Healthcare Services Group, Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; comparisons are with Q1 2019 unless noted. The company provides housekeeping, laundry, linen, facility-maintenance and dietary services to healthcare facilities, primarily long-term-care providers, through two segments: Housekeeping and Dietary.
Financial performance
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Revenue | $449.2 million | $476.1 million | Down 5.7% |
| Costs of services | $387.2 million | $427.3 million | Down 9.4% |
| Selling, general and administrative expense | $30.0 million | $41.1 million | Down 27.0% |
| Income before taxes | $26.8 million | $11.9 million | Up 125.2% |
| Net income | $20.2 million | $9.2 million | Up 120.5% |
| Diluted earnings per share | $0.27 | $0.12 | Up from prior year |
| Operating cash flow | $12.7 million | $17.6 million | Down $4.9 million |
Costs of services were 86.2% of revenue versus 89.7% a year earlier; net margin was 4.4% versus 2.0%. The improvement in earnings occurred despite lower revenue. Management attributed segment revenue declines primarily to exiting facilities amid operator transitions where acceptable terms could not be reached. Lower bad-debt provision compared with the prior-year period and lower SG&A contributed to the expense decline. SG&A also reflected a $5.8 million loss on deferred-compensation investments, which reduced expense because of the corresponding liability accounting; the comparable period included a $3.4 million investment gain that increased expense. Investment and other income was a net expense of $4.8 million, compared with $5.2 million of income in Q1 2019, primarily due to negative market fluctuations related to COVID-19.
- Housekeeping: Revenue was $224.3 million, down 3.8%; segment income before taxes was $23.9 million, down 9.7%. Service costs rose to 89.3% of segment revenue from 88.6%.
- Dietary: Revenue was $224.9 million, down 7.5%; segment income before taxes was $14.3 million, down 7.1%. Service costs were 93.6% of segment revenue, compared with 93.7%.
Balance sheet and liquidity: At March 31, 2020, cash and cash equivalents were $64.5 million and marketable securities were $90.5 million. Working capital was $334.3 million, down from $367.1 million at December 31, 2019; the current ratio was 2.8 versus 3.5. Accounts and notes receivable, net, totaled $353.3 million, compared with $387.9 million at year-end. The allowance for doubtful accounts was $87.5 million for short-term receivables and $4.8 million for long-term notes.
Borrowings under the $475 million credit line were $50.0 million, versus $10.0 million at year-end. The company reported $360.1 million available after $64.9 million of standby letters of credit; it was in compliance with its financial covenants. Operating cash flow was $12.7 million; investing activities used $1.6 million and financing activities provided $26.1 million, including $40.0 million of short-term borrowings. Dividends paid were $15.0 million. The company reported no material off-balance-sheet arrangements other than the standby letters of credit.
Material changes, outlook and risks
- Effective January 1, 2020, the company adopted expected-credit-loss guidance (ASC 326). Adoption increased the allowance by approximately $42.2 million and reduced opening retained earnings by $32.1 million, net of tax. This was an opening balance-sheet adjustment, not a Q1 operating expense. The company reported a $2.1 million bad-debt provision for the quarter, compared with $18.5 million in Q1 2019; management noted that the accounting method changed and that the prior-year provision was affected by an operator restructuring.
- Management said COVID-19 had no material net effect on Q1 operating results, liquidity or asset values through March 31. It stated that services remained essential and it did not then expect COVID-19 to adversely affect future revenue. It also cautioned that the pandemic could affect client census and finances, employee availability, supply costs and continuity of operations; future impacts were uncertain. Management anticipated reimbursement from clients for most incremental COVID-related costs outside contractual obligations, but this was not assured.
- Management said it had not changed its expectations for operating cash flow due to COVID-19 and considered current liquidity and credit capacity adequate. Estimated 2020 capital expenditures were $5.0–$5.5 million. It expected to continue regular quarterly dividends, subject to board review and without assurance. The board declared a subsequent quarterly dividend of $0.20250 per share, payable June 26, 2020.
- Risks include healthcare-client concentration and reliance on Medicare, Medicaid and other reimbursement funding; collection delays, client financial distress and increased credit losses; labor, supply and insurance costs; and pandemic-related disruptions. The filing identifies significant revenue contribution from one customer as a risk but does not provide a clear customer-specific amount in the supplied text.
- The SEC investigation into EPS calculation practices remained ongoing. A shareholder class action alleging securities-law violations was also pending; the company said it could not reasonably estimate potential losses or assess whether an adverse outcome would be material. The company was cooperating with the SEC and vigorously defending the litigation.
Important facts for investors to verify
- Subsequent receivable collections, client credit quality and the adequacy of the ASC 326 allowance, particularly given COVID-19 uncertainty.
- Whether the revenue decline and facility exits continue, and how client census, contract retention and new business affect each segment.
- Actual pandemic-related labor and supply costs, client reimbursements and any effect on operations or liquidity.
- The nature and recurrence of market-driven investment results and deferred-compensation adjustments underlying quarterly earnings.
- Developments in the SEC investigation and shareholder litigation, including any change in potential financial exposure.
- Continued access to credit, covenant compliance, dividend coverage and realized capital expenditures.