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SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For Quarter Ended September 30, 2002 Commission File Number 0-12015
HEALTHCARE SERVICES GROUP, INC.
-------------------------------
(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 PA 19020
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(Address of principal executive office) (Zip code)
Registrant's telephone number, including area code: 215-639-4274
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Indicate 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 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
------ -------
Number of shares of common stock, issued and outstanding as of October 18, 2002
is 11,413,155
Total of 24 Pages
INDEX
-----
PART I. FINANCIAL INFORMATION PAGE NO.
--------------------- --------
Consolidated Balance Sheets as of 2
September 30, 2002 and December 31, 2001
Consolidated Statements of Income for the Three Months ended 3
September 30, 2002 and 2001
Consolidated Statements of Income for the Nine Months ended 4
September 30, 2002 and 2001
Consolidated Statements of Cash Flows for the Nine Months 5
ended September 30, 2002 and 2001
Notes To Consolidated Financial Statements 6 - 11
Management's Discussion and Analysis of Financial Condition 12 - 18
and Results Of Operations
Part II. Other Information 19
-----------------
Exhibits - Certifications 20 - 23
Signatures 24
Healthcare Services Group, Inc.
Consolidated Balance Sheets
(Unaudited)
September 30, December 31,
2002 2001
-----------------------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 42,293,113 $ 34,259,334
Accounts and notes receivable, less
allowance for doubtful accounts of
$9,338,000 in 2002 and $6,936,000 in 2001 51,511,131 54,076,007
Prepaid income taxes 8,188
Inventories and supplies 8,294,469 7,944,199
Deferred income taxes 3,686,231 2,162,845
Prepaid expenses and other 2,396,706 2,156,871
------------ ------------
Total current assets 108,181,650 100,607,444
PROPERTY AND EQUIPMENT:
Laundry and linen equipment installations 6,841,763 6,872,513
Housekeeping and office equipment 11,316,790 10,570,888
Autos and trucks 85,489 57,321
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18,244,042 17,500,722
Less accumulated depreciation 13,719,102 12,738,533
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4,524,940 4,762,189
COST IN EXCESS OF FAIR VALUE OF NET ASSETS
ACQUIRED less accumulated amortization
of $1,743,155 in 2002 and 2001 1,612,322 1,612,322
DEFERRED INCOME TAXES 2,222,458 1,523,144
OTHER NONCURRENT ASSETS 11,601,105 12,285,398
------------ ------------
$128,142,475 $120,790,497
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 6,647,710 $ 6,439,609
Accrued payroll, accrued and withheld payroll taxes 6,144,510 9,705,000
Income taxes payable 937,250
Other accrued expenses 188,655 199,635
Accrued insurance claims 1,434,689 1,155,655
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Total current liabilities 15,352,814 17,499,899
ACCRUED INSURANCE CLAIMS 5,397,162 4,347,464
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value: 30,000,000
shares authorized, 11,603,555 shares
issued in 2002 and 11,337,719 in 2001 116,036 113,377
Additional paid in capital 29,593,535 27,240,496
Retained earnings 79,611,898 73,176,074
Common stock in treasury, at cost
291,200 shares in 2002 and 262,500 shares in 2001 (1,928,970) (1,586,813)
------------ ------------
Total stockholders' equity 107,392,499 98,943,134
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$128,142,475 $120,790,497
============ ============
See accompanying notes.
Healthcare Services Group, Inc.
Consolidated Income Statements
(Unaudited)
For the Three Months Ended
September 30,
2002 2001
--------------------------------
Revenues $ 83,044,730 $ 72,500,363
Operating costs and expenses:
Costs of services provided 73,012,961 64,157,195
Selling, general and administrative 6,494,315 5,610,918
Other Income:
Interest Income 117,132 280,132
------------ ------------
Income before income taxes 3,654,586 3,012,382
Income taxes 1,444,000 1,175,400
------------ ------------
Net Income $ 2,210,586 $ 1,836,982
============ ============
Earnings per share of common stock:
Basic earnings per common share $ 0.20 $ 0.17
============ ============
Diluted earnings per common share $ 0.19 $ 0.17
============ ============
For the Nine Months Ended
September 30,
2002 2001
--------------------------------
Revenues $244,043,351 $208,393,882
Operating costs and expenses:
Costs of services provided 215,310,120 184,642,038
Selling, general and administrative 18,593,605 16,117,233
Other Income:
Interest Income 500,198 844,622
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Income before income taxes 10,639,824 8,479,233
Income taxes 4,204,000 3,308,000
------------ ------------
Net Income $ 6,435,824 $ 5,171,233
============ ============
Earnings per share of common stock:
Basic earnings per common share $ 0.57 $ 0.47
============ ============
Diluted earnings per common share $ 0.55 $ 0.47
============ ============
See accompanying notes
Healthcare Services Group, Inc.
