Differences between the effective tax rate and the applicable U.S. federal statutory rate arise primarily from the effect of state and local income taxes, share-based compensation and tax credits available to the Company. The actual 20172019 effective tax rate will likely vary from the estimate depending on the availability of tax credits and the exercisesexercise of stock options and vesting of share-based awards.
The Company accounts for income taxes using the asset and liability method, which results in recognizing income tax expense based on the amount of income taxes payable or refundable for the current year. Additionally, the Company regularly evaluates the tax positions taken or expected to be taken resulting from financial statement recognition of certain items. Based on the evaluation, there are no0 significant uncertain tax positions requiring recognition in the Company’s financial statements. The evaluation was performed for the tax years ended December 31, 2013 through 20162018 (with regard to U.S. federal income tax returns) and December 31, 2012 through 20162018 (with regard to various state and local income tax returns), the tax years which remain subject to examination by major tax jurisdictions as of September 30, 2017.2019.
The Company may from time to time be assessed interest or penalties by taxing jurisdictions, although any such assessments historically have been minimal and immaterial to its financial results. When the Company has received an assessment for interest and/or penalties, it will be classified in the financial statements as selling, general and administrative expense. In addition, any interest or penalties relating to recognized uncertain tax positions would also be recorded in selling, general and administrative expense.
The Company’s accounting policies for the segments are generally the same as described in the Company’s significant accounting policies. Differences between the reportable segments’ operating results and other disclosed data and the information in the consolidated financial statements relate primarily to corporate level transactions and recording of transactions at the reportable segment level using other than generally accepted accounting principles. There are certain inventories and supplies that are primarily expensed when incurred within the operating segments, while they are capitalized in the consolidated financial statements. In addition, most corporate expenses such as corporate salary and benefit costs, certain legal costs, debt expense, information technology costs, depreciation, amortization of finite-lived intangible assets, share based compensation costs and other corporate-specific costs, are not allocated to the operating segments. There are also allocations for workers’ compensation and general liability expense within the operating segments that differ from the actual expense recorded by the Company under U.S. GAAP. Segment amounts disclosed are prior to elimination entries made in consolidation.
Basic and diluted earnings per common share are computed by dividing net income by the weighted-average number of basic and diluted common shares outstanding, respectively. The weighted-average number of diluted common shares includes the impact of dilutive securities, including outstanding stock options and unvested restricted stock and restricted stock units. The table below reconciles the weighted-average basic and diluted common shares outstanding:
| |
(1)
| Certain outstanding stock option awards are anti-dilutive and were therefore excluded from the calculation of the weighted average number of diluted common shares outstanding. During the three months ended September 30, 2017, there were no anti-dilutive stock options excluded and during the nine months ended September 30, 2017, options to purchase 0.5 million shares having a weighted average exercise price of $39.38 per share were excluded. During the three and nine months ended September 30, 2016, options to purchase 0.5 million shares having a weighted average exercise price of $34.14 per share were excluded. |
Note 12— 15—Other Contingencies
Line of Credit
At September 30, 2017,2019, the Company had a $300$475 million bank line of credit on which to draw for general corporate purposes. Amounts drawn under the line of credit are payable upon demand and generally bear interest at a float rate, based on the Company's leverage ratio, and starting at LIBOR plus 115 basis points (or if LIBOR becomes unavailable, the higher of the Overnight Bank Funding Rate, plus 50 basis points and the Prime Rate). As of September 30, 2017,2019 and December 31, 2018 there were $25.0$10.0 million and $30.0 million in borrowings under the line of credit.credit, respectively. The line of credit requires the Company to satisfy onetwo financial covenant,covenants, with which the Company is in compliance as of September 30, 20172019 and expects to remain in compliance. The line of credit expires on December 18, 2018.21, 2023.
At September 30, 2017,2019, the Company also had outstanding $74.2$62.7 million in irrevocable standby letters of credit, which relate to payment obligations under the Company's insurance programs. In connection with the issuance of the letters of credit, the amount available under the line of credit was reduced by $74.2 million to $200.8$62.7 million at September 30, 2017.2019. The letters of credit were increasedexpire on January 2, 2020. Besides the $62.7 million letters of credit there are no other restrictions as to $77.6the amount which the Company can draw upon the $475 million on October 2, 2017.line of credit.
Tax Jurisdictions and Matters
The Company provides services throughout the continental United States and is subject to numerous state and local taxing jurisdictions. In the ordinary course of business, a jurisdiction may contest the Company’s reporting positions with respect to the application of its tax code to the Company’s services, which could result in additional tax liabilities.
The Company has tax matters with various taxing authorities. Because of the uncertainties related to both the probable outcomes and amount of probable assessments due, the Company is unable to make a reasonable estimate of a liability. The Company does not expect the resolution of any of these matters, taken individually or in the aggregate, to have a material adverse effect on the consolidated financial position or results of operations based on the Company’s best estimate of the outcomes of such matters.
Legal Proceedings
The Company is subject to various claims and legal actions in the ordinary course of business. Some of these matters include payroll and employee-related matters and examinations by governmental agencies. As the Company becomes aware of such claims and legal actions, the Company records accruals for any exposures that are probable and estimable. If adverse outcomes of such claims and legal actions are reasonably possible, Management assesses materiality and provides financial disclosure, as appropriate.
As previously disclosed, the Securities and Exchange Commission (“SEC”) is conducting an investigation into the Company's earnings per share (“EPS”) calculation practices. Following receipt of a letter from the SEC in November 2017 regarding its inquiry into those practices followed by a subpoena in March 2018, the Company authorized its outside counsel to conduct an internal investigation, under the direction of the Company’s Audit Committee, into matters related to the SEC subpoena. This investigation was completed in March 2019 and the Company continues to cooperate with the SEC’s investigation and document requests.
On March 22, 2019, a putative shareholder class action lawsuit was filed against the Company and its Chief Executive Officer in the U.S. District Court for the Eastern District of Pennsylvania. The initial complaint, which was filed by a plaintiff purportedly on behalf of all purchasers of our securities between April 11, 2017 and March 4, 2019 (the "Class Period"), alleges violations of the federal securities laws in connection with the matters related to the Company's EPS calculation practices. On September 17, 2019, the complaint was amended to, among other things, extend the Class Period to cover the period between April 8, 2014 and March 4, 2019, and to name additional individuals affiliated with the Company believes itas defendants. The lead plaintiff seeks unspecified monetary damages and other relief on behalf of the plaintiff class.
While the Company is vigorously defending against all litigation claims asserted, this litigation—along with the ongoing SEC investigation—could result in substantial costs to the Company and a diversion of the Company’s management’s attention and resources, which could harm its business. In addition, the uncertainty of the pending lawsuit or potential filing of additional lawsuits could lead to more volatility and a reduction in the Company’s stock price. Given the early stage of the litigation, at this time the Company is unable to reasonably estimate possible losses or form a judgment that an unfavorable outcome is
either probable or remote. It is not a partycurrently possible to nor are anyassess whether or not the outcome of its properties the subject of, any pending legal proceeding or governmental examination that wouldthese proceedings may have a material adverse effect on the Company’s consolidated financial condition or liquidity.Company.
Government Regulations
The Company’s clients are concentrated in the health carehealthcare industry and are primarily providers of long-term care. The revenues of many of the Company’s clients are highly reliant on Medicare, Medicaid and third party payors’ reimbursement funding rates. New legislation or additional changes in existing regulations could directly impact the governmental reimbursement programs in which the clients participate. The full effect of any such programs would not be realized until these laws are fully implemented and government agencies issue applicable regulations or guidance.
Note 13—16—Subsequent Events
The Company evaluated all subsequent events through the filing date of this Form 10-Q. There were no events or transactions occurring during this subsequent reporting period which require recognition or additional disclosure in these financial statements.
Item 2. Management’s Discussion and Analysisof Financial Condition and Results ofOperations
Results of Operations
The following discussion is intended to provide the reader with information that will be helpful in understanding our financial statements, including the changes in certain key items when comparing financial statements period to period. We also intend to provide the primary factors that accounted for those changes, as well as a summary of how certain accounting principles affect our financial statements. In addition, we are providing information about the financial results of our two operating segments to further assist in understanding how these segments and their results affect our consolidated results of operations. This discussion should be read in conjunction with our financial statements as of September 30, 20172019 and December 31, 20162018 and the notes accompanying those financial statements.
Overview
We provide management, administrative and operating expertise and services to the housekeeping, laundry, linen, facility maintenance and dietary service departments of heath care providers,healthcare facilities, including nursing homes, retirement complexes, rehabilitation centers and hospitals located throughout the United States. We believe we are the largest provider of housekeeping and laundry management services to the long-term care industry in the United States, rendering such services to over 3,5003,300 facilities throughout the continental United States as of September 30, 2017. Although we do not directly participate in any government reimbursement programs, our clients’ reimbursements are subject to government regulation. Therefore, our clients are directly affected by any legislation relating to Medicare and Medicaid reimbursement programs.2019.
We provide our services primarily pursuant to full service agreements with our clients. InUnder such agreements, we are responsible for the day-to-day management of the department serviced, employing Housekeeping or Dietary personnelemployees located at our clients’ facilities, and providingas well as for the provision of certain supplies. We also provide services on the basis of management-only agreements for a limited number of clients. Under a management-only agreement, we provide management and supervisory services while the client facility retains payroll responsibility for the non-supervisory staff. Our agreements with clients typically provide for a renewable one year service terms, cancelableterm, cancellable by either party upon 30 to 90 days’ notice after thean initial period of 60 to 120 days.
We are organized into two reportable segments: housekeeping, laundry, linen and other services (“Housekeeping”), and dietary department services (“Dietary”).
Housekeeping consists of managing the client’sour clients’ housekeeping departmentdepartments, which isare principally responsible for the cleaning, disinfecting and sanitizing of resident rooms and common areas of a client’s facility,the clients’ facilities, as well as the laundering and processing of the bed linens, uniforms, resident personal clothing and other assorted linen items utilized at the clients’ facilities. Upon beginning service with a client facility.facility, we typically hire and train the employees previously employed by such facility and assign an on-site manager to supervise and train the front-line personnel and coordinate housekeeping services with other facility support functions in accordance with client requests. Such management personnel also oversee the execution of various cost and quality control procedures including continuous training and employee evaluation, and on-site testing for infection control.
Dietary consists of managing the client’sour clients’ dietary departmentdepartments, which isare principally responsible for food purchasing, meal preparation and providingprofessional dietitian professional services, which includesinclude the development of menus that meet residents’the dietary needs.needs of residents. On-site management is responsible for all daily dietary department activities, with regular support provided by a District Manager specializing in dietary services. We also offer clinical consulting services to our dietary clients, which may be provided as a stand-alone service, or bundled with other dietary department services. Upon beginning service with a client facility, we typically hire and train the employees previously employed by such facility and assign an on-site manager to supervise and train the front-line personnel and coordinate dietitian services with other facility support functions in accordance with client requests. Such management personnel also oversee the execution of various cost and quality control procedures including continuous training and employee evaluation.
At September 30, 2017,2019, Housekeeping services were provided at essentially all of our more than 3,500approximately 3,300 client facilities, generating approximately 53.7%49.3% or $733.7$687.4 million of our total revenues for the nine months ended September 30, 2017.2019. Dietary department services were provided to over 1,500 client facilities at September 30, 20172019 and contributed approximately 46.3%50.7% or $633.0$706.4 million of our total revenues for the nine months ended September 30, 2017.2019.
Subject to the factors noted in the Cautionary Statement Regarding Forward Looking Statements included in this Quarterly Report on Form 10-Q, and although there can be no assurance thereof, we expect our consolidated revenues for the remainder
Three Months Ended September 30, 20172019 and 20162018
The following table summarizes the income statement key components that we use to evaluate our financial performance on a consolidated and reportable segment basis, for the three months ended September 30, 20172019 and 2016.2018. The differences between the reportable segments’ operating results and other disclosed data and our consolidated financial results relate primarily to corporate level transactions and recording ofadjustments related to transactions recorded at the reportable segment level usingwhich use methods other than generally accepted accounting principles.
21 | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | | | |
| 2019 | | 2018 | | % Change |
| (in thousands) | | | | |
Revenues | | | | | |
Housekeeping1 | $ | 225,347 | | | $ | 240,837 | | | (6.4) | % |
Dietary | 230,259 | | | 264,663 | | | (13.0) | % |
Consolidated | $ | 455,606 | | | $ | 505,500 | | | (9.9) | % |
| | | | | |
Costs of services provided | | | | | |
Housekeeping1 | $ | 203,649 | | | $ | 214,061 | | | (4.9) | % |
Dietary | 221,431 | | | 248,384 | | | (10.9) | % |
Corporate and eliminations | (26,676) | | | (24,183) | | | 10.3 | % |
Consolidated | $ | 398,404 | | | $ | 438,262 | | | (9.1) | % |
| | | | | |
Selling, general and administrative expense | | | | | |
Corporate and eliminations | $ | 33,479 | | | $ | 36,713 | | | (8.8) | % |
| | | | | |
Investment and other income, net | | | | | |
Corporate and eliminations1 | $ | 733 | | | $ | 3,239 | | | (77.4) | % |
| | | | | |
Interest expense | | | | | |
Corporate and eliminations1 | $ | (740) | | | $ | (782) | | | (5.4) | % |
| | | | | |
Income (loss) before income taxes | | | | | |
Housekeeping | $ | 21,698 | | | $ | 26,776 | | | (19.0) | % |
Dietary | 8,828 | | | 16,279 | | | (45.8) | % |
Corporate and eliminations | (6,810) | | | (10,073) | | | 32.4 | % |
Consolidated | $ | 23,716 | | | $ | 32,982 | | | 28.1 | % |
1.Prior year Housekeeping and Corporate revenues, costs of services provided and investment and other income, net were revised for the presentation of the revenue and expenses associated with our wholly-owned captive insurance subsidiary. Refer to Note 1—Description of Business and Significant Accounting Policies herein for additional disclosure regarding the revision.
|
| | | | | | | | | | |
| Three Months Ended September 30, |
| 2017 | | 2016 | | % Change |
| (in thousands) | | |
Revenues | | | | | |
Housekeeping | $ | 247,395 |
| | $ | 239,584 |
| | 3.3 | % |
Dietary | 243,960 |
| | 153,150 |
| | 59.3 | % |
Consolidated | $ | 491,355 |
| | $ | 392,734 |
| | 25.1 | % |
| | | | | |
Costs of Services Provided | | | | | |
Housekeeping | $ | 220,547 |
| | $ | 215,939 |
| | 2.1 | % |
Dietary | 232,594 |
| | 145,266 |
| | 60.1 | % |
Corporate and eliminations | (26,217 | ) | | (24,865 | ) | | 5.4 | % |
Consolidated | $ | 426,924 |
| | $ | 336,340 |
| | 26.9 | % |
| | | | | |
Selling, general and administrative expense | | | | | |
Corporate and eliminations | $ | 32,940 |
| | $ | 27,182 |
| | 21.2 | % |
| | | | | |
Investment and interest income | | | | | |
Corporate and eliminations | $ | 1,439 |
| | $ | 1,359 |
| | 5.9 | % |
| | | | | |
Income (loss) before income taxes | | | | | |
Housekeeping | $ | 26,848 |
| | $ | 23,645 |
| | 13.5 | % |
Dietary | 11,366 |
| | 7,884 |
| | 44.2 | % |
Corporate and eliminations | (5,284 | ) | | (958 | ) | | 451.6 | % |
Consolidated | $ | 32,930 |
| | $ | 30,571 |
| | 7.7 | % |
Housekeeping revenues represented approximately 50.3%49.5% of consolidated revenues for the third quarter 2017.three months ended September 30, 2019. Dietary revenues represented approximately 49.7%50.5% of consolidated revenues for the third quarter 2017.three months ended September 30, 2019.
The following table sets forth the ratio whichof certain items bear to consolidated revenues:
| | | | | | | | | | | |
| Three Months Ended September 30, | | |
| 2019 | | 2018 |
Revenues | 100.0 | % | | 100.0 | % |
Operating costs and expenses: | | | |
Costs of services provided | 87.4 | % | | 86.7 | % |
Selling, general and administrative expense | 7.3 | % | | 7.3 | % |
Other income (expense): | | | |
Investment and other income, net | 0.2 | % | | 0.6 | % |
Interest expense | (0.2) | % | | (0.2) | % |
Income before income taxes | 5.3 | % | | 6.4 | % |
Income tax | 1.2 | % | | 1.4 | % |
Net income | 4.1 | % | | 5.0 | % |
|
| | | | | |
| Three Months Ended September 30, |
| 2017 | | 2016 |
Revenues | 100.0 | % | | 100.0 | % |
Operating costs and expenses: | | | |
Costs of services provided | 86.9 | % | | 85.6 | % |
Selling, general and administrative expense | 6.7 | % | | 6.9 | % |
Investment and interest income | 0.3 | % | | 0.3 | % |
Income before income taxes | 6.7 | % | | 7.8 | % |
Income taxes | 1.9 | % | | 2.8 | % |
Net income | 4.8 | % | | 5.0 | % |
Revenues
Consolidated
Consolidated revenues increased 25.1%decreased 9.9% to $491.4$455.6 million infor the third quarter 2017three months ended September 30, 2019 compared to $392.7$505.5 million for the corresponding period in the third quarter 2016,2018, as a result of the factors discussed below under Reportable Segments.
Reportable Segments
Housekeeping’s 3.3% net growthHousekeeping and Dietary revenues decreased 6.4% and 13.0%, respectively, during the three months ended September 30, 2019 compared to the corresponding period in reportable segment revenues resulted from service agreements entered into2018, partially driven by the termination of several customers due to the Company exiting facilities in conjunction with operator transitions where we have been unable to come to agreeable terms, typically including accelerated payment and stricter credit terms with new clients. Dietary’s 59.3% net growth in reportable segment revenues resulted primarily from providing these servicesoperators. With respect to existing Housekeeping clients.Dietary, the revenue decline was primary related to adjustments to the Company's contractual relationship with Genesis Healthcare® (“Genesis”). Effective December 1, 2018, Genesis assumed responsibility for direct payment to suppliers for food purchases. HCSG will continue to manage food procurement, and as a result, maintain the same benefits of purchasing scale.
Costs of Services Provided
Consolidated
Consolidated costs of services increased 26.9%provided decreased 9.1% to $426.9$398.4 million infor the third quarter 2017three months ended September 30, 2019 compared to $336.3$438.3 million in the third quarter 2016, which is primarily related to our 25.1% growth in consolidated revenues for the same period. As a percentage of consolidated revenues, costs of services increased to 86.9% in the third quarter 2017 from 85.6% in the third quarter 2016.three months ended September 30, 2018.
Certain significant components within our costs of services are subject to fluctuation with changes in our business and client base. Labor and other labor-related costs, dining and housekeeping supplies, and self insurance costs account for most of our consolidated costs of services. See the discussion under Reportable Segments below for additional information on the changes in the components of costs of services.
The following table provides a comparison of key indicators we consider when managing the consolidated costcosts of services provided:
| | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | | | |
Costs of Services Provided - Key Indicators as a % of Consolidated Revenue | | 2019 | | 2018 | | Change |
Bad debt provision | | 0.3% | | | 0.6% | | | (0.3)% | |
Self-insurance costs | | 2.9% | | | 2.7% | | | 0.2% | |
|
| | | | | | |
| | Three Months Ended September 30, |
Costs of Services Provided-Key Indicators as a % of Consolidated Revenue | | 2017 | | 2016 | | Change |
Bad debt provision | | 0.4% | | 0.3% | | 0.1% |
Workers’ compensation and general liability insurance | | 2.6% | | 2.7% | | (0.1)% |
The change in the Company’s bad debt provision as a percentage of consolidated revenue is related to our assessment of the collectability of our accounts and notes receivable.
The decrease in workers’ compensation and general liability insurance expense as a percentage of consolidated revenue is primarily the result of the Company’s ongoing initiatives to promote safety and accident prevention in the workplace, as well as proactive management of workers’ compensation claims, which positively impact our claims experience.
Reportable Segments
Costs of services provided for Housekeeping, as a percentage of Housekeeping revenues, decreasedincreased to 89.1%90.4% for the third quarter 2017three months ended September 30, 2019 from 90.1%88.9% in the third quarter 2016.corresponding period in 2018. Costs of services provided for Dietary, as a percentage of Dietary revenues, increased to 95.3%96.2% for the third quarter 2017three months ended September 30, 2019 from 94.9%93.8% in the third quarter 2016.corresponding period in 2018.
The following table provides a comparison of the key indicators we consider when managing costs of services provided at the segment level, as a percentage of the respective segmentsegment’s revenues:
| | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | | | |
Costs of Services Provided - Key Indicators as a % of Segment Revenue | | 2019 | | 2018 | | Change |
Housekeeping labor and other labor-related costs | | 80.9% | | | 78.9% | | | 2.0% | |
Housekeeping supplies | | 7.4% | | | 7.9% | | | (0.5)% | |
Dietary labor and other labor-related costs | | 64.2% | | | 56.3% | | | 7.9% | |
Dietary supplies | | 29.4% | | | 34.4% | | | (5.0)% | |
|
| | | | | | |
| | Three Months Ended September 30, |
Costs of Services Provided-Key Indicators as a % of Segment Revenue | | 2017 | | 2016 | | Change |
Housekeeping labor and other labor-related costs | | 79.6% | | 81.0% | | (1.4)% |
Housekeeping supplies | | 7.9% | | 7.7% | | 0.2% |
Dietary labor and other labor-related costs | | 58.0% | | 54.5% | | 3.5% |
Dietary supplies | | 35.4% | | 37.8% | | (2.4)% |
The ratios ofVariations within these key indicators generally remain relatively consistent. However, during this period of high-growth, the Company has experienced some inefficiencies when integrating new business and facilities. Such inefficiencies can relate to standardizing work flowsthe provision of services at new facilities and labor resources, establishing administrative structures, provisioning and other operational and logistical activities. Further, variations in these ratios can relate to changes in the mix of clients for whom we provide supplies or do not provide supplies. Management focuses on building efficiencies based on our operational expertise,and managing labor and labor-relatedother costs at the facility level, as well as managing supply chain costs, by leveraging economiesfor new and existing facilities. The increase in dietary labor and the reduction in dietary supplies cost was primarily a result of scale.a modification of our contractual relationship with Genesis.
Consolidated Selling, General and Administrative Expense
Excluding the change in the deferred compensation plan described below, consolidated selling, general and administrative expense increased $5.6 million or 21.3% compared to the third quarter 2016, related primarily to our overall growth.
Included in selling, general and administrative expense are gains and losses associated with changes in the value of investments under the deferred compensation plan thatplan. These investments represent the amounts held on behalf of the participating employees. Changesemployees and changes in the value of these investments affect the amount of our deferred compensation liability. Gains on the plan investments during the third quarter 2017three months ended September 30, 2019 and 20162018 increased our total selling, general and administrative expense for these periods.
Excluding the change in the deferred compensation plan described above, consolidated selling, general and administrative expense decreased $1.7 million or 4.8% for the three months ended September 30, 2019 compared to the corresponding period in 2018, when the Company settled a state-specific sales tax audit.
The table below summarizes the changes in these components of selling, general and administrative expense:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | | | | | |
| 2019 | | 2018 | | $ Change | | % Change |
| (dollar amounts in thousands) | | | | | | | |
Selling, general and administrative expense excluding change in deferred compensation liability | $ | 33,453 | | | $ | 35,139 | | | $ | (1,686) | | | (4.8) | % |
Gain on deferred compensation plan investments | 26 | | | 1,574 | | | (1,548) | | | (98.3) | % |
Selling, general and administrative expense | $ | 33,479 | | | $ | 36,713 | | | $ | (3,234) | | | (8.8) | % |
|
| | | | | | | | | | | | | | |
| Three Months Ended September 30, |
| 2017 | | 2016 | | $ Change | | % Change |
| (in thousands) | | |
Selling, general and administrative expense excluding change in deferred compensation liability | $ | 31,878 |
| | $ | 26,286 |
| | $ | 5,592 |
| | 21.3 | % |
Gain on deferred compensation plan investments | 1,062 |
| | 896 |
| | 166 |
| | 18.5 | % |
Selling, general and administrative expense | $ | 32,940 |
| | $ | 27,182 |
| | $ | 5,758 |
| | 21.2 | % |
Consolidated Investment and InterestOther Income, net
Investment and interestother income increased 5.9%decreased 77.4% for the three months ended September 30, 20172019 compared to the corresponding 20162018 period, primarily due to favorablestagnant market conditions impacting the value of our trading security investments representing the funding for our deferred compensation plan. Realized gains and losses on our available-for-sale municipal bonds also impacted consolidated investment income.
Consolidated Interest Expense
Consolidated interest expense decreased 5.4% to $0.7 million for the three months ended September 30, 2019 compared to the corresponding 2018 period.
Consolidated Income Taxes
During the three months ended September 30, 2019, the Company recognized a provision for income taxes of $5.4 million versus $6.9 million for the same period in 2018.
The actual annual effective tax rate will be impacted by the tax effects of option exercises or vested awards, which are treated as discrete items in the reporting period in which they occur, and therefore cannot be considered in the calculation of the estimated annual effective tax rate. The impact on our income tax provision for the three months ended September 30, 2019 for such discrete items was not material.
Nine Months Ended September 30, 2019 and 2018
The following table summarizes the income statement key components that we use to evaluate our financial performance on a consolidated and reportable segment basis, for the nine months ended September 30, 2019 and 2018. The differences between the reportable segments’ operating results and other disclosed data and our consolidated financial results relate primarily to corporate level transactions and adjustments related to transactions recorded at the reportable segment level which use methods other than generally accepted accounting principles.
| | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, | | | | |
| 2019 | | 2018 | | % Change |
| (in thousands) | | | | |
Revenues | | | | | |
Housekeeping1 | $ | 687,392 | | | $ | 729,400 | | | (5.8) | % |
Dietary | 706,426 | | | 778,249 | | | (9.2) | % |
Consolidated | $ | 1,393,818 | | | $ | 1,507,649 | | | (7.6) | % |
| | | | | |
Costs of services provided | | | | | |
Housekeeping1 | $ | 614,383 | | | $ | 645,763 | | | (4.9) | % |
Dietary | 672,460 | | | 731,669 | | | (8.1) | % |
Corporate and eliminations | (60,689) | | | (33,887) | | | 79.1 | % |
Consolidated | $ | 1,226,154 | | | $ | 1,343,545 | | | (8.7) | % |
| | | | | |
Selling, general and administrative expense | | | | | |
Corporate and eliminations | $ | 113,189 | | | $ | 104,608 | | | 8.2 | % |
| | | | | |
Investment and interest income | | | | | |
Corporate and eliminations1 | $ | 7,329 | | | $ | 7,624 | | | (3.9) | % |
| | | | | |
Interest expense | | | | | |
Corporate and eliminations1 | $ | (2,579) | | | $ | (2,217) | | | 16.3 | % |
| | | | | |
Income (loss) before income taxes | | | | | |
Housekeeping | $ | 73,009 | | | $ | 83,637 | | | (12.7) | % |
Dietary | 33,966 | | | 46,580 | | | (27.1) | % |
Corporate and eliminations | (47,750) | | | (65,314) | | | (26.9) | % |
Consolidated | $ | 59,225 | | | $ | 64,903 | | | (8.7) | % |
1.Prior year Housekeeping and Corporate revenues, costs of services provided and investment and other income, net were revised for the presentation of the revenue and expenses associated with our wholly-owned captive insurance subsidiary. Refer to Note 1—Description of Business and Significant Accounting Policies herein for additional disclosure regarding the revision.
The following table sets forth the ratio of certain items to consolidated revenues:
| | | | | | | | | | | |
| Nine Months Ended September 30, | | |
| 2019 | | 2018 |
Revenues | 100.0 | % | | 100.0 | % |
Operating costs and expenses: | | | |
Costs of services provided | 88.0 | % | | 89.1 | % |
Selling, general and administrative expense | 8.1 | % | | 6.9 | % |
Other income (expense): | | | |
Investment and other income, net | 0.5 | % | | 0.5 | % |
Interest expense | (0.2) | % | | (0.1) | % |
Income before income taxes | 4.2 | % | | 4.4 | % |
Income tax | 1.0 | % | | 0.9 | % |
Net income | 3.2 | % | | 3.5 | % |
Revenues
Consolidated
Consolidated revenues decreased 7.6% to $1.4 billion for the nine months ended September 30, 2019 compared to $1.5 billion for the corresponding period in 2018 as a result of the factors discussed below under Reportable Segments.
Reportable Segments
Housekeeping and Dietary revenues decreased 5.8% and 9.2%, respectively, during the nine months ended September 30, 2019 compared to the corresponding period in 2018, partially driven by the termination of several customers due to the Company exiting facilities in conjunction with operator transitions where we have been unable to come to agreeable terms, typically including accelerated payment and stricter credit terms with new operators. With respect to Dietary, the revenue decline was primary related to adjustments to the Company's contractual relationship with Genesis. Effective December 1, 2018, Genesis assumed responsibility for direct payment to suppliers for food purchases. HCSG will continue to manage food procurement, and as a result, maintain the same benefits of purchasing scale.
Costs of services provided
Consolidated
Consolidated costs of services provided decreased 8.7% to $1.2 billion for the nine months ended September 30, 2019 compared to $1.3 billion for the nine months ended September 30, 2018.
The following table provides a comparison of key indicators we consider when managing the consolidated costs of services provided:
| | | | | | | | | | | | | | | | | | | | |
| | Nine Months Ended September 30, | | | | |
Costs of Services Provided - Key Indicators as a % of Consolidated Revenue | | 2019 | | 2018 | | Change |
Bad debt provision | | 1.6% | | | 2.8% | | | (1.2)% | |
Self-insurance costs | | 2.8% | | | 2.7% | | | 0.1% | |
The decrease in the bad debt provision is related to our current assessment of the collectability of our accounts and notes receivable during the nine months ended September 30, 2019. Our 2018 bad debt provision was adversely impacted by the corporate restructurings of two privately-held, multi-state operators. Our provision for the nine months ended September 30, 2019 of $23.0 million was primarily related to the out-of-court restructuring of a privately held Northeast based operator that occurred during the first quarter.
Reportable Segments
Costs of services provided for Housekeeping, as a percentage of Housekeeping revenues, increased to 89.4% for the nine months ended September 30, 2019 from 88.5% in the corresponding period in 2018. Costs of services provided for Dietary, as a percentage of Dietary revenues, increased to 95.2% for the nine months ended September 30, 2019 from 94.0% in the corresponding period in 2018.
The following table provides a comparison of the key indicators we consider when managing costs of services provided at the segment level, as a percentage of the respective segment’s revenues:
| | | | | | | | | | | | | | | | | | | | |
| | Nine Months Ended September 30, | | | | |
Costs of Services Provided - Key Indicators as a % of Segment Revenue | | 2019 | | 2018 | | Change |
Housekeeping labor and other labor-related costs | | 79.8% | | | 78.9% | | | 0.9% | |
Housekeeping supplies | | 7.5% | | | 7.9% | | | (0.4)% | |
Dietary labor and other labor-related costs | | 63.2% | | | 56.8% | | | 6.4% | |
Dietary supplies | | 29.6% | | | 34.7% | | | (5.1)% | |
Variations within these key indicators relate to the provision of services at new facilities and changes in the mix of clients for whom we provide supplies or do not provide supplies. Management focuses on building efficiencies and managing labor and other costs at the facility level, as well as managing supply chain costs, for new and existing facilities. The increase in dietary labor and the reduction in dietary supplies cost was primarily a result of a modification of our contractual relationship with Genesis.
Selling, General and Administrative Expense
Included in selling, general and administrative expense are gains and losses associated with changes in the value of investments under the deferred compensation plan. These investments represent the amounts held on behalf of the participating employees and changes in the value of these investments affect the amount of our deferred compensation liability. Gains on the plan investments during the nine months ended September 30, 2019 and 2018 increased our total selling, general and administrative expense for these periods.
Excluding the change in the deferred compensation plan described above, consolidated selling, general and administrative expense increased $6.3 million or 6.2% for the nine months ended September 30, 2019 compared to the corresponding period in 2018. The increase was primarily a result of increased legal and other professional fees incurred in connection with the Company's internal investigation related to the Securities and Exchange Commission's inquiry regarding the Company's earnings per share calculation practices.
The table below summarizes the changes in these components of selling, general and administrative expense:
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, | | | | | | |
| 2019 | | 2018 | | $ Change | | % Change |
| (dollar amounts in thousands) | | | | | | | |
Selling, general and administrative expense excluding change in deferred compensation liability | $ | 108,224 | | | $ | 101,916 | | | $ | 6,308 | | | 6.2 | % |
Gain on deferred compensation plan investments | 4,965 | | | 2,692 | | | 2,273 | | | 84.4 | % |
Selling, general and administrative expense | $ | 113,189 | | | $ | 104,608 | | | $ | 8,581 | | | 8.2 | % |
Consolidated Investment and Interest Income, net
Investment and other income decreased 3.9% for the nine months ended September 30, 2019 compared to the corresponding 2018 period, primarily due to market fluctuations in the value of our trading security investments representing the funding for our deferred compensation plan. Realized gains and losses on our available-for-sale municipal bonds also impacted consolidated investment income.
Consolidated Income TaxesInterest Expense
For the third quarter 2017, our effective tax rate was 28.7%, versus 35.5% for the same period in 2016. In the first quarter 2017, the Company adopted ASU 2016-09, under which excess tax benefits relatedConsolidated interest expense increased 16.3% to share-based payments were recognized as a component of income tax expense, as opposed to additional paid-in capital, resulting in a decrease in 2017 income tax expense. Differences between the effective tax rate and the applicable U.S. federal statutory rate generally arise primarily from the effect of state and local income taxes, share-based compensation and tax credits available to the Company.
Nine Months Ended September 30, 2017 and 2016
The following table summarizes the income statement key components that we use to evaluate our financial performance on a consolidated and reportable segment basis,$2.6 million for the nine months ended September 30, 20172019 compared to the corresponding 2018 period.
Consolidated Income Taxes
During the nine months ended September 30, 2019 and 2016. 2018, the Company recognized a provision for income taxes of $13.5 million and $12.9 million, respectively.
The differences betweenactual annual effective tax rate will be impacted by the reportable segments’ operating resultstax effects of option exercises or vested awards, which are treated as discrete items in the reporting period in which they occur, and other disclosed data andtherefore cannot be considered in the calculation of the estimated annual effective tax rate. The impact on our consolidated financial results relate primarily to corporate level transactions and recording of transactions at the reportable segment level using other than generally accepted accounting principles.
|
| | | | | | | | | | |
| Nine Months Ended September 30, |
| 2017 | | 2016 | | % Change |
| (in thousands) | | |
Revenues | | | | | |
Housekeeping | $ | 733,737 |
| | $ | 716,154 |
| | 2.5 | % |
Dietary | 632,984 |
| | 447,943 |
| | 41.3 | % |
Consolidated | $ | 1,366,721 |
| | $ | 1,164,097 |
| | 17.4 | % |
| | | | | |
Costs of Services Provided | | | | | |
Housekeeping | $ | 662,213 |
| | $ | 647,188 |
| | 2.3 | % |
Dietary | 598,251 |
| | 421,840 |
| | 41.8 | % |
Corporate and eliminations | (80,648 | ) | | (70,433 | ) | | 14.5 | % |
Consolidated | $ | 1,179,816 |
| | $ | 998,595 |
| | 18.1 | % |
| | | | | |
Selling, general and administrative expense | | | | | |
Corporate and eliminations | $ | 93,141 |
| | $ | 78,192 |
| | 19.1 | % |
| | | | | |
Investment and interest income | | | | | |
Corporate and eliminations | $ | 4,523 |
| | $ | 2,548 |
| | 77.5 | % |
| | | | | |
Income (loss) before income taxes | | | | | |
Housekeeping | $ | 71,524 |
| | $ | 68,966 |
| | 3.7 | % |
Dietary | 34,733 |
| | 26,103 |
| | 33.1 | % |
Corporate and eliminations | (7,970 | ) | | (5,211 | ) | | 52.9 | % |
Consolidated | $ | 98,287 |
| | $ | 89,858 |
| | 9.4 | % |
Housekeeping and Dietary respectively represented approximately 53.7% and 46.3% of consolidated revenuesincome tax provision for the nine months ended September 30, 2017.2019 for such discrete items was not material.
The following table sets forth the ratio which certain items bear to consolidated revenues:
|
| | | | | |
| Nine Months Ended September 30, |
| 2017 | | 2016 |
Revenues | 100.0 | % | | 100.0 | % |
Operating costs and expenses: | | | |
Costs of services provided | 86.3 | % | | 85.8 | % |
Selling, general and administrative expense | 6.8 | % | | 6.7 | % |
Investment and interest income | 0.3 | % | | 0.2 | % |
Income before income taxes | 7.2 | % | | 7.7 | % |
Income taxes | 2.2 | % | | 2.8 | % |
Net income | 5.0 | % | | 4.9 | % |
Revenues
Consolidated
Consolidated revenues increased 17.4% to $1.4 billion in the nine months ended September 30, 2017 compared to $1.2 billion in the corresponding period in 2016 as a result of the factors discussed below under Reportable Segments.
Reportable Segments
Housekeeping’s 2.5% net growth in reportable segment revenues resulted from service agreements entered into with new clients.
Dietary’s 41.3% net growth in reportable segment revenues resulted primarily from providing these services to existing Housekeeping clients.
Costs of services provided
Consolidated
Consolidated costs of services increased 18.1% to $1.2 billion for the nine months ended September 30, 2017 compared to $1.0 billion for the nine months ended September 30, 2016, which is primarily related to our 17.4% growth in consolidated revenues for the same period. As a percentage of consolidated revenues, costs of services increasedto 86.3% in the nine months ended September 30, 2017 from 85.8% in the corresponding period in 2016.
Certain significant components within our costs of services are subject to fluctuation with changes in our business and client base. Labor and other labor-related costs, dining and housekeeping supplies, and self insurance costs account for most of our consolidated costs of services. See the discussion under Reportable Segments below for additional information on the changes in the components of costs of services.
The following table provides a comparison of key indicators we consider when managing the consolidated cost of services provided:
|
| | | | | | | | | |
| | Nine Months Ended September 30, |
Costs of Services Provided-Key Indicators as a % of Consolidated Revenue | | 2017 | | 2016 | | Change |
Bad debt provision | | 0.3 | % | | 0.3 | % | | — | % |
Workers’ compensation and general liability insurance | | 2.7 | % | | 3.0 | % | | (0.3 | )% |
The decrease in workers’ compensation and general liability insurance expense as a percentage of consolidated revenue is primarily the result of the Company’s ongoing initiatives to promote safety and accident prevention in the workplace, as well as proactive management of workers’ compensation claims, which positively impact our claims experience.
Reportable Segments
Costs of services provided for Housekeeping, as a percentage of Housekeeping revenues, decreased to 90.3% for the nine months ended September 30, 2017 from 90.4% in the corresponding period in 2016. Costs of services provided for Dietary, as a percentage of Dietary revenues, increased to 94.5% for the nine months ended September 30, 2017 from 94.2% in the corresponding period in 2016.
The following table provides a comparison of the key indicators we consider when managing the costs of services at the segment level, as a percentage of the respective segment revenues:
|
| | | | | | | | | |
| | Nine Months Ended September 30, |
Costs of Services Provided-Key Indicators as a % of Segment Revenue | | 2017 | | 2016 | | Change |
Housekeeping labor and other labor-related costs | | 80.0 | % | | 80.0 | % | | — | % |
Housekeeping supplies | | 8.0 | % | | 7.8 | % | | 0.2 | % |
Dietary labor and other labor-related costs | | 55.9 | % | | 53.5 | % | | 2.4 | % |
Dietary supplies | | 36.6 | % | | 38.1 | % | | (1.5 | )% |
The ratios of these key indicators generally remain relatively consistent. However, during this period of high-growth, the Company has experienced some inefficiencies when integrating new business and facilities. Such inefficiencies can relate to standardizing work flows and labor resources, establishing administrative structures, provisioning and other operational and logistical activities. Further, variations in these ratios can relate to changes in the mix of clients for whom we provide supplies or do not provide supplies. Management focuses on building efficiencies based on our operational expertise, managing labor and labor-related costs, as well as managing supply chain costs by leveraging economies of scale.
Selling, General and Administrative Expense
Excluding the change in the deferred compensation plan described below, consolidated selling, general and administrative expense increased $12.7 million or 16.5% during the nine months ended September 30, 2017, related primarily to our overall growth.
Included in selling, general and administrative expense are gains and losses associated with changes in the value of investments under the deferred compensation plan that represent the amounts held on behalf of the participating employees. Changes in the value of these investments affect the amount of our deferred compensation liability. Gains on the plan investments during the nine months ended September 30, 2017 and 2016 increased our selling, general and administrative expense for these periods.
The table below summarizes the changes in these components of selling, general and administrative expense:
|
| | | | | | | | | | | | | | |
| Nine Months Ended September 30, |
| 2017 | | 2016 | | $ Change | | % Change |
| (in thousands) | | |
Selling, general and administrative expense excluding change in deferred compensation liability
| $ | 89,766 |
| | $ | 77,078 |
| | $ | 12,688 |
| | 16.5 | % |
Gain on deferred compensation plan investments | 3,375 |
| | 1,114 |
| | 2,261 |
| | 203.0 | % |
Selling, general and administrative expense | $ | 93,141 |
| | $ | 78,192 |
| | $ | 14,949 |
| | 19.1 | % |
Consolidated Investment and Interest Income
Investment and interest income increased 77.5% for the nine months ended September 30, 2017 compared to the corresponding 2016 period, primarily due to favorable market fluctuations in the value of our trading security investments representing the funding for our deferred compensation plan. Realized gains and losses on our available-for-sale municipal bonds also impacted consolidated investment income.
Consolidated Income Taxes
For the nine months ended September 30, 2017, our effective tax rate was 30.8% compared to 36.5% for the 2016 period. In the first quarter 2017, the Company adopted ASU 2016-09, under which excess tax benefits related to share-based payments were recognized as a component of income tax expense, as opposed to additional paid-in capital, resulting in a decrease in 2017 income tax expense. Differences between the effective tax rate and the applicable U.S. federal statutory rate generally arise primarily from the effect of state and local income taxes, share-based compensation and tax credits available to the Company.
Liquidity and Capital Resources
Cash generated through operations is our primary source of liquidity. At September 30, 2017,2019, we had cash, cash equivalents and marketable securities of $81.4$120.3 million and working capital of $340.2$371.9 million, compared to December 31, 20162018 cash, cash equivalents and marketable securities of $91.6$102.4 million and working capital of $313.8 million. The increase in working capital is driven by growth in new business and by the timing of payments and cash receipts as of September 30, 2017 as compared with December 31, 2016. As of September 30, 2017, we had an unused line of credit of $200.8$344.7 million. Our current ratio was 2.93.3 to 1 at September 30, 20172019 versus 4.13.1 to 1 at December 31, 2016.2018. Marketable securities represents fixed income investments which are highly liquid and can be readily purchased or sold through established markets and are held by our captive insurance company that are required by state insurance regulations to remain in the captive insurance company.
For the nine months ended September 30, 20172019 and 2016,2018, our cash flows were as follows:
| | | | | | | | | | | |
| Nine Months Ended September 30, | | |
| 2019 | | 2018 |
| (in thousands) | | | |
Net cash provided by operating activities | $ | 80,222 | | | $ | 74,509 | |
Net cash used in investing activities | $ | (4,256) | | | $ | (7,621) | |
Net cash used in financing activities | $ | (61,419) | | | $ | (61,248) | |
|
| | | | | | | |
| Nine Months Ended September 30, 2017 | | Nine Months Ended September 30, 2016 |
| (in thousands) |
Net cash provided by operating activities | $ | 3,122 |
| | $ | 37,898 |
|
Net cash used in investing activities | $ | (10,077 | ) | | $ | (14,345 | ) |
Net cash used in financing activities | $ | (5,893 | ) | | $ | (32,415 | ) |
Operating Activities
Our primary sources of cash from operating activities are the revenues generated from our Housekeeping and Dietary department services. Our primary uses of cash forfrom operating activities are the funding of our payroll and other personnel-related costs, as well as the costs of supplies used in providing our services. The timing of cash receipts and cash payments are the primary drivers of the period-over-period changes in net cash provided by operating activities.
Investing Activities
TheOur principal uses of cash for investing activities are the purchases of marketable securities and capital expenditures such as those for housekeeping and food service equipment, computer software and equipment, and furniture and fixtures (see “Capital Expenditures” below for additional information). Such uses of cash are partially offset by proceeds from sales of marketable securities.
Our investments in marketable securities are primarily comprised of tax-exempt municipal bonds and are intended to achieve our goal of preserving principal, maintaining adequate liquidity and maximizing returns subject to our investment guidelines. Our investment policy limits investment to certain types of instruments issued by institutions primarily with investment-grade ratings and places restrictions on concentration by type and issuer.
Financing Activities
The primary use of cash for financing activities is the payment of dividends. We have paid regular quarterly cash dividends since the second quarter of 2003. During 2017,2019, we paid to shareholders regular quarterly cash dividends to shareholders totaling $41.3$44.1 million as follows:
| | | | | | | | | | | | | | | | | |
| Quarter Ended | | | | |
| September 30, 2019 | | June 30, 2019 | | March 31, 2019 |
| (amounts in thousands, except per share data) | | | | |
Cash dividend paid per common share | $ | 0.19875 | | | $ | 0.19750 | | | $ | 0.19625 | |
Total cash dividends paid | $ | 14,789 | | | $ | 14,688 | | | $ | 14,588 | |
Record date | August 23, 2019 | | May 24, 2019 | | February 15, 2019 |
Payment date | September 27, 2019 | | June 28, 2019 | | March 22, 2019 |
|
| | | | | | | | | | | |
| Quarter Ended |
| March 31, 2017 | | June 30, 2017 | | September 30, 2017 |
| (in thousands, except per share amounts) |
Cash dividends paid per common share | $ | 0.18625 |
| | $ | 0.18750 |
| | $ | 0.18875 |
|
Total cash dividends paid | $ | 13,624 |
| | $ | 13,750 |
| | $ | 13,883 |
|
Record date | February 17, 2017 |
| | May 19, 2017 |
| | August 18, 2017 |
|
Payment date | March 24, 2017 |
| | June 23, 2017 |
| | September 22, 2017 |
|
The dividends paid to shareholders during the nine months ended September 30, 20172019 were funded by the existing cash cash equivalents and marketable securities held by the Company.generated from operations. Our Board of Directors reviews our dividend policy on a quarterly basis. Although there can be no assurance that we will continue to pay dividends or regarding the amount of thefuture dividend payments, we expect to continue to pay a regular quarterly cash dividend. Partially offsettingIn connection with the cash used to pay dividends are the proceeds received from the exerciseestablishment of stock options by employees and directors.our dividend policy, we adopted a Dividend Reinvestment Plan in 2003.
The primary source of cash from financing activities is the net borrowings under our bank line of credit. We borrow for general corporate purposes as needed throughout the year. The outstanding short-term borrowings balance as of September 30, 20172019 relates to cash flow requirements due to the timing of cash receipts and cash payments.
We remain authorized to repurchase 1.7 million shares of our Common Stock pursuant to previous Board of Directors’ authorization. During the three and nine months ended September 30, 2019 and 2018, we repurchased our Common Stock as part of the dividend reinvestment related to treasury shares held within the Deferred Compensation Plan. The number of shares and value of shares repurchased were immaterial for the three and nine months ended September 30, 2019 and 2018.
Line of Credit
At September 30, 2017,2019, we had a $300$475 million bank line of credit on which to draw for general corporate purposes. The amountsAmounts drawn under the line of credit are payable upon demand.demand and generally bear interest at a floating rate, based on our leverage ratio, and starting at LIBOR plus 115 basis points (or if LIBOR becomes unavailable, the higher of the Overnight Bank Funding Rate, plus 50 basis points and the Prime Rate). At September 30, 2017,2019, there were $25.0$10.0 million in borrowings under the line of credit.
The line of credit requires us to satisfy two financial covenants. The covenants and their respective status at September 30, 2019 were as follows:
| | | | | | | | |
Covenant Descriptions and Requirements | | As of September 30, 2019 |
Funded debt 1 to EBITDA 2 ratio: less than 3.50 to 1.00 | | 0.95 |
EBITDA to Interest Expense ratio: not less than 3.00 to 1.00 | | 32.84 |
1.All indebtedness for borrowed money including, but not limited to, capitalized lease obligations, reimbursement obligations in respect of letters of credit and guarantees of any such indebtedness.
2.Net income plus interest expense, income tax expense, depreciation, amortization, stock compensation expense and extraordinary non-recurring losses/gains.
As noted above, we were in compliance with our financial covenants at September 30, 2019 and we expect to remain in compliance. The line of credit expires on December 21, 2023.
LIBOR is expected to be discontinued after 2021. Our line of credit agreement provides procedures for determining a replacement or alternative rate in the event that LIBOR is unavailable. However, there can be no assurances as to whether such replacement or alternative rate will be more or less favorable than LIBOR. We intend to monitor the developments with respect to the potential phasing out of LIBOR after 2021 and will work with our lenders to ensure any transition away from LIBOR will have minimal impact on our financial condition. We however can provide no assurances regarding the impact of the discontinuation of LIBOR on the interest rate that we would be required to pay or on our financial condition.
At September 30, 2017,2019, we also had outstanding $74.2$62.7 million in irrevocable standby letters of credit, which relate to payment obligations under our insurance programs. In connection with the issuance of the letters of credit, the amount available under the line of credit was reduced by $74.2 million to $200.8 million at September 30, 2017. The letters of credit were increased to $77.6 million on October 2, 2017.
The line of credit requires us to satisfy one financial covenant. The covenant and its respective status at September 30, 2017 was as follows:
|
| | | |
Covenant Description and Requirement | | As of September 30, 2017 |
Funded debt (1) to EBITDA(2) ratio: less than 3.00 to 1.00
| | 0.72 |
|
| |
(1)
| All indebtedness for borrowed money, including but not limited to, capitalized lease obligations, reimbursement obligations in respect of letters of credit and guaranties of any such indebtedness. |
| |
(2)
| Net income plus interest expense, income tax expense, depreciation, amortization and extraordinary non-recurring losses/gains. |
As noted above, we were in compliance with our financial covenant at September 30, 2017 and we expect to remain in compliance. The line of credit expires on December 18, 2018.
Accounts and Notes Receivable
Any decisionDecisions to grant or to extend credit isto customers are made on a case-by-case basis and is based on a number of qualitative and quantitative factors related to the particular client as well as the general risks associated with operating within the long-term carehealthcare industry.
Our net accounts and notes receivable balance increased from December 31, 2016. Such fluctuationsFluctuations in net accounts and notes receivable are attributable to a variety of factors including, but not limited to, the timing of cash receipts from customers, the Company’s assessment of collectability and corresponding provision for bad debt expense and the inception, transition or termination of client relationships.
There are a variety of factors that impact our clients’ ability to pay us in accordance with our agreements. Primary among these factors is our clients’ participation in programs funded by federal and state governmental agencies. Deviations in the timing or amounts of reimbursements under those programs can impact our clients’ cash flows and the timing of their payments to us. The payment terms in our service agreements are not contingent upon our clients’ cash flows and notwithstanding our efforts to minimize credit risk exposure, various factors affecting our clients’ cash flows could have an indirect, yet material adverse effect on our results of operations and financial condition.
We deploy significant resources and have invested in tools and processes to optimize our credit and collections efforts. When appropriate, we utilize interest-bearing promissory notes as an alternative to accounts receivable to further enhance the collectability of amounts due by providing a definitive repayment planmemorializing the amount and providing a means by which to further evidencerelated payment schedule as well as securing additional business protections and guarantees.
Summarized below are the amounts owed. Atbalances in our allowance for doubtful accounts, along with the provision for bad debts and net write-offs for each quarter during the nine months ended September 30, 20172019. The aggregate client account balances to which the reserve balances relate totaled $111.4 million and $115.7 million as of September 30, 2019 and December 31, 2016, we had $31.9 million2018, respectively.
| | | | | |
| Allowance for Doubtful Accounts |
| (in thousands) |
Balance December 31, 2018 | $ | 57,209 | |
Provision for bad debts | 18,470 | |
Net write-offs of client accounts receivable | (7,049) | |
Balance March 31, 2019 | 68,630 | |
Provision for bad debts | 2,995 | |
Net write-offs of client accounts receivable | (18,206) | |
Balance June 30, 2019 | 53,419 | |
Provision for bad debts | 1,515 | |
Net write-offs of client accounts receivable | (1,662) | |
Balance September 30, 2019 | $ | 53,272 | |
We evaluate our notes receivable for impairment quarterly and $19.2 million,on an individual client basis. Notes receivable are generally evaluated for impairment when the respective clients are in bankruptcy, are subject to collections activity or are slow payers that are experiencing financial difficulties. In the event that the evaluation results in a determination that a note receivable is impaired, it is valued at the present value of expected future cash flows or at the market value of related collateral.
A summary schedule of our impaired notes receivable, net of reserves, respectively,interest, and the related reserve of such promissory notes, outstanding. In addition, we may assist our clients who are adjusting to changes in their cash flows by amending our agreements from full-service to management-only arrangements, or by modifying contractual payment terms to accommodate clients who have in good faith established clearly-defined plans for addressing cash flow issues. These efforts are intended to minimize our collections risk while maintaining our relationships with our clients.
In order to provide for collections issues and the general risk associated with the granting of credit terms, we recorded a bad debt provision (in an Allowance for Doubtful Accounts) of $4.0 million for the nine months ended September 30, 2017. For the nine months ended September 30, 2016, we recorded a bad debt provision2019 is as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| Balance December 31, 2018 | | Additions | | Deductions | | Balance September 30, 2019 |
| (in thousands) | | | | | | |
Impaired notes receivable | $ | 25,704 | | | $ | 3,763 | | | $ | (1,270) | | | $ | 28,197 | |
Reserve for impaired notes receivable | $ | 13,472 | | | $ | 3,273 | | | $ | (1,055) | | | $ | 15,690 | |
Capital Expenditures
The level of capital expenditures is generally dependent on the number of new clients obtained. Such capital expenditures primarily consist of housekeeping and food service equipment purchases, laundry and linen equipment installations, computer hardware and software, and furniture and fixtures. Although we have no specific material commitments for capital expenditures through the end of calendar year 2017,2019, we estimate that for 20172019 we will have capital expenditures of approximately $4.5$5.0 million to $6.0$7.0 million. We believe that our cash from operations, existing cash and cash equivalents balance and credit line will be adequate for the foreseeable future to satisfy the needs of our operations and to fund our anticipated growth. However, should these sources not be sufficient, we would seek to obtain necessary capital from such sources as long-term debt or equity financing.
Material Off-Balance Sheet Arrangements
We have no material off-balance sheet arrangements, other than our irrevocable standby letter of credit previously discussed.
28Critical Accounting Policies and Estimates
Our significant accounting policies are described in the notes to the consolidated financial statements included in our Form 10-K for the period ended December 31, 2018. As described in such notes, we recognize revenue in the period in which the performance obligation is satisfied. Refer to our Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Form 10-K filed with the SEC on March 18, 2019.
assets, liabilities, revenue and expenses. These estimates and assumptions are most significant where they involve levels of subjectivity and judgment necessary to account for highly uncertain matters or matters susceptible to change, and where they can have a material impact on our financial condition and operating performance. If actual results were to differ materially from the estimates made, the reported results could be materially affected.
Critical accounting estimates and the related assumptions are evaluated periodically as conditions warrant, and changes to such estimates are recorded as new information or changed conditions require.
New Accounting Standard Updates
See Note 1—Description of Business and Significant Accounting Policies herein to the condensed consolidated financial statements for a full description of recent accounting standard updates, including the expected dates of adoption.
Item 3. Quantitative and QualitativeDisclosures About Market Risk
At September 30, 2017,2019, we had $81.4$120.3 million in cash, cash equivalents and marketable securities. The fair values of all of our cash equivalents and marketable securities are determined based on “Level 1” or “Level 2” inputs, which are based upon quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. We place our cash investments in instruments that meet credit quality standards, as specified in our investment policy guidelines.
Investments in both fixed-rate and floating-rate investments carry a degree of interest rate risk. The market value of fixed rate securities may be adversely impacted by an increase in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or if there is a decline in the fair value of our investments.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Disclosure controls and procedures are intended to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934 (the “Exchange Act”), such as this Form 10-Q, is reported in accordance with Securities and Exchange Commission rules. Disclosure controls are also intended to ensure that such information is accumulated and communicated to Management, including the President and Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Based on their evaluation as of September 30, 2017,2019, pursuant to Exchange Act Rule 13a-15(b), our Management, including our President and Chief Executive Officer and Chief Financial Officer, believe our disclosure controls and procedures (as defined in Exchange Act 13a-15(e)) are effective.
Changes in Internal Controls over Financial Reporting
In connectionDuring the first quarter of 2019, the Company implemented a new Enterprise Resource Planning system ("ERP"). As a result of this implementation, the Company modified certain existing internal controls as well as implemented new controls and procedures related to the new ERP. The Company continues to evaluate the design and operating effectiveness of these internal controls during the third quarter of 2019.
Except with respect to the evaluation pursuant to Exchange Act Rule 13a-15(d)continued implementation of ourthe ERP, there were no changes in the Company's internal controlcontrols over financial reporting (as defined in Exchange Act Rule 13a-15(f)) by our Management, including our President and Chief Executive Officer and Chief Financial Officer, no changesthat occurred during the quarternine months ended September 30, 2017 were identified2019 that have materially affected, or are reasonably likely to materially affect, ourthe Company’s internal control over financial reporting. The Company continues to review its disclosure controls and procedures, including its internal control over financial reporting, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that the Company’s systems evolve with its business.
Certifications
Certifications of the Principal Executive Officer and Principal Financial and Accounting Officer regarding, among other items, disclosure controls and procedures are included as exhibits to this Form 10-Q.
PART II — OTHER INFORMATION
Item 1. Legal Proceedings
In the normal course of business, Healthcare Services Group, Inc. (the “Company”)the Company is involved in various administrative and legal proceedings, including labor and employment, contracts, personal injury, and insurance matters. The Company believes it
As previously disclosed, the SEC is notconducting an investigation into our EPS calculation practices. Following receipt of a partyletter from the SEC in November 2017 regarding its inquiry into those practices followed by a subpoena in March 2018, we authorized our outside counsel to nor are anyconduct an internal investigation, under the direction of its properties the subject of, any pending legal proceeding or governmental examination that would have a material adverse effect on the Company’s consolidated financial conditionAudit Committee, into matters related to the SEC subpoena. This investigation was completed in March 2019 and we continue to cooperate with the SEC’s investigation and document requests.
On March 22, 2019, a putative shareholder class action lawsuit was filed against the Company and our Chief Executive Officer in the U.S. District Court for the Eastern District of Pennsylvania. The initial complaint, which was filed by a plaintiff purportedly on behalf of all purchasers of our securities between April 11, 2017 and March 4, 2019, alleges violations of the federal securities laws in connection with the matters related to our EPS calculation practices. On September 17, 2019, the complaint was amended to, among other things, extend the Class Period to cover the period between April 8, 2014 and March 4, 2019, and to name additional individuals affiliated with the Company as defendants. The lead plaintiff seeks unspecified monetary damages and other relief on behalf of the plaintiff class.
While the Company is vigorously defending against all litigation claims asserted, this litigation—along with the ongoing SEC investigation—could result in substantial costs to the Company and a diversion of the Company’s management’s attention and resources, which could harm its business. In addition, the uncertainty of the pending lawsuit or liquidity. However,potential filing of additional lawsuits could lead to more volatility and a reduction in the Company’s stock price. Given the early stage of the litigation, at this time the Company is unable to reasonably estimate possible losses or form a judgment that an unfavorable outcome is either probable or remote.
In light of the uncertainties involved in such proceedings, the ultimate outcome of a particular matter could become material to the Company’s results of operations for a particular period depending on, among other factors, the size of the loss or liability imposed and the level of the Company’s operating income for that period.
Item 1A. Risk Factors
During the nine months ended September 30,The SEC’s investigation into our earnings per share (“EPS”) calculation practices could result in potential sanctions or penalties, distraction to our management and result in further litigation from third parties, each of which could adversely affect or cause variability in our financial results.
Beginning in November 2017, the Company has been in dialogue with the SEC regarding EPS calculation, rounding and reporting practices and in March 2018 we learned that the SEC had one client,opened a multi-state provider, which accounted for approximately 16%formal investigation into these matters. In response to the SEC’s investigation, during the fourth quarter of 2018, the Company authorized its outside counsel to conduct an internal investigation, under the direction of the Company’s total consolidated revenues,Audit Committee regarding these matters. The internal investigation was completed in March 2019 and another client which accountedprior to the filing of our Annual Report on Form 10-K for approximately 9%the fiscal year ended December 31, 2018.
Notwithstanding the completion of the Company’s total consolidated revenues. These are among several major clients that contribute significantly tointernal investigation, the Company’s total consolidated revenues. Although the Company expects to continue its relationships with these clients,SEC’s investigation is ongoing and there can be no assurance thereof.that the SEC or another regulatory body will not make further regulatory inquiries or pursue further action that could result in significant costs and expenses including potential sanctions or penalties as well as distraction to management. The loss, individually ongoing SEC investigation and/or any related litigation could adversely affect or cause variability in our financial results.
On March 22, 2019, a putative shareholder class action lawsuit alleging violations of the federal securities laws was filed against the Company and our Chief Executive Officer in the aggregate,U.S. District Court for the Eastern District of Pennsylvania in connection with the matters related to the SEC investigation. The class action complaint was amended on September 17, 2019. Please refer to “Item 1. Legal Proceedings” and “Note 15—Other Contingencies ” to the consolidated financial statements included in this Form 10-Q for more information. We cannot predict the outcome of the lawsuit, the magnitude of any potential losses or the effect such clients,litigation may have on us or aour operations. Regardless of the outcome, lawsuits and investigations involving us, or our current or former officers and directors, could result in significant reductionexpenses and divert attention and resources of our management and other key employees. We could be required to pay damages or other penalties or have injunctions or other equitable remedies imposed against us or our current or former directors and officers including any
obligation to indemnify our current and former directors and officers in connection with lawsuits, governmental investigations and related litigation or settlement amounts. Such amounts could exceed the revenuescoverage provided under our insurance policies. Any of these factors could harm our reputation, business, financial condition, results of operations or cash flows. In addition, the Company receivesmay be subject to further litigation from such clients, could have a material adverse effect onthird parties related to the Company’s results of operations. In addition, if any of these clients change or alter current payment terms, it could increasematters under review by the Company’s accounts receivable balance and have a material adverse effect on the Company’s cash flows.SEC.
There have been no other material changes in the risk factors set forth in Part I, Item 1A, “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.2018.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Other Information
On July 11, 2017, the Company entered into an Amended and Restated Committed Line of Credit Note to increase the existing bank line and letter of credit availability to $300 million. There were no other changes to the terms of the line of credit and amounts drawn under the line of credit remain payable upon demand. The proceeds available under the facility will be used for general corporate purposes.Not applicable.
Item 6. Exhibits
The following exhibits are filed as part of this Report:
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| | | | | | | |
Exhibit Number | | Description |
10.131.1 | | | |
31.1 | | |
31.2 | | | |
32.1 | | | |
101 | | The following financial information from the Company’s Form 10-Q for the quarterly period ended September 30, 20172019 formatted in iXBRL (Inline eXtensible Business Reporting Language (XBRL)Language): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Comprehensive Income, (iii) Consolidated Statements of Cash Flows, (iv) Consolidated Statement of Stockholders’ Equity, and (v) Notes to Consolidated Financial Statements |
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant had duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | | | | | | | | | | |
| | | HEALTHCARE SERVICES GROUP, INC. |
| | | |
Date: | October 25, 2019 | | HEALTHCARE SERVICES GROUP, INC. |
| | | |
Date: | October 27, 2017 | | /s/ Theodore Wahl |
| | | Theodore Wahl |
| | | President & Chief Executive Officer |
| | | (Principal Executive Officer) |
| | | |
Date: | October 27, 201725, 2019 | | /s/ John C. Shea |
| | | John C. Shea |
| | | Chief Financial Officer |
| | | (Principal Financial and Accounting Officer) |
| | | |