UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended
JuneSeptember 30, 2004Commission File Number 0-120152
HEALTHCARE SERVICES GROUP, INC.
------------------------------------------------------ (Exact
(Exact name of registrant as specified in its charter)Pennsylvania 23-2018365 - ------------------------------- ---------------------------- (State or other jurisdiction of (IRS Employer Identification incorporation or organization) number) 3220 Tillman Drive-Suite 300, Bensalem, Pennsylvania 19020 ----------------------------------------------------------- (Address of principal executive office) (Zip code)
Pennsylvania 23-2018365 (State or other jurisdiction of incorporation or organization) (IRS Employer Identification number) 3220 Tillman Drive-Suite 300, Bensalem, Pennsylvania 19020 (Address of principal executive office) (Zip code) Registrant's telephone number, including area code:215-639-4274
------------Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months
( or(or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for past 90 days.YES X NO ----- -----
YES NO Indicate by check mark whether the registrant is an Accelerated Filer (as defined in Rule 12b-2 of the Exchange Act)
YES X NO ----- -----
YES NO Number of shares of common stock outstanding as of
July 26,October 21, 2004 is17,198,30518,422,511
INDEX
-1-
PART I. FINANCIALINFORMATION
PAGE NO. --------------------- --------Item 1.
Financial Statements (Unaudited)FINANCIAL STATEMENTSConsolidated Balance Sheets
as of June 30, 2004 and December 31, 2003 2
(Unaudited) September 30, December 31, 2004 2003 ASSETS CURRENT ASSETS: Cash and cash equivalents $ 71,190,394 $ 64,180,697 Accounts and notes receivable, less allowance for doubtful accounts of $2,683,000 in 2004 and $3,414,000 in 2003 57,293,109 58,145,440 Prepaid income taxes 237,652 — Inventories and supplies 10,766,645 10,454,838 Deferred income taxes 2,092,879 2,016,798 Prepaid expenses and other 3,780,268 3,312,959 Total current assets 145,360,947 138,110,732 PROPERTY AND EQUIPMENT: Laundry and linen equipment installations 2,251,913 2,190,388 Housekeeping and office equipment 13,714,582 12,830,794 Autos and trucks 79,639 79,639 16,046,134 15,100,821 Less accumulated depreciation 11,210,537 10,489,224 4,835,597 4,611,597 NOTES RECEIVABLE- long term portion 4,683,035 7,904,195 DEFERRED COMPENSATION FUNDING 3,550,023 2,847,575 DEFERRED INCOME TAXES- long term portion 3,657,410 3,134,691 OTHER NONCURRENT ASSETS 2,527,827 1,719,342 $ 164,614,839 $ 158,328,132 LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 5,355,972 $ 6,536,395 Accrued payroll, accrued and withheld payroll taxes 10,611,465 14,127,469 Other accrued expenses 2,868,643 874,523 Income taxes payable — 178,862 Accrued insurance claims 3,982,139 2,978,974 Total current liabilities 22,818,219 24,696,223 ACCRUED INSURANCE CLAIMS- long term portion 9,334,813 8,936,921 DEFERRED COMPENSATION LIABILITY 4,530,485 3,496,810 COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Common stock, $.01 par value: 45,000,000 shares authorized, 18,419,534 shares issued in 2004 and 17,938,613 in 2003 184,195 179,386 Additional paid in capital 38,600,027 33,515,234 Retained earnings 98,555,661 91,178,370 Common stock in treasury, at cost, 988,864 shares in 2004 and 652,238 in 2003 (9,408,561 ) (3,674,812 ) Total stockholders' equity 127,931,322 121,198,178 $ 164,614,839 $ 158,328,132 See accompanying notes.
-2-
Consolidated Statements of Income
for the Three Months Ended June 30, 2004 and 2003 3
(Unaudited)
For the Three Months
Ended September 30,2004 2003 Revenues $ 112,324,057 $ 95,878,338 Operating costs and expenses: Costs of services provided 98,643,843 84,347,689 Selling, general and administrative 7,966,903 7,413,050 Other Income: Investment and interest income 292,346 368,610 Income before income taxes 6,005,657 4,486,209 Income taxes 2,282,000 1,683,000 Net Income $ 3,723,657 $ 2,803,209 Basic earnings per common share $ 0.21 $ 0.16 Diluted earnings per common share $ 0.20 $ 0.16 Cash dividends per common share $ 0.07 $ 0.04 Basic weighted average number of common shares outstanding 17,393,200 17,109,626 Diluted weighted average number of common shares outstanding 18,346,738 17,894,141 See accompanying notes
-3-
Consolidated Statements of Income
for the Six Months Ended June 30, 2004 and 2003 4
(Unaudited)
For the Nine Months
Ended September 30,2004 2003 Revenues $ 329,435,363 $ 278,215,404 Operating costs and expenses: Costs of services provided 289,432,712 244,674,740 Selling, general and administrative 23,742,582 21,285,724 Other Income: Investment and interest income 792,093 758,692 Income before income taxes 17,052,162 13,013,632 Income taxes 6,480,000 5,004,000 Net Income $ 10,572,162 $ 8,009,632 Basic earnings per common share $ 0.61 $ 0.47 Diluted earnings per common share $ 0.57 $ 0.45 Cash dividends per common share $ 0.18 $ 0.04 Basic weighted average number of common shares outstanding 17,453,185 16,978,541 Diluted weighted average number of common shares outstanding 18,416,779 17,661,516 See accompanying notes
-4-
Consolidated Statements of Cash Flows
for the Six Months ended June 30, 2004 and 2003 5 Consolidated Statement of Stockholders' Equity for the Six Months ended June 30, 2004 6 Notes To Consolidated Financial Statements 7 - 12 Item 2. Management's Discussion and Analysis of Financial Condition and Results Of Operations 13 - 21 Item 3. Quantitative and Qualitative Disclosures About Market Risk 21 Item 4. Controls and Procedures 22 PART II. OTHER INFORMATION ----------------- Item 1. Legal Proceedings 23 Item 2. Changes in Securities, Use of Proceeds And Issuer Purchases of Equity Securities 23 Item 3. Defaults Upon Senior Securities 23 Item 4. Submission of Matters
(Unaudited)
For the Nine Months
