Ladies and gentlemen, thank you for standing by. And welcome to the HCSG Q4 Earnings Call. At this time, all participants are in a listen-only mode. After the speaker’s presentation, there will be question-and-answer session. [Operator Instructions] I would now like to hand the conference over to Ted Wahl, President and CEO.

The matters discussed on today's conference call include forward-looking statements about the business prospects of Healthcare Services Group Inc. within the meaning of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements are often preceded by words such as believes, expects, anticipates, plans, will, goal, may, intends, assumes or similar expressions. Forward-looking statements reflect management's current expectations as of the date of this conference call and involve certain risks and uncertainties.

The forward-looking statements are based on assumptions that we have made in light of our industry experience and our perceptions of historical trends, current conditions, expected future developments, and other factors that we believe are appropriate under the circumstances.

As with any projection or forecast, they are inherently susceptible to uncertainty and changes in circumstances. Healthcare Services Group'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 performanc.

Some of the factors that could cause future results to materially differ from recent results or those projected in the 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..

Thank you, Sharon, and good morning, everyone. Matt McKee and I appreciate all of you joining us for today's conference call. We released our fourth quarter results yesterday along with announcing the Board-approved increase in our dividend after market close. We also plan on filing our 10-K by the end of next week.

During the quarter, we continued to take actions that position the company for long-term growth. We delivered solid facility-level outcomes as we continue to prioritize, managing the base business, assigning account managers to new opportunities, and maintaining discipline in our credit-related decisions.

In 2020, we will maintain our focus on these near-term priorities as the industry continues to work its way through the latter stages of this challenging cycle and transitions to the Patient-Driven Payment Model.

Our longer-term growth outlook remains positive as we believe there is great opportunity for continued expansion as the demand for our services remain strong with significant white space to drive long-term growth.

We remain committed to returning capital to shareholders as evidenced by our stable and growing dividend, and we'll continue to capture growth opportunities to create value for all stakeholders. With that abbreviated overview, I'll turn the call over to Matt for a more detailed discussion on the quarter..

Thanks, Ted, and good morning, everyone. Revenue for the fourth quarter was $447 million, with Dining & Nutrition at $224.9 million and Housekeeping & Laundry segment revenues reported at $222.1 million. Net income for the quarter came in at $18.9 million and EPS was $0.25 per share.

Direct cost of services is reported at 86.5%, with Housekeeping & Laundry and Dining & Nutrition segment margins reported at 9.5% and 4.1% respectively.

The temporary cost increase relates to approximately $4 million of payroll for account managers, who have transitioned out of a facility that we're no longer servicing as well as some costs related to starting up new business during the quarter.

We expect that – this cost impact to decrease as account managers continue to be assigned to new facilities at which they're budgeted and the new business additions operate on budget.

Direct costs also included an approximately $2 million benefit, primarily related to favorable workers' compensation loss development trends as we continue to successfully execute on its strategy of reducing claim frequency, scope and severity.

Overall, our near-term goal is to manage direct costs at 86%, excluding the temporary investments in management capacity and any new business start-up inefficiencies that may occur. SG&A was reported at $36.8 million or 8.2%. After adjusting for the $2.4 million change in deferred compensation, actual SG&A was $34.4 million or 7.7%.

And during the quarter, SG&A was impacted by approximately $1.5 million of legal and professional fees related to the previously announced SEC matter. The company expects SG&A to approximate 7.5% in the year ahead, excluding any SEC-related costs and there's an ongoing opportunity to garner additional efficiencies.

Other income for the quarter was reported at $2.5 million, but again after adjusting for the $2.4 million change in deferred comp, actual investment income was around $100,000. We reported an effective tax rate of 27% and 24.1% for the fourth quarter and the year respectively.

The fourth quarter and the 2019 tax rates were impacted by a reduction in the Worker Opportunity Tax Credit program credits, primarily due to the fact that, there is historically low unemployment rates and the resulting decrease in WOTC-eligible new hires. And we expect our tax rate for 2020 to be in the 24% to 26% range including WOTC.

To the balance sheet. At the end of the fourth quarter, we had over $118 million of cash and marketable securities and a current ratio of better than 3:1. Cash flow from operations for the quarter was $13.4 million inclusive of the $17.7 million decrease in accrued payroll and cash flow was $93.6 million for the year.

