Healthcare Services Group, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. The company provides housekeeping, laundry, linen, facility maintenance and dietary services to healthcare facilities, primarily long-term-care providers. Its reportable segments are Housekeeping and Dietary.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $506.9 million | $491.4 million | $1,512.4 million | $1,366.7 million |
| Income before taxes | $33.0 million | $32.9 million | $64.9 million | $98.3 million |
| Net income | $26.1 million | $23.5 million | $52.0 million | $68.0 million |
| Diluted EPS | $0.35 | $0.31 | $0.70 | $0.92 |
| Net cash from operations | Not separately presented for Q3 | $74.5 million | $3.1 million |
Q3 revenue grew 3.2%; net income rose about 11%. For the first nine months, revenue increased 10.7%, but pretax income fell 34.0% and net income fell about 23.6%. The nine-month net margin was approximately 3.4%, versus 5.0% a year earlier; Q3 net margin improved to approximately 5.2% from 4.8%.
Costs of services were 86.6% of revenue in Q3, down from 86.9%; for the nine-month period they were 89.0%, up from 86.3%. Nine-month results included a $42.4 million bad-debt provision, versus $4.0 million in the prior-year period, primarily related to the restructurings of two privately held, multi-state operators. The lower 2018 tax provision also supported earnings: the federal statutory rate declined from 35% to 21% effective January 1, 2018.
Segments and material changes
- Q3: Housekeeping revenue declined 2.1% to $242.2 million; Dietary revenue rose 8.5% to $264.7 million, largely from expanding services to existing Housekeeping clients.
- Nine months: Housekeeping revenue was nearly flat at $734.2 million; Dietary grew 22.9% to $778.2 million. Dietary represented 51.5% of nine-month revenue.
- Management adjusted agreements with two regional customers and certain independent facilities to reduce services. It expects the changes to lower Housekeeping revenue by about $10 million per quarter, with half of the decrease reflected in Q3, and to improve future margins.
- Q3 SG&A included a $3 million state-specific sales-tax settlement relating to historical client billings; the company said it should not affect future EPS.
Cash, liquidity and capital
- Operating cash flow was $74.5 million for the first nine months, compared with $3.1 million in 2017. The filing attributes period cash-flow changes mainly to timing of receipts and payments; the 2018 bad-debt provision was also a significant noncash reconciliation item.
- At September 30, cash and cash equivalents were $15.2 million and marketable securities were $74.7 million. Working capital was $341.8 million; the current ratio was 3.1 to 1.
- The company had $10.0 million drawn on its $300 million credit line and reported $224.2 million available after $65.9 million of standby letters of credit. Its funded-debt-to-EBITDA covenant ratio was 0.68 against a limit below 3.00; it reported compliance.
- The credit facility was due to expire December 18, 2018. Management expected renewal or replacement but gave no assurance.
- Cash dividends paid were $42.7 million in the first nine months. The board declared a subsequent quarterly dividend of $0.195 per share. Estimated 2018 capital expenditures were $4.5 million to $6.0 million.
Outlook, risks and contingencies
- Management expected consolidated revenue to continue growing for the remainder of 2018, with Dietary increasing as a share of revenue through expansion among existing Housekeeping clients and Housekeeping growth primarily from new clients.
- Management expected 2018 SG&A to approximate 6.75% of consolidated revenue. The estimated annual effective tax rate was 21% to 23%; actual results could vary with tax credits, stock awards and option exercises.
- Key risks include customer payment delays, client restructurings or bankruptcies, doubtful accounts, and reliance on healthcare customers whose funding is tied to Medicare, Medicaid and other reimbursement rates. Labor, supply, insurance, regulatory and state/local tax costs may pressure margins, especially if increases cannot be passed through to clients.
- The company reported ordinary-course legal and tax matters and did not expect them to have a material adverse effect based on its current assessment. It said there were no material changes to the risk factors in its 2017 Form 10-K.
- ASC 606 adoption in 2018 had no material impact. The company planned to adopt the lease accounting standard on January 1, 2019, expecting balance-sheet recognition of operating-lease assets and liabilities but no material impact on cash flows or results of operations.
Investor verification priorities
- Reconcile the filing’s allowance-for-doubtful-accounts disclosures: the balance sheet and receivables note show a $38.630 million short-term allowance, while the MD&A quarterly rollforward ends at $48.630 million. Confirm the correct figure and related net receivables.
- Assess collectability and recovery prospects for the two restructured customers, the $10 million reserved long-term note and the increased impaired-note balances.
- Track whether revenue reductions from the customer contract changes deliver the expected margin benefit, and whether Dietary growth offsets Housekeeping declines.
- Confirm renewal or replacement of the credit facility before its December 2018 expiration and monitor liquidity, letters of credit and dividend coverage.
- Evaluate operating cash flow quality and sustainability, given the unusually large year-over-year increase and the effects of receivable timing and bad-debt provisions.