Healthcare Services Group, Inc. — Q3 2020 Form 10-Q
Business and period: The company provides housekeeping, laundry, linen, facility-maintenance and dietary services to U.S. healthcare facilities, primarily long-term-care providers. This filing covers the quarter and nine months ended September 30, 2020; figures are unaudited. Its reportable segments are Housekeeping and Dietary.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $435.9 million | $455.6 million | $1,337.1 million | $1,393.8 million |
| Income before taxes | $37.1 million | $23.7 million | $94.3 million | $59.2 million |
| Net income | $27.6 million | $18.3 million | $70.9 million | $45.7 million |
| Diluted EPS | $0.37 | $0.25 | $0.95 | $0.61 |
| Operating cash flow | Not separately stated | Not separately stated | $141.5 million | $80.2 million |
- Revenue and segments: Q3 revenue fell 4.3% year over year. Housekeeping revenue declined 0.9% to $223.4 million; Dietary fell 7.7% to $212.5 million. Nine-month revenue decreased 4.1%, with Housekeeping down 1.7% and Dietary down 6.3%.
- Profitability: Q3 costs of services were 83.8% of revenue versus 87.4% a year earlier; net margin was 6.3% versus 4.1%. For the nine months, service costs were 85.3% of revenue versus 88.0%, and net margin was 5.3% versus 3.2%. SG&A was $37.3 million in Q3, up 11.5%; for nine months it was $108.8 million, down 3.9%.
- Cash flow: Nine-month operating cash flow increased to $141.5 million from $80.2 million. Management attributed period-to-period cash-flow changes partly to receipt/payment timing and a $32.3 million increase from payroll-tax deferrals under the CARES Act.
- Liquidity and debt: Cash and cash equivalents were $109.9 million and marketable securities $94.0 million at quarter-end. Working capital was $403.2 million and the current ratio 4.0, compared with $367.1 million and 3.5 at year-end 2019. No line-of-credit borrowings were outstanding; the $475 million facility had $410.1 million available after letters of credit. The company reported compliance with its financial covenants.
- Other balance-sheet items: Net accounts and notes receivable totaled $316.5 million, down from $387.9 million at year-end 2019. The allowance for doubtful accounts was $82.1 million at September 30. Accrued insurance claims totaled $96.1 million, current and long-term combined.
Material changes and unusual items
- Despite lower revenue, income before taxes rose 56.6% in Q3 and 59.3% for the nine-month period. Management cited lower service costs, including reduced dietary supply spending, as well as stronger segment profitability.
- Q3 revenue included $9.1 million of COVID-19 supplemental billings; nine-month revenue included $26.0 million. These primarily reflected employee pay premiums billed to customers and were offset by lower recurring billings tied to census-driven staffing and purchasing reductions.
- Effective January 1, 2020, the company adopted the expected-credit-loss standard (ASC 326), recording a $42.2 million increase in the allowance and a $32.1 million after-tax reduction to opening retained earnings. The new model recognizes estimated lifetime credit losses earlier than the former incurred-loss model.
- Q3 investment and other income included market-driven gains on deferred-compensation investments; corresponding gains increased SG&A. These valuation effects can cause period-to-period earnings volatility.
Outlook, risks and contingencies
- Management said COVID-19 had no material net impact on consolidated Q3 operating results and had not materially impaired assets or liquidity through September 30. However, the pandemic’s future effects remain uncertain. Risks include lower long-term-care census and customer cash flows, increased bad debts, employee availability and turnover, supply disruption or higher costs, and insurance claims related to COVID-19.
- Management expects continued demand over the long term because its services are essential, but gave no specific earnings or revenue guidance. It estimated 2020 capital expenditures of $4 million to $6 million, with $3.1 million spent through September, and said existing cash, operating cash flow and credit capacity should meet foreseeable needs.
- The company expects to continue regular quarterly dividends, subject to Board review and no assurance of continuation. A $0.205-per-share dividend was declared October 21, 2020, payable December 24 to shareholders of record November 20.
- The SEC continues to investigate the company’s EPS calculation practices. A shareholder securities class action is also pending; the company is defending the matters but cannot reasonably estimate potential losses or assess whether an adverse outcome would be material.
- Customer concentration, healthcare reimbursement changes, customer credit and collections, labor costs, insurance reserves, and the transition away from LIBOR are additional risks discussed in the filing. Management noted that one customer contributed a significant portion of nine-month consolidated revenue, but the filing text does not provide a clear value.
Important facts for investors to verify
- Whether COVID-19 supplemental billings, census-related reductions and customer facility exits continue to affect segment revenue and margins.
- Receivable aging, customer payment trends, reserve adequacy and the impact of the ASC 326 adoption on future bad-debt expense.
- How much of the stronger operating cash flow reflects recurring operations versus the $32.3 million payroll-tax deferral and working-capital timing.
- Developments in the SEC investigation, shareholder litigation and any related costs or potential liabilities.
- Insurance claims and reserve estimates, covenant headroom, availability under the credit facility, and the sustainability of dividends and capital spending.