DSO for the quarter was reported at 70 days, consistent with our previous quarter. And it's worth noting that we continued to make progress in converting customers to a weekly payment model, as we now have around 60% of our customers paying us with the frequency greater than monthly.

And as we've discussed previously in that conversion, both parties collaborate on a solution that works for both sides. For instance in the fourth quarter as part of converting one of our customers to weekly payments, we rolled a portion of their receivable into a promissory note with a three-year term.

And I just want to reiterate the ultimate benefit of this strategy is better allowing us to collect what we bill and to reduce the rollover impact of a missed payment. And because we have called this out previously, we did want to talk to the timing of the payroll and the impact of the payroll accruals.

So, we wanted to point out that the 2020 payroll accruals will have a bit of a different cadence than we've seen in the past two years. The first quarter will have the highest payroll accrual of 17 days; Q2 will be 10 days; Q3 only four days; and then Q4 12 days.

And that compares to 15, 8, 16 and 10 days that we had in 2019 during corresponding periods. But of course the payroll accrual only relates to the timing and the impact ultimately washes out through the full year. As we announced yesterday, the Board of Directors approved an increase in the dividend to $0.20125 per share, payable on March 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 free cash flow and ultimately maximize return to the shareholders.

This will mark the 67th consecutive cash dividend payment since the program was instituted in 2003. We're proud that it's now the 66th consecutive quarter that we've increased the dividend payment over the previous quarter, now a 17-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..

[Operator Instructions] First question comes from Andrew Wittmann with Baird..

Great, thanks for taking my questions. Where am I going to start? Let's start just trying to understand the quarter a little bit better then we'll talk a little bit more about what you guys are seeing in the marketplace.

I guess, Ted or Matt, on the workers' compensation $2 million benefit to the quarter, I wanted to understand -- I mean is this the actuarial adjustment that you guys have to do I guess annually? And is this for in-period as in 2019, or is this a prior period adjustment that drove that? I just want to understand the source of the accounting-related benefit here that you got in the quarter..

it trues up the accrual that we had made in the previous year; and then it also establishes the rate at which we accrue as a percentage of payroll for the upcoming year. So that $2 million adjustment relates to the 2019 accrual and it's a true-up of that accrual based on the experience and development in claims that we've seen through that period.

And then the actuarial report also then will trigger the upcoming percentage of payroll that will accrue for 2020 here and then have that year end adjustment as needed as well..

Okay, that's helpful. And then, I guess, the other thing I wanted to understand here a little bit more detail was on the $4 million that you called out related to access manager as well as start-up costs. Could you just break that into the two components? I guess that is -- the total of that is down sequentially from last quarter.

So I just wanted to understand the pace at which you see this improving. I mean you did mention that over the course of 2020 you expect that those will get better absorbed.

Is it going to take the entirety of 2020 do you think, or what's the best way the proper way to think about those costs and those costs getting absorbed with new revenue in 2020?.

Yes. So you called out the $4 million Andy and the split is roughly $3.5 million or so relates to management costs, management salaries that we continue to carry and then about $0.5 million related to inefficiencies that come with starting the new business that we did in the quarter.

So the anticipation is that we'll continue to selectively and with a very disciplined approach find new business opportunities and obviously assigning the managers to new business opportunities at which they're budgeted has the impact of not only the top-line implications, but from a cost perspective having those folks budgeted is beneficial to the company.

But we're going to -- the emphasis will be on caution and discipline. So I would allow ourselves likely the balance of 2020 to fully assign those folks. We continue to have a customer base that's working their way through the tail-end of some industry challenges. We're still not even six months into the transition to PDPM.

So as far as the customer priorities, we'll consider that as well with respect to onboarding new business. So I think expectation would be first half of the year continued caution. We'll selectively find opportunities to place those managers into new opportunities.

If our view and assessment becomes more beneficial or more positive then there's an opportunity perhaps to pull some opportunities forward. But I would expect that the bulk of real business additions come more in the back half of the year.

So I think fair to assume that every opportunity for us to reallocate those managers to new business opportunities full expectation to do so within 2020, but would likely allow ourselves the full year to do so..

Okay, great. And then, I guess, my final question here was just around some of the WOTC commentary. It's an interesting dynamic that with the low unemployment the groups that are able to be WOTC-ed if you will if I could make the verb there they're just -- it sounds like they're just not as available as maybe they used to be.

