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Hello, my name is Kirsten, I will be your conference operator today. At this time, I would like to welcome everyone to the HCSG 2023 Second Quarter Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]
The matters discussed on today's conference call include forward-looking statements about the business prospects of Healthcare Services Group, Inc. For Healthcare Services Group, Inc.’s most recent forward-looking statements notice, please refer to the press release issued this morning which can be found on our website www.hcsg.com.
Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the risk factors MD&A and other sections of the Annual Report on Form 10-K and Healthcare Services Group, Inc.’s other SEC filings. And as indicated our most recent forward-looking statements notice. Additionally, management will be discussing certain non-GAAP financial measures. A reconciliation of these items to US GAAP can be found in this morning's press release. Thank you.
Ted Wahl, Chief Executive Officer, you may begin.
Thank you and good morning, everyone. Matt McKee, 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. For the three months ended June 30, 2023, we reported revenue of $418.9 9 million, GAAP net income of $8.6 million or $0.12 per share, and adjusted EBITDA of $26.3 million. Today in my opening remarks, I'll discuss our second quarter key accomplishments as well as our outlook for the back half of the year. I'll then turn the call over to Matt for a more detailed discussion on the quarter.
Overall, we delivered strong service execution during the quarter. Our KPIs related to customer experience, systems adherence and regulatory compliance, all trended positively in Q2, leading to high quality and consistent outcomes for our client partners. I'd now like to highlight our second quarter key accomplishments. The first accomplishment I'd like to highlight is our strong core earnings. For the third consecutive quarter, we achieved our direct cost target of 86% excluding CECL, we managed SG&A within our targeted range, and we delivered adjusted EBITDA of $26.3 million.
The second key accomplishment I'd like to highlight is collecting what we build in May in June. This achievement came on the heels of falling short of our April cash collections target as our clients brace for the May 11 expiration of the public health emergency. And although we did not meet our quarterly cash collection objectives, the results we delivered in May and June provides us with positive momentum heading into Q3 and positions us well for a strong back half of the year.
Lastly, I'd like to highlight the continued progress we made in replenishing our new business pipeline during the first half of the year, as we continue to have a growing pipeline of future client partners heading into the back half of 2023 and 2024. And while the timing of new business ads remains dynamic, we are planning for sequential top line growth in the second half of the year, compared to the first half of the year, an estimated Q3 revenue range of $420 million to $430 million.
Looking ahead, industry fundamentals continue to improve and a stabilizing labor market and select state based reimbursement increases have contributed to the gradual but steady occupancy recovery. And while there remains uncertainty as to what a minimum staffing requirement might look like for the industry, we remain hopeful that CMS will fully consider the impact on operators before finalizing a rule and have confidence in our customers’ ability to manage any such rule.
We enter the second half of the year with three clear priorities. The first is continuing to manage direct cost at86% Excluding CECL, the second is collecting what we bill building on the strong momentum gained in May and June. The third and perhaps the most impactful is the realization of our business development efforts yielding new facility starts. There is a high level of internal enthusiasm as we pivot the growth mode through the back half of 2023 and then to 2024.
So with those introductory comments, I'll turn the call over to Matt, for more detailed discussion on our Q2 results.
Thanks, Ted. Good morning, everyone. Revenue for the quarter was recorded at $418.9 million, with housekeeping and laundry, and dining and nutrition segment revenues of $190.8 million and $228.1 million, respectively. Housekeeping and laundry, and dining and nutrition segment margins were 8.7% and 5.5%, respectively. Direct cost of services was reported at $367.7 million, or 87.8%. Direct costs included an $11.3 million increase in our CECL AR reserves. As Ted mentioned 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%, excluding CECL. SG&A was reported at $41.4 million after adjusting for the $2.3 million increase in deferred compensation, actual SG&A was $39.1 million, or 9.3%. We expect 2023 SG&A between 8.5% to 9.5%. The effective tax rate was 24.6%. And the company expects that 2023 tax rate of 24% to 26%.