Ended September 30,2004 2003 Cash flows from operating activities: Net Income $ 10,572,162 $ 8,009,632 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 1,394,643 1,427,521 Bad debt provision 2,600,000 3,800,000 Deferred income tax benefits (598,800 ) (106,200 ) Tax benefit of stock option transactions 1,687,554 682,356 Unrealized gain on deferred compensation fund investments (73,942 ) (132,655 ) Changes in operating assets and liabilities: Accounts and notes receivable (1,747,670 ) (4,345,288 ) Prepaid income taxes (237,652 ) 883,282 Inventories and supplies (311,807 ) (1,029,520 ) Notes receivable- long term 3,221,159 1,553,653 Deferred compensation funding (628,506 ) (724,674 ) Accounts payable and other accrued expenses 813,697 835,535 Accrued payroll, accrued and withheld payroll taxes (3,149,827 ) (3,075,605 ) Deferred compensation liability 1,033,675 1,029,924 Income taxes payable (178,862 ) 699,937 Accrued insurance claims 1,401,057 2,357,096 Prepaid expenses and other assets (1,275,792 ) (1,114,258 ) Net cash provided by operating activities 14,521,089 10,750,736 Cash flows from investing activities: Disposals of fixed assets 266,534 149,154 Additions to property and equipment (1,885,177 ) (1,549,688 ) Net cash used in investing activities (1,618,643 ) (1,400,534 ) Cash flows from financing activities: Dividends paid (3,194,871 ) (686,789 ) Purchase of treasury stock (5,999,467 ) (163,448 ) Reissue of treasury stock pursuant to Dividend Reinvestment Plan 6,657 422 Proceeds from the exercise of stock options 3,294,932 1,852,402 Net cash provided by (used in) financing activities (5,892,749 ) 1,002,587 Net increase in cash and cash equivalents 7,009,697 10,352,789 Cash and cash equivalents at beginning of the period 64,180,697 48,320,098 Cash and cash equivalents at end of the period $ 71,190,394 $ 58,672,887 Supplementary Cash Flow Information: Issuance of 48,224 shares of Common Stock in 2004 and 36,212 shares of Common Stock in 2003 pursuant to Employee Stock Plans $ 366,177 $ 205,199 -5-
Consolidated Statements of Stockholders' Equity
(Unaudited)
For the SixNine Months EndedJuneSeptember 30, 2004-------------------------------------- Additional Total Common Stock Paid-in Retained Treasury Stockholders' Shares Amount Capital Earnings Stock Equity ------ ------ ---------- -------- -------- -------------Balance, December 31, 2003 17,938,613 $179,386 $33,515,234 $91,178,370 ($3,674,812) $121,198,178 Net income 6,848,503 6,848,503 Exercise of stock options 215,387 2,154 1,386,418 1,388,572 Tax benefit arising from stock option transactions 642,912 642,912 Purchase of common stock for treasury (359,798 shares) (5,617,004) (5,617,004) Shares issued pursuant to Employee Stock Plans (48,224 shares) 94,478 271,699 366,177 Cash dividends paid - $.11 per common share (1,984,799) (1,984,799) Shares issued pursuant to Dividend Reinvestment Plan (247 shares) 2,123 1,561 3,684 ---------- -------- ----------- ----------- ----------- ------------ Balance, June 30, 2004 18,154,000 $181,540 $35,641,165 $96,042,074 ($9,018,556) $122,846,223 ========== ======== =========== =========== =========== ============See accompanying notes.
Common Stock Additional Total Paid-in Retained Treasury Stockholders' Shares Amount Capital Earnings Stock Equity Balance, December 31, 2003 17,938,613 $ 179,386 $ 33,515,234 $ 91,178,370 $ (3,674,812 ) $ 121,198,178 Net income 10,572,162 10,572,162 Exercise of stock options
480,921 4,809 3,298,997 (8,874 ) 3,294,932 Tax benefit arising from stock option transactions 1,687,554 1,687,554 Purchase of common stock for treasury
(384,753 shares)(5,999,467 ) (5,999,467 ) Shares issued pursuant to Employee Stock Plans (48,224 shares) 94,478 271,699 366,177 Cash dividends paid - $.18 per common share (3,194,871 ) (3,194,871 ) Shares issued pursuant to Dividend Reinvestment Plan (425 shares)3,764 2,893 6,657 Balance, September 30, 2004 18,419,534 $ 184,195 $ 38,600,027 $ 98,555,661 $ (9,408,561 ) $ 127,931,322 See accompanying notes -6-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
(Unaudited)NOTENote 1
- BASIS OF REPORTING— Basis of ReportingThe accompanying financial statements are unaudited and do not include certain information and note disclosures required by generally accepted accounting principles for complete financial statements. However, in our opinion , all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. The balance sheet shown in this report as of December 31, 2003 has been derived from, and does not include, all the disclosures contained in the financial statements for the year ended December 31, 2003. The financial statements should be read in conjunction with the financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2003. The results of operations for the three and
sixnine month periods endedJuneSeptember 30, 2004 and 2003 are not necessarily indicative of the results that may be expected for the full fiscal year.NOTENote 2
- THREE-FOR-TWO STOCK SPLIT— Three-For-Two Stock SplitOn February 12, 2004, our Board of Directors approved a three-for-two stock split in the form of a 50% common stock dividend which was paid on March 1, 2004 to shareholders of record on February 23, 2004. All share and earnings per common share information for all periods presented have been adjusted to reflect the three-for-two stock split.
NOTENote 3
- OTHER CONTINGENCIES—Other ContingenciesWe have an $18,000,000 bank line of credit on which we may draw to meet short-term liquidity requirements in excess of internally generated cash flow. The credit facility contains several financial covenants that we are required to meet. We are in compliance with all financial covenants at both
JuneSeptember 30, 2004 and December 31, 2003 and expect to continue to remain in compliance. This facility expires on January 31, 2005. We believe the line of credit will be renewed at that time. Amounts drawn under the line of credit are payable upon demand. At bothJuneSeptember 30, 2004 and December 31, 2003, there were no borrowings under the line of credit. However, at such dates, we had outstanding $15,925,000 and $14,500,000, respectively, of an irrevocable standby letter of credit which relate to payment obligations under our insurance program. As a result of the letter of credit issued, the amount available under the line of credit was reduced by $15,925,000 and $14,500,000 atJuneSeptember 30, 2004 and December 31, 2003, respectively.We are also involved in miscellaneous claims and litigation arising in the ordinary course of business. We believe that these matters, taken individually or in the aggregate, will not have a material adverse affect on our financial position or results of operations.