Is that really what the dynamic is here? It seems like a pretty big change in your tax rate. So I just wanted to try to gauge your level of confidence that this is going to be the hiring environment and the impact of that tax rate around 25%..

Yes. I think barring some significant change in the macroeconomic environment and unemployment rate we would expect in this tight labor environment that there's just less employees that are receiving some of the governmental assistance that typically drives a WOTC-eligible -- WOTC eligibility so it's that straightforward.

So yes we're comfortable with the rate that we're guiding towards that 24% to 26% range Andy, but again almost exclusively driven by just fewer eligible WOTC employees within the hiring pool..

Okay. Interesting. All right, guys. Thanks for the time..

Terrific..

Next question comes from Sean Dodge with RBC Capital Markets..

Good morning. Thank you. Maybe going back to the spare managers for a moment, the roughly $3.5 million of elevated payroll costs you're carrying there.

Is the expectation that all of those managers are going to be placed in net new facilities, or are there going to be some proportion of those that are used to backfill open spots or things like upgrading underperformers?.

It will be an all-of-the-above strategy Sean, where obviously the single most desirable option is to place a freed up manager into a newly minted account or to backfill for an existing manager who is being placed into a new account.

But like any other cycle any other time, it's a fairly dynamic business where there's always opportunities, both with new customers as well as within existing customer facilities.

So, a portion of the managers will be reassigned to backfill or to replace existing management, strengthen the bench so to speak and then others will be assigned to new opportunities as they present themselves.

And still others are being used to further strengthen specific areas, whether it be as an assistant manager or as a supplement project work in a given area that's required. So, all-of-the-above strategy..

Okay. And then, as we think about margins over the coming year, you'll get lift in gross margins as these spare managers are deployed.

And in your prepared remarks, it sounded like there could be some other cost levers or efficiencies you may be able to garner outside of those spare managers over the course of the year that give you a little bit of lift there?.

Yeah. I think it will be levering SG&A, primarily. As we grow the top line, a significant portion of our SG&A is fixed. So, that's really the other I'd say, near-term margin lever in addition to deploying some of the excess management capacity that we currently are carrying..

All right. Good. Thanks again..

Thank you, Sean..

Next question comes from Jason Plagman with Jefferies..

Hi. good morning, guys. Just wanted to ask about the timing of the clients you added in Q4.

Was that towards the beginning of the quarter or [Technical Difficulty] carryover impact in Q1? And then, just kind of the growth trajectory or your thinking given your kind of cautious and disciplined approach for 2020, how should we be kind of pacing the sequential growth in revenue throughout 2020?.

Yeah. I'm having a little bit of difficulty hearing you there Jason, but I think I've got the questions. The first of which is about the timing of the new business that we onboarded in the fourth quarter. Nearly all of which was in the early parts of the quarter, so there'll be very over -- very little rather carryover impact in Q1.

So, nearly all of the revenue impact of the new business that we onboarded in the fourth quarter was recognized in that quarter.

And as to kind of the 2020 growth prospects, which I think was the second part of your question, obviously having exited quite a bit of business for various reasons in 2019, you set up some challenging comps with respect to year-over-year revenue.

So, the expectation is I think probably generally speaking to think more of a flattish to slightly increased growth trajectory of the early parts of 2020, and then the opportunity sequentially to step up from there.

So I think all told, when you look at 2020 compared to 2019, a comparable year would be a successful year with respect to replacing the business that we exited in 2019.

So, if we saw 2020 revenue is slightly down or even with 2019 revenues, I think that would mean that not only have we done the right things in execution, but that we're feeling a lot more comfortable about the state of the industry..

Got it. Thanks. And I wanted to ask about the bad debt accrual you called out that adjustment for accounting-related reasons. My math would say that should be about a $30 million to $40 million incremental accrual that you'll be taking in Q1.

Is that accurate?.

Yeah, that's a fair range..

Got it.

And will that impact the go-forward quarterly accrual, as you move forward for what you're allow -- accruing for allowance for bad debt going forward, or can you just walk through if that will have an impact on the revenue going forward?.

