U.S. Markets closed

Edited Transcript of HCSG earnings conference call or presentation 24-Jul-19 12:30pm GMT

Q2 2019 Healthcare Services Group Inc Earnings Call

BENSALEM Aug 5, 2019 (Thomson StreetEvents) -- Edited Transcript of Healthcare Services Group Inc earnings conference call or presentation Wednesday, July 24, 2019 at 12:30:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Matthew J. McKee

Healthcare Services Group, Inc. - Chief Communications Officer

* Theodore Wahl

Healthcare Services Group, Inc. - President, CEO & Director

================================================================================

Conference Call Participants

================================================================================

* Andrew John Wittmann

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Caleb Benjamin Harris

Crédit Suisse AG, Research Division - Research Analyst

* Chad Christopher Vanacore

Stifel, Nicolaus & Company, Incorporated, Research Division - Senior Analyst

* Jason Michael Plagman

Jefferies LLC, Research Division - Equity Associate

* Lalishwar Mitra Ramgopal

Sidoti & Company, LLC - Healthcare Sell Side Analyst

* Ryan Scott Daniels

William Blair & Company L.L.C., Research Division - Partner and Healthcare Analyst

* William Sutherland

The Benchmark Company, LLC, Research Division - Equity Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good morning. My name is Jessa, and I will be your conference operator today. At this time, I would like to welcome everyone to the Healthcare Services Group, Inc. Second Quarter 2019 Earnings Conference Call. (Operator Instructions) The matters discussed on today's conference call include forward-looking statements about the business prospects of Healthcare Services Group, Inc. within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are often preceded by words such as believes, expects, anticipates, plans, will, goal, may, intends, assumes or similar expressions. Forward-looking statements reflect management's current expectations as of the date of this conference call and involve certain risks and uncertainties. The forward-looking statements are based on assumptions that we have made in light of our industry experience and our perceptions of historical trends, current conditions, expected future developments and other factors that we believe are appropriate under the circumstances.

As with any projection or forecast, they are inherently susceptible to uncertainties and changes in circumstances. Healthcare Services Group's actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, and the forward-looking statements are not guarantees of performance. Some of the factors that could cause future results to materially differ from recent results or those projected in forward-looking statements are included in our earnings press release issued prior to this call and in our filings with the Securities and Exchange Commission, including the SEC's ongoing investigation. There can be no assurance that the SEC or another regulatory body will not make further regulatory inquiries or pursue further action that could result in significant costs and expenses, including potential sanctions or penalties as well as distraction to management. The ongoing SEC investigation and/or any related litigation could adversely affect or cause variability in our financial results. We are under no obligation and expressly disclaim any obligation to update or alter the forward-looking statements, whether as a result of such changes, new information, subsequent events or otherwise.

I would now like to turn the conference over to Ted Wahl, President and CEO. Please go ahead, sir.

--------------------------------------------------------------------------------

Theodore Wahl, Healthcare Services Group, Inc. - President, CEO & Director [2]

--------------------------------------------------------------------------------

Great. Thank you, Jessa, and good morning, everyone. Matt McKee and I appreciate all of you joining us for today's conference call. We released our second quarter results yesterday after the close and plan on filing our 10-Q by the end of the week.

During the quarter, we continued to make progress on our near-term priorities of systems adherence with Q2 normalized cost of services coming in below 86%, customer payment frequency with over 55% of our customers on an accelerated payment model and cash collections exceeding billings for the quarter as well as management development, as we increased our management strength and depth in both segments and across the majority of divisions.

We made progress on these near-term priorities in what is still a tough operating environment. The industry continues to work through a challenging cycle that has negatively impacted some of our customers as we saw play out over the past year or so with some client payment issues and restructurings. Additionally, I know last quarter, we talked about expecting a flat to slightly lower top line in Q2, and I wanted to call out some of the factors that resulted in lower-than-anticipated revenues in the quarter.

Over the past few months, we worked through an unprecedented level, nearly 500 facility owner-operator transitions. Many of these transitions occurred under difficult circumstances with tight timelines and new facility operators that had varying degrees of experience, and, in some cases, limited access to capital. All of which we believe significantly increased the operators' execution risks, at least in the near term. These considerations led to an unusually high number of facilities that we were unable to reach a mutually agreeable term with and ultimately exited. The volume of facility operator changes also impacted some of our new business activity as our field-based leaders focused their attention on facility operator changes and transitioning or retaining that business as opposed to new business opportunities. It's worth noting that the 150 facilities or so we exited were partnerships that we felt did not benefit the company presently. However, and as always, we aim to part ways as friends and hope that the new operators find success, establish their financial footing and believe we are well positioned to consider re-engaging at these facilities when the opportunity presents itself.

Looking ahead, the patient-driven payment model and 2.5% increase in Medicare reimbursement, both starting in October, along with recent improving occupancy trends should go a long way in strengthening industry fundamentals heading into 2020. Our focus in the back half of the year will continue to center on customer experience and our near-term priorities to ensure we are well positioned for the year ahead and the long-term growth opportunity that awaits, which is compelling.