Cash flow from operations for the quarter was $7.4 million, and was impacted by an $18.8 million increase in accrued payroll and a $39 million increase in accounts receivable related to the timing of cash collections. DSO for the quarter was 83 days. Also we would point out that the Q3 payroll accrual will be seven days. That compares to the 13 days that we had in the second quarter of 2023. And the six days that we had in the third quarter of 2022. But the payroll accrual only relates to timing, and the impact ultimately washes out through the full year. And with those opening remarks, we'd now like to open up the call for questions.
[Operator Instructions]
Our first question is from Sean Dodge with RBC Capital Markets.
Yes. Thanks. Good morning. Ted, I just want to start with your comments around collections stuff in April. But sounds like improved in May and June, I guess post, the close of the quarter. Are there any big outstanding balances you've now collected? That kind of helped through some of this up? I maybe just kind of give us a sense of DSOs for 83 in the second quarter? Are those going to be able to come down as we go through the balance of the year?
Yes, it's a great question, Sean. And we've talked about DSO before in this forum and other forums, DSO for us, we view more as a byproduct of executing our collection strategies and an indicator as to our success. Obviously, it's something we consider and we focus on but we do view each and every account holistically in terms of our assessments. I think to your question, specifically, if we're going to be recapturing some of the specifically the April delayed payments, and I can tell you, we are actively working with our customers on finalizing plans, including in the form of promissory notes to make up some of that April shortfall in the coming months. The timing is TBD on that. But we are actively engaged on repayment plans, which could be a nice cashflow tailwind for the back half of the year. Beyond that our goal remains to be to collect what we build in the quarter ahead. And we're going to continue to focus on increasing payment frequency, proactively using and utilizing promissory notes and then remaining disciplined in our decision making for both new customers as well as existing business. So again, it's, we did not meet our objective in April, but the momentum we gained in May and June and what we've seen, July to date has really been positive and we feel good about the back half of the year from a collection standpoint.
Okay, great. And then if we look across the sales and adjust up to CECL reserves, through the first two quarters, you've actually been able to manage that closer to 85%. With your comment that you're continuing to target 86% for the full year, is that just a function of the investments you're making around kind of staffing up and positioning now for growth or there's something else that's happening there that we should expect kind of core cost of sales, again, excluding CECL to the kind of kind of increase over the course of the year?
Yes, at or below 86%, Sean, to your point is the target. We exited the year with the 86% run rate, third consecutive quarter now that we've been able to ex CECK, deliver on that target. And to your point, it's accounting for, of course execution risk, which is always a consideration of growth, when we factor in growth the back half of the year, that's always going to be a temporary, having a negative temporary impact on cost of sales. As well as anyone, when we start a new piece of business, we're inhering the existing payrolls, we're inheriting the supply budgets. Typically, there's a degree of margin compression, as we work to implement our systems and staffing patterns over the first 60 to 90 days. But I think that'll be viewed and should be viewed as a positive as we head into the second half of the year because we are expecting and have pivoted already to growth mode going into the second half of 2023.
The next question is from Andy Wittmann with Baird.
Yes, good morning, guys. And thanks for taking my question. I guess, Ted, I wanted to ask about the new business pipeline. Here's what you know over the years, the challenge for you has been keeping facility managers in your training program. And having those people ready to go when you're ready to launch new facilities. I guess in the last couple of years, I haven't been asking you about the strength and the performance, and the amount of people you've got in this training program. But given that you're talking more constantly about growth now I thought it'd be worth talking to you and having you talk about how you're able to hire for those positions, the fullness of that training pipeline. And if you're ready to go, should some of your customers decide to turn on the switch for Healthcare Services Group?
Yes, Andy, I'll address that, this is Matt. I'm glad you asked about this. And I think we touched on this component of our growth trajectory a bit last quarter. But to dive in a little bit deeper, you're exactly right. One of the major contingencies of our ability to grow historically has always been overall our management capacity, but more specifically, having the appropriate number of managers working through the Q in our management training program. And our compelling pitch, if you will, or the employee based value proposition historically has been that one is able to grow one's career with Healthcare Services Group that as the company grows, one has the opportunity to develop one's own career and promotional trajectory. In light of not having put up much top line growth over the course of the past few years, that's created a different challenge for the organization.
