Healthcare Services Group Q1 2023 Earnings Call Transcript

Quartr
Provided by Quartr
April 26, 2023

There are 10 speakers on the call.

Operator

Good morning, and welcome to Healthcare Service Group, Inc. 1st Quarter 2023 Earnings Call. All participants are in a listen only mode. After the speakers' presentation, we will conduct a question and answer session. As a reminder, this conference call is being recorded.

Operator

The matters discussed on today's conference call include forward looking statements about the business prospects of Healthcare Services Group, Inc. For Healthcare Services Group, Inc. Most recent forward looking statement notice, please refer to the press release issued this morning, which can be found on our website, www.hgsg.com. Actual results may differ materially from those expressed or implied as a result of various risks, Uncertainties and important factors, including those discussed in the Risk Factors, MD and A and other sections of the Annual Report on Form 10 ks and Healthcare Services Group, Inc. Other SEC filings and as indicated in our most recent forward looking statements notice.

Operator

Additionally, management will be discussing certain non GAAP financial measures. A reconciliation of these items to U. S. GAAP can be found in this morning's press release. I would now like to turn the call over to Ted Wall, President and CEO.

Operator

Thank you. Please go ahead, Mr. Wall.

Speaker 1

Thank you, and good morning, everyone. Matt McKean, 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. For the 3 months ended March 31, 2023, we reported revenues of $417,200,000 GAAP net income of $12,700,000 or $0.17 per share and adjusted EBITDA of $27,500,000 an 18% increase over Q1 of last year. We also repurchased $2,200,000 worth of our common stock as an opportunistic and tax efficient way to return capital to shareholders.

Speaker 1

Today, in my opening remarks, I will discuss our Q1 key accomplishments as well as our outlook for the rest of the year. I'll then turn the call over to Matt for a more detailed discussion on the quarter. We delivered strong operating results and service execution during the quarter as our relentless focus on customer experience, Systems adherence and regulatory compliance led to high quality and consistent outcomes for our client partners. The first key accomplishment I'd like to highlight is that for the 2nd consecutive quarter, we achieved our cost of services target of 86%. This achievement underscores the strength of our customer relationships, our commitment to operational excellence and our enhanced value proposition.

Speaker 1

The second key accomplishment I'd like to highlight is the marked improvement In Q1 cash collections year over year, in what has historically been our most challenging collections quarter. This accomplishment follows our strong Q4 cash collections, further validates our overall collection strategy and provides a strong foundation and positive momentum heading into the rest of the year. Lastly, I'd like to highlight the successful exit of the final tranche of facilities related to the completion of the contract modification initiative. This accomplishment not only marks the final action of our contract modification initiative, but underscores our disciplined approach to managing the business and our ability to simultaneously deliver in the short term and prepare for the long term. As far as our outlook for the rest of the year, we expect industry fundamentals to continue to improve as a stabilizing labor market and stronger reimbursement environment, especially at the state level, contribute to a gradual occupancy recovery.

Speaker 1

We will continue to closely monitor industry dynamics and remain confident that the industry is on a path towards recovery, albeit a prolonged one. We also expect to continue to build on the significant progress we made over the past 6 months in replenishing our new business pipeline. And although the timing of new business adds remains dynamic, we anticipate a flattish top line in Q2 and a return to growth in the back half of the year. In the months ahead, we shall remain confident in our ability to control the controllables, Realistic about the ongoing challenges that remain within our industry and broader economy and focused on executing on our So with those introductory comments, I'll turn the call over to Matt for a more detailed discussion on our Q1 results.

Speaker 2

Thanks, Ted, and good morning, everyone. Revenue for the quarter was reported at $417,200,000 with Housekeeping and Laundry and Dining and Nutrition segment revenues of 190 $3,400,000 $224,000,000 respectively. Housekeeping and Laundry and Dining and Nutrition segment margins were 10.4% and 6.6% respectively. Direct cost of services was reported at $361,000,000 or 86.5 percent And direct costs included a $6,900,000 increase in our CECL AR reserves. As Ted highlighted in his opening remarks, We again met our goal of managing the business with cost of services in line with our historical target of 86%.