With that abbreviated overview, I'll turn the call over to Matt for a more detailed discussion on the quarter.

--------------------------------------------------------------------------------

Matthew J. McKee, Healthcare Services Group, Inc. - Chief Communications Officer [3]

--------------------------------------------------------------------------------

Thanks, Ted, and good morning, everyone. Revenue for the quarter was $462 million, down about $14 million sequentially, primarily due to exiting of facilities in conjunction with operator transitions that Ted just alluded to, including those related to the previously announced Chapter 11 reorganization of senior care centers. Approximately half of that revenue step-down is reflected in the current quarter. Dining & Nutrition and Housekeeping and Laundry segment revenues were reported at $233 million and $229 million, respectively.

Net income for the quarter came in at $18.2 million, and earnings per share was $0.24 per share. Direct cost of services is reported at 86.7%, with Housekeeping and Dining segment margins reported at 10.8% and 4.2%, respectively. Direct costs included about $4 million of elevated payroll costs, about half of which resulted from the transition and redeployment of account managers related to the facility operator changes mentioned earlier, with the balance related to the company's ongoing investment in its training and development ramp up. The split of the $4 million is about $1 million in housekeeping and $3 million in dining.

With the additional management depth we've gained from the recent facility exits, along with the progress we've made over the past year in replenishing the management pipeline, our expectation is that the management development function will return to its normal cadence during the third quarter without the stop-start dynamic that we've seen bear out from 2017 through the present. And overall, our near-term goal is to manage direct costs below 86% in the year ahead.

SG&A was reported at 8.4% for the quarter. There was about $1.5 million impact from the change in the deferred compensation investment accounts that are held for and by our management people, so our actual SG&A was 8%. And SG&A was also impacted by about $2 million of legal and professional fees related to the SEC matter. As a result of some of the recent revenue step downs, along with the fixed nature of certain SG&A related costs, we'd expect that SG&A is around 7.5% until revenue growth reaccelerates.

Other income and expenses for the quarter was reported as $610,000, but after making that $1.5 million adjustment for the change in deferred comp, actual expense was around $1 million. And it's worth noting that the Q2 numbers were impacted by timing, the timing of certain captive related expenses, as well as interest income on our notes receivable, compared to last quarter.

Our effective tax rate in the second quarter was 23%, and we expect our tax rate for the rest of the year to be in that 21% to 23% range, including WOTC, but excluding other discrete items that impacted the 2018 tax rate.

Over to the balance sheet. At the end of the second quarter, we had over $95 million of cash and marketable securities and a current ratio of better than 3:1. Cash flow from operations for the quarter came in at around $3 million, and that was unfavorably impacted by the $21 million decrease in accrued payroll. And because we did call out the timing of the payroll and the impact of the payroll accrual previously, just wanted to remind you that the second half of the year payroll accrual will have a similar cadence to 2018 in that Q3 will be higher and Q4 a bit lower. But of course, that only relates to timing and ultimately washes out through the full year.

DSO came in at around 68 days. As announced yesterday, the Board of Directors approved an increase in the dividend to $0.19875 per share, payable September 27, the cash flows and cash balance is supported 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 the value and free cash flow back to the shareholders. This will be the 65th consecutive cash dividend payment since the program was instituted in 2003 after the change in tax law, and it's the 64th consecutive quarter that we've increased the dividend payment over the previous quarter. That's now a 16-year period, that's included four 3 for 2 stock splits.

So with those opening remarks, we'd like to now open up the call for questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Your first question comes from the line of A.J. Rice from Crédit Suisse.

--------------------------------------------------------------------------------

Caleb Benjamin Harris, Crédit Suisse AG, Research Division - Research Analyst [2]

--------------------------------------------------------------------------------

This is Caleb Harris on for A.J. this morning. So I'd just like to start with the operator transitions you're talking about. I understand that a lot of that is self-inflicted with a high level of terminations, just in terms of protecting the company and so forth. But is there anything that's fundamentally different about the way those negotiations are going today, is there -- are they demanding lower fees generally? Is there any risk of margins getting squeezed? Are there more that are thinking they can take it in-house? So I guess, the question is just around whether there's anything that's fundamentally different about those conversations today relative to the past?

--------------------------------------------------------------------------------

Theodore Wahl, Healthcare Services Group, Inc. - President, CEO & Director [3]

--------------------------------------------------------------------------------

Well, we think of it as almost a natural progression of the industry cycle, where you have industry stress and strain on the providers that result in -- as it manifested itself with us, some payment issues and some client restructurings. As it works its way through the cycle, there was lease cost issues and lease renegotiations that took place between landlord and provider. And then ultimately as some of the dust settles, there's a decision to be made as who is going to move forward on the provider side in this space. And I think what we saw as being different, Caleb, to your question is, sheer volume. Again, nearly 500 over the past few months of operator-related transitions. It's unprecedented, it's not something we've seen historically, and we do not expect that to be a new norm going forward. It's just in this particular situation -- and there was a concentration that was in Texas as well, a state which has had some challenges and continues to have some challenges from a reimbursement perspective, Medicaid specific. But again, the biggest difference over the past few months compared to historical norms would be sheer volume, and we do not expect that to recur going forward.

