Healthcare Services Group, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. The company provides housekeeping, laundry, linen, maintenance and dietary management services to healthcare facilities, primarily long-term-care providers, across 48 states. It reported two segments: Housekeeping and Dietary.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $392.7 million | $360.2 million | $1,164.1 million | $1,070.8 million |
| Income before taxes | $30.6 million | $26.7 million | $89.9 million | $78.1 million |
| Net income | $19.7 million | $17.1 million | $57.1 million | $48.9 million |
| Diluted EPS | $0.27 | $0.24 | $0.78 | $0.68 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $37.9 million | $52.5 million |
Q3 revenue increased 9.0%, pretax income 14.3%, and net income 15.4% year over year. For the first nine months, revenue grew 8.7%, pretax income 15.1%, and net income 16.8%. Reported net margin was 5.0% in Q3 versus 4.7% a year earlier, and 4.9% for the nine-month period versus 4.6%.
Costs of services were 85.6% of revenue in Q3, slightly improved from 85.7%; for nine months they rose to 85.8% from 85.6%. SG&A was 6.9% of revenue in Q3 versus 6.5%, but 6.7% for nine months versus 7.0%. The nine-month effective tax rate was 36.5%, down from 37.4%; management attributed the decrease primarily to tax credits recognized in Q3.
Segments and operating changes
- Housekeeping: Q3 segment revenue rose 5.2% to $239.6 million; nine-month revenue rose 5.1% to $716.2 million. Management attributed growth to new client agreements. Segment pretax income rose 8.6% in Q3 and 7.5% for nine months.
- Dietary: Q3 segment revenue increased 15.7% to $153.2 million; nine-month revenue rose 15.0% to $447.9 million, mainly by extending services to more existing Housekeeping clients. Segment pretax income fell 4.3% in Q3 but rose 4.4% for nine months. Dietary service costs increased as a share of segment revenue in both comparisons.
- Bad-debt provision was $3.2 million for nine months, up from $2.2 million; it represented 0.3% of revenue versus 0.2%. Workers’ compensation and general-liability costs declined as a share of revenue, which the company linked to safety and claims-management initiatives.
Cash, liquidity and capital
At September 30, 2016, cash and cash equivalents were $24.3 million, marketable securities were $80.6 million, and working capital was $308.8 million; the current ratio was 3.7. Cash plus marketable securities totaled $105.0 million, compared with $102.7 million at December 31, 2015. The company had no bank-line borrowings and reported no funded debt; its $200 million credit line was reduced by a $78.1 million insurance-related standby letter of credit, which was reduced to $63.7 million on October 25. The company reported covenant compliance, with a funded-debt-to-EBITDA ratio of 0.71 against a maximum of 3.00.
Nine-month operating cash flow fell to $37.9 million from $52.5 million. A $55.0 million increase in accounts and notes receivable was the principal cash use, partly offset by increases in accrued payroll, taxes payable and accrued insurance claims. Investing activities used $14.3 million, including $10.6 million of net marketable-security purchases and $3.9 million of capital expenditures. Financing activities used $32.4 million, principally $39.8 million of dividends, partly offset by $5.6 million from option exercises. The company paid quarterly dividends and declared a Q4 dividend of $0.185 per share, payable December 23, 2016.
Outlook, risks and other matters
- Management said remaining-2016 revenue performance may be comparable to historical ranges, with segment revenue mix expected to approximate the reported mix. It expected Dietary growth primarily from existing Housekeeping clients and Housekeeping growth mainly from new clients. No quantified earnings or cash-flow guidance was provided.
- Management estimated remaining-2016 capital expenditures of $1.125 million to $1.5 million and said cash, operating cash flow and the credit line should meet foreseeable operating and growth needs.
- Key risks include clients’ dependence on Medicare, Medicaid and other reimbursement; client payment delays, insolvencies and collection disputes; customer concentration (several clients contributed at least 3% of revenue, with one as high as 9%); labor and insurance costs; and regulatory, taxability and minimum-wage changes. The company warned that cost increases may hurt results if they cannot be passed to clients.
- Legal and tax matters arise in the ordinary course. Management said no pending proceeding was expected to materially affect financial condition or liquidity; it could not reasonably estimate liabilities for certain tax matters but did not expect them, individually or together, to have a material adverse effect.
- Investment and interest income turned positive, partly due to favorable investment-market movements. Deferred-compensation valuation changes also affected SG&A. The company noted interest-rate risk in its fixed- and floating-rate investments.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. No material change to the prior annual report’s risk factors was reported.
Important facts for investors to verify
- Whether the sharp increase in receivables and lower operating cash flow reflect timing or a sustained deterioration in client collections; review aging, allowance adequacy and subsequent receipts.
- Whether Dietary’s rapid revenue growth can improve segment margins, given higher service costs as a percentage of revenue and weaker Q3 segment pretax income.
- Whether labor, insurance and bad-debt costs remain controlled, and whether safety-related insurance savings continue.
- Client concentration and exposure to reimbursement changes, bankruptcies, slow payers and disputes; assess the reported $16.4 million of notes receivable net of reserves.
- Dividend sustainability relative to cash generation, planned spending, and the credit line’s availability after the insurance letter of credit.
- The effects of pending accounting standards, particularly revenue recognition, credit-loss measurement and lease accounting; the filing says their impacts were still under evaluation.