Healthcare Services Group, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019. The company provides housekeeping, laundry and linen services, and dietary services to U.S. healthcare facilities, primarily long-term-care providers. Results are unaudited.
Financial performance
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Revenue | $476.1 million | $500.6 million | Down 4.9% |
| Costs of services | $427.3 million | $469.3 million | Down 8.9% |
| SG&A | $41.1 million | $33.8 million | Up 21.7% |
| Income (loss) before tax | $11.9 million | $(1.4) million | Improved |
| Net income | $9.2 million | $0.1 million | Improved |
| Diluted EPS | $0.12 | $0.00 | Improved |
| Operating cash flow | $17.6 million | $23.9 million | Down 26.6% |
Net margin was approximately 1.9%, versus near breakeven in Q1 2018. Costs of services were 89.7% of revenue, down from 93.7%; SG&A was 8.6% of revenue, up from 6.7%. The filing attributes the lower bad-debt provision year over year primarily to large operator restructurings in Q1 2018; Q1 2019 still included an $18.5 million provision, primarily related to an out-of-court restructuring of a Northeast operator.
Housekeeping revenue was $233.1 million, down 4.9%; Dietary revenue was $243.0 million, also down 4.9%. Dietary pretax income increased 4.7% to $15.4 million, while Housekeeping pretax income decreased 6.5% to $26.5 million.
Liquidity, debt and capital
- Cash, cash equivalents and marketable securities totaled $106.9 million at March 31, 2019. Working capital was $349.5 million; the current ratio was 3.0 to 1.
- Operating cash flow of $17.6 million funded, among other uses, $14.6 million of cash dividends. Cash increased $2.3 million during the quarter.
- Borrowings were $30.0 million under the $475 million revolving line of credit, due December 2023. The company reported compliance with its financial covenants. Standby letters of credit totaled $62.7 million and reduce availability under the facility.
- Net accounts and notes receivable totaled $392.4 million. The allowance for doubtful accounts was $68.6 million in aggregate, including $10.0 million against long-term notes receivable.
- Q1 capital expenditures were $1.3 million; management estimated full-year 2019 capital expenditures of $5 million to $7 million.
Changes, outlook and notable items
- Management expects consolidated revenue to grow for the remainder of 2019. It expects Dietary to increase as a share of revenue, principally by extending services to existing Housekeeping clients; Housekeeping growth is expected primarily from new clients. No numerical growth guidance was provided.
- Revenue declined partly following adjustments to client contracts. For Genesis Healthcare, effective December 1, 2018, Genesis assumed direct payment to food suppliers while HCSG continued managing food procurement. This reduced reported Dietary revenue and supply costs.
- Investment and other income rose to $5.2 million from $1.8 million, primarily due to favorable market movements in deferred-compensation investments. The filing also reports a $3.4 million unrealized gain on those investments, which increased SG&A through the related deferred-compensation liability.
- SG&A excluding the deferred-compensation investment effect rose 12.3%, primarily because of legal and professional fees related to the SEC inquiry into EPS calculation practices.
- The company adopted the new lease accounting standard in Q1 2019, recognizing operating lease right-of-use assets and liabilities; it reported no opening retained-earnings adjustment. Estimated 2019 annual effective tax rate is 21% to 23%.
- The board declared a quarterly dividend of $0.19750 per share, payable June 28, 2019. Management said it expects to continue regular quarterly dividends, but future payments are not assured.
Risks and contingencies
- The SEC investigation into EPS calculation practices remained ongoing after the company’s internal investigation was completed in March 2019. A putative shareholder class action filed March 22, 2019 seeks unspecified damages. The company could not estimate potential losses or determine the likelihood of an unfavorable outcome.
- Client credit and collection risks are significant: customers are concentrated in healthcare and depend in part on Medicare, Medicaid and other reimbursement. Delayed payments, bankruptcy, litigation or reimbursement changes could increase bad debts. A significant share of revenue came from one customer, but the filing text does not provide a clear value for that concentration.
- Labor and labor-related cost increases, regulation, client retention and the ability to pass through higher supply costs may affect results. The company also identified interest-rate exposure in its investments.
- The company implemented a new ERP system during Q1 and modified or added related controls. Management considered disclosure controls effective as of March 31, 2019.
Investor verification priorities
- Track receivable aging, the allowance and collections from the Northeast operator and other financially stressed clients.
- Assess the status and potential cost of the SEC investigation and shareholder litigation, including any subsequent disclosures.
- Separate underlying client and service growth from the Genesis change in food purchasing and other contract adjustments when evaluating revenue trends.
- Evaluate whether investment gains and the related deferred-compensation effects are recurring, and compare operating cash flow with dividends and earnings.
- Monitor customer concentration, labor costs, ERP control implementation, credit-facility availability after letters of credit, and progress against the stated growth outlook.