--------------------------------------------------------------------------------

Caleb Benjamin Harris, Crédit Suisse AG, Research Division - Research Analyst [4]

--------------------------------------------------------------------------------

Okay. And just talking about the state of the industry and cycles and so forth. With the reimbursement change that's coming up, PDPM, I know it's a budding issue of the industry, and I think a lot of the operators and other stakeholders are feeling pretty positive about it. But it will have some pretty significant distributional impacts on different operators. And I'm just wondering if you guys have any insight into your own client base and where they fall in that curve of who's going to be impacted more positively and more negatively by those distributional impacts? And how prepared do you think your client base is for that?

--------------------------------------------------------------------------------

Theodore Wahl, Healthcare Services Group, Inc. - President, CEO & Director [5]

--------------------------------------------------------------------------------

Yes. Again, all anecdotally, obviously within our customer base. But generally speaking, the feedback from the customer is consistent with the overall industry feedback, where it's an overall positive. There will be, obviously, some operators that are better positioned than others. But on a net basis, Caleb, we think it's going to be a positive overall for our customer mix.

--------------------------------------------------------------------------------

Caleb Benjamin Harris, Crédit Suisse AG, Research Division - Research Analyst [6]

--------------------------------------------------------------------------------

Was there any one in your portfolio, where you said, it looks like you're going to take a certain percentage hit from this reimbursement change, and that was a reason that you might have discontinued the contracts?

--------------------------------------------------------------------------------

Theodore Wahl, Healthcare Services Group, Inc. - President, CEO & Director [7]

--------------------------------------------------------------------------------

It's always one of the considerations. That's not -- we would never point to that or have not pointed to that as being the single reason as to why we would decide to move forward with or not with a particular customer. We look at every customer relationship holistically and make decisions based on that assessment.

--------------------------------------------------------------------------------

Caleb Benjamin Harris, Crédit Suisse AG, Research Division - Research Analyst [8]

--------------------------------------------------------------------------------

Okay. And then just one more. In the press release, you mentioned the transition to an accelerated payment model as being above 55%, which was, I think, the same figure that you cited last quarter. So I'm just wondering if that slowed down at all. If that was intentional if it did slow down? And how you expect that to proceed moving forward?

--------------------------------------------------------------------------------

Matthew J. McKee, Healthcare Services Group, Inc. - Chief Communications Officer [9]

--------------------------------------------------------------------------------

So you're right, Caleb, on a net basis, we were right around 55% at the end of Q1. We're pretty pleased to have remained at greater than 55% through 500 transitional conversations, right. I mean, $350 million of which resulted in us retaining the business. So obviously we needed to have those conversations. We needed to keep those transitional facilities and customers on the weekly payment model, and we're almost 100% comprehensively successful in doing so. So there remains an opportunity for us to continue chipping away at the current customer base. And as we've mentioned previously, the default position with new prospects and new customers is the weekly payment structure. So as we grow the business, as we onboard new customers, that percentage will continue to increase. We've been open in calling out the fact that the first 55% would be achieved a lot more rapidly than the remaining 45% or so. But that 55%, we expect to grow as we onboard new business, coupled with continued dialogue and opportunities within the existing customer base.

--------------------------------------------------------------------------------

Operator [10]

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Andrew John Wittmann, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [11]

--------------------------------------------------------------------------------

I wanted to just talk about -- excuse me, the $4 million you called out, the dining/housekeeping split there. But it sounds like there was both training costs in there as well as -- I don't know what you'd call it, I guess, frictional costs from exiting the facilities. Maybe just a little bit more detail, guys, on kind of how those were incurred? And it sounds like, Matt, I think, in your comments, you said that you got a little bit of work to do in the third quarter, but you kind of feel like you're going to be on better footing that some of these types of costs are going to subside, so that sounded like, I guess, there, that the fourth quarter you think can be clean. So I just wanted to get some of the rationale behind your confidence that these are temporary and will subside.

--------------------------------------------------------------------------------

Theodore Wahl, Healthcare Services Group, Inc. - President, CEO & Director [12]

--------------------------------------------------------------------------------

Yes, I think the way you framed it, Andy, is fair. We do find ourselves in the rare and enviable position of having sufficient strength and depth of management talent. And the candidates that we onboarded in Q4 of '18 and the first quarter of '19 are now in the final stages of completing their training. So it's, at this point, more about seeing those folks through the completion of the training program rather than having the explicit focus on recruiting efforts and continuing to sort of feed the funnel. So obviously, exiting 150 facilities has further freed up additional management capacity of the folks who would have been running those facilities. So for the balance of the year, as I say, not as much focused on recruiting or hiring and feeding that funnel, but much more so on seeing the current trainees through the training program and determining the best way to utilize them going forward in addition to identifying the most productive way to redeploy those managers who have now recently transitioned out of those facilities that we've left. So that will take the form of replacing -- locally, replacing underperforming managers or filling vacancies, supporting and supplementing certain client groups, again locally serving in a district support function as it's needed, and ideally then beginning to be assigned to new facility adds.

