Business Context and Reporting Period
Healthcare Services Group, Inc. filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2017. It provides housekeeping, laundry, linen, facility-maintenance and dietary management services to U.S. healthcare facilities, primarily long-term-care providers. Housekeeping and Dietary are its two reportable segments. At quarter-end, Housekeeping served more than 3,500 facilities and Dietary more than 1,500.
Financial Results and Key Metrics
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $491.4 million | $392.7 million | $1,366.7 million | $1,164.1 million |
| Income before taxes | $32.9 million | $30.6 million | $98.3 million | $89.9 million |
| Net income | $23.5 million | $19.7 million | $68.0 million | $57.1 million |
| Diluted EPS | $0.31 | $0.27 | $0.92 | $0.78 |
| Costs of services / revenue | 86.9% | 85.6% | 86.3% | 85.8% |
| Net income / revenue | 4.8% | 5.0% | 5.0% | 4.9% |
Revenue increased 25.1% in Q3 and 17.4% year to date. Q3 revenue growth was concentrated in Dietary, up 59.3%, while Housekeeping grew 3.3%. For the nine-month period, Dietary grew 41.3% and Housekeeping 2.5%. Management attributed Dietary growth primarily to adding its services for existing Housekeeping clients, and Housekeeping growth to new clients.
Q3 net income increased 19.1%, slower than revenue growth; pretax income rose 7.7%. For the nine months, net income increased 19.2% and pretax income 9.4%. The effective tax rate was 28.7% in Q3 versus 35.5% a year earlier, and 30.8% year to date versus 36.5%, partly reflecting adoption of share-based-payment accounting guidance. The estimated 2017 annual effective tax rate was approximately 31.9%.
Operating cash flow for the first nine months fell to $3.1 million from $37.9 million. The filing cites timing of receipts and payments as a key driver; accounts and notes receivable used $103.7 million of cash, compared with $55.0 million in the prior-year period. Investing activities used $10.1 million, including $4.6 million for an acquisition; financing activities used $5.9 million. Cash and cash equivalents were $11.0 million at September 30, versus $23.9 million at year-end 2016.
At quarter-end, cash, cash equivalents and marketable securities totaled $81.4 million, working capital was $340.2 million, and the current ratio was 2.9:1, down from 4.1:1 at year-end. Net accounts and notes receivable was $367.0 million, versus $271.3 million at year-end; net promissory notes outstanding were $31.9 million, versus $19.2 million. The allowance for doubtful accounts increased to $9.8 million from $6.9 million.
The company had $25.0 million drawn on its $300 million demand line of credit and $200.8 million available after $74.2 million of standby letters of credit. The letters of credit increased to $77.6 million on October 2. The company reported compliance with its debt covenant, with funded debt to EBITDA of 0.72 against a maximum of 3.00. The line expires December 18, 2018.
Material Changes and Management Commentary
- Growth outpaced profit growth as consolidated service costs rose faster than revenue. Costs of services increased to 86.9% of revenue in Q3 from 85.6%; management cited high-growth integration inefficiencies. Dietary labor costs rose as a share of segment revenue, while Dietary supplies declined as a share.
- Housekeeping pretax segment income was $26.8 million in Q3, up 13.5%; Dietary pretax segment income was $11.4 million, up 44.2%. Corporate and eliminations costs increased to $5.3 million from $1.0 million.
- Workers’ compensation and general-liability insurance costs declined as a share of revenue year to date, which management attributed to workplace safety and claims-management initiatives.
- Dietary-related asset acquisitions increased goodwill and intangible assets. The filing reports $4.6 million cash paid for an acquisition and shares issued or contingently issuable in connection with an acquisition.
- Cash dividends paid during the first nine months totaled $41.3 million. A quarterly dividend of $0.19 per share was declared October 17, payable December 22, 2017.
Outlook, Risks and Contingencies
Management expected consolidated revenue for the remainder of 2017 to continue improving compared with historical ranges, without providing a numerical forecast. It expected Dietary to grow as a share of revenue by expanding services among existing Housekeeping clients, and Housekeeping growth to come primarily from new clients. Management expected 2017 capital expenditures of approximately $4.5 million to $6.0 million and believed available cash, operating cash flow and credit facilities would meet foreseeable needs. It expected to continue regular quarterly dividends, but gave no assurance on future payments or amounts.
Key risks include customer concentration—one client represented approximately 16% and another approximately 9% of nine-month revenue—collection delays, client financial distress, and dependence of many clients on Medicare, Medicaid and other reimbursement funding. Labor and labor-related cost increases, minimum-wage and other regulatory changes, insurance claims, and the ability to pass cost increases to clients could also affect results. The company noted ongoing legal, payroll and employment matters, but said no pending proceeding was expected to have a material adverse effect on consolidated financial condition or liquidity. It could not reasonably estimate liabilities related to certain tax matters, though it did not expect their resolution to have a material adverse effect.
The company planned to adopt the new revenue-recognition standard on January 1, 2018 using the modified retrospective method and did not expect a material accounting impact, though disclosure requirements would increase. It planned to adopt the new lease standard in 2019 and was still evaluating the impact, principally expected to involve recognition of operating-lease assets and liabilities.
Important Facts for Investors to Verify
- Whether the sharp increase in receivables and the decline in operating cash flow reflect timing or indicate a sustained deterioration in collections; track bad-debt provisions and client payment trends.
- Whether margins recover as the company integrates new business, particularly given rising service-cost ratios and Dietary labor costs.
- The sustainability of growth and client retention, including exposure to the two clients representing approximately 25% of nine-month revenue combined.
- Cash requirements and credit availability after the increase in standby letters of credit, alongside dividends, acquisition spending and planned capital expenditures.
- Potential effects of reimbursement changes, labor-cost inflation, insurance claims and unresolved tax or legal matters.