Yeah. I think as far as the go-forward bad debt expense impact I think Jason if we continue to meet our goal of collecting what we bill week in and week out then we'll likely have a very stable if not decreasing bad debt expense levels likely more in line with what we saw the past three quarters or the last three quarters in 2019.

To the extent, there's accounts rolling over in the aging buckets, or if there's a specific event like a customer restructuring, then we would likely see elevated bad debt expense levels. But again, our goal in the year ahead is to collect what we bill week in and week out..

Got it. And last one for me. I just wanted to make sure we understood the moving parts around investment income in Q4.

So, did your treatment of the deferred compensation change? And if so what changed for where that was hitting in the income statement in Q4 versus prior quarters?.

No. In fact deferred comp has been treated in the same manner really since its inception over a decade ago. So it's – again, just to remind all of our shareholder partners what -- that deferred compensation represents investments that are held by and for our management people.

And the deferred compensation adjustment that takes place each and every quarter is the market -- mark-to-market for the non-HCSG stock portion of those investments.

And the way that's reflected in our P&L is that to the extent the mark-to-market is made upward, then it represents an increase in our SG&A costs, as well as an increase in investment income like we saw this past quarter. To the extent, there's a downward adjustment in that mark-to-market then the inverse would be true.

It would be reflected as a decrease in SG&A costs and a corresponding decrease in investment income. There's no net impact on earnings, but that's why we call it out the way we do each and every quarter..

Okay. I think that's helpful. I was just -- there was a footnote in the press release on -- mentioning previously recorded as revenue and related costs and cost of services, so I can follow-up….

That actually just -- yeah, I got you. That relates to our captive insurance subsidiary and voluntary health and welfare benefits that the captive insurance administered -- that the captive insurance subsidiary administers on behalf of the company to its employees….

Okay. Got it..

…unrelated to deferred compensation, correct..

Next question comes from Ryan Daniels with William Blair..

Yeah. Good morning guys. Just one question for me this morning. I'm curious Ted for your state of the industry. I noticed for the first time in a while you commented in the press release about the new payment model and the rate update and increasing occupancy.

So I'm curious what you're seeing both on the reimbursement front, and how it's impacting your client base and stability? And then also on the occupancy front if there's something notable that you're seeing in the space that gives you more comfort to state that? Thanks..

Hey, thank you, Ryan. I think -- well, just specifically PDPM, I mean, it's still the early stages obviously five months in. But the initial certainly reimbursement data as well as the initial feedback from the operators is generally positive that revenue trends have been neutral to slightly favorable as expected.

And there's been some modest rehab cost savings that have been realized again as expected. So overall specific to PDPM both from the limited data -- there's not a ton of data out there, but from the data as well as from our customers and just the general operator community we continue to hear both positive expectations and experiences.

Again, I caution that we're only five months into the transition, but certainly so far so good. I think even beyond that though overall we definitely see industry fundamentals continue to improve. Longer-term demographic trends aside, which as we all know are extraordinarily favorable the data we're seeing are encouraging.

You mentioned occupancy trends.

Since the end of 2018, we continued to see each of the past three quarters a stable if not improving occupancy environment both as a result perhaps of the tip of the baby boom sphere entering the long-term care continuum, but also from the reduced supply that's in the marketplace today from, let's say, some of the hard work that's been done the past decade or so in the space as well as the reimbursement programs improving, PDPM, I mentioned.

The 2.5% Medicare increase, which also took place October 1. So again, we're seeing these improvements. And I think hearing the positive sentiment, firsthand within our customer base. But, again we're not out of the woods yet. We have to remain disciplined in our decision-making, especially when it comes to credit-related matters.

And Ryan, we're going to continue to apply that discipline, when we're evaluating both existing customers as well as new business opportunities. But overall, I do believe we're in the latter stages of this -- what has been by all accounts a difficult cycle..

Okay. Thanks for the color guys..

Hey. Thank you, Ryan..

Next question comes from Mitra Ramgopal with Sidoti..

Yes. Hi. Good morning. Just one question for me, I know the focus is also on improving efficiencies and driving margins. And I was just hoping to get some color in terms of the promotion of Andy, the COO. And maybe some of the changes we should expect, as a result of that..

Yeah. Well, look, Andy has been -- I'll start with the comments around Andy. But he's certainly been a great contributor to the company, in many respects over the past decade, as a leader in risk management and human resources, operational excellence and most recently, leading the day-to-day field-based operations, over the past six months or so.