The Balance Budget Act of 1997 changed Medicare policy in a number of ways, most notably the phasing in, effective July 1, 1998, of a Medicare Prospective Payment System for skilled nursing facilities which significantly changed the manner and the amounts of reimbursement they receive. Many of
the -7-our clients'clients’ revenues are highly contingent on Medicare and Medicaid reimbursement funding rates. Therefore, they have been and continue to be adversely affected by changes in applicable laws and regulations, as well as other trends in the long-term care industry. This has resulted in certain of our clients filing for bankruptcy protection. Others may follow. These factors, in addition to delays in payments from clients, have resulted in and could continue to result in significant additional bad debts in the near future.NOTE-7-
Note 4
- SEGMENT INFORMATION—Segment InformationReportable Operating Segments
We manage and evaluate our operations in two reportable operating segments. The two operating segments are Housekeeping services (housekeeping, laundry, linen and other services), and Food services. Although both segments serve the same client base and share many operational similarities they are managed separately due to distinct differences in the type of service provided, as well as the specialized expertise required of the professional management personnel responsible for delivering the respective
segment'ssegment’s services. We consider the various services provided within the Housekeeping services segment to be one reportable operating segment since such services are rendered pursuant to a single service agreement and the delivery of such services is managed by the same management personnel.Differences between the reportable
segments'segments’ operating results and other disclosed data, and our consolidated financial statements relate primarily to corporate level transactions, as well as transactions between reportable operating segments and our warehousing and distribution subsidiary. Thissubsidiary'ssubsidiary’s transactions with reportable segments are made on a basis intended to reflect the fair market value of the goods transferred. Additionally, included in the differences between the reportablesegments'segments’ operating results and other disclosed data are amounts from our investment holding company subsidiary. This subsidiary does not transact any business with the reportable segments. Segment amounts disclosed are prior to any elimination entries made in consolidation.The Housekeeping services segment provides services in Canada, although essentially all of its revenues and net income, 99% in both categories, are earned in one geographic area, the United States. Food services are provided solely in the United States.
Housekeeping Food Corporate and services services eliminations Total Quarter Ended September 30, 2004 Revenues $ 90,190,386 $ 23,227,820 $ (1,094,149 ) $ 112,324,057 Income before income taxes $ 7,112,409 $ 234,164 $ (1,340,916 )(1) $ 6,005,657 Quarter Ended September 30, 2003 Income before income taxes $ 80,301,521 $ 16,457,117 $ (880,300 ) $ 95,878,338 Revenues $ 5,608,773 $ 317,527 $ (1,440,091 )(1) $ 4,486,209
Housekeeping Food Corporate(1) represents primarily corporate office cost and services services eliminations Total ------------ -------- -------------- ------Quarter Ended June 30, 2004 - --------------------------- Revenues $ 88,773,502 $ 21,794,596 $( 78,613) $110,489,485 Income before income taxes $ 7,546,850 $ 779,251 $( 2,631,792)(1) $ 5,694,309 Quarter Ended June 30, 2003 - --------------------------- Revenues $ 78,363,077 $ 14,441,576 $ 1,061 $ 92,805,714 Income before income taxes $ 6,245,398 $ 559,413 $( 3,520,301)(1) $ 4,284,510(1) represents primarily corporate office cost and related overhead, as well as certain consolidated subsidiaries'related overhead, as well as certain consolidated subsidiaries’ operating expenses that are not allocated to the service segments-8-
Housekeeping Food Corporate and services services eliminations Total Nine Months Ended September 30, 2004 Revenues $ 266,755,677 $ 63,876,964 $ (1,197,278 ) $ 329,435,363 Income before income taxes $ 22,458,807 $ 1,510,486 $ (6,917,131 )(1) $ 17,052,162 Nine Months Ended September 30, 2003 Revenues $ 234,243,575 $ 44,319,601 $ (347,772 ) $ 278,215,404 Income before income taxes $ 17,939,821 $ 1,348,655 $ (6,274,844 )(1) $ 13,013,632 (1) represents primarily corporate office cost and related overhead, as well as certain consolidated subsidiaries’ operating expenses that are not allocated to the service segments. Revenues from Clients
The following revenues earned from clients differ from segment revenues reported above due to the
service segments. -8-
Housekeeping Food Corporate and services services eliminations Total ------------ -------- -------------- ------Six Months Ended June 30, 2004 - ------------------------------ Revenues $ 176,565,291 $ 40,649,144 $( 103,130) $217,111,305 Income before income taxes $ 15,346,398 $ 1,276,322 $( 5,576,217)(1) $ 11,046,503 Six Months Ended June 30, 2003 - ------------------------------ Revenues $ 153,942,154 $ 27,862,484 $ 532,428 $182,337,066 Income before income taxes $ 12,331,048 $ 1,031,128 $( 4,834,753)(1) $ 8,527,423(1) represents primarily corporate office cost and related overhead, as well as certain consolidated subsidiaries' operating expenses that are not allocated to the service segments.inclusion of adjustments used for segment reporting purposes by management. We earnedrevenuerevenues from clients in the following service categories:For the quarter ended June 30, ------------------------------ 2004 2003 ---- ---- Housekeeping services $ 61,961,274 $55,319,200 Laundry and linen services 26,313,529 22,736,888 Food services 21,690,477 14,361,554 Maintenance services and Other 524,205 388,072 ------------ ----------- $110,489,485 $92,805,714 ============ =========== For the quarter ended June 30, ------------------------------ 2004 2003 ---- ---- Housekeeping services $123,612,468 $109,124,971 Laundry and linen services 52,386,782 44,565,528 Food services 40,110,356 27,908,515 Maintenance services and Other 1,001,699 738,052 ------------ ------------ $217,111,305 $182,337,066 ============ ============
For the quarter ended September 30,
2004 2003
Housekeeping services $ 62,687,886 $ 55,628,692 Laundry and linen services 26,464,812 23,708,141 Food services 22,595,831 16,152,997 Maintenance services and Other 575,528 388,508 $ 112,324,057 $ 95,878,338 For the nine months ended September 30, 2004 2003 Housekeeping services $ 186,300,354 $ 164,753,663 Laundry and linen services 78,851,595 68,273,669 Food services 62,706,187 44,061,512 Maintenance services and Other 1,577,227 1,126,560 $ 329,435,363 $ 278,215,404 Major Client
We have one client, a nursing home chain, which in the
sixnine month periods endedJuneSeptember 30, 2004 andJuneSeptember 30, 2003 accounted for approximately21%20% and 23%, respectively, of consolidated revenues. In thesixnine month period endedJuneSeptember 30, 2004, we derived approximately 19% and 27%, respectively, of the Housekeeping services and Food servicessegments'segments’ revenues from such client. Although we expect to continue our relationship with this client, the loss of such client would adversely affect the operations of our two operating segments.-9-
NOTENote 5
- EARNINGS PER COMMON SHARE— Earnings Per Common ShareA reconciliation of the numerator and denominator of basic and diluted earnings per common share is as follows:
