In March 2017, we published our initial article about outsourced healthcare services company Healthcare Services Group (HCSG), and how it appeared that the company had been actively engaging FOR OVER A DECADE in aggressive accounting by fiddling with its revenues and/or expenses in order to ensure that its earnings per share rounded up to the nearest penny every quarter. This helped enable the company to meet or beat the consensus sell-side earnings expectation most quarters, which in turn helped the company achieve a premium earnings multiple for the stock. Arguably, this allowed founder and Chairman Daniel McCartney to personally realize millions of dollars more for the stock that he sold to the public than he otherwise would have.

In our article, we informed readers that “we have alerted the Securities and Exchange Commission to the extreme outlier nature of HCSG’s reported EPS history, and will let that agency determine if HCSG’s accounting practices require a deeper dive.” Our follow-up article in April 2017 stated that “this troubling pattern should give investors considerable pause, and should result in investors questioning, in a very serious manner, among others, HCSG’s CFO John Shea, HCSG’s entire finance and accounting organization, HCSG’s Audit Committee (Robert Moss, John Briggs, and Dino Ottaviano), and HCSG’s auditor (Grant Thornton), about the company’s accounting processes, and checks & balances.”

Well, it appears that the SEC took our concerns seriously. HCSG disclosed on Monday that it received a letter from the SEC in November 2017 inquiring about the company’s EPS rounding practices, and then received a subpoena last March. Furthermore, during the fourth quarter of 2018, HCSG authorized its outside counsel to conduct an internal investigation, under the direction of the Company’s Audit Committee, into these matters. As a result, HCSG is unable to file its Annual Report on form 10-K on time.

We suspected that something was afoot, because shortly after we published our article and informed the company, the company’s sell-side analysts, and the SEC of our findings, HCSG appeared to dramatically amend its practice of managing its quarterly earnings per share:

As well, the Wall Street Journal reported last summer that, according to people familiar with the matter, “[e]nforcement officials at the Securities and Exchange Commission have sent queries to at least 10 companies, asking the firms to provide information about accounting adjustments that could push their reported earnings per share higher.” Based on our in-depth analysis of historical earnings data for all publicly-traded companies, we were highly confident that the SEC would never find a more outlandish “strategic rounding” offender than it would in HCSG. As a result, we knew with certainty that HCSG would have been on this short list of companies to which the SEC sent queries.

It is difficult to conclude with any certainty what will become of the SEC’s investigation and HCSG’s internal investigation into this matter. However, we can state with absolute certainty that investors have not heard the last of this. We would not be at all surprised if senior executives at the company lose their jobs and if the company and its executives eventually enter into settlement agreements with the SEC that result in meaningful financial payments to the government. As well, the legal costs that the company ends up incurring will most certainly be meaningful.

When we published our articles on this matter in 2017, we became the objects of derision, both in the comments sections of our articles and offline, by many people who were invested in the company. We attempted to make the point that “if HCSG’s management has been willing to manipulate its EPS in this manner for over a decade, what else might it be willing to do to achieve higher valuation multiples”; however, our argument fell on many deaf ears, as HCSG’s stock continued to soar throughout 2017. Including Monday’s $366 million of value destruction, HCSG has now underperformed the S&P 500 by more than 40% since we published our initial article. This goes to show that sometimes it’s worth paying attention to the details when analyzing one’s investments.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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2019-03-04