So from a training perspective, again, just to sort of put a bow on it, it would be seeing those folks through completion of the training program to ultimately be assigned here in the back half of the year, and likewise execute locally plans to redeploy those managers that became available as a result of those facility exits.

--------------------------------------------------------------------------------

Andrew John Wittmann, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [13]

--------------------------------------------------------------------------------

Okay. So I mean, you guys have talked for a long time that there's pent-up demand. If you just had more managers, like you said, I think you used the word enviable position, you've got these managers. Obviously, there's been a lot going on. You mentioned that new business development wasn't something you could really focus on during all these transitions. Here today, halfway through the quarter, a bit of the way through the quarter here, I mean, are you starting to ramp up those new accounts, so that those people can find new homes and find new accounts that are willing to sign up to the new conditions that you guys are emphasizing, including the weekly payments? I mean, how have those been seen and responded to by new customers, and can you start getting those people back out there sooner rather than later?

--------------------------------------------------------------------------------

Theodore Wahl, Healthcare Services Group, Inc. - President, CEO & Director [14]

--------------------------------------------------------------------------------

Yes. I think what we talked about really over the past few months and last quarter about second half of the year, expecting sequential growth compared to the first half of the year still holds true. I guess, as a result of some of the unanticipated outcomes that we had with the high level -- high number of ownership and operator changes and the impact that had on revenue, we're just starting from a new base. So the expectation, though, in terms of sequential growth holds true, where the new run rate in and around 448, right, with the $14 million running through the Q3 results, but we would expect to grow, to see some growth in Q3 off of that base, and then again in Q4 compared to Q3, off of that base. So yes, we are going to be actively focused on selectively expanding. And I think Caleb asked the question about PDPM. That's certainly something we're looking forward to and the industry at large is looking forward to that, along with the 2.5%. So I think certain -- back half of the year, modest sequential growth first half compared to second half, now off of the 448 base though, and then having that momentum carry into 2020. That's the expectation.

--------------------------------------------------------------------------------

Andrew John Wittmann, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [15]

--------------------------------------------------------------------------------

All right. Great. And then just my final question has to do with, I guess, cash flow. One of the things that was not here was that there were not any AR write-offs, and I think it's a welcome sight from everyone. But you previously commented that the second half of the year, you thought of '19 would look a lot like the cash flow, the second half of '18, probably in and around $50 million. You previously said that now you've walked away from a bunch of business that, I think, maybe it was in your prior forecast, isn't anymore. Is $50 million still the right way of thinking about it off of the new lower revenue base for the second half of the year cash flow?

--------------------------------------------------------------------------------

Matthew J. McKee, Healthcare Services Group, Inc. - Chief Communications Officer [16]

--------------------------------------------------------------------------------

Yes, I think that's still a fair number, Andy. If it -- if we're off, because there's a few million dollars that would have been related to the revenue we transitioned were a step down on, then we'll call that out. But that $50 million is still a fair number to have.

--------------------------------------------------------------------------------

Operator [17]

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Ryan Scott Daniels, William Blair & Company L.L.C., Research Division - Partner and Healthcare Analyst [18]

--------------------------------------------------------------------------------

Just a couple of quick follow-ups at this point. In regards to the $2 million in SG&A costs related to the SEC investigation, how should we think about that trending forward? Is that something that's just going to be a continuing cost until it's closed or could that accelerate or decelerate? Just trying to get a better feel on the SG&A numbers for our model?

--------------------------------------------------------------------------------

Theodore Wahl, Healthcare Services Group, Inc. - President, CEO & Director [19]

--------------------------------------------------------------------------------

Yes, Ryan, I would say, going forward, we do expect some level of elevated costs, and we'll certainly call that out as it's incurred each quarter. Over the back half of the year, sitting here today, just looking at the fact that there's no real updates to share, it's been fairly quiet, we continue to remain cooperative, but there's not any really -- any noteworthy updates. We would expect it to be somewhat less than what it was this past quarter, where there was some carryover from the internal review from Q1. Difficult to project out. There will be some elevated costs back half of the year. We'd expect it to be less than what we incurred this quarter. But again, that's difficult to forecast depending on whether or not we need to utilize more man hours from a professional or legal perspective.

--------------------------------------------------------------------------------

Ryan Scott Daniels, William Blair & Company L.L.C., Research Division - Partner and Healthcare Analyst [20]

--------------------------------------------------------------------------------

Okay. Fair enough. And then can you speak to the COO transition a little bit more? Did that relate to any of the kind of issues you're seeing lately, #1? And then #2, is that position being eliminated and consolidated into Andrew's role or is that something where you will be looking for another COO going forward?

--------------------------------------------------------------------------------

Theodore Wahl, Healthcare Services Group, Inc. - President, CEO & Director [21]

--------------------------------------------------------------------------------

Yes. I'd say for that, it was more -- that's more about the evolution of the company org, design and structure as well as Andy's leadership and role more than any -- more than it is anything else, Ryan. I think in his prior role and Andy's prior role as CIO, he either managed or was intimately involved in operational excellence or training and development function, risk management. He's touched HR over the years as well as some of the key strategic and continued process improvement initiatives we've been focusing on. And he certainly has demonstrated a great deal of expertise and capacity in those roles. So again, I think the expanded responsibility of now overseeing the field-based ops is more of a natural progression. We're excited for the possibilities it creates. But the reality is the hard work still has to happen in the 4 walls of each facility, and that's ultimately dependent on the strength of our local leadership team. So it all comes down to the basics of running the day-to-day in the field.

--------------------------------------------------------------------------------

Operator [22]

--------------------------------------------------------------------------------

Your next question comes from the line of Bill Sutherland from Benchmark.

--------------------------------------------------------------------------------

William Sutherland, The Benchmark Company, LLC, Research Division - Equity Analyst [23]

--------------------------------------------------------------------------------

I wanted just to think a little bit more about this sudden spurt of negotiations you guys had to do in the second quarter. And kind of how to think about the possibility of just kind of continuing higher-than-normal set of circumstances in the months ahead? I mean, I know you've canvassed, to the degree which you can, all the possible outcomes. But, I mean, I guess, I'm looking to gauge your comfort level at this point.

--------------------------------------------------------------------------------

Matthew J. McKee, Healthcare Services Group, Inc. - Chief Communications Officer [24]

--------------------------------------------------------------------------------

Yes. I mean, as you sort of framed the question, Bill, we've gone through a pretty significant scrubbing of the customer base as it relates to certainly transitions in which we're actively negotiating with the new operators, having initiated the conversation with respect to the transition to weekly payment with, at this point, the significant majority of our customers of our current customer base. We feel good about where we sit presently, but this is an ever-evolving business, it always has been and it always will be. So we'll remain diligent. We will continue to have conversations with our customers. We'll continuously assess their position, both financially, operationally and otherwise. So there may be a continuation of that trend of elevated transitions maybe in Q3, but we would certainly envision that diminishing in Q4. And the expectation is that Q3 wouldn't approach what we saw unfold in Q2 and even in Q1. So I think the bulk of that transitional activity has occurred. We've navigated our way fairly well through it. Some expectation for continued transitions in Q3, although we do believe we're very well positioned looking out at the likely transitions that we see ahead. But we will remain vigilant. We'll do the work, and we'll continue to continually assess, not only transitional customers but the current book of business as well.

--------------------------------------------------------------------------------

Theodore Wahl, Healthcare Services Group, Inc. - President, CEO & Director [25]

--------------------------------------------------------------------------------

And just to add a little more context to Matt's feedback. I think, Bill, just to help kind of, again, put some color around it. Typically, if you look what our historical conversion rate has been, more than 9 out of every 10 operator type change, we are successfully transitioning here, with 7 out of 10. And when you look at it in terms of sheer volume, coupled with where some of the facilities were situated, what the makeup of those facilities was in terms of their historical experience, and then layered on top of that, the operators -- some of the operators coming in, as I mentioned earlier, with, in some cases, limited access to capital and varying degrees of experience, it just made sense for us to exit with our best day being our last day is always the goal, but to exit and kind of move forward and lay in wait until it makes sense to maybe reengage. So that's atypical in terms of leaving more this quarter, both in terms of 7 out of 10 instead of our typical greater than 9 out of 10, and the sheer volume amplified the impact it had on revenues.

--------------------------------------------------------------------------------

William Sutherland, The Benchmark Company, LLC, Research Division - Equity Analyst [26]

--------------------------------------------------------------------------------

Great. That's helpful, Ted. One -- just one more. What is your exposure in Texas now going forward?

--------------------------------------------------------------------------------

Theodore Wahl, Healthcare Services Group, Inc. - President, CEO & Director [27]

--------------------------------------------------------------------------------

It's really pretty relative to the size of the state, as is our typical geographical distribution. If you look at each state, based on the number of facilities they have, we don't talk about specific exposures by customer or by state per se, but we're very comfortable. On the heels of the senior care reorganization and the fact that we're fully reserved there and obviously the impact that had with some of those facilities transitioning this quarter, coupled with some of the other work we've done in Texas to solidify existing customer relationships, we're comfortable with where we're at in that state.

--------------------------------------------------------------------------------

Operator [28]

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Lalishwar Mitra Ramgopal, Sidoti & Company, LLC - Healthcare Sell Side Analyst [29]

--------------------------------------------------------------------------------

Just a couple of questions. First, I just want to get a sense in terms of the adjusted contractual relationships you started in 3Q '18, how have those progressed? And any surprises there? And are we likely to see some of those getting done later this year?