Speaker 2

SG and A was reported at $40,000,000 after adjusting for the $1,500,000 increase in deferred compensation, Actual SG and A was $38,500,000 or 9.2 percent, and we expect 2023 SG and A between 8.5% to 9.5%. The effective tax rate was 27.8%, which included discrete items specific to Q1. The company expects a 2023 tax rate 24% to 26%. For those of you who saw the press release this morning, you might have noticed the table introducing non GAAP financial measure, specifically adjusted EBITDA. The rationale for introducing adjusted EBITDA as a new metric is to enhance transparency, Increased period to period comparability and more closely align our reporting with how management views the business.

Speaker 2

Having said that, adjusted EBITDA for Q1 was $27,500,000 or 6.6 percent of revenue. That compares with $23,300,000 for the same period in Q1 of 2022, which was 5.5 percent of revenue. Cash flow used in operations for the quarter was $16,300,000 and was impacted by a $21,200,000 decrease in accrued payroll and a $20,600,000 increase in accounts receivable related to the timing of cash collections. DSO for the quarter was 76 days. Also, we would point out that the Q2 payroll accrual will be 13 days.

Speaker 2

That compares to the 6 days that we had in Q1 of 2023 and the 12 days that we had in Q2 of 2022. But the payroll accrual only relates to timing and the impact ultimately washes out through the full year. So with those opening remarks, we'd now like to open up the call for questions.

Operator

Thank you. Our first question comes from A. J. Rice from Credit Suisse. Please go ahead.

Operator

Your line is open.

Speaker 3

Hi, everybody. Thanks for the question. Maybe I'll just ask a couple So when we think about the margins you're posting this quarter, the 10.4% for housekeeping and 6.6% for dining, Your modifications are done. Are these sort of normalized and you think Margins in this range for the rest of the year are going to be achievable or any reasons to think they would either trend a little better or a little worse as we progress through the rest of the year?

Speaker 1

Yes, A. J, it's a great question. I think specifically from a segment perspective, you're always going to see some movement month The month quarter to quarter largely due to execution, new business adds and other considerations that are happening Each and every day out in our field based operations. I think maybe to bring it back to our reported number, we're proud that Our margins for the Q2 in a row, the 2nd consecutive quarter came out in that 86% target range. And We expect those positive trends to continue into Q2 of 2023 and feel confident in our ability to manage at those levels for the rest of the year.

Speaker 1

No, I alluded to it in my initial response, but there's always going to be execution risk. We don't talk about that enough, but Managing this business is difficult. There's a lot that goes into it. The client experience, budget versus actual regulatory and compliance Reporting. So for us, execution is always the key to the business.

Speaker 1

We've talked about CECL in the past, Which introduces a degree of variability as well. One of the reasons it wasn't the catalyst for it, but I think now providing that adjusted EBITDA table will at least provide A bit of context to any sort of CECL adjustment quarter to quarter. The only other variable to our ability Deliver on those margins as we see it would be growth, which would be a good thing. And as you know, that's always a factor No, because when we're starting new business and inheriting the existing payrolls and supply budgets, there's typically some initial margin compression As we work to implement our systems and staffing patterns, typically that lasts anywhere from 60 to 90 days, but that could be a temporary drag as well. I think overall though, we feel very good about the underlying business and the KPIs and trends related to experience, Systems adherence, regulatory compliance and budget discipline, all of which are factors in margin consistency.

Speaker 3

Okay, that's great. I know the CECL accrual gets involved quarter to quarter. I think you had an increase of 6.9 You're calling out this quarter. Anything about that that says, hey, this is going to we're going to have an ongoing accrual of bad debts at a higher rate or Is that sort of a one time adjustment or how should we think about that? I know it's sort of formulaic, but any thought on that going forward?

Speaker 1

Yes. I think we introduced adjusted EBITDA for a few reasons, primarily to really increase transparency and increase the And it increased the comparability quarter to quarter, period to period. But more importantly, it's more closely aligned with how management views Business including bad debt expense. CECL, as you alluded to, is very formulaic. In our adjusted EBITDA Table, we show the difference between the CECL bad debt reserve and what our actual write offs have been using the same look back period.