Consolidated Cash Flow
For the Nine Months Ended
September 30,
--------------------------------
2002 2001
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Cash flows from operating activities:
Net Income $ 6,435,824 $ 5,171,233
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization 1,533,881 1,665,854
Bad debt provision 4,950,000 3,350,000
Deferred income tax benefits (2,222,700) (1,073,500)
Tax benefit of stock option transactions 509,295 64,261
Unrealized loss on SERP investments 77,088 42,376
Changes in operating assets and liabilities:
Accounts and notes receivable (2,385,124) (3,404,641)
Prepaid income taxes 8,188 704,090
Inventories and supplies (350,270) 491,476
Changes to long term notes receivable 1,127,433 (492,278)
Accounts payable and other accrued expenses 197,122 (436,483)
Accrued payroll, accrued and withheld payroll
taxes (3,430,840) (2,868,973)
Accrued insurance claims 1,328,731 1,510,739
Income taxes payable 937,250
Prepaid expenses and other assets (760,065) (163,386)
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Net cash provided by operating activities 7,955,813 4,560,768
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Cash flows from investing activities:
Disposals of fixed assets 74,406 178,470
Additions to property and equipment (1,371,038) (1,456,886)
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Net cash used in investing activities (1,296,632) (1,278,416)
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Cash flows from financing activities:
Purchase of treasury stock (342,157) (824,938)
Proceeds from the exercise of stock options 1,716,755 391,163
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Net cash provided by (used in) financing activities 1,374,598 (433,775)
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Net increase in cash and cash equivalents 8,033,779 2,848,577
Cash and cash equivalents at beginning of the year 34,259,334 22,841,618
------------ ------------
Cash and cash equivalents at end of the period $ 42,293,113 $ 25,690,195
============ ============
Supplementary Cash Flow Information:
Issuance of 23,926 and 38,753 shares of
Common Stock in 2002 and 2001, respectively
pursuant to Employee Stock Purchase Plan $ 129,649 $ 209,993
============ ============
See accompanying notes
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 - Basis of Reporting
The 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 the opinion
of the Company, 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, 2001 has been derived from, and
does not include, all the disclosures contained in the financial statements for
the year ended December 31, 2001. The financial statements should be read in
conjunction with the financial statements and notes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2001. The
results of operations for the quarters and nine month periods ended September
30, 2002 and 2001 are not necessarily indicative of the results that may be
expected for the full fiscal year.
Note 2 - Other Contingencies
The Company has an $18,000,000 bank line of credit under which it may
draw to meet short-term liquidity requirements or for other purposes, that
expires on September 30, 2003. The Company expects the line to be renewed at
that time. Amounts drawn under the line are payable upon demand. At September
30, 2002, there were no borrowings under the line. However, at such date, the
Company had outstanding $14,500,000 of irrevocable standby letters of credit,
which relate to payment obligations under the Company's insurance program. As a
result of the letters of credit issued, the amount available under the line was
reduced by $14,500,000 at September 30, 2002.
The Company is also involved in miscellaneous claims and litigation
arising in the ordinary course of business. The Company believes that these
matters, taken individually or in the aggregate, would not have a material
adverse impact on the Company's financial position or results of operations.