So his promotion to Chief Operating Officer, his well-deserved promotion, is really a natural progression of his leadership, within the organization. I would also add that, he's demonstrated a pretty remarkable level of capacity and expertise in each and every one of those roles.

And maybe most importantly Mitra, he's always helped, lead and deliver strong results. So, we're certainly excited about the possibilities of his expanded role. But the reality is the hard work still has to happen in the four walls of every facility. Our business is oriented around the facilities.

And our success is determined by the outcomes in the facility, which is led by local leadership. And it gets back to the same kind of four critical aspects of the business, delivering on customer satisfaction, budget versus actual, systems implementation, and compliance objectives. And that is, a 7-day-a-week, 365-day-a-year exercise..

Okay. Thanks. And then, just a quick follow-up regarding the -- I think you've converted about 60% now of your customers to the advance or accelerated payment model.

How much, I don't know in terms of the remaining customers and potentially how those conversations are going? And kind of, where you see yourself by the end of 2020, on that front?.

Yeah. We've not thrown down a marker Mitra as far as a specific quantitative objective. Although, the two major components, as we see it are number one, that weekly payment structure absolutely being the default position with new customers. So, that's definitely a stance that we've taken.

And we're holding firm to that, as we think about new business opportunities coming onboard here in 2020. Now as we think about onboarding new customers and new facilities, that dynamic in and of itself with the commitment to the weekly payments will have an impact of lifting that overall percentage.

And then the other bucket would be, with existing customers of ours. Obviously as we've discussed previously, this was a strategy, that was somewhat borne out of necessity. And the customers that we converted in the early stages of the strategy were those where there was either the greatest concern or the greatest opportunity.

So we've moved through those, as we look at the balance of our customers, within the customer portfolio. There's less urgency, short of a specific catalyst or a significant change in their financial conditions. We'll more selectively and opportunistically look to convert those folks.

So, there's nothing that is a fundamental obstacle to ultimately continuing to drive that number upward, which we'll do as I said, as a result of onboarding new customers, and selectively converting within the existing customer base..

Okay. Thanks for taking my questions..

Next question comes from Bill Sutherland with The Benchmark Company..

Thanks. Good morning, guys. So I'm thinking about, as you move back into more of a growth mode here, and just looking at the incredibly low unemployment situation.

How are you thinking about the challenges of the salary churn? And whether that might impact direct costs, in some way that is a little more than normal?.

Well it's interesting Bill. As you sort of frame out the question and related to growth, the typical gating factor on our ability to grow the company is in management capacity.

We find ourselves in somewhat of a unique situation relative to the company's history and now having management capacity at our avail and spread fairly well geographically throughout the country.

So those are local assessments as to the qualification of pipeline opportunities and making sure that we have the corresponding availability of managers to place into those new business opportunities. So as it relates to the overall labor environment, we find ourselves with managers ready to go.

As we've discussed previously, they are being put to productive purposes as we sit here. But to have that flexibility to place them into new facilities, new business opportunities as they arise is certainly advantageous to us.

The other component from a labor perspective is the line staff employees, our associates that are the housekeepers, the pot washers, the dishwashers.

And the benefit that we face in that regard is that the customer in fact controls the conditions of employment at the facility, specifically as it relates to starting wages, the timing and amount of any wage increases and the adjustments to benefits.

And the component of cost savings that we bring in the value prop is that we can typically operate more efficiently, so we can do more with fewer bodies. So and as much as there's an opportunity for us to potentially reduce the cost of a prospective customer, but at a minimum, certainly better contain their costs that's viewed very favorably.

And as you can imagine, that's a significant driver of the increase that we're seeing in the demand for our services and the continued build-out of our sales pipeline..

Right. So even with your existing facilities where I assume hourly employees just going to be a little harder to get at least on the incremental side, you're actually freeing up in most cases some of those hourly people when you take on new business, so some offset there.

And then finally, the -- on the cash front, which is going in the right direction. I know you're committed to the dividend.

Is the Board possibly going to start to think about any other capital direction such as buyback?.

Look it's -- that specifically is something we certainly discuss each and every quarter. I know we've had conversations about just that on calls like this in the past.