Speaker 1

So that's another indicator, another way to look at if pass is prologue, what we could expect moving forward.

Speaker 3

Okay. One last question. You had a $16,000,000 use of cash this quarter. It looks like that was Primarily driven by the volatility in the accrued payroll and so forth. And you said you pointed out how that's going to swing around in Q2.

Speaker 3

Can you just give us a sense of what where you think a normalized cash flow run rate is for you? Do you have a target for the year or range that you Think is the right way to think about cash flow normalizing for the volatility in the payables?

Speaker 1

Yes. I'd say for any given year, the best proxy for free cash flow continues to be net income. Having said that, we are in a period where as the industry is recovering, there's a bit more fits and starts With cash collections in any given quarter specifically as we called out our expectations around the first half of the year. But To your question, based on the timing and the impact of the Q2 payroll accrual, we would project a free cash flow range in that $15,000,000 to $25,000,000 Territory and then for the second half of the year, A. J, dollars 20,000,000 to $30,000,000 So net net for the year that gets you To about a $30,000,000 free cash flow number, which will likely prove to be conservative, but it gives you at least a flavor for how we're thinking about the cadence for Balance of the year.

Speaker 3

Okay, that's great. Thanks so much. Thank you.

Operator

Our next question comes from Andy Wittmann from Baird. Please go ahead. Your line is open.

Speaker 4

Great. Good morning, guys, and thank you for taking my question. Sorry, I just wanted to make sure that And maybe everybody else is on the same page about the AR definitions here in your adjusted EBITDA. So let me try to articulate it A different way and see if I've understood this correctly. So, you took a total CECL AR reserve against bad debt of $6,900,000 That was the way you're thinking about that is that's actually just $4,000,000 I guess higher than the way you think about it.

Speaker 4

And I guess the way you think about it is kind of the old methodology before CECL became the standard. Is that The right way of kind of thinking about what you're doing there with that reconciliation?

Speaker 1

Let me play it back a different way For you, Andy, I'd say CECL and you're right is showed $6,900,000 this quarter. What we did is we used that same 7 year look back period And compared actual write offs against actual revenue in that 7 year look back period. And then that was and then the resulting difference was the adjustment in the adjusted EBITDA table. Said another way, The $6,900,000 CECL reserve was about 1.6%, 1.7% of revenue. The write off reserve would have been 70 basis points of revenue.

Speaker 1

So the difference of that is the adjustment in the table. It's just presenting What we actually wrote off over that 7 year period versus what is being reserved for. Because Right. What we're reserving for within CECL is not necessarily indicative of what's going to be written off because a lot of it just relates to timing, not necessarily Risk profile.

Speaker 4

And is it also is the adjustment here, I guess, conceptually reflective of the last 7 years, Which is required under the GAAP. We're obviously a tough 7 years in terms of the write offs, but With the improvements that you've made over the last actually more than just a year, year and a half, 2 years in this, the thought is that it will be in a better position that those 7 past years are not indicative of the first of the coming years in the future. Is that part of the thought process in doing what you're doing here as well?

Speaker 1

Well, it's just showing what we actually wrote off, right? I mean, not what we're not as being not what necessarily what's being reserved, but what's being written off. But To your point, Andy, I mean, whether the past is necessarily indicative of the future, we're not willing to accept a single write off. For us, any write off is disappointing. We work hard for every single dollar we're able to earn as a company and which is why and Highlighted it, I guess, in concept, but we've spent a lot of time, whether it's increasing payment frequency and the strategy that we've had around that today still greater than 60% of our customers are paying us at a frequency of greater than monthly.

Speaker 1

In most cases, it's weekly. In some cases, it's biweekly. But We were sitting here a couple of years ago, we would have been able to count on one hand the number of customers that were paying us at a frequency greater than monthly. We are more proactively than ever utilizing promissory notes as a critical tactic in our overall collection strategy, and we've been successful in that endeavor. And perhaps most importantly, remaining disciplined in our decision making, not just for existing business, but also for new business.