--------------------------------------------------------------------------------

Matthew J. McKee, Healthcare Services Group, Inc. - Chief Communications Officer [30]

--------------------------------------------------------------------------------

Yes. As we alluded to at the time, Mitra, we've largely remained in contact with those folks. In some instances, we have gone back in, in some capacity or another, whether it's dipping the toe back in, in a management capacity or fully reengaging in a full-service operation. But there hasn't been significant movement, that would be noteworthy relative to that total book of business. So I would say that conversations are ongoing. We, of course, as Ted said, you always want your last day to be your best day. You want to shake hands and part ways as friends, remain in contact. So there are varying degrees of progress that we've made in sort of reengaging with those folks and finding ourselves back into the facilities in a full-service capacity. But I would say, looking at that total book of business, as we sit here presently, not a significant amount of which would have resumed to a full-service partnership. But as is the case, we continue that dialogue, and that is ultimately the direction that we'd like to end up with those folks. And we remain optimistic that, that is a possibility with those customers, specifically from the Q3 of '18 housekeeping adjustments.

--------------------------------------------------------------------------------

Lalishwar Mitra Ramgopal, Sidoti & Company, LLC - Healthcare Sell Side Analyst [31]

--------------------------------------------------------------------------------

Okay. No, that's great. And then just going back in terms of the candidates you've brought on, just wondering where you are relative to your goal, given the tight labor market, how difficult it is to sort of get there? And are we going to see an easing up now as we look out to 2020?

--------------------------------------------------------------------------------

Theodore Wahl, Healthcare Services Group, Inc. - President, CEO & Director [32]

--------------------------------------------------------------------------------

I think Matt mentioned it. But by virtue of some of the facility exits, the higher than what we've typically experienced facility exits, the silver lining would be the strength and the depth that, that added to our existing management team. So the hard work we've done over the past year to replenish the management pipeline continues, but we expect that kind of stuffing of the funnel to subside during the third quarter, coupled with the additional management capacity we have now as a result of the facility exits, I think, puts us in a very good position. But, as you know, Mitra, management development, making sure we're hiring and developing high-quality people that are acclimated to the company, have the benefit of going through some apprenticeship period, that's where everything begins for us. That's the life blood of the company, that's where all of our successes or lack thereof, ultimately emanate from. So that's an ongoing process that we're going to have to continue to -- we just don't want to continue to focus on it. We just don't expect to see the stops and the starts that we have seen over the past year or so.

--------------------------------------------------------------------------------

Lalishwar Mitra Ramgopal, Sidoti & Company, LLC - Healthcare Sell Side Analyst [33]

--------------------------------------------------------------------------------

Okay. And finally, just trying to get a sense if you're seeing increased or having increased conversations in terms of potential clients looking to give you their business given, as you indicated, starting in October, going forward, do you expect the industry to start, things to improve, if you're seeing that in terms of the calls you're making or receiving?

--------------------------------------------------------------------------------

Theodore Wahl, Healthcare Services Group, Inc. - President, CEO & Director [34]

--------------------------------------------------------------------------------

Yes, our new business pipeline is as large as it's been at any point in time in the history of the company. So the demand for the services as well as the opportunity to grow has never been greater. But for us, again, given the environment, the industry cycle and some of the -- as we talked about even this past quarter, the number of ownership and operator transitions that have taken place, we are being more selective, certainly in the near term, so we're ready when that opportunity presents itself, we'll be prepared to reaccelerate growth.

--------------------------------------------------------------------------------

Operator [35]

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Jason Michael Plagman, Jefferies LLC, Research Division - Equity Associate [36]

--------------------------------------------------------------------------------

It's Jason Plagman. Just a question on the SG&A. So normalized SG&A was about $37 million, excluding the deferred compensation accrual, and that was down a little bit from Q1, even though the expenses from the SEC investigation dropped pretty significantly, I think, from $6 million to $2 million. Were there other items impacting SG&A in Q2 that we should -- that you would call out?

--------------------------------------------------------------------------------

Theodore Wahl, Healthcare Services Group, Inc. - President, CEO & Director [37]

--------------------------------------------------------------------------------

Well, I think the deferred comp adjustment gets you to $37 million, but then there's another $2 million of SEC related costs as well, which would get you to something closer to $35 million.

--------------------------------------------------------------------------------

Jason Michael Plagman, Jefferies LLC, Research Division - Equity Associate [38]

--------------------------------------------------------------------------------

Yes. I -- in Q1, I think the normalized level after backing out the SG&A was a little bit lower than $35 million, according to my math. Anything that would have caused that SG&A to step-up in Q2 or was it just kind of normal course?

--------------------------------------------------------------------------------

Theodore Wahl, Healthcare Services Group, Inc. - President, CEO & Director [39]

--------------------------------------------------------------------------------

Yes, nothing notable.

