Earnings Call Transcript - HCSG Q1 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 these 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 any regulatory body will make no 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. Ladies and gentlemen, thank you for standing by, and welcome to the HCSG 2021 First Quarter Continue Call. At this time, all participants are in a listen-only mode. After the speaker’s presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to Mr. Ted Wahl, President and CEO. Please go ahead.

Ted Wahl, CEO

Great. Thank you, Sharon, and good morning everyone. Matt McKee and I appreciate you joining us today. We released our Q1 results this morning and plan on filing our 10-Q by the end of the week. Overall, the vaccine rollout has been a real game changer for the industry and a significant first step towards recovery with new COVID cases among patients and residents dropping over 90% between Q4 and Q1. We've seen similarly positive new case trends among facility staff as well. The success of the vaccine has led to stabilizing occupancy and has been a huge morale boost for frontline workers. As positive an impact as the vaccine has had, the reality is the exact pace and even pathway of recovery is still uncertain. But we do feel good about the stabilization that's occurred and at least directionally where things appear to be trending. Our highest level view of recovery continues to be that it will happen but we're looking at a 12 to 18-month process with fits and starts along the way. Ongoing federal and state agency funding and actions and supportive providers will be crucial in ensuring as timely and orderly recovery as possible. Even with all of the pandemic related variables, we again delivered outstanding operational and financial outcomes in Q1. Again similar to the themes of the past four quarters we did a great job of controlling the controllables around service execution, customer satisfaction, and budget adherence and we expect those positive trends to continue into Q2. As far as top-line growth with the revenue puts and takes that remain in play namely depressed census levels and facility access challenges coupled with our own more cautious approach during this most early stage of recovery, we continue to expect Q2 revenues to be flattish relative to Q1. So while COVID remains a near-term headwind on revenue, some of the recent more positive industry and customer data have provided us with improved top-line visibility for potential growth opportunities in the back half of the year, which is really exciting for us to start to think about and plan for. Before we move on to the discussions on Q1 results, I'd like to briefly touch on the SEC update we provided last quarter and again in this morning's release. As we previously highlighted, the company and the SEC have commenced discussions regarding a potential resolution to the investigation. We're pleased that the matter has moved into this phase and hope to continue to work with the SEC to reach a final resolution. As I'm sure all of you can appreciate beyond what we've disclosed previously and in this morning's release, we continue to be limited in what we can say about this matter especially while these resolution discussions are active and ongoing. So with those introductory comments, I'll turn the call over to Matt for a more detailed discussion on the quarter.

Matt McKee, CFO

Thanks, Ted, and good morning, everyone. Revenue for the quarter was $407.8 million with housekeeping and laundry and dining and nutrition segment revenues of $215 million and $192.8 million, respectively. Revenue included $3.9 million of COVID related supplemental billings, primarily related to employee pay premiums, which were initiated by and then passed through to our customers. Net income for the quarter came in at $24.7 million and earnings per share was $0.33 per share. Direct cost of services was $336.6 million or 82.6%, well below the company's historical target of 86%. Housekeeping and laundry and dining and nutrition segment margins were 13.1% and 10.4%, respectively. SG&A was reported at $40 million or 9.8%. But after adjusting for the $1.3 million increase in deferred compensation, actual SG&A was $38.7 million or 9.5%. And during the quarter, SG&A was also impacted by about $2 million of legal and professional fees related to the previously announced SEC matter. Longer term excluding any COVID or SEC-related costs, the company's target remains 7.5% with the primary leverage existing in top-line growth. Investment and other income for the quarter was reported at $1.8 million, but after adjusting for the $1.3 million change in deferred compensation, actual investment income was about $0.5 million. The company reported an effective tax rate of 25.2% and expects a 2021 tax rate of 24% to 26%. Cash flow from operations for the quarter was $3.5 million. This includes a $30.7 million decrease in accrued payroll. And because we called out the timing of the payroll and the impact of the payroll accrual last year, we would point out that the 2021 payroll accruals should have a similar cadence to what we saw last year. Q1 had the lowest payroll accrual of four days; Q2 should be 11 days; Q3 five days; and then Q4 13 days. Q4 will also be impacted by one-half or $24 million of the CARES Act deferred payroll tax repayment. That compares to the payroll accrual of three days, 10 days, four days, and 12 days that we had in 2020 during corresponding periods. But of course, the payroll accrual only relates to timing and the impact ultimately washes out through the full year. We are pleased with the ongoing strength of the 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 $0.2075 per share payable on June 25. The cash flows and cash balances support it. And with the dividend tax rate in place for the foreseeable future, the cash dividend program continues to be the most tax-efficient way to get free cash flow and ultimately maximize return to shareholders. This will mark the 72nd consecutive cash dividend payment since the program was instituted in 2003 and the 71st consecutive quarterly increase that's now an 18-year period that's included four three-for-two stock splits. We recognize the dividend is important to our shareholders and we have increased it in line with our performance track record. Additionally, the company remains authorized to repurchase 1.7 million shares of our common stock pursuant to the previous Board of Directors authorization and expects to repurchase up to one million shares through February of 2022. And with those opening remarks, we'd like to now open up the call for questions.

Operator, Operator

The first question comes from Sean Dodge with RBC Capital Markets.

Sean Dodge, Analyst

Thanks. Good morning. To start with the margins, there has been a significant sequential improvement across both segments. Could you discuss what contributed to that? Also, as Ted mentioned, there is potential for revenue growth to resume later this year. Can we expect these margin levels to be sustainable, or should we anticipate some decrease as you prepare for investments to drive growth again?

Matt McKee, CFO

Good morning, Sean. You know, you're right. We've talked a lot about managing the services we provide and our costs as efficiently as possible especially, in light of the census pressure that our clients continue to face. So from a go-forward perspective, our expectation is to continue managing the staffing, the purchasing, and the production based on census and maintain that focus as census recovers. As to the go-forward, there is a portion of that margin improvement that we expect will be sustainable. We're just not at a point yet where we're ready to quantify that. Because exactly as you alluded to with growth will bring some inefficiencies and margin pressure as we inherit the inefficiencies of an in-house operation that we're assuming. It takes us some time to implement our systems and fully get those new opportunities on budget. So 86% remains our target, but we are very much committed to ongoing management of the labor and supply cost as well as cash collections. So we do expect to maintain some of those improvements going forward just not yet in the spot to quantify.

Ted Wahl, CEO

Hi, Sean. And just to piggyback onto Matt's answer as well. As you're well aware there's a significant portion of that margin improvement that is just math, right? It's the revenue reductions and the corresponding cost reductions that as census recovers, which we expect over the next 12 months to 18 months that math will work in the other direction. So you have that coupled with the mix of business, right? And that changing, but as Matt highlighted there's a portion with the operational imperative and what we've been focusing on even pre-pandemic that we believe to be sustainable.

Sean Dodge, Analyst

Okay. Thanks. And then on the revenue outlook. Ted the kind of the more encouraging outlook for the back half of the year. Can you walk us through what you need to see? What needs to happen for that to take place? You've got vaccinations done. What other kind of milestones or markers are you looking for to I guess begin moving forward with the plans to implement new facilities?

Ted Wahl, CEO

To address your question and provide some context, the vaccine has had a significant effect, reducing cases among patients, residents, and frontline staff by over 90%. This improvement has resulted in stability in census quarter-to-quarter, indicating an early sign of recovery. However, as I noted earlier, the timing and extent of recovery remain uncertain. Over the long term, we are confident in recovery due to demographic trends, which suggest that the mix will shift more towards long-term residents rather than short-term patients. Regarding occupancy recovery and its relation to our revenue, I view revenue as a lagging indicator, with census fluctuations occurring first, followed by costs and revenue dynamics. With occupancy stabilizing in the first quarter and only modest new business and facility exits, we anticipate second quarter revenues to be relatively flat. Nonetheless, the stabilization in the latter half of the year should provide us with clearer opportunities, particularly in dining services, as these represent cross-selling chances where previous access challenges have eased. While I can't specify exact figures, we are optimistic about seeing sequential growth when comparing the first half of the year to the second half.

