Healthcare Services Group, Inc. — Q2 2019 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 unaudited filing covers the quarter and six months ended June 30, 2019; comparisons are with the corresponding 2018 periods.
Key financial results
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $462.1 million | $501.6 million | $938.2 million | $1,002.1 million |
| Income before taxes | $23.6 million | $33.3 million | $35.5 million | $31.9 million |
| Net income | $18.2 million | $25.8 million | $27.3 million | $25.9 million |
| Diluted EPS | $0.24 | $0.35 | $0.37 | $0.35 |
| Operating cash flow | Not separately reported for the quarter | $20.3 million | $27.4 million |
- Margins: Q2 costs of services were 86.7% of revenue versus 87.0%; pretax margin was 5.0% versus 6.7%, and net margin was 3.8% versus 5.2%. For the six months, costs of services were 88.2% of revenue versus 90.3%; pretax margin was 3.8% versus 3.2%, and net margin was 2.9% versus 2.6%.
- Liquidity and debt: At June 30, cash and cash equivalents were $16.2 million, marketable securities were $79.5 million, and working capital was $357.6 million. The company had $30.0 million drawn on its $475 million credit line, plus $62.7 million of standby letters of credit that reduced available capacity. It reported compliance with both credit covenants: funded debt/EBITDA of 0.62 versus a maximum of 3.50, and EBITDA/interest expense of 35.05 versus a minimum of 3.00.
- Cash flow and capital returns: Six-month investing cash outflow was $3.5 million and financing cash outflow was $26.7 million, including $29.3 million of dividends. Cash declined $9.9 million to $16.2 million. Estimated 2019 capital expenditures are $5 million to $7 million.
Material changes and management commentary
- Q2 revenue fell 7.9%; six-month revenue fell 6.4%. Both segments declined: Q2 Housekeeping revenue decreased 6.0% and Dietary 9.7%; six-month declines were 5.4% and 7.3%, respectively. Management cited customer terminations and, for Dietary, changes to the Genesis Healthcare arrangement. Effective December 1, 2018, Genesis took over direct payment to food suppliers while HCSG continued managing procurement.
- Q2 net income and diluted EPS decreased from the prior year, while six-month net income increased 5.6% and diluted EPS rose to $0.37 from $0.35. Six-month pretax income increased 11.2%, despite lower revenue.
- SG&A increased 13.2% in Q2 and 17.4% for the first six months. Management attributed the increase primarily to legal and professional fees related to the SEC inquiry into EPS calculation practices. Excluding deferred-compensation investment effects, SG&A rose 11.6% in Q2 and 12.0% for the first half.
- Six-month bad-debt provision was $21.5 million, down from $39.4 million in 2018, which had been affected by restructurings of two private operators. The 2019 provision was primarily related to an out-of-court restructuring of a Northeast operator in Q1. Self-insurance costs as a share of revenue increased year over year.
- Management expects cash, operating cash flow and the credit line to be adequate for foreseeable operating and growth needs, anticipates regular quarterly dividends, and expects 2019 capital expenditures of $5 million to $7 million. It gave no earnings or revenue forecast.
Risks, contingencies and unusual items
- The SEC investigation into EPS calculation practices remains ongoing; the company’s internal investigation concluded in March 2019. A shareholder class action filed in March 2019 seeks unspecified damages. The company cannot estimate potential losses or determine whether an adverse outcome is probable or remote; costs, penalties, management distraction and further litigation could be material.
- Receivables and collections remain significant risks given client exposure to long-term care, Medicare and Medicaid reimbursement, client financial distress, bankruptcies and litigation. Net accounts and notes receivable were $388.7 million; the allowance for doubtful accounts totaled $53.4 million short-term and $10.0 million long-term.
- Other risks include labor and insurance costs, minimum-wage and healthcare regulatory changes, reimbursement-rate changes, customer concentration, and inability to pass cost increases to clients. The filing warns that one customer contributed a significant portion of consolidated revenue but does not provide a clear concentration percentage in the supplied text.
- ASC 842 lease accounting was adopted January 1, 2019, adding operating lease right-of-use assets and liabilities. The company reported $19.0 million of right-of-use assets and $12.1 million of long-term lease liabilities at June 30; the filing also reports lease liabilities within current accrued expenses.
- Favorable deferred-compensation investment gains affected reported income and SG&A. The company also revised prior-year presentation of captive-insurance activity; it states the revisions had no impact on net income.
Investor verification priorities
- Track revenue, customer retention and segment margins, particularly the impact of Genesis-related changes and customer terminations.
- Review receivable aging, reserve adequacy, impaired notes and collections from financially distressed clients.
- Monitor SEC and shareholder litigation developments, related expenses and any potential financial exposure.
- Assess cash generation against dividends, capital spending and the credit line, including letters of credit and covenant headroom.
- Verify whether labor, self-insurance and other operating-cost pressures can be offset through efficiencies or passed through to clients.