassroots efforts tied to our concentrated facility base and workforce. We are still successfully opening new business. While staffing challenges are a priority for us, and we are aware of the need to be prepared to execute on new opportunities, this won’t deter us from pursuing new business. In fact, it has heightened the demand from potential customers as they see us as a valuable partner to help staff these essential departments critical to their success.

Mitra Ramgopal, Analyst

And then just wanted to know a little on the new business add-ons. Just curious if you could give us a little more color in terms of maybe was this something you're working on for a while, or maybe the pandemic maybe speeded up a little in terms of the needs of that customer, and it might affect them being able to bring a new business going forward?

Ted Wahl, President and CEO

Yes. We have been experiencing many new business opportunities, which vary in their timelines. Most of these involve existing clients we have partnered with for years, along with a good mix of regional companies with different geographical areas, and several independent facilities also spread out geographically. This has provided us with a diverse range of clients. However, COVID has certainly affected how we approached these new business opportunities, making the process longer than usual. The expansion with existing clients is beneficial, as we have a higher level of comfort with them. This is promising for our future. We will continue to pursue opportunities as they arise, maintaining a cautious outlook for the rest of the year. Although there are positive indicators regarding census recovery and new case rates in facilities, new challenges are emerging, such as variants and staffing issues mentioned by Matt. Nevertheless, we feel confident about returning to a growth phase, while remaining selective in our approach.

Operator, Operator

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

Tao Qiu, Analyst

Thank you. Good morning. Just to expand on an earlier question regarding the Delta variant and its impact. The long-term care facilities, I think, have generally done a good job immunizing residents and patients. So they have pretty much well protected there, but staff vaccination rate has stagnated. Given the rising cases, just wondering if you're keeping track of your staff immunization rate across your client base? I imagine you can work with your clients on vaccine mandates for your line stuff. What percentage of your customer base are requiring staff to get the vaccine? Any trend you can call there?

Matt McKee, Executive Vice President

Yes, you're exactly right, Tao, in the sentiment that you expressed in that. We very much follow the lead of our customers on a facility-by-facility basis as to any and all of their COVID-related protocol, right? Whether that's temp screenings, entering through a certain entrance to the facility, exiting through another, and likewise for mandated vaccination of employees. We've rhetorically heard some customers express an intention to do that. We're really not seeing that bear out yet in the facilities. And it will be a challenge. As I said, we worked very much arm and arm with our customers to motivate and encourage and educate our employees about vaccination. But you have to keep in mind that, to a large degree, especially some of these lower-level associate-type employees are drawing from demographics that are typically resistant to vaccination. So it's a challenge. It's one that we will very much work arm in arm with our customers and various departments of health to address. But we are supportive. We will definitely promote, educate and support their endeavors in as much as we're in a position to, but we've not implemented nor instituted any company-specific mandates that would, in any way, interfere or perhaps run counter to what it is our customers are implementing at their specific facilities.

Ted Wahl, President and CEO

And one of the reasons, Tao, when you think of the industry specifically long-term and post-acute care and the success they've had even with the spiking of the variants outside of the facility, the long-term care world. It's not just about vaccinations, it's also about timely testing as well as PPE, right? So these are environments that are matt talked about infection prevention and control. Great learnings on that front over the past 18 months. So I think the industry today is much better prepared than it was when 18 months ago when the pandemic first broke.

Tao Qiu, Analyst

Yes, that's fair. And what we've seen on the senior housing side with some of the larger state operators have really jumped on the bandwagon and mandating their workers to get the vaccine, sounds like you haven't really seen that in your portfolio just yet.

Ted Wahl, President and CEO

Yes. We haven't. And as Matt said, it's something that's been talked about and is being considered or trialed in some cases, but it's not something that we've seen on a broad basis. And one of the challenges, again, I know we've talked about staffing throughout is that's a balance, right? Depending on where you're located or what the local labor environment as you're balancing, having adequate staff, can you mitigate the risk of infection with PPE and adequate testing, if you mandate it, what does that do in a challenging labor environment that in all likelihood will begin to normalize in September, October, when some of the federal programs subside, but that remains to be seen.

Tao Qiu, Analyst

Yes, that makes sense. So my second question is also on Genesis. I think, Matt, you mentioned in your prepared remarks that DSO ticked up this quarter, and I think you attributed most of that to Genesis. Just wondering if you have modified the payment terms of frequency with Genesis in that agreement? Also, are there any changes to their notes payable to you?

Matt McKee, Executive Vice President

There was no effect on the notes, Tao. But as to the sort of general bucket of payment terms/credit, there were adjustments to the contractual relationship in that regard, and those changes will remain in place through December of 2022.

Tao Qiu, Analyst

So should we expect DSO to continue to tick up next quarter to reflect that? Or is this already in this quarter's number?

Matt McKee, Executive Vice President

No, that's correct. The latter, Tao.

Tao Qiu, Analyst

Okay. Yes. Also like on the new contract, I think the $50 million you guys mentioned adding in 3Q is very encouraging, but I didn't hear any remarks regarding how many new contracts did you add this quarter?

Matt McKee, Executive Vice President

No. There was very little activity in dining and nutrition, and that was only related to facility starts that occurred at the end of this quarter. However, those figures will be included in the run rate we indicated would be effective in the third quarter. While there were some operational starts at the end of this quarter, the new business starts we are discussing and the $50 million in annualized new business will primarily be recognized as third quarter starts, with the run rate effect reflected in Q3.

Tao Qiu, Analyst

Got you. And one last question from me. Ted, I think you've said in the past the penetration of customers with your contract is less than 50%. Where do you think you can go to on that penetration rate longer term? Is there any internal timeline you could share with us in terms of ramping it up?

Ted Wahl, President and CEO

Yes. While we don't have a specific timeline, we don't believe that the entirety of our current housekeeping and laundry clients will adopt this change. Customers on the EVS or housekeeping and laundry sides have already accepted outsourcing as a viable option and view us as a good partner. However, cross-selling into dining has proven to be a different kind of sale, relying heavily on relationships and performance-based transitions. We are optimistic about continuing to implement this strategy, exploring EVS as a new opportunity to expand our presence, followed by introducing dining and nutrition services. As we mentioned before, there's potential for dining services to become a primary or at least a co-primary offering, which it already is in many situations.

Tao Qiu, Analyst

Okay. That's all. Thank you for taking my questions.

Operator, Operator

And at this time, there are no further questions. I would like to turn the call back over to Ted Wahl, President and CEO.

Ted Wahl, President and CEO

Okay. Thank you. We know the second half of the year will have its share of pandemic-related challenges, but with the success of the vaccine, positive census trends and our learnings and innovations from over the past 18 months, we are well positioned to succeed and grow whatever may come. As the industry continues its gradual shift from crisis mode to a state of recovery, our commitment to opportunistic growth, internal investment, and returning capital to shareholders underscores our positive longer-term outlook and creates value for all stakeholders. So on behalf of Matt and all of us at Healthcare Services Group, I wanted to thank Phyllis for hosting the call today, and thank you all again for joining us.

Operator, Operator

That does conclude today's conference call. We thank you for participating. You may now disconnect.