The Balance Budget Act of 1997 ("BBA") changed Medicare policy in a
number of ways, most notably the phasing in, effective July 1, 1998, of a
Medicare Prospective Payment System ("PPS") for skilled nursing facilities which
significantly changed the reimbursement procedures and the amounts of
reimbursement they receive. Many of the Company's 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 the Company's clients filing for bankruptcy
protection. Others may follow. Since the passage of the BBA, Congress has passed
additional legislation, principally the Balanced Budget Refinement Act of 1999
("BBRA") and the Benefit Improvement and Protection Act of 2000 ("BIPA"). These
enactments were intended primarily to mitigate, temporarily, the reduction in
reimbursement for skilled nursing facilities under the Medicare PPS. In total,
four add-on payments were established by the enactments to offset the impact of
PPS. On April 23, 2002, the Center for Medicare and Medicaid Services ("CMS")
announced that it would delay implementation of any refinements to the scope of
two of the add-on payments enacted pursuant to the BBRA and BIPA, thereby
extending the related add-ons to at least September 30, 2003. The other two
add-on payment provisions expired on September 30, 2002. The Senate introduced
legislation during the first week of October 2002 which included a partial
reinstatement of the add-on payment provision limited to the nursing component
of the Medicare rate. This legislative proposal would provide for certain
increases annually beginning in 2003 through 2005. There can be no assurance as
to whether this proposal will be adopted. Any decisions by the government to
discontinue or adversely modify legislation relating to reimbursement funding
rates will have a material adverse affect on the Company's clients' revenues.
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.
At September 30, 2002, the Company has receivables of approximately
$4,000,000 ($1,500,000, net of reserves) from a client group currently Debtors
in Chapter 11 bankruptcy proceedings. The Company expects the client group will
file bankruptcy plans sometime during 2003. If the amount collected is
materially less than $1,500,000, it could adversely affect the Company's results
of operations and financial condition.
Note 3 - Segment Information
The Company manages and evaluates its operations in two reportable
operating segments. The two operating segments are housekeeping, laundry, linen
and other services, and food service. 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 segments' services. Prior to December
31, 2001, food service was not deemed a reportable operating segment as its
revenues did not meet the quantitative threshold of FASB SFAS 131 ( Disclosure
about Segments of an Enterprise and Other Related information). The Company
considers the various services provided within the housekeeping, laundry, linen
and other 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' operating results and
other disclosed data, and the Company's consolidated financial statements relate
primarily to corporate level transactions, as well as transactions between
reportable operating segments and the Company's warehousing and distribution
subsidiary. The subsidiary's transactions with reportable segments are
immaterial and are made on a basis intended to reflect the fair market value of
the goods transferred. Segment amounts disclosed are prior to any elimination
entries made in consolidation.
During the quarter ended September 30, 2002, the Company refined its
method of allocating divisional overhead to its two reportable operating
segments. The revised allocation is based on a relationship using the number of
facilities serviced by the respective segments as opposed to the previous method
which utilized a gross segment revenue relationship. Such revision increased
income before income taxes in the food services' segment by $275,319 and
$53,462, respectively for the three and nine month periods ended September 30,
2002. Correspondingly, the Company's housekeeping, laundry, linen and other
services' segment's income before income taxes was decreased by the same amounts
for the respective 2002 periods.
The housekeeping, laundry, linen and other services' segment of the Company
does provide 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.
Housekeeping,
laundry, linen
and other Food Corporate and
services services eliminations Total
-------- -------- ------------ -----
Quarter Ended Sept 30, 2002
- ---------------------------
Revenues $ 70,182,650 $ 13,639,456 $ (777,376) $ 83,044,730
Income before income taxes $ 5,489,371 $ 230,809 $ (2,065,594)(1) $ 3,654,586
Quarter Ended Sept 30, 2001
- ---------------------------
Revenues $ 62,279,676 $ 10,747,998 $ (527,311) $ 72,500,363
Income before income taxes $ 3,991,544 $ 554,437 $ (1,533,599)(1) $ 3,012,382
Nine Months Ended Sept 30, 2002
- -------------------------------
Revenues $206,571,578 $ 37,679,260 $ (207,487) $244,043,351
Income before income taxes $ 16,826,225 $ 1,071,799 $ (7,258,200)(1) $ 10,639,824
Nine Months Ended Sept 30, 2001
- -------------------------------
Revenues $179,230,471 $ 29,175,949 $ (12,538) $208,393,882
Income before income taxes $ 13,022,657 $ 1,434,849 $ (5,978,273)(1) $ 8,479,233
(1) represents primarily corporate office cost and related overhead, as
well as certain operating expenses that are not allocated to the
service operating segments.
The Company earned revenue in the following service categories:
For the quarter ended September 30,
-----------------------------------
2002 2001
---- ----
Housekeeping services $49,414,525 $43,306,942
Laundry and linen services 19,924,367 17,866,018
Maintenance services and Other 281,718 761,380
Food Services 13,424,120 10,566,023
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$83,044,730 $72,500,363
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For the nine months ended September 30,
---------------------------------------
2002 2001
---- ----
Housekeeping services $146,421,798 $125,594,493
Laundry and linen services 58,994,287 51,599,357
Maintenance services and Other 1,308,049 2,218,478
Food Services 37,319,217 28,981,554
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$244,043,351 $208,393,882
============ ============
The Company has one client which, for the nine months ended September
30, 2002 and 2001 accounted for approximately 16% and 13%, respectively of
consolidated revenues. With respect to such client, the Company derived revenues
from both operating segments.
Note 4 - Earnings Per Common Share
A reconciliation of the numerator and denominator of basic and diluted earnings
per common share is as follows:
Quarter Ended September 30, 2002
--------------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
----------- ------------- ------
Net income $ 2,210,586
===========
Basic earnings per common share $ 2,210,586 11,317,662 $ .20
Effect of dilutive securities:
Options 528,232 (.01)
----------- ---------- -------
Diluted earnings per common share $ 2,210,586 11,845,894 $ .19
=========== ========== =======
Quarter Ended September 30, 2001
--------------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
----------- ------------- ------
Net income $1,836,982
==========
Basic earnings per common share $1,836,982 10,916,889 $ .17
Effect of dilutive securities:
Options 207,370
---------- ---------- -------
Diluted earnings per Common share $1,836,982 11,124,259 $ .17
========== ========== =======
Nine Months Ended September 30, 2002
------------------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
----------- ------------- ------
Net income $ 6,435,824
===========
Basic earnings per common share $ 6,435,824 11,237,560 $ .57
Effect of dilutive securities:
Options 508,763 (.02)
----------- ---------- -------
Diluted earnings per Common share $ 6,435,824 11,746,323 $ .55
=========== ========== =======
Nine Months Ended September 30, 2001
------------------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
----------- ------------- ------
Net income $5,171,233
==========
Basic earnings per common share $5,171,233 10,916,253 $ .47
Effect of dilutive securities:
Options 106,749
---------- ---------- -------
Diluted earnings per Common share $5,171,233 11,023,002 $ .47
========== ========== =======
Options to purchase approximately 359,401 and 743,277 shares of common stock at
an average exercise price of $8.71 and $8.12 per common share for the quarter
and nine month period ended September 30, 2001, respectively, were outstanding
but not included in the computation of diluted earnings per common share because
the options' exercise prices were greater than the average market value of the
common shares. For the quarter and nine month period ended September 30, 2002,
no outstanding options were excluded in the computation of diluted earnings per
common share, as none have an exercise price in excess of the average market
value of the Company's Common Stock.
Note 5 - Effect of Recently Issued Accounting Pronouncements
Business Combinations and Intangible Assets - Accounting for Goodwill
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As of January 1, 2002, the Company has adopted SFAS 142, "Goodwill and
Other Intangible Assets", which eliminated the amortization of purchased
goodwill. Upon adoption of SFAS No. 142, the Company performed an impairment
test of its goodwill (amounting to $1,612,322 at January 1, 2002) and determined
that no impairment of the recorded goodwill existed. Under SFAS No. 142,
goodwill will be tested for impairment at least annually and more frequently if
an event occurs which indicates the goodwill may be impaired.
The following table presents a reconciliation of net income and
earnings per share amounts, as reported in the financial statements, to those
amounts adjusted for goodwill and intangible asset amortization determined in
accordance with SFAS 142.
For the Quarter Ended September 30,
-----------------------------------
2002 2001
---- ----
Reported net income $2,210,586 $1,836,982
Addback: goodwill amortization - 26,906
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Adjusted net income $2,210,586 $1,863,888
========== ==========
Basic earnings per Common share:
Reported net income $ .20 $ .17
Goodwill amortization - -
---------- ----------
Adjusted net income $ .20 $ .17
========== ==========
Diluted earnings per Common share:
Reported net income $ .19 $ .17
Goodwill amortization - -
---------- ----------
Adjusted net income $ .19 $ .17
========== ==========
For the Nine Months Ended September 30,
---------------------------------------
2002 2001
---- ----
Reported net income $6,435,824 $5,171,233
Addback: goodwill amortization - 80,717
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Adjusted net income $6,435,824 $5,251,950
========== ==========
Basic earnings per common share:
Reported net income $ .57 $ .47
Goodwill amortization - .01
---------- ----------
Adjusted net income $ .57 $ .48
========== ==========
Diluted earnings per common share:
Reported net income $ .55 $ .47
Goodwill amortization - .01
---------- ----------
Adjusted net income $ .55 $ .48
========== ==========
Accounting for the Impairment or Disposal of Long-lived Assets
--------------------------------------------------------------
As of January 1, 2002 the Company has adopted SFAS No. 144, Accounting
for the Impairment or Disposal of Long-lived Assets which supersedes SFAS No.
121, Accounting for the Impairment of Long-lived Assets and for Long-lived
Assets to be Disposed Of. The adoption of SFAS No. 144 had no effect on the
Company.
Accounting for Costs Associated with Exit or Disposal Activities
----------------------------------------------------------------
In July 2002, The Financial Accounting Standards Board ("FASB") issued
Statement 146 Accounting for Costs Associated with Exit or Disposal Activities
("SFAS 146"). SFAS 146 addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies Emerging Issues Task
Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)". The principal difference between SFAS 146
and Issue 94-3 relates to its requirements for recognition of a liability for a
cost associated with an exit or disposal activity. SFAS 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred. Under Issue 94-3, a liability for an exit cost
as defined in Issue 94-3 was recognized at the date of an entity's commitment to
an exit plan. The provisions of this Statement are effective for exit or
disposal activities that are initiated after December 31, 2002. The Company has
determined this new standard will have no effect on its results of operations or
financial condition.
PART I.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
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 Sept 30, Nine Months Ended Sept 30,
------------------------------ --------------------------
2002 2001 2002 2001
---- ---- ---- ----
Revenues 100.0% 100.0% 100.0% 100.0%
Operating costs and expenses:
Costs of services provided 87.9 88.5 88.2 88.6
Selling, general and Administration 7.8 7.7 7.6 7.7
Interest income .1 .4 .2 .4
----- ----- ----- -----
Income before income taxes 4.4 4.2 4.4 4.1
Income taxes 1.7 1.6 1.7 1.6
----- ----- ----- -----
Net income 2.7% 2.6% 2.7% 2.5%
===== ===== ===== =====
Revenues for the quarter and nine month period ended September 30, 2002
increased approximately 15% and 17%, respectively as compared to the
corresponding 2001 periods. The growth in revenues in each period is a result of
a net increase in service agreements entered into with new clients, as well as
providing additional services to existing clients. Additionally, in the third
quarter and nine month period, approximately 73% and 77%, respectively of the
revenue growth resulted by the Company's housekeeping, laundry and linen, and
other services provided. The remaining approximately 27% third quarter's, and
the 23% nine month period's revenue growth generated from the Company's food
service division. The Company believes that in 2002 both housekeeping, laundry,
linen and other services, and food services' revenues, as a percentage of total
revenues, will remain approximately the same as their respective 2001
percentages.
The Company has one client which for the nine month periods ended
September 30, 2002 and 2001 accounted for approximately 16% and 13%,
respectively of consolidated revenues. With respect to such client, the Company
derived revenues from both operating segments.
Cost of services provided as a percentage of revenues decreased to
87.9% for the third quarter of 2002 from 88.5 % in the corresponding 2001
quarter. The primary factors affecting specific variations in the 2002 third
quarter's cost of services provided as a percentage of revenue and its affect on
the respective .6% decrease are as follows: a decrease of .9% in labor costs,
which is primarily a result of efficiencies achieved in managing the
housekeeping, laundry, linen and other services' segment labor; a decrease of
..4% in workers' compensation insurance. Offsetting these decreases were
increases of .7% in bad debt expense and .5% in the cost of supplies consumed in
performing housekeeping, laundry and linen services.
Cost of services provided as a percentage of revenue decreased to 88.2%
for the nine month period ended September 30, 2002 from 88.6% in the same 2001
period. The primary factors affecting specific variations in the 2002 nine month
period's cost of services provided as a percentage of revenue and its affect on
the respective .4% decrease are as follows: a decrease of .7% in labor costs
which is primarily a result of efficiencies achieved in managing the
housekeeping, laundry, linen and other services' segment labor. Offsetting these
decreases were increases of .4% in health insurance and employee benefits' costs
and .4% in bad debt expense.
Selling, general and administrative expenses as a percentage of revenue
remained essentially unchanged in the 2002 third quarter and nine month period
ended September 30, 2002 compared to the same 2001 periods. These results are
primarily attributable to the Company's ability to control these expenses while
comparing them to a greater revenue base in the respective periods.
Interest income decreased in both the third quarter and nine month
period ended September 30, 2002, as compared to the corresponding 2001 periods.
The decreases are attributable to lower rates of return on the Company's cash
balances, as well as a decrease in the net asset value of funds invested through
the Company's Deferred Compensation Plan.
Critical Accounting Policies
The policies discussed below are considered by the Company's management
to be critical to an understanding of the Company's financial statements because
their application places the most significant demands on management's 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 all of these policies, management cautions that future events
rarely develop exactly as forecast, and the best estimates routinely require
adjustment.
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 management's
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.
The Company has had varying collection experience with respect to its
accounts and notes receivable. When contractual terms are not met, the Company
generally encounters difficulty in collecting amounts due from certain of its
clients. Therefore, the Company has 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 its credit evaluations, in
addition to analyzing and anticipating, where possible, the specific cases
described above, management considers the general collection risks associated
with trends in the long-term care industry. The Company also establishes credit
limits, as well as performing ongoing credit evaluation and account monitoring
procedures to minimize the risk of loss.
In accordance with the risk of extending credit, the Company regularly
evaluates its accounts and notes receivable for impairment or loss of value and
when appropriate will provide in its Allowance for Doubtful Accounts for such
receivables. The Company generally follows a policy of reserving for receivables
from clients in bankruptcy, as well as clients, with which the Company is in
litigation for collection. Correspondingly, once the Company's recovery of a
receivable is determined through either litigation, bankruptcy proceedings or
negotiation at less than the recorded amount on its balance sheet, it will
charge-off the applicable amount to the Allowance for Doubtful Accounts.
Notwithstanding the Company's efforts to minimize its credit risk
exposure, the Company's clients could be adversely affected if future industry
trends, as more fully discussed under liquidity and capital resources below, and
as further described in the Company's Form 10-K filed with Securities and
Exchange Commission for the year ended December 31, 2001 in Part I thereof under
"Government Regulation of Clients", "Competition" and "Service
Agreements/Collections", change in such a manner as to negatively impact their
cash flows. If the Company's clients experience such significant impact in their
cash flows, it could have a material adverse effect on the Company's results of
operations and financial condition. At September 30, 2002, the Company has
receivables of approximately $4,000,000 ( $1,500,000, net of reserves ) from a
client group currently Debtors in a Chapter 11 bankruptcy proceeding. The
Company expects the client group will file bankruptcy plans sometime during
2003. If the amount collected is materially less than $1,500,000, it could
adversely affect the Company's results of operations and financial condition.
Accrued Insurance Claims
- ------------------------
The Company currently has a Paid Loss Retrospective Insurance Plan for
general liability and workers' compensation insurance. Under these plans,
pre-determined loss limits are arranged with an insurance company to limit both
the Company's per occurrence cash outlay and annual insurance plan cost.
For workers' compensation, the Company records 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 the Company's
historical data and actuarial analysis done by an independent company
specialist. The present value of the payout is determined by applying an 8%
discount factor against the estimated remaining pay-out period.
Management regularly evaluates its claims' pay-out experience, present
value factor and other factors related to the nature of specific claims in
arriving at the basis for its accrued insurance claims' estimate. Management
evaluations are based primarily on current information derived from reviewing
Company claims' experience and industry trends. In the event that the Company's
claims' experience and/or industry trends result in an unfavorable change, it
could have an adverse effect on the Company's results of operations and
financial condition.
Liquidity and Capital Resources
At September 30, 2002 the Company had working capital and cash of
$92,828,837 and $42,293,113, respectively, compared to December 31, 2001 working
capital and cash of $83,107,545 and $34,259,334. The Company's current ratio at
September 30, 2002 increased to 7.1 to 1 from 5.7 to 1 at December 31, 2001.
Management views the Company's cash, $42,293,113 at September 30, 2002 as its
principal measure of liquidity.
The net cash provided by the Company's operating activities was
$7,955,813 for the nine month period ended September 30, 2002 as compared to net
cash provided by operating activities of $4,560,768 in the same 2001 nine month
period. The principal sources of net cash flows from operating activities for
the nine month period ended September 30, 2002 were net income, charges to
operations for bad debt provisions, and depreciation and amortization.
Additionally, operating activities' cash flows were increased by the timing of
payments under the Company's various insurance plans of $1,328,731 during the
2002 nine month period. The operating activities that used the largest amount of
cash during the nine month period ended September 30, 2002 were a decrease of
$3,430,840 in accrued payroll and payroll related taxes as a result of the
timing of such payments, as well as net increases in accounts and notes
receivable and long term notes receivable of $1,257,691. The increases in
accounts and notes receivable and long term notes receivable resulted primarily
from the growth in the Company's revenues, as well as the timing of collections
from clients. The principal sources of net cash flows from operating activities
for the nine month period ended September 30, 2001 were net income, charges to
operations for bad debt provisions and depreciation and amortization.
Additionally, operating activities' cash flows were increased by the timing of
payments under the Company's various insurance plans of $1,510,739 in the nine
month period ended September 30, 2001. The operating activities that used the
largest amount of cash during the nine month period ended September 30, 2001
were net increases in accounts and notes receivable and long term notes
receivable of $3,896,919. These increases resulted primarily from the growth in
the Company's revenues, as well as the timing of collections from clients.
Additionally, operating activities' cash flows in the nine month period ended
September 30, 2001 were negatively impacted by a $2,868,973 decrease in accrued
payroll and related payroll taxes resulting from the timing of such payments.
The Company's principal use of cash in investing activities in each of
the nine month periods ended September 30, 2002 and 2001, respectively was the
purchase of housekeeping equipment and computer software and equipment.
The Company expends considerable effort to collect the amounts due for
its services on the terms agreed upon with its clients. Many of the Company's
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 ("BBA") changed Medicare
policy in a number of ways, most notably the phasing in, effective July 1, 1998,
of a Medicare Prospective Payment System ("PPS") for skilled nursing facilities
which significantly changed the reimbursement procedures and the amounts of
reimbursement they receive. Many of the Company's 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 the Company's clients filing for bankruptcy
protection. Others may follow. Since the passage of the BBA, Congress has passed
additional legislation, principally the Balanced Budget Refinement Act of 1999
("BBRA") and the Benefit Improvement and Protection Act of 2000 ("BIPA"). These
enactments were intended primarily to mitigate, temporarily, the reduction in
reimbursement for skilled nursing facilities under the Medicare PPS. In total,
four add-on payments were established by the enactments to offset the impact of
PPS. On April 23, 2002, the Center for Medicare and Medicaid Services ("CMS")
announced that it would delay implementation of any refinements to the scope of
two of the add-on payments enacted pursuant to the BBRA and BIPA, thereby
extending the related add-ons to at least September 30, 2003. The other two
add-on payment provisions expired on September 30, 2002. The Senate introduced
legislation during the first week of October 2002 which included a partial
reinstatement of the add-on payment provision limited to the nursing component
of the Medicare rate. This legislative proposal would provide for certain annual
increases beginning in 2003 through 2005. There can be no assurance as to
whether this proposal will be adopted. Any decisions by the government to
discontinue or adversely modify any legislation relating to reimbursement
funding rates will have a material adverse effect on the Company's clients'
revenues.