--------------------------------------------------------------------------------

Jason Michael Plagman, Jefferies LLC, Research Division - Equity Associate [40]

--------------------------------------------------------------------------------

Okay. That's -- I just wanted to clarify that. And then your ability to redeploy the freed up managers, how should we be thinking about the pace of that, given that you talked about kind of increased vetting and scrutiny of clients. How quickly should we expect to see those folks back on -- into new clients or move to existing clients, replacing underperforming managers?

--------------------------------------------------------------------------------

Matthew J. McKee, Healthcare Services Group, Inc. - Chief Communications Officer [41]

--------------------------------------------------------------------------------

Yes, it's interesting, Jason, the way you framed the question. Because with respect to new facility adds, timing is always the greatest variable for us. Certainly, we've always talked very openly about management capacity is the first box that we have to check. Clearly, as an organization, we find ourselves with that management capacity in hand at the moment and largely distributed evenly geographically. So the other component, of course, is the fact that the conversations regarding growth are happening locally. It's the combination of the sales conversation, building out that sales pipeline, coupled with the operational coordination to ensure that we do, in fact, have the management capacity to onboard that business. The first question of which is, do you have a manager that you can place into that facility. Secondarily, obviously, in a geography in which you're managing a greater number of ownership changes and operational transitions, you're not going to be equipped to handle new facility adds per se. Because in many respects when there's an ownership change or even an operator change, we treat that as a new facility start, right? I mean, there's often a getting-to-know-you period of a new administrator, often with several new department heads as well. So that does require operational resources to manage through those transitions.

Ultimately, as we've talked about, management capacity exists. We are, in fact, initiating and continuing conversations with folks, with prospective customers, about initiating and engaging to add new facilities, likewise, having conversations with existing housekeeping customers of ours to think about adding dining services. But we will take that selective approach, almost a cautious approach as we work through the diligence in assessing the financial footing of all of those customer and prospective customer types to ensure that now is the right time to engage with them. We want to make sure that we're adding business that benefits the company, not only in the near term, but in the long term, and doesn't, in fact, handcuff us as it relates to credit assessments or payment related decisions.

So expectation, as Ted said, we'll see the impact from a revenue perspective of the facility transitions fully run through Q3 results, all the while expecting to be adding -- selectively adding facilities in Q3, expectation being that we'd be adding a greater number of facilities in Q4 than Q3, and then having that position us very favorably to be looking at 2020 at the point to be able to assess what is the right go-forward growth rate for us, given the management considerations, operating environment and then, of course, layering in those customer-specific considerations.

--------------------------------------------------------------------------------

Jason Michael Plagman, Jefferies LLC, Research Division - Equity Associate [42]

--------------------------------------------------------------------------------

Okay. That's very helpful. And then last one, just any thoughts or framework for the split of the approximately 150 managers that have been freed up, how many will ultimately end up with new clients versus how many will be kind of backfilling or replacing under vacancy -- current vacancies or underperformers?

--------------------------------------------------------------------------------

Matthew J. McKee, Healthcare Services Group, Inc. - Chief Communications Officer [43]

--------------------------------------------------------------------------------

Very hard for us to talk to that at kind of the top side level here, Jason. The reality is, as I said, those assessments are and decisions are executed locally within the District framework and it may roll up to a regional level, in which the Director of Operations is making those assessments. Obviously, we've talked about this consistently for -- since 1976, that we are a management company and having management capacity always benefits us as it relates to upgrading current management folks and, of course, looking at the management pipeline as a means to feed the business development pipeline. So we would have to look in a very bottoms-up type way. But just to sort of summarize, I would say that we feel very good at total company that we're able to have those discussions and have the options of upgrading management within the local management structure and/or be in a position to think about adding new facilities within the local districts and regions.

--------------------------------------------------------------------------------

Operator [44]

--------------------------------------------------------------------------------

Your next question comes from the line of Chad Vanacore from Stifel.

--------------------------------------------------------------------------------

Chad Christopher Vanacore, Stifel, Nicolaus & Company, Incorporated, Research Division - Senior Analyst [45]

--------------------------------------------------------------------------------

So Ted and Matt, given that you're making management changes in operations, what sort of operational improvements do you think we can effect near-term? Then what levels and types of expense savings or efficiencies can you garner in the next 12 months?

--------------------------------------------------------------------------------

Theodore Wahl, Healthcare Services Group, Inc. - President, CEO & Director [46]

--------------------------------------------------------------------------------

Yes, Chad. It wasn't, as I mentioned earlier, with one of the questions, that there wasn't a catalyst per se, as you're maybe alluding to or thinking about it. It was more the natural evolution of the org design, the structure and then the leadership teams. So that's -- nothing that we would call out as saying, as a result of X, we're going to be able to execute on Y and Z. It just wasn't about that.

--------------------------------------------------------------------------------

Matthew J. McKee, Healthcare Services Group, Inc. - Chief Communications Officer [47]

--------------------------------------------------------------------------------

Yes, I would just add, Chad. Of course, as is always the case and probably with any organization, we're in a perpetual state of seeking operational improvements and seeking efficiencies. So that will always have a mindful eye on attempting to be better. But they're -- as Ted said, there aren't any explicit opportunities that we've identified in which we're saying A plus B yields C by way of specific financial outcomes per se.