And it's one that we were certainly mindful of, if not outright concerned about what that required of us was to sort of be overly communicative and transparent with our managers, both our existing managers who've committed at least a significant portion of their careers to the organization, and folks to whom we were having, with whom we were having discussions from a recruiting perspective. And we've been very transparent about the rationale as to why it didn't make sense for us to be onboarding new business and in growth mode, over the course of the past few years, that's enabled us quite honestly, Andy, to be a bit more selective and judicious not only in our hiring, but in replacing managers who perhaps were underperforming and what have clearly been significantly challenging operational times and an overall challenging operating environment.
You think back to the clinical challenges and limitations that COVID presented on the heels of that the labor challenges and the overall US struggles that we faced with respect to the availability of labor and managing our payroll related costs. So we needed top notch managers through all of those conditions. So that's been a bit of a carrot that we've been able to hold out for folks to keep them motivated and engaged within the organization. Ted alluded to in his opening remarks, this sort of palpable enthusiasm that's running through the organization as we pivot to growth mode, and that has massive effects and reverberations in that not only is everyone excited to see our results and putting up top line growth, but from a more personal career developmental perspective, what does that mean by way of growth opportunity? So long end around an answer to your question, I would remind you that the recruiting efforts in the management training program is executed locally. So, of course, as is always the case, we're going to have variability as to some districts and regions being far ahead of the curve, and really being prepared for specific onboarding opportunities as to new business in the third and fourth quarters here. Whereas other geographies may still be struggling with labor market implications and staffing challenges. So perhaps they're not quite as far along that continuum. But as an organization in total, Andy, very much having been focused on the back half of the year as the inflection point toward growth, we have been building and managing our management capacity toward that. And we feel extremely confident that our management capacity aligns very well with the geographic opportunities that we've indicated as most likely to come on board here in the back half of the year.
Great, that's helpful. I guess, just as a follow up to that, I guess I just wanted to understand a little bit more on the confidence level of the second half revenue growth, where you gave this 420 to 430, obviously, that suggests sequential growth, which is good. I guess maybe the first question would be, does that 420 to 430 range is that already, is that business that's already been started as we sit here today? Or are there other facilities that still need to transition here during the rest of the quarter unable to hit that target? And then I guess, maybe just more broadly, Ted, maybe if you could just comment on, sounds like the pipeline's there, you made a comment that if and when the the customers decide to go. What needs to happen do you think for those customers to really pull the trigger? Do you've been having dialogue with? Do you feel like you're -- could add to the top line? What needs to happen to get them over the hump?
Yes, I think in terms of the confidence or conviction around the 420 to 430, it's a mix, Andy, we obviously we wouldn't have provided that range if we didn't have a high degree of conviction that we were going to be able to deliver in that range. So it's a combination of business that we've already have in hand that we started towards the end of Q2 and new business ads that we'll have throughout the quarter. I guess, the bigger question you had about the pipeline, and what’s the gating factor to a customer pulling the trigger? It's a collaboration. The pipeline's robust, every customer group, every prospective customer has a different set of circumstances to it. In many cases, it's just to piggyback off of Matt's commentarial management development. It's a function of where do we have the depth? Where do we have the bench strength to be able to take on new business. We've always talked about the single greatest gating factor on growth is it the demand for the services or the amount of opportunities that are out there, it's our own ability to hire, develop, train, and then successfully deploy management candidates that remains as true as ever today. I know, we haven't talked about it in recent quarters and years as much as we had historically, but pivoting to growth mode here, that'll be front and center and our own internal assessments and analysis and focus. And I imagine it'll be a conversation we have quarter-to- quarter in this forum. So nothing necessarily as generally speaking as a catalyst to put a specific customer group over the hump, it's just a process of prospective client by client assessment. And where our management development efforts and capacity match up with the demand. That's where we're able to execute on the growth strategy.
The next question is from Brian Tanquilut with Jefferies.
Hi, good morning. You have Tazi on for Brian, thank you for taking my question. So my first question has to do with margins in both segments, right? You had housekeeping at 8.7%, dining at 5.5%. So as we think about your pivot into growth mode for the second half of the year, just curious what particularly needs to happen in order for you to see alleviation margins, especially throughout the year in both segments, and for you to see that translation to the bottom line.