Quarter Ended June 30, 2004 --------------------------- Income Shares Per-share (Numerator) (Denominator) Amount ----------- ------------- ---------Net income $3,530,309 ========== Basic earnings per common share $3,530,309 17,483,148 $ .20 Effect of dilutive securities: Options -- 983,932 (.01) ---------- ------------- --------- Diluted earnings per Common share $3,530,309 18,467,080 $ .19 ========== ============= ========= Quarter Ended June 30, 2003 --------------------------- Income Shares Per-share (Numerator) (Denominator) Amount ----------- ------------- --------- Net income $2,660,510 ========== Basic earnings per common share $2,660,510 16,956,909 $ .16 Effect of dilutive securities: Options -- 620,702 (.01) ---------- ------------- --------- Diluted earnings per Common share $2,660,510 17,577,611 $ .15 ========== ============= ========= Six Months Ended June 30, 2004 ------------------------------ Income Shares Per-share (Numerator) (Denominator) Amount ----------- ------------- --------- Net income $6,848,503 ========== Basic earnings per common share $6,848,503 17,483,836 $ .39 Effect of dilutive securities: Options -- 968,622 (.02) ---------- ------------- --------- Diluted earnings per Common share $6,848,503 18,452,458 $ .37 ========== ============= =========
Quarter Ended September 30, 2004
Income Shares Per-share (Numerator) (Denominator) Amount Net income $ 3,723,657 Basic earnings per common share $ 3,723,657 17,393,200 $ .21 Effect of dilutive securities: Options — 953,538 (.01 ) Diluted earnings per Common share $ 3,723,657 18,346,738 $ .20 Quarter Ended September 30, 2003 Income Shares Per-share (Numerator) (Denominator) Amount Net income $ 2,803,209 Basic earnings per common share $ 2,803,209 17,109,626 $ .16 Effect of dilutive securities: Options — 784,515 — Diluted earnings per Common share $ 2,803,209 17,894,141 $ .16 Nine Months Ended September 30, 2004 Income Shares Per-share (Numerator) (Denominator) Amount Net income $ 10,572,162 Basic earnings per common share $ 10,572,162 17,453,185 $ .61 Effect of dilutive securities: Options — 963,594 (.04 ) Diluted earnings per Common share $ 10,572,162 18,416,779 $ .57 Nine Months Ended September 30, 2003 Income Shares Per-share (Numerator) (Denominator) Amount Net income $ 8,009,632 Basic earnings per common share $ 8,009,632 16,978,541 $ .47 Effect of dilutive securities: Options 682,976 (.02 ) Diluted earnings per Common share $ 8,009,632 17,661,517 $ .45 -10-
Six Months Ended June 30, 2003 ------------------------------ Income Shares Per-share (Numerator) (Denominator) Amount ----------- ------------- ---------Net income $5,206,423 ========== Basic earnings per common share $5,206,423 16,912,637 $ .31 Effect of dilutive securities: Options 632,207 (.01) ---------- ------------- --------- Diluted earnings per Common share $5,206,423 17,544,844 $ .30 ========== ============= =========No outstanding options were excluded for any of the reported periods ended
JuneSeptember 30, 2004 orJuneSeptember 30, 2003, as none have an exercise price in excess of the average market value of our Common Stock at such dates.NOTENote 6
- STOCK BASED COMPENSATION— Stock Based CompensationAt both
JuneSeptember 30, 2004 and December 31, 2003, we had and continue to have stock based compensation plans. As permitted by the Statement of Financial Accounting Standards No. 123,"Accounting“Accounting for Stock BasedCompensation"Compensation”, we account for stock-based compensation arrangements in accordance with provisions of Accounting Principles Board("APB"(“APB”) Opinion No. 25"Accounting“Accounting for Stock Issued toEmployees"Employees”. Compensation expense for stock options issued to employees is based on the difference on the date of grant, between the fair value of our common stock and the exercise price of the option. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock at the date of grant.We account for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force
("EITF"(“EITF”) Issue No. 96-18,"Accounting“Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction With Selling, or in Conjunction With Selling Goods orServices"Services”. All transactions in which goods or services are the consideration received for the issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable. There were no such equity instruments issued during thesixnine month periods endedJuneSeptember 30, 2004 orJuneSeptember 30, 2003.-11-The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS No. 123 to stock based compensation:
Quarter Ended September 30, 2004 2003 Net Income As reported $ 3,723,657 $ 2,803,209 Deduct: Total stock based employee compensation expense determined under fair value based method
for all awards, net of related tax effects-0- -0- Pro forma net income $ 3,723,657 $ 2,803,209 Basic Earnings Per Common Share As reported $ .21 $ .16 Pro forma $ .21 $ .16 Diluted Earnings Per Common Share As reported $ .20 $ .16 Pro forma $ .20 $ .16 -11-
Nine Months Ended September 30, 2004 2003 Net Income As reported $ 10,572,162 $ 8,009,632 Deduct: Total stock based employee compensation expense determined under fair value based
method for all awards, net of related tax effects(1,279,000 ) (1,383,000 ) Pro forma net income $ 9,293,162 $ 6,626,632 Basic Earnings Per Common Share As reported $ .61 $ .47 Pro forma $ .53 $ .39 Diluted Earnings Per Common Share As reported $ .57 $ .45 Pro forma $ .50 $ .38 -12-
Quarter Ended June 30, ---------------------- 2004 2003 ---- ---- Net IncomeAs reported $3,530,309 $2,660,510 Deduct: Total stock based employee compensation expense determined under fair value based method for all awards, net of related tax effects ( 512,000) ( 553,000) ---------- ---------- Pro forma net income $3,018,309 $2,107,510 ========== ========== Basic Earnings Per Common Share As reported $ .20 $ .16 Pro forma $ .17 $ .12 Diluted Earnings Per Common Share As reported $ .19 $ .15 Pro forma $ .16 $ .12 Six Months Ended June 30, ------------------------- 2004 2003 ---- ---- Net Income As reported $6,848,503 $5,206,423 Deduct: Total stock based employee compensation expense determined under fair value based method for all awards, net of related tax effects (1,279,000) (1,383,000) ---------- ---------- Pro forma net income $5,569,503 $3,823,423 ========== ========== Basic Earnings Per Common Share As reported $ .39 $ .31 Pro forma $ .32 $ .23 Diluted Earnings Per Common Share As reported $ .37 $ .30 Pro forma $ .30 $ .22ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -12-ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSCautionary Statements Regarding Forward Looking Statements
This quarterly report on Form 10-Q includes forward-looking statements that are subject to risks and uncertainties that could cause actual results or objectives to differ materially from those projected. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Such risks and uncertainties include, but are not limited to, risks arising from providing our services exclusively to the health care industry, primarily providers of long-term care; credit and collection risks associated with this industry; one client accounting for approximately
21%20% of revenues in 2004; our claims experience related toworkers'workers’ compensation and general liability insurance; the effects of changes in laws and regulations governing the industry and risk factors described in our Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2003 in Part I thereof under"Government“Government Regulation ofClients"Clients”,"Competition"“Competition” and"Service“Service Agreements/Collections"Collections”. Many of ourclients'clients’ revenues are highly contingent on Medicare and Medicaid reimbursement funding rates, which have been and continue to be adversely affected by the change in Medicare payments under the 1997 enactment of the Medicare Prospective Payment System. That change, and lack of substantive reimbursement funding rate reform legislation, as well as other trends in the long-term care industry have resulted in certain of our clients filing for bankruptcy protection. Others may follow. Any decisions by the government to discontinue or adversely modify legislation related to reimbursement funding rates will have a material adverse affect on our clients. These factors, in addition to delays in payments from clients have resulted in and could continue to result in significant additional bad debts in the near future. Additionally, our operating results would be adversely affected if unexpected increases in the costs of labor and labor related costs, materials, supplies and equipment used in performing our services could not be passed on to our clients.In addition, we believe that to improve our financial performance we must continue to obtain service agreements with new clients, provide new services to existing clients, achieve modest price increases on current service agreements with existing clients and maintain internal cost reduction strategies at our various operational levels. Furthermore, we believe that our ability to sustain the internal development of managerial personnel is an important factor impacting future operating results and successfully executing projected growth strategies.
- -13-
RESULTS OF OPERATIONSResults of Operations
The following discussion is intended to provide the reader with information that will assist in understanding our financial statements including the changes in certain key items in 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 results of operations. This discussion should be read in conjunction with our financial statements as of September 30, 2004 and the nine month period then ended and the notes accompanying those financial statements.
Overview
We provide housekeeping, laundry, linen, facility maintenance and food services to the health care industry, including nursing homes, retirement complexes, rehabilitation centers and hospitals. We believe that we are the largest provider of housekeeping and laundry services to the long-term care industry in the United States. Although we do not directly participate in any government reimbursement programs, our clients are subject to government regulation. Therefore, they are directly effected by any legislation relating to Medicare or Medicaid programs.
We provide our services primarily pursuant to full service agreements with our clients. In such agreements, we assume both the management and payroll responsibility for the respective service segment’s employees. We provide services on the basis of a management only agreement for a limited number of clients. Our agreements with clients typically provide for a one year service term, cancelable by either party upon 30 or 90 days’ notice after the initial 90-day period.
Additionally, we operate two wholly owned subsidiaries. HCSG Supply, Inc. purchases, warehouses and distributes our supplies and equipment used in providing our services. Huntingdon Holdings, Inc. invests our cash and cash equivalents.
Consolidated Operations
Revenues for the quarter ended
JuneSeptember 30, 2004 increased19.1%17.2% or$17,683,771$16,445,719 to$110,489,485$112,324,057 as compared to$92,805,714$95,878,338 in the corresponding 2003 quarter.The Housekeeping services
segment'ssegment’s 2004secondthird quarter revenues increased 12.3% to$88,773,502, or 13.3% as$90,190,386 compared to thesecondthird quarterof2003 segment revenues of$78,363,077.$80,301,521. This growth is primarily a result of a net increase in service agreements entered into with new clients.The Food service
segment'ssegment’s 2004secondthird quarter revenues increased approximately51.0%41.1% to$21,794,596$23,227,820 as compared to thesecondthird quarterof2003 revenues of$14,441,576.$16,457,117. This growth is a result of providing this service to additional existing Housekeeping servicessegment'ssegment’s clients.Revenues for the
sixnine month period endedJuneSeptember 30, 2004 increased19.1%18.4% or$34,774,239$51,219,959 to$217,111,305$329,435,363 as compared to$182,337,066$278,215,404 in the corresponding 2003 period.-14-
The Housekeeping services
segment'ssegment’s 2004sixnine months period revenues increased to$176,565,291,$266,755,677, or14.7%13.9% from the comparable 2003period'speriod’s revenues of$153,942,154.$234,243,575. This growth is primarily a result of a net increase in service agreements entered into with new clients.The Food services
segment'ssegment’s 2004sixnine months period revenues increased approximately45.9%44.1% to$40,649,144$63,876,964 from the comparable 2003period'speriod’s revenues of$27,862,484.$44,319,601. This growth is a result of providing this service to additional existing Housekeepingservice'sservice’s segment clients.Although there can be no assurance thereof, we anticipate future revenue growth. We believe that
during the remainder of 2004 the revenuesuch growthfrom both Housekeeping services and Food services,will decrease, as a percentage oftotal revenues,revenue, since such growth willapproximate their respective 2004 six month percentages.be measured against our increasing revenue base.The following table sets forth, for the periods indicated, the percentage which certain items bear to revenues:
Relation to Total Revenues For the Quarter Ended June 30, For the Six Months Ended June 30, ------------------------------ --------------------------------- 2004 2003 2004 2003 ---- ---- ---- ----Revenues 100.0% 100.0% 100.0% 100.0% Operating costs and expenses: Costs of services provided 88.1 88.0 87.9 87.9 Selling, general and administration 7.0 7.6 7.3 7.6 Investment and interest income .3 .2 .3 .2 ----- ----- ----- ----- Income before income taxes 5.2 4.6 5.1 4.7 Income taxes 2.0 1.7 1.9 1.8 ----- ----- ----- ----- Net income 3.2% 2.9% 3.2% 2.9% ===== ===== ===== =====-14-
Relation to Total Revenues For the Quarter Ended Sept 30, For the Nine Months Ended Sept 30, 2004 2003 2004 2003 Revenues 100.0 % 100.0 % 100.0 % 100.0 % Operating costs and expenses: Costs of services provided 87.8 88.0 87.8 88.0 Selling, general and administration 7.1 7.7 7.2 7.6 Investment and interest income .2 .4 .2 .3 Income before income taxes 5.3 4.7 5.2 4.7 Income taxes 2.0 1.8 2.0 1.8 Net income 3.3 % 2.9 % 3.2 % 2.9 % Major client
We have one client, a nursing home chain, which in the
six monthsnine month periods endedJuneSeptember 30, 2004 andJuneSeptember 30, 2003 accounted for approximately21%20% and 23%, respectively, of consolidated revenues. In thesixnine months endedJuneSeptember 30, 2004 we derived approximately 19% and 27%, respectively, of the Housekeeping services and Food servicessegments'segments’ revenues from such client. Although we expect to continue our relationship with this client, the loss of such client would adversely affect the operations of our two operating segments.2004
SecondThird Quarter Compared with 2003SecondThird QuarterCost of services provided as a percentage of revenues
remained essentially unchanged at 88.1% fordecreased to 87.8% in thesecondthird quarter of 2004 compared to88.0%88.0 % in the corresponding 2003 quarter. The primary factors affecting thisslight increasedecrease are as follows: an increase of 1.5% in the cost of supplies consumed in providing services which was primarily attributable to increased costs associated with the Food services segment’s growth. Offsetting this increase was a decrease of 1.5% in workers compensation insurance. This decrease in workers’ compensation insurance is a result of a current reduction in average claim cost.-15-
Selling, general and administrative expenses as a percentage of revenue decreased to 7.1% in the 2004 third quarter compared to 7.7% in the 2003 third quarter. This is primarily attributable to our ability to control these expenses, as well as comparing these expenses to a greater revenue base in the current quarter.
Our effective income tax rate increased to 38% in the 2004 third quarter compared to 37.5% in the 2003 third quarter. The increase is primarily attributable to graduated income tax rates being applied against increased levels of taxable income. Our effective income tax rate differs from the federal income tax statutory rate principally because of the effect of state and local income taxes.
As a result of the matters discussed above, net income for the three month period ended September 30, 2004 increased to 3.3% as a percentage of revenue, compared to 2.9% in the 2003 comparable three month period.
2004 Nine Month Period Compared with 2003 Nine Month Period
Cost of services provided as percentage of revenues decreased to 87. 8% in the 2004 nine month period compared to 88.0%in the 2003 nine month period. The primary factors affecting this change when comparing the two nine month periods were an increase of 1.6% in the cost of supplies consumed in providing services, which was primarily attributable to increased costs associated with the Food services
segment'ssegment’s growth.Offsetting thisThis increasewerewas offset by decreases of.9%.7%,.6% and .5% in workers’ compensation insurance, bad debt provision.6% in workers compensation insurance,anda .5%labor costs, respectively. The decrease in labor costswhich isresulted primarilya result offrom efficiencies achieved in managing the Housekeeping servicessegment'ssegment’s labor. The decrease in workers’ compensation insurance is a result of a current reduction in average claim cost. The decrease in the bad debt provision is a result of improved collection experience. Although there can be no assurance thereof, we believe that the cost of services provided, as a percentage of revenues, for the remainder of 2004 will approximate the same percentage as recognized in the firstsixnine months of 2004.Selling, general and administrative expenses as a percentage of revenue decreased to 7.0% in the 2004 second quarter compared to 7.6% in the 2003 second quarter. This is primarily attributable to our ability to control these expenses and comparing these expenses to a greater revenue base in the current quarter. Our effective income tax rate remained unchanged at 38% comparing the 2004 second quarter to the 2003 second quarter. Our effective income tax rate differs from the federal income tax statutory rate principally because of the effect of state and local income taxes. As a result of the matters discussed above, net income for the three month period ended June 30, 2004 increased to 3.2% as a percentage of revenue, compared to 2.9% in the 2003 comparable three month period. 2004 Six Month Period Compared with 2003 Six Month Period Cost of services provided as percentage of revenues remain unchanged at 87.9% in the 2004 six month period compared with the 2003 six month period. Even though the percentage of cost of services remained unchanged, certain components of the cost of services did change. The primary components that changed when comparing the two six month periods were an increase of 1.6% in the cost of supplies consumed in providing services, which was primarily attributable to increased costs associated with the Food services segment's growth, which was offset by decreases of .8% and .6% in bad debt provision and labor costs, respectively. The decrease in labor costs resulted primarily from efficiencies achieved in managing the Housekeeping services segment's labor. -15-Selling, general and administrative expenses as a percentage of revenue decreased in the
sixnine month period endedJuneSeptember 30, 2004 to7.3%7.1% from7.6%7.7% in the comparable 2003 period. This is primarily attributable to our ability to control these expenses,andas well as comparing these expenses to a greater revenue base in the currentsixnine month period.Our 2004
second quarternine month period effective income tax rate decreased slightly to 38.0% from39.0%38.5% in the comparable 2003second quarter.nine month period. The decrease primarily results from a reduction in our state and local tax liability. The effective income tax rate differs from the federal income tax statutory rate principally because of the effect of state and local income taxes.As a result of the matters discussed above, net income for the
sixnine month period endedJuneSeptember 30, 2004 increased to 3.2% as a percentage of revenue compared to 2.9% in the comparable 2003sixnine month period.CRITICAL ACCOUNTING POLICIES-16-
Critical Accounting Policies
We consider the two policies discussed below to be critical to an understanding of our financial statements because their application places the most significant demands on our judgment. Therefore, it should be noted that financial reporting results rely on estimating the effect of matters that are inherently uncertain. Specific risks for these critical accounting policies are described in the following paragraphs. For these policies, we caution that future events rarely develop exactly as forecast, and the best estimates routinely require adjustment.
The two policies discussed are not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by generally accepted accounting principles, with no need for our judgment in their application. There are also areas in which our judgment in selecting another available alternative would not produce a materially different result. See our audited consolidated financial statements and notes thereto which are included in our Annual Report for the year ended December 31, 2003 which contain accounting policies and other disclosures required by generally accepted accounting principles.
Allowance for Doubtful Accounts
The allowance for doubtful accounts is established as losses are estimated to have occurred through a provision for bad debts charged to earnings. The allowance for doubtful accounts is evaluated based on our periodic review of accounts and notes receivable and is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
We have had varying collection experience with respect to our accounts and notes receivable. When contractual terms are not met, wegenerally encounter difficulty in collecting amounts due from certain of our clients. Therefore, we have sometimes been required to extend the period of payment for certain clients beyond contractual terms. These clients include those in bankruptcy, those who have terminated service agreements and slow payers experiencing financial difficulties. In making credit evaluations, in addition to analyzing and anticipating, where possible, the specific cases described above, we consider the general collection risks associated with trends in the long-term care industry. We also establish credit limits, perform ongoing credit evaluation, and monitor accounts to minimize the risk of loss.
-16-In accordance with the risk of extending credit, we regularly evaluate our accounts and notes receivable for impairment or loss of value and when appropriate will provide in our Allowance for Doubtful Accounts for such receivables. We generally follow a policy of reserving for receivables from clients in bankruptcy,
as well asclients with which we are in litigation forcollection.collection and other certain slow paying clients. The reserve is based upon our estimates of ultimate collectibility. Correspondingly, once our recovery of a receivable is determined through either litigation, bankruptcy proceedings or negotiation at less than the recorded amount on our balance sheet, we will charge-off the applicable amount to the Allowance for Doubtful Accounts.- -17-
Notwithstanding our efforts to minimize credit risk exposure, our clients could be adversely affected if future industry trends, as more fully discussed under Liquidity and Capital Resources below, and as further described in our Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2003 in Part I thereof under
"Government“Government Regulation ofClients"Clients” and"Service“Service Agreements/Collections"Collections”, change in such a manner as to negatively impact the cash flows of our clients. If our clients experience a negative impact in their cash flows, it would have a material adverse affect on our results of operations and financial condition.Accrued Insurance Claims
We have a Paid Loss Retrospective Insurance Plan for general liability and
workers'workers’ compensation insurance. Under these plans, pre-determined loss limits are arranged with an insurance company to limit both our per occurrence cash outlay and annual insurance plan cost.For
workers'workers’ compensation, we record a reserve based on the present value of future payments, including an estimate of claims incurred but not reported, that are developed as a result of a review of our historical data, open claims and actuarial analysis done by an independent insurance specialist. The present value of the payout is determined by applying an 8% discount factor over the estimated remaining pay-out period.For general liability, we record a reserve for the estimated amounts to be paid for known claims.
We regularly evaluate our
claims'claims’ pay-out experience, present value factor and other factors related to the nature of specific claims in arriving at the basis for our accrued insuranceclaims'claims’ estimate. Our evaluations are based primarily on current information derived from reviewing ourclaims'claims’ experience and industry trends. In the event that ourclaims'claims’ experience and/or industry trends result in an unfavorable change, it would have an adverse affect on our results of operations and financial condition.-17-LIQUIDITY AND CAPITAL RESOURCESLiquidity and Capital Resources
At
JuneSeptember 30, 2004 we had cash and cash equivalents of$74,726,696$71,190,394 and working capital of$117,435,330$122,542,728 compared to December 31, 2003 cash and cash equivalents, and working capital of $64,180,697 and $113,414,509, respectively. We view our cash and cash equivalents of$74,726,696$71,190,394 atJuneSeptember 30, 2004 as our principal measure of liquidity. Our current ratio atJuneSeptember 30, 2004decreased slightlyincreased to5.26.4 to 1 from 5.6 to 1 at December 31, 2003.The net cash provided by our operating activities was
$17,800,773$14,521,089 for thesixnine month period endedJuneSeptember 30, 2004. The principal sources of net cash flows from operating activities for thesixnine month period endedJuneSeptember 30, 2004 were net income, including non-cash charges to operations for depreciation and bad debt provisions. Additionally, operatingactivities'activities’ cash flows were increased bythe timing of payments for accounts payable and other accrued expenses, as well as,a$4,177,761$1,473,489 net decrease in accounts and notes receivable andlong termlong-term notes receivable due primarily to improved collections experience. Operating activities cash flows were also increased by the timing of payments under the Company’s various insurance plans of $1,401,057. The operatingactivityactivities that used the largest amount of cash during thesixnine month period endedJuneSeptember 30, 2004was an increasewere decreases in accrued payroll and accrued and withheld payroll taxes of$527,329 in$3,149,827, and prepaid expenses and other assets of $1,275,792. The changes resulted primarily from thefundingtiming ofour deferred compensation plan.such payments.-18-
Our principal use of cash in investing activities in the
sixnine month period endedJuneSeptember 30, 2004 was the purchase of housekeeping equipment and computer software and equipment.On February 12, 2004, our Board of Directors approved a three-for-two stock split in the form of a 50% common stock dividend which was paid on March 1, 2004 to shareholders of record on February 23, 2004. An amount equal to the par value of the shares of Common Stock issued was transferred from Additional Paid In Capital to Common Stock in the March 31, 2004 balance
sheet.sheet to reflect such transaction. All share and earnings per common share information presented in this report have been adjusted to reflect the three-for-two stock split. The effect of this action was to increase shares outstanding at March 1, 2004 by 6,016,799 to 17,646,172.During the
sixnine month period endedJuneSeptember 30, 2004, we have expended$5,617,004$5,999,467 for open market purchases of359,798384,753 shares of our common stock. We remain authorized to purchase524,452499,497 shares pursuant to previous Board ofDirectors'Directors’ actions. See “ Part II — Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities “ for more information.During the
sixnine month period endedJuneSeptember 30, 2004, we issued215,387480,921 shares of common stock and received net proceeds of$1,388,572$3,294,932 from the exercise of stock options by employees and directors.We paid regular quarterly dividends since the second quarter of 2003. In the
sixnine month period endedJuneSeptember 30, 2004 we paid regular quarterly dividends totaling$1,984,799.$3,194,871. Such regular quarterly dividends paid were $.05, $.06 and$.06$.07 per common share on February 14, 2004,andMay 14, 2004 and August 13, 2004, respectively. Such payments were made to shareholders of record as of January 31, 2004,April 30, 2004 andAprilJuly 30, 2004, respectively. Additionally, onJuly 20,October 19, 2004, our Board of Directors declared a regular cash dividend of$.07$.08 per common share to be paid onAugust 13,November 12, 2004 to shareholders of record as ofJuly 30,October 29, 2004.-18-Accounts and Notes Receivable
We expend considerable effort to collect the amounts due for our services on the terms agreed upon with our clients. Many of our clients participate in programs funded by federal and state governmental agencies which historically have encountered delays in making payments to its program participants. The Balance Budget Act of 1997 changed Medicare policy in a number of ways, most notably the phasing in, effective July 1, 1998 of a Medicare Prospective Payment System for skilled nursing facilities which significantly changed the reimbursement procedures and the amounts of reimbursement they receive. Many of our