--------------------------------------------------------------------------------

Chad Christopher Vanacore, Stifel, Nicolaus & Company, Incorporated, Research Division - Senior Analyst [48]

--------------------------------------------------------------------------------

All right. Well, adjacent to that question would be, you mentioned a shift to a more internal focus, take some time, look at your structure and how you're doing things. On the other side of that, should we expect some more upfront investment in either people or systems from now to the end of the year?

--------------------------------------------------------------------------------

Matthew J. McKee, Healthcare Services Group, Inc. - Chief Communications Officer [49]

--------------------------------------------------------------------------------

As we sit here, Chad, we wouldn't expect that. And when we talk about sort of that internal focus, I just want to be clear that, that's -- in making sure that our internal designs appropriately reflect customer needs, right? I mean, it's an ever-changing environment. Our aim is to deliver a tremendous customer experience. So of course, we want to be mindful that our organization continues to evolve, to position us to be most favorably positioned relative to customer expectations, customer needs. So no, I would say that sitting here today, there will be continued evolution of our organization, both in the near-term and most likely in the long term, but we don't expect that, that will require any further investment or any additional costs from a management or a personnel perspective.

--------------------------------------------------------------------------------

Chad Christopher Vanacore, Stifel, Nicolaus & Company, Incorporated, Research Division - Senior Analyst [50]

--------------------------------------------------------------------------------

All right. In your comments, you signaled maybe a pause on new business, and taking on that more internal focus, what would it take for you to return to signing new contracts again at the levels that we've seen historically? Is it a matter of sorting out an existing customer base or is it a function of assessing how reimbursement changes affect customer and credit quality?

--------------------------------------------------------------------------------

Theodore Wahl, Healthcare Services Group, Inc. - President, CEO & Director [51]

--------------------------------------------------------------------------------

Yes. I think one is related to the other. And that's why we have, as you're well aware of these 2 significant industry events happening in October, both the implementation of PDPM, coupled with the 2.5% increase in Medicare reimbursement as well as -- and alongside of the improving and ongoing improvement around census and occupancy trends. So I think that certainly bodes well. If not for Q4, as all of that is being implemented and integrated, but certainly for 2020, meaning, we believe the industry is going to be stronger in 2020 than it is in '19, generally. So our goal is to be well positioned heading into next year, so we can take advantage of those opportunities that I mentioned earlier. Because pipeline, demand for the services, growth opportunities with both new customers, greenfield opportunities as well as cross-selling, Dining & Nutrition Services to existing customers, all available and all as great as they've ever been. It's a matter of us executing on it. So there's no specific bright line we're looking to cross to say, hey, now we're ready to go. It's going to be a customer-by-customer assessment. And obviously, the local operators have something to say about that. Our local leadership teams have something to say about that. Because in order for us to take full advantage of all those opportunities, we have -- need to have the management capacity, which we're much further along today than we were a year ago.

--------------------------------------------------------------------------------

Chad Christopher Vanacore, Stifel, Nicolaus & Company, Incorporated, Research Division - Senior Analyst [52]

--------------------------------------------------------------------------------

Given that you've just given up some contracts, does that actually give you the necessary management capacity to go ahead and expand when you need to?

--------------------------------------------------------------------------------

Matthew J. McKee, Healthcare Services Group, Inc. - Chief Communications Officer [53]

--------------------------------------------------------------------------------

Absolutely. It's an additive sort of management capacity benefit relative to the trainees that have been built into the training program via the recruiting and onboarding efforts that we undertook in Q4 of '18 and Q1 of '19. So this does nothing but further supplement the existing and developing management capacity.

--------------------------------------------------------------------------------

Operator [54]

--------------------------------------------------------------------------------

There are no further questions at this time. I turn the call back over to Mr. Wahl for closing remarks.

--------------------------------------------------------------------------------

Theodore Wahl, Healthcare Services Group, Inc. - President, CEO & Director [55]

--------------------------------------------------------------------------------

Okay. Well, thank you, Jessa. And 2019 is our 43rd year of business, and the company's underlying fundamentals are as strong as ever. Our leadership and management team, our business model and visibility we have into our business performance, our key learning platforms, operating trends around systems adherence, customer experience, employee engagement and margins, a rock-solid balance sheet, a strong demand for the services and the growth opportunity that lies ahead for the company, our employees and all of our stakeholders. It's exciting to imagine all of the future possibilities and know that our future begins with our great people going beyond in living out our purpose, exemplifying our values and fulfilling our vision. PVV is our company touchstone and is the pathway to us delivering sustainable, profitable growth over the long term. So on behalf of Matt and all of us at HCSG, I wanted to thank Jessa for hosting the call today, and thank you again to everyone for participating.

--------------------------------------------------------------------------------

Operator [56]

--------------------------------------------------------------------------------

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