Yes, Tazi, it's a great question. I think specifically, from a segment perspective, there's always going to be some movement, whether it be month-to-month or quarter-to-quarter, largely due to execution. And you alluded to it new business ads, and there's other considerations that are happening each and every day in our field based operations. And they're just as an add on to that there's, we don't talk about it because it's not really material, but around the edges. There's even some seasonality whether it's the number of holidays in a quarter, sometimes the timing of supplemental billings, we had union buyouts at different times during the year. I would say, just for some additional context from a margin perspective, if you look back pre-COVID, our segment margins were in that 9% to 10% range for EVS and 5% to 6% range for dining, we would expect to track and trend in and around those levels for 2023. Even with the expectations we have around growth and the margin compression that could create, again with a degree of quarter-to-quarter variability.
Thanks. That's really helpful. And then just last question for me. Just curious as we think about CECL AR reserves and other adjustments. Can you maybe talk about sustainability at these adjustments? I think you had talked about how like CECL is pretty formulaic, and at times volatile, but any thoughts around where this could settle out when you expect to, I guess, see the adjustments kind of taper out in your P&L?
Yes, and I know, we've discussed it at previous times on this call, just to maybe take a step back to your question, Tazi, but the industry is still recovering and has not yet recovered. And that's the primary reason why coming into the year, even on the heels of a very strong Q4 cash collections quarter, we expected some fits and starts on the collections front, especially in the first half of the year. That's why we provided coming into the year more modest cash flow estimates. And that's why we highlighted our expectation for volatility around CECL. We don't expect that to be the new norm in the quarters and years ahead. But in this current environment, it was expected that we would see some CECL volatility. I think that said, and specifically to this quarter as it was a difficult environment, we expected that, especially with the May 11, expiration of the public health emergency, we saw clients really looking to maximize their own liquidity and flexibility. And that impacted our April efforts. But overall, any negative impact on our customer base specific to the public health emergency was really less than feared. And we were successful in executing on our strategies in May and June, which is why we highlighted that strong momentum heading into the back half of the year. So getting back to your question around CECL, specifically, as we're consistently collecting what we built, we would absolutely expect CECL to moderate and to become more normalized. We'll continue to make the adjustment in the adjusted EBITDA table irrespective of whether it's an upward adjustment or a downward adjustment, because we do believe longer term write-offs, actual write-offs is a more effective way and probably a more indicative of what would actually be a P&L charge for HCSG. But, again, in terms of the actual business side of it as cash flow and cash collections improve, which we expect them to do the back half of the year, we would expect to see sort of moderate.
The next question is from Jack Malek with William Blair.
Yes. Hi, good morning, Jack on for Ryan this morning. Any additional insight into how you're getting comfort over any potential exposure to the finalized rule that might increase staffing requirements? Is the comfort coming from client conversations? Are you doing more site specific analogies to gauge risk? And just kind of curious how you're thinking about this potential headwind?
Yes, Jack, it's a good question. And it's certainly as you alluded to, it's certainly a talk within the industry right now. And I think the latest is that the proposed plan is expected soon, although, we've heard that for months at this point, but all industry stakeholders remain on high alert, I'd say the industry view/ perspective is around minimum staffing is that if there were an appropriate pilot and appropriate phase in periods, and with it a recognition of the labor constraints, and it was fully funded, then the industry would and really has leaned into that type of framework. But if it's an unfunded mandate, without recognizing the realities on the ground. I do not believe that would be well received. No from our perspective assuming there is a minimum staffing requirement announced later this year, our assessment of it is it would likely be very narrow, meaning it would be related to patient care staff only, it would likely have a phasing period of up to five years, probably in the three to five year range, there would likely be a robust waiver process, especially for rural facilities. And it would have to survive political changes and administration and all the inevitable litigation that would come with it. So there's a lot of roads to hoe here, Jack, but I would say stay tuned. There's going to be more to come from a minimum staffing perspective. But in the meantime, we'll wait and see. I think just to bring it back to us for a moment. The fact that uncertainty is out there, around not just the regulatory environment, but also the recovery of the industry, the reimbursement environment, does force to a degree providers to look for ways to create more certainty in their business. And we've talked about this before, but the central theme in our value proposition is providing operational and financial peace of mind. So not just with the minimum staffing requirements, but all of the other variables within the industry, some of which are not necessarily new, creates that demand for the types of services that we're able to provide.