Speaker 1

So all of that Are going to be focal points for us moving forward and we believe will bear fruit in 2023, but certainly in the years ahead.

Speaker 4

Got it. Okay. So just a couple more questions along that line. Can you talk maybe Matt, you've got the number handy. What was How much was converted into promissory notes in the quarter?

Speaker 4

And

Speaker 5

is the bad debt, can

Speaker 4

you just remind me, is that reflected in your COGS Or is that in your SG and A line?

Speaker 6

I think it's intact, but I just want to verify.

Speaker 2

Yes, Andy. It was about $14,000,000 that was converted Two promissory notes in the quarter, excuse me, and that was both a combination of the final sort of cleanup and conclusion of the contract modification initiatives And then just normal course, because as we've discussed previously, we increasingly view the promissory note as not simply a workout tool, but really a Favorable proactive tool by which we can really capture and secure receivable balances with our clients.

Speaker 4

Got it. Okay. On the COGS question?

Speaker 2

Sorry, could you repeat that one, Andy?

Speaker 4

The second half of my question was the bad debt. Is that reported in the gross margins or in the SG and A?

Speaker 2

Yes, that's in gross margin and cost of services.

Speaker 4

Okay. And then sorry, last question here. Just more fundamentally, I guess, Ted, now that the contract review process is done, I guess How much of a benefit could that be to your top line, presuming that you'll have to walk away from fewer contracts In 'twenty three than you did in 'twenty two, in other words, your customer retention, I suspect will be better this year than it was last year. How much help do you think that offers you to your top line growth rate this year, if any?

Speaker 1

Yes. I wouldn't be able to quantify No, the necessarily puts and takes around your question other than to say we feel very confident in how solid Our core customer bases today, I mean, one of the benefits of the contract modification initiative, Andy, beyond making sure we were rightsizing The increases in a way where they couldn't keep up with the significant inflation we've experienced is the connectivity and the contact we had with our customers. I mean, we've described it before, but it was bottoms up, all hands on deck. It wasn't done out of a home office with maps and pushpins. It was No, our field based operators, our field based leaders working with their counterparts, aligning on a future, what it could look like from a contract Perspective, what some of the operational adjustments maybe that were aligning the operations more with their preferences.

Speaker 1

So it was very collaborative. We could have taken a different approach and sent dear valued customer letters that would have failed on day 1. So we were very pleased aside from No, the financial outcome and maybe more importantly, the durability that it provides to these client partnerships was the Enhance customer relationships we had moving forward. So I think that although it doesn't necessarily answer your question quantitatively, I think we'll in order to the company's benefit for months years to come.

Speaker 4

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

Speaker 1

Thanks, Andy.

Operator

Our next question comes from Sean Dodge from RBC Capital Markets. Please go ahead. Your line is open.

Speaker 5

Yes, thanks. Good morning. Just to

Speaker 7

start, I have one more on CECL and the reserving process just to make sure I'm clear there. If we kind of roll forward in your collections performance, if that stabilizes or improves, would there be additional CECL reserves in each quarter? Or is this Are you resorting kind of above or below some type of like baseline?

Speaker 1

It's not a baseline. It's the CECL calculation essentially looking back over 7 years and assigning percentages to each aging bucket And then that produces the reserve and the difference quarter to quarter reserve, the resulting difference quarter to quarter is the bad debt expense. But To your point, Sean, as we depending on cash collections and the timing of cash collections, The way the formula has worked historically, the stronger the cash collections in any given quarter, the lower the CECL reserve. So we could end up Some point in the future, which we've had in the past where we actually have a credit balance resulting in bad expense. If we have a couple of strong cash collection quarters, Depending on how that's applied to the reserve buckets and the clients within those buckets, we could have a pickup within bad debt expense, which I'll be honest with you, I don't believe that's appropriate either.

Speaker 1

So that's why we're anchoring it back to what have we historically written off. So in some quarters, as our cash collections Improve and become stronger in the months years ahead as CECL becomes lower. We're still going to in our adjusted EBITDA table Show what the actual write offs have been. Okay. It's just to present a different context and really more aligned with the way management views No, the result of the work that we do in our financial services department.