The Board's thinking around capital allocation continues to be the same as it was previously that first and foremost in terms of capital allocation, organic growth is the priority, beyond that with really consistency and sustainability as the guidepost, which leads us to the first commitment after organic growth being the dividend.

So certainly, with continued strong cash flow and cash generation, Bill you could foresee a scenario, where either the dividend has increased or a buyback could make sense. But I would not anticipate anything in the year ahead specific to either one of those scenarios. However, it is something we discuss each and every quarter..

Got it. Thanks guys..

Hey. Thank you, Bill..

[Operator Instructions] We have a question from Chad Vanacore with Stifel. Chad, your line is open..

Can you hear me?.

Yeah, we got you now. Hello..

Okay, got it. All right.

So thinking about the new business that you won in the quarter, what was the characteristic of those accounts? And how do they compare to the accounts that you lost in the quarter?.

Could you be more specific Chad? I'm not sure exactly what you mean when you talk about....

So these mean local players, regional players, national players, what made them want to outsource to you rather than insource? And how does that compare with the accounts that you lost?.

So I would say that this -- the growth that we had were with a couple of smaller regional-type players. There was one player that kind of skewed to the larger side relative to the business that we did onboard in the quarter, but it was really a number of different regional chains pretty fairly distributed geographically.

And a pretty nice split likewise between housekeeping and dining. So, really kind of the -- just like we talked about the business that we onboarded in the third quarter, it's really kind of the optimal sort of mix that you'd like to see with respect to geography customer type and split of services..

All right.

And I'm assuming that, when you say split of services, you're providing both services to most of those accounts?.

Correct..

Okay.

And then, just thinking about the write-down for doubtful account that you expect in the first quarter, can you give us some more details on the amount? And then how do you go about evaluating the collectability and then determining impairment? So, what we're getting out is -- what would trigger further write-offs?.

Yes. Well just to be very clear Chad, it wasn't a write-off. This was driven by a new FASB standard that was required -- that required us and all public filers to adopt beginning January 1.

And that adoption changes the AR allowance reserving methodology from what was with us and most public filers an incurred loss model to what now is an expected loss approach. So, I think there was two components to it. One is that initial -- I guess, you're referring to the initial reserve not write-off.

Initial reserve adjustment was developed based on a seven-year look-back period, analyzing agings and collection experience, write-off percentages, litigation and restructuring actions, also considering industry and macroeconomic considerations.

Now, obviously using a seven-year look back, meant that 2018 and Q1 of 2019 bad debt levels, which were clearly elevated relative to the past four decades of the company's experience had a disproportionate impact in determining that initial reserve.

But that aside that was the methodology for determining the initial reserve, which again is -- increases the reserve and then has a corresponding tax-affected reduction to equity. I think beyond that, I mentioned earlier as far as the go-forward bad debt expense impact, it's very simple.

If we continue to meet our goal of collecting what we bill, which is in fact our expectation, then we should have certainly a stable if not decreasing bad debt levels certainly in line or maybe more favorable than what we saw over the past three quarters.

If we have eroding experience or challenged accounts that are rolling over from one bucket to another, then we would have -- or if there's a specific customer-related event that we have to specifically identify then we would likely have elevated bad debt levels..

All right. On the flip side of that, you had a $2 million benefit from workers' comp in the quarter.

Is that a continuing benefit that you're going to continue to book in subsequent quarters or is that a onetime benefit?.

So, that relates to the adjustment looking back on the 2019 period, Chad. So, we reserved the accrual based on a percentage of payroll, that comes at the recommendation of the actuary, based on their annual review. So, that $2 million adjustment relates back to 2019 and prior year experience.

And now, we'll make an adjustment in the percentage of payroll that we've reserved for 2020. We'll go through that same actuarial assessment at the end of this year to determine, did we appropriately accrue? Did we accrue enough or not enough and make those adjustments.

So, the expectation is that, as we gain further experience in the captive, the predictability from an actuarial perspective gets tighter and tighter and you've obviously in the end of year adjustments continue to diminish..

All right. So that's an unusual true-up that happens at the end of the year. We shouldn't expect that benefit going forward..

Not necessarily, as a benefit, no. There will be a true-up, but like I said, can't predict whether it's to the good or to the bad. And certainly expectation is that that should be continuing to decline..