clients'clients’ revenues are highly contingent on Medicare and Medicaid reimbursement funding rates. Therefore, they have been and continue to be adversely affected by changes in applicable laws and regulations, as well as other trends in the long-term care industry. This has resulted in certain of our clients filing for bankruptcy protection. Others may follow. These factors, in addition to delays in payments from clients have resulted in and could continue to result in significant additional bad debts in the near future. Whenever possible, when a client falls behind in making agreed-upon payments, we convert the unpaid accounts receivable to interest bearing promissory notes. The promissory notes receivable provide a means by which to further evidence the amounts owed and provide a definitive repayment plan and therefore may ultimately enhance our ability to collect the amounts due. AtJuneSeptember 30, 2004 and December 31, 2003, we had approximately$10,985,000$9,049,000 and $12,638,000, net of reserves, respectively of such notes outstanding. Additionally, we consider restructuring service agreements from full service to management-only service in the case of certain clients experiencing financial difficulties. We believe that the restructuring provides us with a means to maintain a relationship with the client while at the same time minimizing collection exposure.-19-
We have had varying collection experience with respect to our accounts and notes receivable. When contractual terms are not met, we generally encounter difficulty in collecting amounts due from certain of our clients. Therefore, we have sometimes been required to extend the period of payment for certain clients beyond contractual terms. These clients include those in bankruptcy, those who have terminated service agreements and slow payers experiencing financial difficulties. In order to provide for these collection problems and the general risk associated with the granting of credit terms, we have recorded bad debt provisions (in an Allowance for Doubtful Accounts) of
$1,750,000$2,600,000 and$2,950,000$3,800,000 in thesixnine month periods endedJuneSeptember 30, 2004 andJuneSeptember 30, 2003, respectively. These provisions represent approximately .8% and1.6%1.4%, as a percentage of revenue for such respective periods. In making credit evaluations, in addition toanalyzinganalyzin g and anticipating, where possible, the specific cases described above, we consider the general collection risks associated with trends in the long-term care industry. We also establish credit limits, perform ongoing credit evaluation and monitor accounts to minimize the risk of loss. Notwithstanding our efforts to minimize credit risk exposure, our clients could be adversely affected if future industry trends change in such a manner as to negatively impact their cash flows. If our clients experience such significant impact in their cash flows, it would have a material adverse effect on our results of operations and financial condition.Insurance Programs
We have a Paid Loss Retrospective Insurance Plan for general liability and
workers'workers’ compensation insurance. Under these plans, pre-determined loss limits are arranged with an insurance company to limit both our per occurrence cash outlay and annual insurance plan cost.For
workers'workers’ compensation, we record a reserve based on the present value of future payments, including an estimate of claims incurred but not reported, that are developed as a result of a review of our historical data, open claims and actuarial analysis done by an independent insurance specialist. The present value of the payout is determined by applying an 8% discount factor over the estimated remaining pay-out period.For general liability, we record a reserve for the estimated amounts to be paid for known claims.
- -20-
We regularly evaluate ourclaims'claims’ pay-out experience, present value factor and other factors related to the nature of specific claims in arriving at the basis for our accrued insuranceclaims'claims’ estimate. Our evaluation is based primarily on current information derived from reviewing ourclaims'claims’ experience and industry trends. In the event that ourclaims'claims’ experience and/or industry trends result in an unfavorable change, it would have an adverse effect on our results of operations and financial condition.-20-Line of Credit
We have an $18,000,000 bank line of credit on which we may draw to meet short-term liquidity requirements in excess of internally generated cash flow. The line of credit contains several financial covenants that we are required to meet. We are in compliance with all financial covenants at both
JuneSeptember 30, 2004 and December 31,2003 and2003. We expect to continue to remain incompliance.compliance with all such financial covenants. This line of credit expires on January 31, 2005. We believe the line of credit will be renewed at that time. Amounts drawn under the line of credit are payable on demand. AtJuneSeptember 30, 2004 there were no borrowings under the line of credit. However, at such date, we had outstanding $15,925,000 of an irrevocable standby letter of credit, whichrelaterelates to payment obligations under our insurance program. As a result of the letter of credit issued, the amount available under the line of credit wasreducedred uced by $15,925,000 atJuneSeptember 30, 2004.Capital Expenditures
Our level of capital expenditures is generally dependent on the number of new clients obtained. Such capital expenditures primarily consist of housekeeping equipment, laundry and linen equipment installations, and computer hardware and software. Although we have no specific material commitments for capital expenditures through the end of calendar year 2004, we estimate that we will incur capital expenditures of approximately $2,500,000 during all of 2004 in connection with housekeeping equipment and laundry and linen equipment installations in our
clients'clients’ facilities, as well as expenditures relating to internal data processing hardware and software requirements. We believe that cash from operations, existing cash balances and available credit line will be adequate for the foreseeable future to satisfy the needs of our operations and to fund our continued growth. However, shouldcash flows from current operationsthese sources not besufficient,suf ficient, we would,utilize our existing working capital andif necessary, seek to obtainnecessaryworking capital from such sources as long-term debt or equity financing.Material Off-Balance Sheet Arrangements
We have not entered into any material off-balance sheet arrangements.
Effects of Inflation
WeAlthough there can be no assurance thereof, we believe that in most instances we will be able to recover increases in costs attributable to inflation by passing through such cost increases to our clients.
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ITEM 3. QUANTITATIVE AND QUALITATIVE
DISCLOSUREDISCLOSURES ABOUT MARKET RISKOur exposure to market risk is not significant.
-21-ITEM 4. CONTROLS AND PROCEDURES
Disclosure controls are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports under the Securities Exchange Act of 1934, such as this Form 10-Q, is reported in accordance with the Securities and Exchange
Commission'sCommission’s (the"SEC"“SEC”) rules. Disclosure controls are also designed with the objective of ensuring that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer as appropriate to allow timely decisions regarding required disclosure.As of the end of the period covered by this Form 10-Q, we carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Securities Exchange Act Rules 13a-15(e) and 15d-15(e). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to insure that information required to be disclosed in the reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the
SEC'sSEC’s rules and regulations. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of theirevaluation.evaluati on.Certifications of the Chief Executive Officer and Chief Financial Officer regarding, among other items, disclosure controls and procedures are included as exhibits to this Form 10-Q.
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PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Not Applicable. ITEM 2.