Business context and reporting period
Healthcare Services Group, Inc. provides housekeeping, laundry, linen, facility-maintenance and dietary services to U.S. healthcare facilities, primarily long-term-care providers. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2017; comparisons are with the same 2016 periods.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $470.9 million | $386.6 million | $875.4 million | $771.4 million |
| Income before taxes | $33.1 million | $29.7 million | $65.4 million | $59.3 million |
| Net income | $22.6 million | $18.8 million | $44.6 million | $37.4 million |
| Diluted EPS | $0.30 | $0.26 | $0.60 | $0.51 |
- Q2 revenue rose 21.8% and net income rose about 20%; six-month revenue rose 13.5% and net income rose about 19%.
- Q2 costs of services were 86.5% of revenue, up from 85.9%; net margin was 4.8%, down from 5.0%. For the six months, costs of services were 86.0% versus 85.9%, while net margin improved to 5.1% from 4.9%.
- Q2 effective tax rate was 31.8% versus 36.8%; the six-month rate was 31.8% versus 36.9%. Adoption of ASU 2016-09 brought excess share-based compensation tax benefits into income tax expense.
- Housekeeping revenue grew 1.9% in Q2 and 2.1% for six months. Dietary revenue grew 53.7% and 32.0%, respectively, largely from adding dietary services for existing housekeeping clients. Dietary-related asset acquisitions in Q2 also increased goodwill and intangible assets; the filing does not quantify their revenue contribution.
Cash flow, liquidity and debt
- Operating cash flow was negative $6.6 million for the first half of 2017, versus positive $20.2 million a year earlier. The largest disclosed working-capital pressure was a $69.2 million increase in accounts and notes receivable; cash and cash equivalents fell to $7.1 million from $23.9 million at year-end.
- Cash, cash equivalents and marketable securities totaled $77.1 million at June 30, versus $91.6 million at December 31, 2016. Working capital was $329.2 million; the current ratio was 3.2, down from 4.1.
- The company reported $16.2 million drawn on its line of credit at June 30 and $70.7 million in standby letters of credit. The $200 million facility had $129.3 million available as reported; the company was compliant with its funded-debt-to-EBITDA covenant (0.64 versus a maximum of 3.00).
- On July 11, the company amended the facility, increasing line and letter-of-credit availability to $300 million. It reported $225.8 million available after the amendment. Amounts drawn remain payable on demand; the facility expires December 18, 2018.
- Investing cash outflow was $6.3 million and financing cash outflow was $3.9 million in the first half. Dividends paid were $27.4 million. Management estimated 2017 capital expenditures of $4.5–$6.0 million.
Outlook, commentary and risks
- Management expected consolidated revenue for the remainder of 2017 to continue improving versus historical ranges, with Dietary growing as a share of revenue, primarily by extending services to existing Housekeeping clients. Housekeeping growth was expected mainly from new clients. This is qualitative outlook, not numerical guidance.
- Management cited labor and labor-related costs as key cost pressures and said it focuses on operational efficiencies and supply-chain costs. Workers’ compensation and general-liability costs declined as a percentage of revenue, attributed to safety and claims-management initiatives.
- Receivables and collections are significant risks: net accounts and notes receivable rose to $338.4 million from $271.3 million at year-end; net promissory notes were $21.2 million. The company warned that delayed client payments, client financial distress or bankruptcy could increase bad debt and harm cash flow.
- Two clients represented approximately 13% and 9% of first-half revenue. Loss of, or payment-term changes by, major clients could materially affect results or cash flows. Other risks include reliance on long-term-care clients exposed to Medicare and Medicaid reimbursement, labor-cost inflation, regulation and service taxability, and insurance claims.
- The company reported ordinary-course legal, employment, insurance and tax matters, but no pending proceeding expected to materially adversely affect consolidated financial condition or liquidity. It could not reasonably estimate potential liabilities for certain tax matters. No material off-balance-sheet arrangements were reported apart from standby letters of credit.
- Management expected the 2017 annual effective tax rate to be approximately 33.7% (35.7% excluding ASU 2016-09). The company expected no material effect on revenue accounting from adopting the new revenue standard in 2018, though additional disclosures were anticipated; the impact of the new lease standard was still under evaluation.
Investor verification priorities
- Track receivables, cash collections, bad-debt provisions and operating cash flow, given the large receivable increase and negative first-half operating cash flow.
- Assess whether Dietary growth persists and translates into segment profitability, and clarify the contribution and terms of the Q2 dietary-related asset acquisition.
- Monitor labor-cost trends and service-cost ratios, which increased relative to revenue in both segments.
- Confirm major-client retention and payment behavior, and verify ongoing compliance with the credit covenant and reported facility availability.
- Compare subsequent results with management’s qualitative 2017 revenue outlook, dividend expectations and capital-expenditure estimate.