Okay. And then just thinking about cash flow in the quarter, it was pretty solid. Talk us through, how you expect cash flow to go.

Are there any reversals in terms of use of -- or source of net working capital that we should expect? How should we expect 2020 to look?.

Yes. Well, I would say -- not to take issue with your solid word I would say cash flow when you really take a step back in what arguably is the most challenging environment the industry has ever experienced maybe rivaled by the late 1990s and the Balanced Budget Act timeframe, I would suggest that record cash flows -- not even close.

I mean record cash flows for this year and certainly on the heels of a record cash flow from prior year is certainly a great accomplishment for the company and a direct testament to not only the mindset that has been instilled here the collaboration with our customers and the partnership that we have with our customers and then ultimately the strategy that we developed vis-à-vis the weekly payment initiatives.

So I think all of that puts us in a very good position to be able to execute in a consistent way moving forward on our cash collection strategy week-in and week-out. From an expectation perspective in the year ahead, Chad I think pointing more towards that $80 million target and that is lower than the $94 million that we had in 2019.

But the reason for I think maybe the conservative baseline that we have in the year ahead would be more oriented towards the fact that we want to maintain flexibility. And I know Matt talked about some of the opportunities both in his opening remarks as well as in some of the Q&A around weekly payment conversions.

We want to maintain that flexibility where when there's a mutually beneficial opportunity with a particular customer to convert them to a weekly payer which is -- which we hold in high regard from a sustainability of relationship and scalability of the company's model perspective. There may be an opportunity with that customer to collaborate.

And if they're in fact paying January services that are due at the end of February today maybe it's in the best interest of us and them that they pay January services 4 times in March. So they get some sort of additional cash flow benefit. That does create a temporary dyssynergy if you will relative to DSO and cash flow.

But again, we believe that certainly puts us in the best position from a long-term sustainability of that customer relationship. So those are the types of discussions and conversations we're having right now. And that's why our outlook for the year ahead is in and around $80 million..

All right. And then just thinking about one key aspect of this we're expecting a slow top-line growth in the year. And then so that margin becomes an important aspect of the store and specifically direct cost.

So can you give us some idea of what the upside to your direct cost is and maybe some risk to that in 2020?.

Yes. I think the goal -- the stated goal remains Chad and that's to get direct costs to 86%. The pathway to that is really by the end of the year primarily driven by the growth. Just exactly as you call out it's the growth, but it's in placing the managers into facilities at which they're budgeted.

There tends to be a little bit of a put-and-take with respect to growth. And that -- and obviously as we're able to assign those managers to new facilities that's beneficial there tends to be corresponding margin pressure though as we inherit the inefficiencies of a new facility and a new operation.

It does take us some time to get those new facilities on budget. So I would say that expectation is to return to 86% cost of services but likely given the dynamics I just described allowing ourselves until the end of the year to accomplish that..

Okay.

So some progression through the year but it's difficult just given the limited top line growth to deploy those managers any faster?.

I think that's fair..

Okay. All right. So – all right. That’s it from me. Thanks so much for taking all the questions..

Hey, take care, Chad..

The last question comes from A.J. Rice with Credit Suisse..

Hi, everybody. Just a couple of things. Do you have the margins by the two segments? I know you said you'd hope to get to 14% overall gross margin by the end of the year, but when you normalize for the unusual items with the dining and the housekeeping did in the fourth quarter..

Yes. The margin – well, the margins for the segments for the quarter are 9.5% in housekeeping and 4.1% in dining.

Now the way that relates back to the -- that relates to the company total company margins in that -- that's directly off of our operating statements, which has a fixed payroll, a fixed workers' comp burden, a fixed general liability burden, et cetera.

So, there's some eliminations between those segment-level margins and the total company margin that's reported on the external results..

So to get to the 14%, where are you at as you exit 2019, and on a relative basis would you say? Again eliminating the unusual items?.

Yeah. I wouldn't be able to guesstimate that on this call A.J., in terms of where we're at.

What I can say is the pathway for us to work our way back to 14% margins are pretty clear in that as we reallocate and reassign the excess management costs that we have, that will have a direct and natural lift both to the segment-level margins and the corresponding total company margins proportionately..

And I'd say the visibility that we do have A.J. is in the base business, right? And from our perspective, the base business is performing to budgetary expectations.