Speaker 7

Okay. So there will likely always be Some type of reserve in the quarter, but that reserve will get smaller as your performance improves?

Speaker 1

I think that as our cash collections improve, I think that's a fair it's not a guarantee because again, it depends on the aging of the buckets and the customers within those buckets. But yes, I think directionally that is a fair statement.

Speaker 7

Okay, okay, good. And then Ted, you said the plan is still to return to growth in the back half of the year. Should we think about the kind of the first motion there being the dining cross sell, so kind of targeting existing housekeeping customers and adding in the dining services. And then I guess maybe give us an update on where you are as far as Re ramping all of the manager recruiting and training efforts needed to feed that. Is that kind of all getting underway now?

Speaker 2

Yes, absolutely, Sean. We've talked for quite some time and with conviction about the lowest Hanging fruit for us as an organization with respect to growth being that cross sell opportunity, given that as we sit here, if we look at our Existing customers from a housekeeping and laundry perspective, we're still with less than 50% penetration in also providing dining services. Now in this environment, obviously, we can make a more accurate and a higher level of conviction assessment The financial health of that existing housekeeping and laundry customer to determine if it's appropriate to then add dining services To the mix of services provided as compared to making that assessment with a greenfield opportunity for our prospective customer off the street. Without a doubt that remains an appealing and attractive growth opportunity for us is that cross sell of dining services, keeping in mind that We continue to view environmental services, housekeeping and laundry services as the greenfield sales lead opportunity and then We view the cross sell as secondary from there. There are instances in which we do initiate a relationship with a new customer and provide both services, But that's far less frequent than offering housekeeping and laundry services as the lead.

Speaker 2

Just to sort of digress and think about Bigger picture as to the growth prospects. We've certainly spoken previously about restocking our prospect pipeline and we continue to see that pipeline grow. We're Focusing on growth, especially as we look to the back half of the year. And some of the other factors that contribute to that view, Sean, in addition to the cross sell Dining services that you alluded to would be, of course, the ongoing industry recovery, which puts both customers and prospects on firmer financial footing. And that's bolstered by some of the census recovery that we're seeing out there and some of the reimbursement wins that we're seeing really Not only at the federal Medicare level, but state by state some of the Medicaid improvements that we're seeing.

Speaker 2

The increased resonance Of our value proposition, which affects not only our new business pipeline, but also our ability to retain the existing business, the continued build out of our management capacity, As you noted through recruiting efforts, hiring and training and all of that being executed locally at our facilities just as it always has been. And then another element that we've maybe not talked as much about previously is the fact that we're in an increasingly transactional environment as far as facility ownership changes. There were survey data and our experience certainly mirrors this that saw 2022 as a record year for deals within the skilled nursing space. The frequency of SNF deals accelerated in the last 4 months of 2022 and in a separate study nearly 3 quarters of owners, executives and administrators Predicted that their organization would likely be engaged in an acquisition sale or merger in 2023. So in those instances, We continue to assess the new operating ownership and determine a course of action that's best for the company, specifically whether it makes sense Continue providing services or to exit the business.

Speaker 2

And on a net basis, Sean, we expect that this transactional environment should allow us to expand our partnerships with The strong acquiring operators. Now as always, we'll guard against engaging with distressed or unproven players. But Overall, we're definitely building toward growth. And of course, we'll manage growth in a measured way so as to ensure that we're appropriately assessing new prospects and ensuring that we have The managerial wherewithal to deliver operationally, but I can tell you that there's a palpable enthusiasm within the organization for getting back into that growth cycle.

Speaker 7

Okay. That's great. Thanks again.

Operator

Our next question

Speaker 8

We're seeing consistent market improvement in dining margin over the past two quarters, which has been a major contributor to the bottom line. I think that 6.6 Percent margin number is higher than the averages pre pandemic. I believe some of that is to catch up on food costs from contract modification, Which ties your rate to some type of cost index. Is there any reason do you think you can or can't be sustained at that level in the context of moderating CPI numbers? And second to that, I think in the past you have a higher single digit level of margin for that business.

Speaker 8

Is that still the case?

Speaker 2

Yes. To speak specifically to your point about the food inflation, Tal, you're exactly right in that. In the quarter, food at home inflation was 0.4%. That was a sequential improvement from Q4, which was 1.1%. And then with respect to the pass through mechanism, you're exactly right that the inflation that we experienced in the Q3 of 2022 Would have been passed through in this Q1 and the Q3 inflation was 2.7%.

Speaker 2

So you're exactly right in that we're getting a 2.7% increase Inflationary increase in Q1 and that compared to the actual inflation that we saw in the quarter of 0.4%. Definitely, if inflation continues to move in a favorable direction, that will be beneficial. As a matter of fact, it's worth noting that In March, we actually showed 30 basis points of deflation in that CPI Food at Home data. So definitely something to an eye on there and that could be a favorable benefit if we continue to see food deflation. And with respect to the dining margin, The target, as Ted alluded to in his opening remarks, is a little bit of a moving target with respect to not only operational execution, but new Adds as well.

Speaker 2

So for the time being, we continue to view an appropriate segment level margin for dining in that sort of Mid single digit, mid to high single digit.

Speaker 8

Got you. Yes, I don't think we have talked On labor so far, I think a few healthcare services providers that have reported continue to see sequential improvement on labor conditions. Could you maybe shed more light on your experience this quarter in terms of hiring, open positions, turnovers, etcetera?

Speaker 2

Yes, Tal, I mean broadly speaking on a national level, the labor force participation rate Continues to trend positive and has picked up 10 bps each of the past 3 months. Job openings and wage growth are all trending downward. I would probably use the word stabilization to describe our overall experience relative to the labor market. However, one of the themes that we mentioned on our last call As far as kind of the haves and have nots continues to bear out. And generally speaking, we've seen greater improvement in suburban and urban markets As compared to the rural markets and there are definitely some markets that remain more challenging than others, but that offers HCSD really an opportunity To demonstrate one of the key components of our value prop and that's the fact that we have more resources and are better equipped to manage through these challenges That an in house managed operation or a would be competitor.

Speaker 2

So overall, Tal, I would characterize our general environment as stable With market improvement in certain markets.

Speaker 8

Okay. Last question for me. I The nursing home industry is anxiously waiting for the announcement of the federal minimum staffing rule. Now understanding that the regulation is Focus on the clinical side of the labor force. I'm curious, what is your perspective on how that might affect your business?

Speaker 8

Does it make it more likely or less likely that potential clients will be interested in outsourcing as new services?

Speaker 1

Yes. I'd say overall, we're going to continue to monitor the industry recovery along with the reimbursement and regulatory dynamics, Probably the most awaited one, Tal, you pointed out very closely so we can make informed decisions along the way. I think just generally inclusive of The minimum staffing, the fact that there's uncertainty or when there isn't uncertainty, whether it's around the timing of recovery, reimbursement Or any sort of regulation. It almost forces providers to find ways to create more certainty in their business. And when you think about it, the central theme of our value proposition is providing peace of mind, operational and financial peace of mind.

Speaker 1

So still too early to tell generally what impact, if any, that would have. You think if the mandate is Has an appropriate pilot. It has a phase in period. Along with it, a recognition of labor availability constraints. And this is the big one and it's fully funded.

Speaker 1

I think the industry would lean into that type of framework, but an unfunded mandate, Obviously, not recognizing the realities on the ground would not be well received. So stay tuned, all of us, right? We'll be able to react and adapt to whatever Happens, but generally speaking, I think given our value proposition, if anything, it would only increase the demand for our services.

Speaker 8

Got it. Thank you.

Operator

Our next Question comes from Ryan Daniels from William Blair. Please go ahead. Your line is open.

Speaker 9

Yes. Hi. This is Jack Nalge on for Ryan, a quick question. With Q1 in the books, any update you'd like to give on the share repurchase program? And Any highlights to a change in strategy on that front?

Speaker 9

Thank you.

Speaker 1

No change in strategy. We did purchase about 2 point $2,000,000 worth of shares during the quarter and we really view the buyback as opportunistic and as a tax efficient way to return capital. Again, we'll be very opportunistic with respect to timing and that timing will depend on a variety of factors, whether it's liquidity, expected cash flow, Of course, our share price will look at annual dilution rates and always alternative use analysis, where can we deliver the highest returns. But that was the quarterly activity and we'll continue to evaluate it each and every week and each and every quarter.

Speaker 9

Okay. And if you could also provide a bit more color into what drove weaker top line performance this quarter, Maybe a bit of detail on the mix between contract modification price increases versus facility exits. I guess if I'm thinking about Correctly. Was it more end market driven or is there something else to call out?

Speaker 2

No, Jack. Last quarter, we obviously estimated Q1 revenue would be in the $420,000,000 to $425,000,000 range and we reported $417,000,000 just outside that estimated range, Largely due to the fact that we pulled forward the final tranche of the contract modification related exits, Meaning, we exited some of that business earlier than we had originally anticipated. So looking ahead, We'll continue to build on our work over the last 6 months in replenishing that business pipeline as I alluded to earlier. Although the timing of some of the new business adds does remain dynamic, We anticipate flattish top line into Q2, with the contract modification work behind us and a return to growth in the back half of the year.

Speaker 9

Great. Appreciate the detail.

Operator

Our next question comes from Bill Sutherland from Benchmark. Please go ahead. Your line is open.

Speaker 5

Hey, good morning, guys. Good to see all the progress. I was curious, Ted, Does the Medicaid redetermination issue have what are you hearing on that as far as any impact on the clients?

Speaker 1

What was that, Bill? I'm not sure I heard you.

Speaker 5

This is not in the current period, but Looking at what Medicaid what's being proposed or not proposed with the redetermination process That's going on with the Medicaid beneficiaries?

Speaker 1

Yes. I think I would include that as Part of the overall environment, Bill, going line by line for each and every one of these items, it's all dependent on the market And the specific management companies and or clients that any one piece of regulation or reimbursement Impacts, when you think about a lot of these calls, we find ourselves speaking at higher level kind of rolled up type Reports and numbers, but to really think about the business and evaluate the business in a meaningful way, which Which is what we're doing each and every day. You really have to look not just within the state, but also within a local market and how the facts or again any piece of reimbursement or regulatory pressure may impact a given operator. So I would include That or any other executive order, regulation reimbursement, as part of our collective that we're evaluating In our assessment of the business and certainly informs could inform a decision that we may make.

Speaker 5

Okay. I was noticing that absent the CECL reserve, your core cost of goods was actually Closer to 85%. So when you guys talk core, you're assuming a certain level of reserving, right?

Speaker 1

That's right.

Speaker 5

Okay. I just wanted to clarify that. And then education, can you give us any color On how that did in the quarter or how that's looking? Thank you.

Speaker 1

Yes. We've been at it for less than 2 years and it's Beyond the pilot stage at this point, Bill, and I would say it's formally into the startup phase. The early returns have been remarkably positive, But it is still somewhat nascent. And to your question, it still makes up less than 5% of our revenues. That said, It's an opportunity that we're deeply committed to further exploring in 2023.

Speaker 1

There's many similarities between our core market And the education space, just the most similar being that they're both highly fragmented, largely in sourced and vast. And I would say our value proposition very much resonates in this market where we're providing a similar product offering And it has similar margin profiles and working capital profiles. So the early returns continue to be positive and we have a Strong commitment to exploring the opportunity further in the year ahead, more as a complement to our 2023 growth strategy, But beyond that perhaps something more meaningful.

Speaker 5

All righty. Thanks again.

Speaker 7

Thank you, Bill.

Operator

Our last question will come from Brian Tanquilut from Jefferies. Please go ahead. Your line is open.