Okay, that's super insightful. Appreciate that. I guess just switching gears a little bit. Any update on your capital allocation strategy?
No, from our perspective, it continues to go down the path, we expected it to our number one capital allocation priority continues to be internal investment and investment in organic growth drivers. We remain active on the inorganic front, and exploring activities looking to build selectively inorganic opportunities that we can fold in strategically within the company. There's nothing to announce. But that's something we remain active in. And we continue to keep an eye open for buyback opportunities. We did not have any buybacks in Q2, but that will continue to be a very selective, a very opportunistic approach that we take towards buybacks.
The next question is from Bill Sutherland with the Benchmark Company.
Hey, good morning, guys. Thanks for the question. The state based reimbursement that you called out in the PR this morning. Can you give us a little color on states that we have a higher number of contracts? Just kind of curious, the benefits that those facilities are starting to see at a state level?
Yes, Bill over the past 12 months, really, there's been a number of fees based wins, and some of those states are high density states for us with respect to our client facilities. You think about Florida, Illinois, Pennsylvania more recently, Texas and Ohio. And there's variability there, right. I mean, although one may classify a reimbursement increase in a particular state as a win, there's degrees, right, for instance, the state of Ohio just had a pretty substantial dollar PPD increase that was above what was expected, Ohio historically has not been the best state from an operating perspective. You contrast that with Texas, that did in fact get an increase, but it was I'll say less than what operators were hoping for, it's been quite some time. Since the state of Texas did, in fact, get an increase. So you could put that on the board, technically, as a win and that it was an increase that providers were able to secure but still deemed insufficient. Another state would be New York, which was a bit mixed, where there was 6.5% reimbursement rate increase. That was a bit higher than what was initially proposed, but certainly sub what the industry was looking for in light of massively increasing costs for operators in that state, and really quite a lag in time from the prior reimbursement rate increase. So it's a mixed bag, and certainly something that we pay attention to, Bill, at the state based levels and from an overall regulatory and reimbursement based perspective, but much more important for us, obviously, is how that trickle down and impacts the facility and the operator. So it's one component of that overall financial assessment, inclusive of occupancy, payer mix, and how they're able to staff and manage their nursing departments as well. And the effect that has overall on occupancy.
Okay. I noticed housekeeping revenue was down just a bit quarter-on-quarter. Is that a couple more exits involved there? I'm just curious about the renewal rate.
Yes, that's right, Bill, we would -- we did exit some business. We would classify that as more normal course exits. So nothing substantial, the full run rate of which was reflected in the quarter. While we're talking about the segment level revenue, I would note that dining, we saw a bit of a step up there. And that was just a couple of new business ads. Again, nothing substantial. So both the housekeeping exit and the dining ads, really, were fully reflected in the run rate revenue for the quarter.
Okay. And are your contract, the expansion that you're getting in education, you're reflecting in the overall numbers. Is that right?
That's correct, Bill, they're reflected, respectively in housekeeping and laundry, and then also dining segment as well.
Okay, and there, is that part of the back half uplift?
It is. That's correct.
Okay. And then last one, you mentioned doing least $30 million in free cash for the full year, that's still look like the right way to think about it.
Yes, I think looking to the back half of the year, specifically, we're still targeting that $25 million to $30 million range. So depending on where we fall in that range, or if we exceed that range that could obviously have an impact on the number you just shared, but $20 million to $30 million is our back half of the year target for no free cash flow.
We have no further questions at this time. I'll turn it back to the presenters for any closing remarks.
Great, thank you, Chris. In the months ahead. We remain confident in our ability to control the controllables, realistic about the ongoing challenges that remain with our industry and broader economy, and focused on executing on our strategic priorities to drive growth and deliver long- term value to our shareholders. So on behalf of Matt and all of us at Healthcare Services Group, I wanted to thank Chris for hosting the call today and thank you to everyone for joining.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.