Business context and reporting period
Healthcare Services Group, Inc. provides housekeeping, laundry and linen, facility maintenance, and dietary management services to healthcare facilities. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2012, compared with the same 2011 periods. Housekeeping served approximately 3,000 facilities in 47 states; Dietary served approximately 650 facilities.
Financial performance and liquidity
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Revenue | $267.1 million | $211.5 million | $527.7 million | $419.9 million |
| Income before taxes | $18.3 million | $14.7 million | $32.1 million | $27.1 million |
| Net income | $11.3 million | $9.8 million | $19.9 million | $17.6 million |
| Diluted EPS | $0.17 | $0.15 | $0.29 | $0.26 |
| Operating cash flow | Not separately reported | Not separately reported | $27.4 million | $15.5 million |
Revenue rose 26.3% in Q2 and 25.7% for the six months. Net income increased approximately 15% and 13%, respectively. Net margin was 4.3% in Q2 (4.7% prior year) and 3.8% for the six months (4.2% prior year). Costs of services were 86.2% of revenue in Q2 and 86.7% for the six months, versus 85.9% and 86.1%, respectively.
At June 30, cash and cash equivalents were $55.6 million and marketable securities were $21.4 million, totaling $77.0 million; working capital was $190.9 million and the current ratio was 4.2:1. The company had no line-of-credit borrowings. Its $57 million credit facility was reduced by a $40.42 million standby letter of credit, leaving approximately $16.58 million available; the facility expires June 30, 2013, and management expected renewal. The company reported compliance with its financial covenants. Total liabilities were $90.4 million, including insurance claims and deferred compensation; no funded debt was reported.
Cash dividends paid were $21.8 million in the first half, compared with operating cash flow of $27.4 million. The board declared a further $0.16375 per-share dividend in July, payable August 24, 2012.
Material changes versus prior comparable periods
- Dietary segment revenue grew 58.6% in Q2 and 56.2% in the first half, mainly from adding Dietary services for existing Housekeeping clients. Housekeeping revenue increased 15.5% and 15.6%, primarily through new client agreements.
- Despite rapid growth, service costs rose faster than revenue in the first half. Housekeeping labor inefficiencies and higher supplies costs, and modestly higher Dietary labor costs, pressured segment service margins. Dietary supply costs improved in Q2.
- SG&A excluding changes in the deferred compensation fund increased 22.7% in Q2 and 21.5% year to date, below revenue growth; management attributed the leverage to payroll, travel and professional-fee costs declining as a share of revenue.
- The effective tax rate increased to approximately 38% for both the quarter and first half, versus approximately 33% and 35%, respectively, in 2011, principally because certain tax credits were unavailable or had expired.
- Operating cash flow improved year over year. Cash and marketable securities increased from $70.0 million at year-end 2011 to $77.0 million at June 30, 2012, while the current ratio declined from 5.1:1 to 4.2:1, partly reflecting higher accounts payable and income taxes payable.
Outlook, risks and unusual items
The company gave no formal earnings or revenue guidance. Management said it expected Dietary to represent a greater share of revenue during the remainder of 2012; it anticipated Dietary growth primarily from existing Housekeeping clients and Housekeeping growth primarily from new clients. Planned capital expenditures for the remainder of 2012 were approximately $2 million to $3 million. Management believed operating cash flow, cash and the credit line would support operations and anticipated growth.
Key risks include client exposure to Medicare and Medicaid funding and payment delays. The filing notes a CMS rule effective October 1, 2011 that reduced Medicare payments to nursing centers by 11.1%, and warns that further reimbursement changes or state Medicaid funding pressures could weaken clients’ ability to pay. Labor and supply cost increases may also affect results if they cannot be passed through to clients. One nursing-home chain represented 7% of revenue in the first half, down from 9% a year earlier; management said its loss or a significant revenue reduction could materially harm results. The company also identified claims experience under its workers’ compensation and general liability programs, collection risk, and state and local tax interpretations as exposures.
Accounts and notes receivable were $135.8 million, net of a $5.0 million doubtful-account allowance; net promissory notes receivable were $8.4 million. Accrued insurance claims totaled $21.1 million, current and long-term. The company said it could not reasonably estimate liabilities for certain tax matters, but did not expect their resolution to materially adversely affect results or financial position. It reported no material change in previously disclosed risk factors, no material off-balance-sheet arrangements other than the standby letter of credit, and no subsequent event requiring disclosure.
Most important facts for investors to verify
- Whether high Dietary growth and Housekeeping client wins continue, and whether service-cost ratios stabilize after first-half deterioration.
- Whether client reimbursement pressures, payment delays, and the major-client concentration affect collections and operating cash flow.
- Whether the $57 million credit facility is renewed before its June 30, 2013 expiration, and the status of the insurance-related letter of credit.
- Whether the Work Opportunity Tax Credit is renewed retroactively, affecting the stated approximately 38% tax-rate outlook.
- Whether insurance-claim estimates, receivable reserves, and unresolved state and local tax matters change materially.