Speaker 6

Hey, good morning guys and congrats on the quarter. I guess my question, as you mentioned improving occupancy trends for your end clients being a factor in the improvement of the business, How are the conversations changing, I mean, in terms of inbounds and how your clients are thinking about their business today that Gives us maybe visibility into future growth or your ability to accelerate growth, let's just say beginning in the back half of this year?

Speaker 2

Yes. I think you touched on the biggest factor that relates to our assessment of prospective clients. And quite honestly, Brian, their Willingness to engage an outsourcing partner from an operational capacity and Availability perspective in that occupancy, while not a panacea, is certainly a significant contributor to the overall financial health of the client. That is, As we've discussed in a very much a cause and effect way tied to the availability of professional nursing staff and Not to sort of beat the dead horse here on this theme of haves and have nots, but that continues to bear out. I talked about the impact of The sort of geographic impacts of suburban and urban labor market as compared to rural Labor market and that has a direct effect on the ability to drive census.

Speaker 2

We're looking at, of course, national occupancy data. But when we look at our own internal data with respect to our clients occupancy, there's a fairly significant delta between occupancy As a percentage of capacity in the urban and suburban facilities as compared to rural. So without a doubt, occupancy does have an impact. We are seeing this thematic have and have not really kind of continued to bear out. So All of that is definitely something that we keep in mind and keep top of mind.

Speaker 2

It certainly flavors our view of Not only the health of our existing customer base, but how we assess and consider prospective customer partners, But much more than any national level data or even our own existing sort of customer base data In assessing new prospects is really to dig in and do that full financial assessment, not only of their current state As it relates to their financial wherewithal and well-being, but just as importantly, if not more so, is their go forward prospects. And that's an assessment not only of kind of their Geographical positioning, what state they're operating in, what other states they may have exposure to in their portfolio And really the specific conditions within the four walls of that facility in making our assessment as to determining a healthy prospect or A target that we would perhaps put on the shelf and reconsider when they find themselves in a more favorable financial position. So Definitely, as I noted, not the panacea occupancy, but certainly a significant driver of that assessment.

Speaker 6

Got you. Now that makes sense. And then I guess as I think about DSOs, any thoughts that we need to be considering in our models For like seasonality of DSOs going forward?

Speaker 1

Not beyond, I'd say the cash collection or cash flow estimates, Brian, I provided to A. J. Earlier in the call, meaning as we're our goal each and every quarter is to collect what we bill. And if we achieve that goal, when we achieve that goal, DSO is going to remain flattish with a downward trajectory in a quarter like Q1, which is traditionally our weakest quarter of the year. You typically would see a DSO uptick.

Speaker 1

And then If we're successful in executing on our strategy for the remainder of the year, you'd see a downtick. And that's what our goal would be. So it's a good indicator. It's not the only indicator, when you think about underlying customer health and future prospects of collection, but it's An indicator and something we should all continue to monitor and we certainly do going forward. But again, as our cash collections improved Throughout the rest of the year, I would expect DSO to trend downward.

Speaker 7

Okay. Thank you, guys.

Speaker 1

Thank you, Brian.

Operator

We have no further questions in queue. I'd like to turn the call back over to Ted Wall for closing remarks.

Speaker 1

Okay, great. Thank you, Julianne. And In the months ahead, we remain committed to executing on our 2023 priorities. Operational excellence With the goal of delivering on our operational imperative of customer experience, systems adherence, regulatory compliance and budget discipline, Cash collections with the goal of collecting what we bill and growth with the goal of opportunistically adding new business from our growing pipeline of future client partners. Longer term, we remain excited about our rebalanced capital allocation strategy, which prioritizes more proactive, impactful and enduring ways to create shareholder value.

Speaker 1

Our future investments in organic growth drivers, inorganic growth opportunities and opportunistic share repurchases We'll not only accelerate value creation, but more importantly, best position the company to deliver sustainable, profitable growth over the long term. So on behalf of Matt and all of us at Healthcare Services Group, I wanted to thank Julianne for hosting the call today And thank you again to everyone for participating.

Operator

This concludes today's conference call. Thank you for your participation. You may now disconnect.

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Earnings Conference Call
Healthcare Services Group Q1 2023
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