Sean Dodge, Analyst

Okay. Sounds good. Thanks again.

Ted Wahl, CEO

Hey, thanks, Sean.

Operator, Operator

Next question comes from A.J. Rice with Credit Suisse.

Rob Moon, Analyst

Hi. This is Rob Moon on for A.J. Rice. Thanks for taking my questions guys. Around your largest customer Genesis we've seen them divest about 40 facilities in 2020 and talk to at least 70 more in 2021. Just curious, if those facilities rolling off in your kind of outlook for growth opportunities in the second half? And then also if you could talk to maybe the retention rate you guys generally have when a facility rolls off or even the process that takes place when a new operator comes in and if you have a chance to go after that business or what those discussions look like?

Matt McKee, CFO

Yeah. Good morning, Rob. I would say just sort of to speak at a very high level as to kind of the health of the Genesis partnership. From the facility level up through the C-suite, that relationship, that partnership remains strong and it's an important one for I would say both us and for Genesis. They've been a great partner. There's frequent and very open communication. And from our perspective, they've continued to pay us within terms, which is an especially important marker as to the health of the relationship. Quite honestly, Genesis has continued to execute the plans that they've outlined both publicly and to us, right? And that's both their portfolio optimization plan and continuing to seek relief from landlords and leases. That portfolio optimization plan being an important part in rightsizing their holdings and really refining their operational focus. So we expect to continue working with the Genesis leadership and to deliver our services at the facility level as to those pending and perhaps even future facility transitions that you alluded to. As those details unfold, we expect that at a minimum we'll have a seat at the table. We'll have an opportunity to engage with the new operators and determine if maintaining a partnership at those facilities would be mutually beneficial. There is a process that unfolds. We largely treat those as a new business opportunity. Now obviously, we have insight into the inner workings from an operational perspective of those facilities, but we have to assess the financial health and well-being of that acquiring company to make sure that they're a partner with whom we feel comfortable working. So, going into it the companies that Genesis has partnered with to date have yielded good results for us and we've been able to retain almost all if not all of that business. So, at a minimum we expect to have a seat at the table. We expect to have those conversations. And we're not assuming any loss of that business going forward. But, if things change, we'll certainly keep you apprised of any of those developments.

Rob Moon, Analyst

Thank you. I have a follow-up question. It appears that your customer base is stabilizing positively. However, it seems that the advance Medicare payments still need to be repaid through payroll taxes. I'm interested in your perspective on the potential for an increase in bad debt expense. Are we in the clear on that, or is there still some risk in the upcoming quarters concerning the customer base? What insights do you have on this?

Ted Wahl, CEO

I believe that with the weekly payment design we’ve implemented over the last two years, we have gained better visibility and predictability regarding payments. Looking back over the past couple of years, we have collected what we've billed in eight of the last nine quarters. For us, it’s about continuous execution on a daily, weekly, and monthly basis. We can never be fully confident regardless of how stable or unstable the environment may be. However, with our weekly payment initiative and our ongoing focus in that area, we feel optimistic about achieving our goals moving forward. Regarding the repayment of the Medicare Accelerated and Advance Payment Program, we will continue to closely monitor the actions from both federal and state governments. We are taking a cautious approach. In the previous administration, there was a clear perspective on these issues, but with the new administration and its appointees, we still need to wait and see. Early discussions have been positive, but concerning the repayment of the Accelerated and Advance Payments, the Medicare three-day rule waiver, and the completed CARES Act, as well as upcoming legislation, we will keep a watchful eye on how these may impact our customers. This will directly influence the actions we take with our customers.

Rob Moon, Analyst

Great. Thanks, guys, and good job in the quarter.

Ted Wahl, CEO

Thank you.

Matt McKee, CFO

Thanks, Rob.

Operator, Operator

Next question comes from Andy Wittmann with Baird.

Andy Wittmann, Analyst

Hey, great. I guess I just wanted to drill in a little bit more on some of the prior questions and around that growth outlook, Ted. It sounded like stabilizing occupancy is one of the core reasons, if not the most important reason for the second half more positive outlook that you're kind of feeling here today. But, just in terms of new facilities, I was hoping you could just comment on what the outlook is on the potential for net new facilities recognizing that the industry is deconsolidating your track record pertaining them is excellent. There might be some that do slide to the cracks just given the amount of deconsolidation. So again, can you just like talk about kind of the pluses and minuses on potential for adding new facilities not just occupancy?

Ted Wahl, CEO

Yes, when considering the latter half of the year, I want to emphasize census in relation to revenue and its influence over the past six to twelve months, which I expect will serve as a positive factor for revenue growth in the upcoming months. However, my main focus was on new opportunities for growth and cross-selling, specifically the actual increase in net facilities. When I mention having clearer insights for the second half of the year, I mean the growth of new facilities rather than just recovery in occupancy, which will contribute positively to revenue growth.

Matt McKee, CFO

I think, Andy, regarding the deconsolidation in the industry, we see it as neutral. Our customer base has always reflected the broader industry, including large national operators, regional players, and smaller independent or nonprofit facilities. The regional players show the most growth potential going forward, which is positive for us. This situation does not alter our approach to targeting, selling, or operating the business. We assess each facility as a unique opportunity, independent of its ownership structure or whether it’s part of a large chain or a standalone location. Understanding how we would staff and supply each facility, as well as our specific cost structure related to that facility, is crucial. We will honor the specific conditions of employment, like wage rates and benefits. Thus, our prospecting, sales process, and operational efforts remain unchanged. We are pleased to adapt as the industry evolves.

Andy Wittmann, Analyst

I understand. I have a follow-up question that I haven't heard you address in a while. It's not directly related to this quarter but is more about the overall picture. You’ve mentioned exploring other classes of senior living and potential opportunities in assisted living dining and other areas of senior care. Given the significant changes occurring in the skilled nursing facility sector, I wanted to know if you have any updated thoughts on your interest in expanding that business. Have you taken any steps to measure progress in that area, or have you primarily focused on addressing the current challenges posed by COVID in your core business? I'd appreciate an update on this.

Ted Wahl, CEO

Yes. We're always evaluating always assessing. And I've talked about before how one of the great benefits we have as a company and being designed in almost a franchise-like way with an entrepreneurial spirit throughout the organization is that we are able to trial, evaluate and even commit on a trial basis, when we're interested in whether it's a new service line as you said or a new initiative. I'd say for the moment though, Andy we've had our hands full just in focusing on the task at hand which has been COVID within our niche, but still continuing to evaluate new opportunities. And there have been new opportunities or new situations that we were proposed to pursue with all of the changes just in society and certainly within cleaning and sanitization that have been brought our way. So, we're going to continue to explore those opportunities. But for the moment our focus is almost exclusively dedicated to the niche and navigating our way through with our customers this situation and the pandemic.

Andy Wittmann, Analyst

Okay. Thanks a lot guys. Have a good day.

Ted Wahl, CEO

You too, Andy.

Matt McKee, CFO

Thanks Andy.

Operator, Operator

Next question comes from Ryan Daniels with William Blair.

Nick Spiekhout, Analyst

Hey guys, Nick Spiekhout here for Ryan. Congrats on the quarter and thanks for taking my questions. I guess the first one would be going on from the sales process. I wonder if you can provide kind of an update on, how SNFs are kind of allowing you guys to come in? Are you guys on-site or is it still kind of a little bit of the COVID era sales process right now?

Matt McKee, CFO

Yes, Ted mentioned this earlier, but I would say that our most immediate sales opportunities lie in cross-selling dining services to our current housekeeping customers. We have not fully penetrated this market yet, as we are still providing dining services to less than 50% of these customers. The challenges faced in the industry over the past 13 months have opened up significant opportunities to engage with our housekeeping and laundry clients, some of whom have been waiting for dining services for years. Our ability to deliver these services has been limited by capacity issues. While the focus on infection prevention and control in environmental services has garnered attention, the growth potential in dining services is becoming more accessible. There still exists variability in access, depending on geographic locations and customer groups. Our sales teams continue to foster discussions and respond to incoming requests to prepare for swift action when we gain access to these facilities. This process must align with local operations teams to ensure a thorough facility analysis, allowing us to implement our systems and meet budgetary requirements while conducting detailed financial assessments of potential partners. Evaluating their financial stability, contract integrity, payment capability, and intent to pay promptly is critical in our sales approach. Overall, we are starting to see easing in access restrictions faced over the past year, and we are optimistic about our ability to pursue new business as we enter the latter half of the year.

Nick Spiekhout, Analyst

Thank you. As we move into a period of more normal growth in the second half, I'm assuming that, given the margin profile, there isn't a significant number of management trainees prepared at the moment. Are you starting to build that up now? Will it be a situation where these trained management personnel can hit the ground running as we enter the second half of the year?

Ted Wahl, CEO

It's actually a bit different from your assumption in that we are in a business-as-usual environment regarding management development and the recruitment of managers. This process is spread across the country, with various areas at different stages of management development. It's a crucial aspect of our business, and we always strive to improve in this area. However, I wouldn't classify our views on the second half of the year and growth opportunities as just business as usual at this moment; it's something we'll keep assessing. Nonetheless, we are optimistic that we will have opportunities to expand our footprint from a directional and visibility standpoint.

Nick Spiekhout, Analyst

Okay. Great. Thanks guys for the color.

Ted Wahl, CEO

Thank you.

Operator, Operator

Next question comes from Brian Tanquilut with Jefferies.

Brian Tanquilut, Analyst

Hi guys. Congrats on the quarter. I guess, you clarified Ted. Yeah. No, definitely. And just to clarify on your comments on, the revenue expectation for Q2 and the back half of the year. So on the Genesis assets that are being transferred to ProMedica, are you assuming that those stay with you through the whole year? Is that the way you're thinking about that?

Ted Wahl, CEO

When we discuss growth, we’re not considering it only on a net basis due to certain uncertainties. My focus on growth involves acquiring new clients, whether those are entirely new or existing clients to whom we can offer additional services like dining. Our confidence in this area has strengthened thanks to increased visibility. However, predicting outcomes with customer transitions, whether they are small independent businesses or others, is challenging. A reliable data point is our historical success in retaining over 90% of customers during transitions. This is fundamental to our growth since we constantly engage with clients, at all levels, whether they are administrators or owners. We have demonstrated our capability to forge new relationships and, when opportunities arise, utilize those connections for company expansion or growth with new clients. We are optimistic and believe that, with better visibility, we should experience some sequential growth in the latter half of the year compared to the first half. Our past performance should inform our expectations regarding customer retention during transitions, whether involving administrators, principals, or owners.

Brian Tanquilut, Analyst

Got you. And then I guess just a follow-up to the question on consolidation versus deconsolidation. As we see some of these new players emerge like ProMedica, how do you see your relationships with the emerging new consolidators? Are these existing relationships already, or are these new opportunities for you as things open up in the space?

Matt McKee, CFO

Yes. It's interesting, Brian. This is an industry that tends to be fairly incestuous, if not quite incestuous then certainly exceptionally highly networked, right? So whether you're talking about a new regional player or a mom-and-pop that's building some momentum, it tends to be that we either are familiar with the principals or if we don't know them directly we know someone who knows them. So it has been fairly fluid for us to gain introductions and to begin to build relationships with some of the newer operators that are getting more aggressively into the space. But I would again sort of point back to the paradigm for us, which is that regardless of the ownership structure, the complexity of the organization or the design, the size of their holdings it has to be a bottoms-up approach for us in both our targeting and our sales efforts and even ultimately in our contracting and then certainly very clearly in our operational pull-through and execution. So regardless of that topside ownership structure, management structure, we certainly want to make sure that we are comfortable with and develop relationships with the C-suite inasmuch as that's applicable. But much more important for us is the grassroots efforts. And that holds within our district and regional structures. Ted alluded to the element of that that relates to management development, but it also holds for business development where our local operators are responsible to cultivate their relationships and use those relationships as an opportunity and an avenue for future growth. So, very much more a bottoms-up than a top-down process for us as it relates to new business opportunities.

Brian Tanquilut, Analyst

Got you. And then Matt just really quick for me. Just a clarification. On the cost of revenue line any call out this quarter workers' comp bad debts that changed in terms of accrual rate?

Matt McKee, CFO

No. No, nothing as noteworthy as the work comp that you called out from last quarter.

Brian Tanquilut, Analyst

Okay. Got it. Thank you.

Matt McKee, CFO

Thanks, Brian.

Operator, Operator

Last question comes from Mitra Ramgopal with Sidoti.

Mitra Ramgopal, Analyst

Yes. Hi. Good morning. Thanks for taking the question. First, just on the financial health of your clients and just the industry in general. I believe you talked about in the past about $5 billion being allocated towards the industry to help through the pandemic. And I was just curious if your clients are receiving that funding or still waiting on that?

Ted Wahl, CEO

Yes, I would say that the recovery of census will take place over the next 12 to 18 months. The most important aspect regarding business recovery is that the clinical crisis appears to be behind us due to the success of the vaccine. However, the challenges related to funding and operating at still low census levels, which are 10 to 15 points below pre-pandemic levels, are crucial. I've addressed this in my earlier comments and responses, but we will closely monitor federal and state actions, both administrative and otherwise, in the coming months to gauge commitment levels. This includes considerations about the three-day waiver, the repayment process for the Accelerated and Advance Payment Program, and the proposed 1.3% increase in Medicare Part A payments. CMS is also considering recalibrating PDPM. There are many factors at play that we will keep a close watch on. Ultimately, census will be the key driver for both financial and operational stability in the industry.

Mitra Ramgopal, Analyst

Okay. No, that's great. And then just on the vaccine rollout. I saw a recently article that highlighted that maybe about 90% of nursing home residents have been vaccinated, but maybe only about 60% of the health care workers within those facilities. And is that disconnect impacting the ability to maybe see a quick recovery than we might have seen otherwise?

Matt McKee, CFO

Yes, I don't think so Mitra. I think the most important population in that setting who needs to be immunized would be the residents very clearly. And I think, there's not been data that I've seen that have sort of parsed the lower vaccination rates among employees relative to those who have had a COVID infection previously and would thus be naturally immune versus those who have flat outright objected to receiving the vaccine versus those who have received it. So I've not seen any really compelling data that show that the disconnect between resident vaccination rates as compared to staffing vaccination rates have had any negative impact on tamping down infections within the facility because certainly, the data that we show with respect to COVID infections among both the resident and the employee populations have gone down far greater than 90%. So, we're seeing that very much effective immunization levels within the facilities. Now, interestingly to your point, when we have seen some community outbreaks, there's been some level of corresponding facility level outbreaks and that's probably driven by the employees. So there is certainly some credence to the notion that you floated. But generally speaking, I would say that predominant focus has been on the residents, that's for sure.

Mitra Ramgopal, Analyst

Okay. That’s great. Thanks for taking the question.

Operator, Operator

And at this time, I will turn the call over to the presenters for closing remarks.

Ted Wahl, CEO

Thank you, Sharon. We know 2021 will still have its share of pandemic-related challenges, but the early success of the vaccine, coupled with learnings and innovations of the past year is cause for optimism. As the industry continues its gradual shift from crisis mode to a state of recovery, our commitment to internal investment and returning capital to shareholders, underscores our positive longer-term growth outlook and creates value for all stakeholders. So, on behalf of Matt and all of us at HCSG, I wanted to again thank Sharon for hosting the call today and thank you to everyone for participating.

Operator, Operator

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