So, the challenge, as Ted said, in kind of giving you a specific answer to your question on this call is, if you look at the impact of some of the one-time or at least nonrecurring costs that we faced in the year, whether it was bad debt or excess management costs or start-up costs.

Those will always be a factor and should have as we've talked about a diminishing impact on the 2020 results and beyond. But, as we look at the base business, which is the most important and controllable factor for us, we're doing a really good job. And that's going to be the most important driver of us achieving that 86%..

Okay. I know you made the comment that with the strong economy, you're able to still get the management talent you need and that obviously you got the pass-through aspect of your contract for the hourly workers. But I know that the contracts do reset up, if you're seeing wage inflation.

So, is the rate of increase overall in the contracted rates moving up, or is it still sort of steady with what we're seeing?.

It's customer-specific A.J., and the reason we call that out is that in some facilities if there's -- if it's a union environment and there's a collective bargaining agreement, that will have a prescribed -- specifically prescribed wage increase.

Whereas other nonunion facilities, it's dependent upon the customers' assessment to respond to the labor market conditions. And the benefit from where we sit is that they need to respond to the same labor market conditions that we do. They're essentially hiring from the same pool of would be employees that we are.

For us to hire into the housekeeping, laundry and dining departments, you're typically talking about the same caliber of candidate that the customer would hire into their activities maintenance and often CNA departments. So, it really is in the hands of the customer.

We'll certainly advise them, and we'll share the experience that we're seeing with respect to the facility-specific challenges in onboarding new employees. If we think the starting wage is too low or the challenge in keeping employees in the department, if there is a requirement for a wage increase to remain competitive in a particular market.

So, it's a conversation with the customer, but ultimately lies in the hand of that customer specific to the facility..

I guess I was sort of thinking more in terms of your rate increases on your contracts. You've been running 2% to 3%. And now because the hourly wages on average are going up 4% 5% that also affects the portion that you retain as profits and has a positive impact on that.

Are you seeing any of that yet or not really?.

Relative to historical norms, it maybe a bit elevated in the aggregate A.J., but it's not significant to the point of really moving the needle..

Okay. And then, I guess just to go back finally to your comment about -- you're still looking at the portfolio and all. Do you see either because of -- I guess there's always the expectation that with this new PDPM in the skilled nursing area. There will be some winners and some losers.

Any sense -- I mean do you feel like the bulk of the pruning is done, or are you -- is there still a number of facilities that you're watching? And can you say with confidence you do expect to see net additions overall to the customer base in 2020?.

Yeah. I would say, the latter that we do expect to see net additions in 2020. Having said that, when you talk about pruning, if a partnership is trending in the wrong direction A.J. and we don't believe it's in the best interest of the company. We have to reserve the right.

And maintain committed to being able to make that decision that may be painful in the short-term. But best positions us for the long-term, so, nothing imminent. And again, we've done quite a bit of pruning over the past 18 months, contract restructurings and otherwise. So for us, we feel good about where we're at.

And Matt talked about that growth cadence, where we do think of a more flattish first half of the year, with maybe more modest sequential growth, in the back half of the year.

Having said all of that, and you mentioned PDPM, if we start to see the initial favorable trends within PDPM specifically, continue that would certainly give us a higher degree of confidence of maybe pulling in some expected growth opportunities, back half of this year, first half of 2021, maybe into the first half of 2020.

So, that's the way we're thinking about, certainly, the current environment and our near-term growth prospects, relative to that environment..

Okay. All right, thanks a lot..

Hey, thank you, A.J..

And at this time, I will turn the call over to, Mr. Ted Wahl..

Great. Thank you, Sharon. We look forward to starting 2020 off strong, and laying the groundwork for the rest of the year. Industry fundamentals continue to improve with the positive impact of the PDPM. And 2.4% Medicare increase, both of which took effect October 1st of last year, along with more favorable occupancy trends.

Over the course of 2020, we will continue to prioritize, managing the base business, assigning account managers to new opportunities. And maintaining discipline in credit-related decisions.

We will also remain committed to taking actions that best position us, to take advantage of the growth opportunity that lies ahead, and deliver shareholder value over the long-term. So on behalf of Matt, and all of us at Healthcare Services Group, I wanted to again thank Sharon for hosting the call today. And thank you everyone, for participating..

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect..