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, 2018March 31, 2019 and December 31, 20172018 and the notes accompanying those financial statements.
We provide management, administrative and operating expertise and services to the housekeeping, laundry, linen, facility maintenance and dietary service departments of 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 nation, rendering such services to over 3,500 facilities throughout the continental United States as of September 30, 2018.March 31, 2019.
We are organized into two reportable segments: housekeeping, laundry, linen and other services (“Housekeeping”), and dietary department services (“Dietary”).
Housekeeping consists of managing our clients’ housekeeping departments, which are principally responsible for the cleaning, disinfecting and sanitizing of resident rooms and common areas of 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, we will 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 our clients’ dietary departments, which are principally responsible for food purchasing, meal preparation and professional dietitian services, which include the development of menus that meet the dietary needs of residents. On-site management is responsible for all daily dietary department activities, with regular support being provided by a District Manager specializing in dietary services, as well as a registered dietitian.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 will 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.
Three Months Ended September 30,March 31, 2019 and 2018 and 2017
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, 2018March 31, 2019 and 2017.2018. 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.
| | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, | | | | |
| 2019 | | 2018 | | % Change |
| (in thousands) | | | | |
Revenues | | | | | |
Housekeeping 1 | $ | 233,134 | | $ | 245,161 | | (4.9) | % |
Dietary | 242,977 | | 255,401 | | (4.9) | % |
Consolidated | $ | 476,111 | | $ | 500,562 | | (4.9) | % |
| | | | | |
Costs of services provided | | | | | |
Housekeeping 1 | $ | 206,627 | | $ | 216,820 | | (4.7) | % |
Dietary | 227,552 | | 240,671 | | (5.5) | % |
Corporate and eliminations | (6,914) | | 11,761 | | (158.8) | % |
Consolidated | $ | 427,265 | | $ | 469,252 | | (8.9) | % |
| | | | | |
Selling, general and administrative expense | | | | | |
Corporate and eliminations | $ | 41,101 | | $ | 33,777 | | 21.7 | % |
| | | | | |
Investment and other income, net | | | | | |
Corporate and eliminations1 | $ | 5,203 | | $ | 1,796 | | 189.7 | % |
| | | | | |
Interest expense | | | | | |
Corporate and eliminations1 | $ | 1,056 | | $ | 724 | | 45.9 | % |
| | | | | |
Income (loss) before income taxes | | | | | |
Housekeeping | $ | 26,507 | | $ | 28,341 | | (6.5) | % |
Dietary | 15,425 | | 14,730 | | 4.7 | % |
Corporate and eliminations | (30,040) | | (44,466) | | 32.4 | % |
Consolidated | $ | 11,892 | | $ | (1,395) | | 952.5 | % |
|
| | | | | | | | | | |
| Three Months Ended September 30, |
| 2018 | | 2017 | | % Change |
| (in thousands) | | |
Revenues | | | | | |
Housekeeping | $ | 242,208 |
| | $ | 247,395 |
| | (2.1 | )% |
Dietary | 264,663 |
| | 243,960 |
| | 8.5 | % |
Consolidated | $ | 506,871 |
| | $ | 491,355 |
| | 3.2 | % |
| | | | | |
Costs of services provided | | | | | |
Housekeeping | $ | 215,002 |
| | $ | 220,547 |
| | (2.5 | )% |
Dietary | 248,384 |
| | 232,594 |
| | 6.8 | % |
Corporate and eliminations | (24,183 | ) | | (26,217 | ) | | (7.8 | )% |
Consolidated | $ | 439,203 |
| | $ | 426,924 |
| | 2.9 | % |
| | | | | |
Selling, general and administrative expense | | | | | |
Corporate and eliminations | $ | 36,713 |
| | $ | 32,940 |
| | 11.5 | % |
| | | | | |
Investment and interest income | | | | | |
Corporate and eliminations | $ | 2,027 |
| | $ | 1,439 |
| | 40.9 | % |
| | | | | |
Income (loss) before income taxes | | | | | |
Housekeeping | $ | 27,206 |
| | $ | 26,848 |
| | 1.3 | % |
Dietary | 16,279 |
| | 11,366 |
| | 43.2 | % |
Corporate and eliminations | (10,503 | ) | | (5,284 | ) | | 98.8 | % |
Consolidated | $ | 32,982 |
| | $ | 32,930 |
| | 0.2 | % |
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.
Housekeeping revenues represented approximately 47.8%49.0% of consolidated revenues for the three months ended September 30, 2018.March 31, 2019. Dietary revenues represented approximately 52.2%51.0% of consolidated revenues for the three months ended September 30, 2018.March 31, 2019.
The following table sets forth the ratio which certain items bear to consolidated revenues:
| | | | | | | | | | | |
| Three Months Ended March 31, | | |
| 2019 | | 2018 |
Revenues | 100.0 | % | | 100.0 | % |
Operating costs and expenses: | | | |
Costs of services provided | 89.7 | % | | 93.7 | % |
Selling, general and administrative expense | 8.6 | % | | 6.7 | % |
Other income (expense): | | | | | |
Investment and other income, net | 1.1 | % | | 0.4 | % |
Interest expense | (0.2) | % | | (0.1) | % |
Income (loss) before income taxes | 2.6 | % | | (0.1) | % |
Income tax (benefit) | 0.6 | % | | (0.3) | % |
Net income | 2.0 | % | | 0.2 | % |
|
| | | | | |
| Three Months Ended September 30, |
| 2018 | | 2017 |
Revenues | 100.0 | % | | 100.0 | % |
Operating costs and expenses: | | | |
Costs of services provided | 86.6 | % | | 86.9 | % |
Selling, general and administrative expense | 7.2 | % | | 6.7 | % |
Investment and interest income | 0.4 | % | | 0.3 | % |
Income before income taxes | 6.6 | % | | 6.7 | % |
Income taxes | 1.4 | % | | 1.9 | % |
Net income | 5.2 | % | | 4.8 | % |
Revenues
Consolidated
Consolidated revenues increased 3.2%decreased 4.9% to $506.9$476.1 million for the three months ended September 30, 2018March 31, 2019 compared to $491.4$500.6 million for the corresponding period in 2017,2018, as a result of the factors discussed below under Reportable Segments.
During the quarter ending September 30, 2018 we adjusted our contractual relationships with two regional customers as well as a number of independent facilities to reflect a reduced provision of services. Our expectation is the contract changes will impact housekeeping segment revenues by approximately $10 million per quarter, with half of the decrease being reflected in the quarter ending September 30, 2018, and will favorably impact future margins.
Reportable Segments
Housekeeping’s segment revenues decreased 2.1%4.9% compared to the corresponding period in 2017.2018. This was partially driven bythe Company's adjustment of its contracts with several customers during the three months ended March 31, 2019. Dietary revenues decreased 4.9% compared to the corresponding period in 2018 primarily from two regional customers as wellthe 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 numberresult, maintain the same benefits of independent facilities adjusting their contractual relationships with the Company during the quarter ending September 30, 2018. Dietary’s 8.5% net growth in reportable segment revenues resulted primarily from providing these services to existing Housekeeping clients.purchasing scale.
Costs of Services Provided
Consolidated
Consolidated costs of services provided increased 2.9%decreased 8.9% to $439.2$427.3 million for the three months ended September 30, 2018March 31, 2019 compared to $426.9$469.3 million for the three months ended September 30, 2017, which is primarily related to our 3.2% growth in consolidated revenues for the same period. As a percentage of consolidated revenues, costs of services provided decreased to 86.6% in the three months ended September 30,March 31, 2018 from 86.9% in the corresponding period in 2017..
Certain significant components within our costs of services provided 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 provided. See the discussion under Reportable Segments below for additional information on the changes in the components of costs of services provided.
The following table provides a comparison of key indicators we consider when managing the consolidated costs of services provided:
| | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended March 31, | | | | |
Costs of Services Provided - Key Indicators as a % of Consolidated Revenue | | 2019 | | 2018 | | Change |
Bad debt provision | | 3.9% | | | 7.4% | | | (3.5)% | |
Self-insurance costs | | 2.4% | | | 2.6% | | | (0.2)% | |
|
| | | | | | |
| | Three Months Ended September 30, |
Costs of Services Provided - Key Indicators as a % of Consolidated Revenue | | 2018 | | 2017 | | Change |
Bad debt provision | | 0.6% | | 0.4% | | 0.2% |
Self-insurance costs | | 2.7% | | 2.6% | | 0.1% |
The increasedecrease in the bad debt provision is related to our current assessment of the collectability of our accounts and notes receivable.receivable in the first quarter of 2019. The first quarter of 2018 related to corporate restructurings of two privately-held, multi-state operators. Our provision for the three months ended March 31, 2019 of $18 million was primarily related to the out-of-court restructuring of a privately held Northeast based operator.
Reportable Segments
Costs of services provided for Housekeeping, as a percentage of Housekeeping revenues, decreasedincreased to 88.8%88.6% for the three months ended September 30, 2018March 31, 2019 from 89.1%88.4% in the corresponding period in 2017.2018. Costs of services provided for Dietary, as a percentage of Dietary revenues, decreased to 93.8%93.7% for the three months ended September 30, 2018March 31, 2019 from 95.3%94.2% in the corresponding period in 2017.2018.
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:
| | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended March 31, | | | | |
Costs of Services Provided - Key Indicators as a % of Segment Revenue | | 2019 | | 2018 | | Change |
Housekeeping labor and other labor-related costs | | 79.1% | | | 78.8% | | | 0.3% | |
Housekeeping supplies | | 7.7% | | | 7.9% | | | (0.2)% | |
Dietary labor and other labor-related costs | | 61.7% | | | 56.3% | | | 5.4% | |
Dietary supplies | | 29.6% | | | 35.9% | | | (6.3)% | |
|
| | | | | | |
| | Three Months Ended September 30, |
Costs of Services Provided - Key Indicators as a % of Segment Revenue | | 2018 | | 2017 | | Change |
Housekeeping labor and other labor-related costs | | 78.4% | | 79.6% | | (1.2)% |
Housekeeping supplies | | 7.8% | | 7.9% | | (0.1)% |
Dietary labor and other labor-related costs | | 56.3% | | 58.0% | | (1.7)% |
Dietary supplies | | 34.4% | | 35.4% | | (1.0)% |
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 reduction in dietary supplies cost was primarily a result of a modification of our contractual relationship with Genesis, which was effective December 1, 2018 and whereby Genesis assumed responsibility for direct payment to suppliers for food purchases.
Consolidated Selling, General and Administrative Expense
Excluding the change in the deferred compensation plan described below, consolidated selling, general and administrative expense increased $3.3 million or 10.2% during the three months ended September 30, 2018 compared to the corresponding period in 2017. Selling, general and administrative expense was reported at 7.2% of revenues, but after adjusting for the $1.6 million change in deferred compensation, actual expense was 6.9% of consolidated revenues. During the quarter, selling, general and administrative expense was also impacted by a $3 million, state-specific sales tax settlement. The settlement, related to certain of the Company’s historical client service billings, resolved the outstanding sales tax considerations and accordingly, will have no impact on future earnings per share. Going forward, the Company expects selling, general and administrative expense to approximate 6.75% of consolidated revenues, with the on-going opportunity to garner additional efficiencies.
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 three months ended September 30,March 31, 2019 and 2018 and 2017 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 $4.1 million or 12.3%, to 7.9% of consolidated revenues, for three months ended March 31, 2019 compared to the corresponding period in 2018. The increase was primarily a result of increased legal and other professional fees incurred during the first quarter of 2019 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:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, | | | | | | |
| 2019 | | 2018 | | $ Change | | % Change |
| (in thousands) | | | | | | |
Selling, general and administrative expense excluding change in deferred compensation liability | $ | 37,683 | | $ | 33,546 | | $ | 4,137 | | 12.3 | % |
Gain on deferred compensation plan investments | 3,418 | | 231 | | 3,187 | | 1,379.7 | % |
Selling, general and administrative expense | $ | 41,101 | | $ | 33,777 | | $ | 7,324 | | 21.7 | % |
|
| | | | | | | | | | | | | | |
| Three Months Ended September 30, |
| 2018 | | 2017 | | $ Change | | % Change |
| (in thousands) | | |
Selling, general and administrative expense excluding change in deferred compensation liability | $ | 35,139 |
| | $ | 31,878 |
| | $ | 3,261 |
| | 10.2 | % |
Gain on deferred compensation plan investments | 1,574 |
| | 1,062 |
| | 512 |
| | 48.2 | % |
Selling, general and administrative expense | $ | 36,713 |
| | $ | 32,940 |
| | $ | 3,773 |
| | 11.5 | % |
Consolidated Investment and InterestOther Income, net
Investment and interest other income increased 40.9%189.7% for the three months ended September 30, 2018March 31, 2019 compared to the corresponding 20172018 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. Refer to Note 1—Description of Business and Significant Accounting Policies herein for additional disclosure regarding the reclassification.
Consolidated Interest Expense
Consolidated interest expense increased 45.9% for the three months ended March 31, 2019 compared to the corresponding 2018 period, due to an increase in the Company's interest rate under its $475 million bank line of credit compared to the Company's previous credit agreement which expired during the fourth quarter of 2018.
Consolidated Income Taxes
During the three months ended September 30, 2018,March 31, 2019, the Company recognized a provision for income taxes of $6.9$2.7 million versus a provision for n income taxestax benefit of $9.5$1.5 million for the same period in 2017. On December 22, 2017, the U.S. enacted the Tax Cuts and Jobs Act, which lowered our U.S. statutory federal income tax rate from 35% to 21% effective January 1, 2018.
Our 2018 estimated annual effective tax rate is expected to be approximately 21% to 23%. 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 recognized from such discrete itemsprovision for the three months ended September 30, 2018 was immaterial.
Nine Months Ended September 30, 2018 and 2017
The following table summarizes the income statement key components that we use to evaluate our financial performance on a consolidated and reportable segment basis,March 31, 2019 for the nine months ended September 30, 2018 and 2017. 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, |
| 2018 | | 2017 | | % Change |
| (in thousands) | | |
Revenues | | | | | |
Housekeeping | $ | 734,164 |
| | $ | 733,737 |
| | 0.1 | % |
Dietary | 778,249 |
| | 632,984 |
| | 22.9 | % |
Consolidated | $ | 1,512,413 |
| | $ | 1,366,721 |
| | 10.7 | % |
| | | | | |
Costs of services provided | | | | | |
Housekeeping | $ | 648,943 |
| | $ | 662,213 |
| | (2.0 | )% |
Dietary | 731,669 |
| | 598,251 |
| | 22.3 | % |
Corporate and eliminations | (33,887 | ) | | (80,648 | ) | | (58.0 | )% |
Consolidated | $ | 1,346,725 |
| | $ | 1,179,816 |
| | 14.1 | % |
| | | | | |
Selling, general and administrative expense | | | | | |
Corporate and eliminations | $ | 104,608 |
| | $ | 93,141 |
| | 12.3 | % |
| | | | | |
Investment and interest income | | | | | |
Corporate and eliminations | $ | 3,823 |
| | $ | 4,523 |
| | (15.5 | )% |
| | | | | |
Income (loss) before income taxes | | | | | |
Housekeeping | $ | 85,221 |
| | $ | 71,524 |
| | 19.2 | % |
Dietary | 46,580 |
| | 34,733 |
| | 34.1 | % |
Corporate and eliminations | (66,898 | ) | | (7,970 | ) | | 739.4 | % |
Consolidated | $ | 64,903 |
| | $ | 98,287 |
| | (34.0 | )% |
Housekeeping revenues represented 48.5% of consolidated revenues for the nine months ended September 30, 2018. Dietary revenues represented approximately 51.5% of consolidated revenues for the nine months ended September 30, 2018.
The following table sets forth the ratio which certain items bear to consolidated revenues:
|
| | | | | |
| Nine Months Ended September 30, |
| 2018 | | 2017 |
Revenues | 100.0 | % | | 100.0 | % |
Operating costs and expenses: | | | |
Costs of services provided | 89.0 | % | | 86.3 | % |
Selling, general and administrative expense | 6.9 | % | | 6.8 | % |
Investment and interest income | 0.3 | % | | 0.3 | % |
Income before income taxes | 4.4 | % | | 7.2 | % |
Income taxes | 0.9 | % | | 2.2 | % |
Net income | 3.5 | % | | 5.0 | % |
Revenues
Consolidated
Consolidated revenues increased 10.7% to $1.5 billion for the nine months ended September 30, 2018 compared to $1.4 billion for the corresponding period in 2017 as a result of the factors discussed below under Reportable Segments.
During the quarter ending September 30, 2018 we adjusted our contractual relationships with two regional customers as well as a number of independent facilities to reflect a reduced provision of services. Our expectation is the contract changes will impact housekeeping segment revenues by approximately $10 million per quarter, with half of the decrease being reflected in the quarter ending September 30, 2018, and will favorably impact future margins.
Reportable Segments
Housekeeping’s 0.1% net growth in reportable segment revenues resulted from service agreements entered into with new clients. This growth was also offset from two regional customers as well as a number of independent facilities adjusting their contractual relationships with the Company. Dietary’s 22.9% 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 14.1% to $1.3 billion for the nine months ended September 30, 2018 compared to $1.2 billion for the nine months ended September 30, 2017, which is primarily related to our 10.7% growth in consolidated revenues for the same period. As a percentage of consolidated revenues, costs of services increasedto 89.0% in the nine months ended September 30, 2018 from 86.3% in the corresponding period in 2017.
Certain significant components within our costs of services provided 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 provided. See the discussion under Reportable Segments below for additional information on the changes in the components of costs of services provided.
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 | | 2018 | | 2017 | | Change |
Bad debt provision | | 2.8% | | 0.3% | | 2.5% |
Self-insurance costs | | 2.6% | | 2.7% | | (0.1)% |
The increase in the bad debt provision is related to the first quarter 2018 increase to the accounts receivable allowance, which was primarily related to the corporate restructuring of two privately-held multi-state operators.
Reportable Segments
Costs of services provided for Housekeeping, as a percentage of Housekeeping revenues, decreased to 88.4% for the nine months ended September 30, 2018 from 90.3% in the corresponding period in 2017. Costs of services provided for Dietary, as a percentage of Dietary revenues, decreased to 94.0% for the nine months ended September 30, 2018 from 94.5% in the corresponding period in 2017.
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 | | 2018 | | 2017 | | Change |
Housekeeping labor and other labor-related costs | | 78.4% | | 80.0% | | (1.6)% |
Housekeeping supplies | | 7.9% | | 8.0% | | (0.1)% |
Dietary labor and other labor-related costs | | 56.8% | | 55.9% | | 0.9% |
Dietary supplies | | 34.7% | | 36.6% | | (1.9)% |
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.
Selling, General and Administrative Expense
Excluding the change in the deferred compensation plan described below, consolidated selling, general and administrative expense increased $12.2 million or 13.5% during the nine months ended September 30, 2018 compared to the corresponding period in 2017, related primarily to our overall growth. Selling, general and administrative expense, excluding the change in the deferred compensation plan, increased to 6.7% of consolidated revenues for the nine months ended September 30, 2018 compared to 6.6% in the corresponding period in 2017.
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, 2018 and 2017 increased our total 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, |
| 2018 | | 2017 | | $ Change | | % Change |
| (in thousands) | | |
Selling, general and administrative expense excluding change in deferred compensation liability | $ | 101,916 |
| | $ | 89,766 |
| | $ | 12,150 |
| | 13.5 | % |
Gain on deferred compensation plan investments | 2,692 |
| | 3,375 |
| | (683 | ) | | (20.2 | )% |
Selling, general and administrative expense | $ | 104,608 |
| | $ | 93,141 |
| | $ | 11,467 |
| | 12.3 | % |
Consolidated Investment and Interest Income, net
Investment and interest income decreased 15.5% for the nine months ended September 30, 2018 compared to the corresponding 2017 period, primarily due to higher interest costs associated with our short–term borrowings. Partially offsetting the decrease in investment and interest income, net was higher interest received on our outstanding notes receivable.
Consolidated Income Taxes
For the nine months ended September 30, 2018, the Company recognized a provision for income taxes of $12.9 million versus a provision for income taxes of $30.2 million for the same period in 2017. On December 22, 2017, the U.S. enacted the Tax Cuts and Jobs Act, which lowered our U.S. statutory federal income tax rate from 35% to 21% effective January 1, 2018.
The 2018 estimated annual effective tax rate is expected to be approximately 21% to 23%. 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 of such discrete items was a $1.2 million income tax benefit for the nine months ended September 30, 2018.approximately $0.1 million.
Liquidity and Capital Resources
Cash generated through operations is our primary source of liquidity. At September 30, 2018,March 31, 2019, we had cash, cash equivalents and marketable securities of $89.9$106.9 million and working capital of $341.8$349.5 million, compared to December 31, 20172018 cash, cash equivalents and marketable securities of $82.8$102.4 million and working capital of $343.2 million. The decrease in working capital was driven by a decrease in the Company’s net receivables, primarily as a result of the increase in the accounts receivable allowance as of September 30, 2018 compared with December 31, 2017. As of September 30, 2018, we had an unused line of credit of $224.2$344.7 million. Our current ratio was 3.13.0 to 1 at September 30, 2018March 31, 2019 versus 2.93.1 to 1 at December 31, 2017.2018.
For the ninethree months ended September 30,March 31, 2019 and 2018, and 2017, our cash flows were as follows:
| | | | | | | | | | | |
| Three Months Ended March 31, | | |
| 2019 | | 2018 |
| (in thousands) | | |
Net cash provided by operating activities | $ | 17,577 | | $ | 23,931 |
Net cash used in investing activities | $ | (2,010) | | $ | (4,202) |
Net cash used in financing activities | $ | (13,230) | | $ | (18,797) |
|
| | | | | | | |
| Nine Months Ended September 30, |
| 2018 | | 2017 |
| (in thousands) |
Net cash provided by operating activities | $ | 74,509 |
| | $ | 3,122 |
|
Net cash used in investing activities | $ | (7,621 | ) | | $ | (10,077 | ) |
Net cash used in financing activities | $ | (61,248 | ) | | $ | (5,893 | ) |
Operating Activities
Our primary sources of cash from operating activities are the revenues generated from our Housekeeping and Dietary services. Our primary uses of cash from 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
Our 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 2018,2019, we paid regular quarterly cash dividends to shareholders totaling $42.7$14.6 million as follows:
| | | | | |
| Quarter Ended |
| March 31, 2019 |
| (amounts in thousands, except per share data) |
Cash dividend paid per common share | $ | 0.19625 |
Total cash dividends paid | $ | 14,588 |
Record date | February 15, 2019 |
Payment date | March 22, 2019 |
|
| | | | | | | | | | | |
| Quarter Ended |
| March 31, 2018 | | June 30, 2018 | | September 30, 2018 |
| (amounts in thousands, except per share data) |
Cash dividend paid per common share | $ | 0.19125 |
| | $ | 0.19250 |
| | $ | 0.19375 |
|
Total cash dividends paid | $ | 14,149 |
| | $ | 14,249 |
| | $ | 14,350 |
|
Record date | February 16, 2018 |
| | May 25, 2018 |
| | August 24, 2018 |
|
Payment date | March 23, 2018 |
| | June 29, 2018 |
| | September 28, 2018 |
|
The dividends paid to shareholders during the ninethree months ended September 30, 2018March 31, 2019 were funded by cash 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 future dividend payments, we expect to continue to pay a regular quarterly cash dividend.
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, 2018March 31, 2019 relates
to cash flow requirements due to the timing of cash receipts and cash payments. Another source of cash from financing activities are the proceeds from the exercise of stock options by employees and directors. In connection with the establishment of our dividend policy, we adopted a Dividend Reinvestment Plan in 2003.
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,March 31, 2019 and 2018, and 2017, 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, 2018March 31, 2019 and 2017.2018.
Line of Credit
At September 30, 2018,March 31, 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 and generally bear interest at a floating rate, based on our leverage ratio, and starting at LIBOR plus 75115 basis points.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, 2018,March 31, 2019, there were $10.0$30.0 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 March 31, 2019 were as follows:
| | | | | | | | |
Covenant Descriptions and Requirements | | As of March 31, 2019 |
Funded debt 1 to EBITDA 2 ratio: less than 3.50 to 1.00 | | 0.49 |
EBITDA to Interest Expense ratio: not less than 3.00 to 1.00 | | 38.55 |
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 March 31, 2019 and we expect to remain in compliance. The line of credit expires on December 21, 2023.
At September 30, 2018,March 31, 2019, we also had outstanding $65.9$62.7 million in irrevocable standby letters of credit, which relate to payment obligations under our insurance programs. In connection with the issuance
The line of credit requires us to satisfy one financial covenant. The covenant and its respective status at September 30, 2018 was as follows:
|
| | | |
Covenant Description and Requirement | | As of September 30, 2018 |
Funded debt(1) to EBITDA(2) ratio: less than 3.00 to 1.00
| | 0.68 |
|
| |
(1)
| All indebtedness for borrowed money including, but not limited to, 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. |
As noted above, we were in compliance with our financial covenant at September 30, 2018 and we expect to remain in compliance. The line of credit expires on December 18, 2018. Although no assurances can be provided that we will renew the line of credit or secure other financing, we expect the line of credit to be renewed prior to expiration, or substituted with another form of financing.
Accounts and Notes Receivable
Decisions to grant or to extend credit to customers are made on a case-by-case basis and 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 healthcare industry.
Fluctuations 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.
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 memorializing the amount and related payment schedule as well as securing additional business protections and guarantees.
Summarized below are the balances in our allowance for doubtful accounts, along with the provision for bad debts and net write-offs for each quarter for the ninethree months ended September 30, 2018. The change in our provision from during the first quarter of 2018 is primarily related to the corporate restructuring of two privately–held multi– state operators.March 31, 2019. The aggregate client account balances to which the reserve balances relate totaled $30.0 million, $98.2 million, $102.6$115.7 million and $103.0$133.8 million as of December 31, 2017,2018 and March 31, 2018, June 30, 2018 and September 30, 2018,2019, 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 |
|
| | | |
| Allowance for Doubtful Accounts |
| (in thousands) |
Balance December 31, 2017 | $ | 11,984 |
|
Provision for bad debts | 37,137 |
|
Net write-offs of client accounts receivable | (216 | ) |
Balance March 31, 2018 | 48,905 |
|
Provision for bad debts | 2,250 |
|
Net write-offs of client accounts receivable | (1,446 | ) |
Balance June 30, 2018 | 49,709 |
|
Provision for bad debts | 3,000 |
|
Net write-offs of client accounts receivable | (4,079 | ) |
Balance September 30, 2018 | $ | 48,630 |
|
We evaluate our notes receivable for impairment quarterly and 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. The increase in
A summary schedule of our impaired notes receivable and the related reserve during the nine months ended September 30, 2018 was related to the corporate restructuring of a privately held, multi-state operator that occurred during the first quarter of 2018. A result of the corporate restructuring was a long-term promissory note receivable of $10.0 million,, net of interest, and therelated reserve which was finalized during of such notes, for the three months ended September 30, 2018.
A summary schedule of the our impaired notes receivable, and the related reserve, for the nine months ended September 30, 2018March 31, 2019 is as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| Balance December 31, 2018 | | Additions | | Deductions | | Balance March 31, 2019 |
| (in thousands) | | | | | | |
Impaired notes receivable | $ | 25,704 | | $ | 3,726 | | $ | (527) | | $ | 28,903 |
Reserve for impaired notes receivable | $ | 13,472 | | $ | 2,546 | | $ | (497) | | $ | 15,521 |
|
| | | | | | | | | | | | | | | |
| Balance December 31, 2017 | | Additions | | Deductions | | Balance September 30, 2018 |
| (in thousands) |
Impaired notes receivable | $ | 6,854 |
| | $ | 20,582 |
| | $ | (4,532 | ) | | $ | 22,904 |
|
Reserve for impaired notes receivable | $ | 2,884 |
| | $ | 10,846 |
| | $ | (1,938 | ) | | $ | 11,792 |
|
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 2018,2019, we estimate that for 20182019 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.
Critical 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 March18, 2019.
In preparing our financial statements, management is required to make estimates and assumptions that, among other things, affect the reported amounts of 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, 2018,March 31, 2019, we had $89.9$106.9 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, 2018,March 31, 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 continued to evaluate the design and operating effectiveness of these internal controls during the first 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 quarter ended September 30, 2018 were identifiedMarch 31, 2019 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, the “CompanyCompany 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.
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 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. The plaintiffs seek unspecified monetary damages and other relief.
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
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 opened a 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 Audit Committee regarding these matters. The internal investigation was completed in March 2019 and prior to the filing of our Annual Report on Form 10-K.
Notwithstanding the completion of the internal investigation, the SEC’s investigation is ongoing and there can be no assurance 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 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 U.S. District Court for the Eastern District of Pennsylvania in connection with the matters related to the SEC investigation. 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 litigation may have on us or our operations. Regardless of the outcome, lawsuits and investigations involving us, or our current or former officers and directors, could result in significant expenses 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 coverage 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 may be subject to further litigation from third parties related to the matters under review by the 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, 2017.2018.
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
Not applicable.
Item 6. Exhibits
The following exhibits are filed as part of this Report:
|
| | | | | | | |
Exhibit Number | | Description |
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, 2018March 31, 2019 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: | May 3, 2019 | | HEALTHCARE SERVICES GROUP, INC./s/ Theodore Wahl |
| | | Theodore Wahl |
Date: | October 19, 2018 | | /s/ Theodore Wahl |
| | | Theodore Wahl |
| | | President & Chief Executive Officer |
| | | (Principal Executive Officer) |
| | | |
Date: | October 19, 2018May 3, 2019 | | /s//s/ John C. Shea |
| | | John C. Shea |
| | | Chief Financial Officer |
| | | (Principal Financial and Accounting Officer) |
| | | |