Healthcare Services Group, Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. The company provides housekeeping, laundry, linen, facility maintenance and dietary services to healthcare facilities, primarily long-term-care providers, through its Housekeeping and Dietary segments.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $455.6 million | $505.5 million | $1,393.8 million | $1,507.6 million |
| Net income | $18.3 million | $26.1 million | $45.7 million | $52.0 million |
| Diluted EPS | $0.25 | $0.35 | $0.61 | $0.70 |
| Net margin | 4.1% | 5.0% | 3.2% | 3.5% |
- Revenue and profit: Q3 revenue fell 9.9% year over year and net income fell 29.7%. For the nine months, revenue declined 7.6% and net income declined 12.1%.
- Costs and margins: Costs of services were 87.4% of Q3 revenue, versus 86.7% a year earlier; nine-month costs were 88.0%, versus 89.1%. Nine-month SG&A rose to 8.1% of revenue from 6.9%. Pretax margin was 5.3% for Q3 and 4.2% for the nine-month period, compared with 6.4% and 4.4%, respectively, in 2018.
- Cash flow: Nine-month operating cash flow was $80.2 million, compared with $74.5 million. Investing activities used $4.3 million and financing activities used $61.4 million. Cash and cash equivalents increased to $40.6 million from $26.0 million at year-end 2018.
- Liquidity and debt: Cash, cash equivalents and marketable securities totaled $120.3 million. Working capital was $371.9 million and the current ratio was 3.3:1. Borrowings under the $475 million credit facility were $10.0 million; $62.7 million of standby letters of credit reduced availability. The company reported compliance with its financial covenants.
- Receivables and bad debt: Net accounts and notes receivable totaled $386.5 million. Nine-month bad-debt provision was $23.0 million, down from $42.4 million in 2018; management attributed the prior-year level partly to restructurings of two operators. The 2019 provision primarily related to a first-quarter out-of-court restructuring of a Northeast operator.
Material changes and management commentary
- Housekeeping revenue decreased 6.4% in Q3 and 5.8% year to date; Dietary revenue decreased 13.0% and 9.2%, respectively. Management cited facility exits during operator transitions where acceptable payment and credit terms could not be reached.
- Dietary revenue and cost mix were affected by Genesis Healthcare’s contract change effective December 1, 2018: Genesis began paying food suppliers directly, while HCSG continued managing procurement. Management said this preserved purchasing-scale benefits; reported dietary labor costs as a share of segment revenue increased while supplies costs declined.
- Self-insurance costs were 2.9% of revenue in Q3, versus 2.7% a year earlier, and 2.8% for the nine months, versus 2.7%. The company cited labor and labor-related cost increases as risks if they cannot be passed on to clients.
- Nine-month SG&A increased 8.2%. Excluding deferred-compensation investment changes, it increased 6.2%, primarily due to legal and professional fees related to the SEC inquiry into EPS calculation practices.
- Management identified new client wins, retaining and expanding existing relationships, modest price increases, cost controls and managerial development as important to improving performance. It estimated 2019 capital expenditures of $5–$7 million and expected cash, operations and credit availability to fund foreseeable needs. It expected to continue regular quarterly dividends, subject to Board review; a $0.20-per-share dividend was declared for payment in December 2019.
Risks, contingencies and unusual items
- The SEC investigation into EPS calculation practices remains ongoing. A shareholder class action, amended in September 2019 to expand the class period and add defendants, seeks unspecified damages. The company is defending the litigation but said it cannot reasonably estimate possible losses or determine whether an unfavorable outcome is probable or remote.
- Client concentration in healthcare and long-term care exposes the company indirectly to Medicare, Medicaid and other reimbursement changes. Delayed client payments, bankruptcy, litigation and restructuring may increase credit losses; one customer represented a significant share of consolidated revenue, but the filing text does not provide a clear percentage.
- The company adopted lease accounting standard ASC 842 in 2019, recognizing operating-lease right-of-use assets and liabilities. It reported a $19.9 million right-of-use asset and an $11.6 million long-term lease liability at September 30; current lease liabilities are included in other accrued expenses.
- The company revised prior-period presentation of captive-insurance income and expenses and corrected an immaterial cash-flow presentation error; management reported no impact on prior-period net income or operating cash flow from these corrections.
- Disclosure controls were deemed effective. A new ERP system was implemented in the first quarter, and the company continued evaluating related internal controls.
Important facts for investors to verify
- Whether revenue declines and client exits stabilize, particularly in Dietary, and how the Genesis contract change affects reported revenue and margins.
- Receivable aging, subsequent collections and further credit provisions or write-offs, given client financial stress and the $23.0 million nine-month bad-debt provision.
- Developments, potential costs and any financial or regulatory consequences from the SEC investigation and shareholder litigation.
- Whether labor and self-insurance costs can be controlled or passed through, and whether segment margins recover.
- Credit-facility availability after letters of credit, covenant compliance, and the sustainability of dividends relative to operating cash flow.