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, the Company converts 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 the Company's ability to
collect the amounts due. At September 30, 2002 and December 31, 2001, the
Company had approximately, net of reserves, $13,410,000 and $14,159,000,
respectively, of such notes outstanding. In some instances the Company obtains a
security interest in certain of the debtors' assets. Additionally, the Company
considers restructuring service agreements from full service to management-only
service in the case of certain clients experiencing financial difficulties. The
Company believes that the restructuring provides it with a means to maintain a
relationship with the client while at the same time minimizing collection
exposure.
The Company has had varying collection experience with respect to its
accounts and notes receivable. When contractual terms are not met, the Company
generally encounters difficulty in collecting amounts due from certain of its
clients. Therefore, the Company has 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, the Company has recorded bad debt provisions (in an Allowance for
Doubtful Accounts) of $4,950,000 and $3,350,000 in the nine month periods ended
September 30, 2002 and 2001, respectively. These provisions represent
approximately 2.0% and 1.6%, as a percentage of revenue for such respective
periods. In making its evaluation, in addition to analyzing and anticipating,
where possible, the specific cases described above, management considers the
general collection risk associated with trends in the long-term care industry.
The Company also establishes credit limits, as well as performing ongoing credit
evaluation and account monitoring procedures to minimize the risk of loss.
Notwithstanding the Company's efforts to minimize its credit risk exposure, the
Company's clients could be adversely affected if future industry trends change
in such a manner as to negatively impact their cash flows. If the Company's
clients experience such significant impact in their cash flows, it could have a
material adverse affect on the Company's results of operations and financial
condition. At September 30, 2002, the Company has receivables of approximately
$4,000,000 ( $1,500,000, net of reserves ) from a client group currently Debtors
in Chapter 11 bankruptcy proceedings. The Company expects the client group will
file bankruptcy plans sometime during 2003. If the amount collected is
materially less than $1,500,000, it could adversely affect the Company's results
of operations and financial condition.
The Company currently has a Paid Loss Retrospective Insurance Plan for
general liability and workers' compensation insurance. Under these plans,
pre-determined loss limits are arranged with an insurance company to limit both
the Company's per occurrence cash outlay and annual insurance plan cost. For
workers' compensation, the Company records 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 the Company's open claims and
actuarial analysis done by an independent company specialist. The present value
of the payout is determined by applying an 8% discount factor against the
estimated remaining pay-out period.
Management regularly evaluates its claims' pay-out experience, present
value factor and other factors related to the nature of specific claims in
arriving at the basis for its accrued insurance claims' estimate. Management
evaluations are based primarily on current information derived from reviewing
Company claims' experience and industry trends. In the event that the Company's
claims' experience and/or industry trends result in an unfavorable change, it
could have an adverse affect on the Company's results of operations and
financial condition.
The Company has an $18,000,000 bank line of credit on which it may draw
to meet short-term liquidity requirements in excess of internally generated cash
flow. This facility expires on September 30, 2003. The Company believes the line
will be renewed at that time. Amounts drawn under the line are payable on
demand. At September 30, 2002, there were no borrowings under the line. However,
at such date, the Company had outstanding $14,500,000 of irrevocable standby
letters of credit, which relate to payment obligations under the Company's
insurance program. As a result of the letters of credit issued, the amount
available under the line was reduced by $14,500,000 at September 30, 2002. In
addition, the Company has lease commitments totaling $2,613,790 through 2008.
The level of capital expenditures by the Company is generally dependent
on the number of new clients obtained. Such capital expenditures primarily
consist of housekeeping equipment and laundry and linen equipment installations.
Although the Company has no specific material commitments for capital
expenditures through the end of calendar year 2002, it estimates that it will
incur capital expenditures of approximately $2,500,000 during this period in
connection with housekeeping equipment and laundry and linen equipment
installations in its clients' facilities, as well as expenditures relating to
internal data processing hardware and software requirements. The Company
believes that its cash from operations, existing balances and credit line will
be adequate for the foreseeable future to satisfy the needs of its operations
and to fund its continued growth. However, should cash flows from current
operations not be sufficient, the Company would seek to obtain necessary working
capital from such sources as long-term debt or equity financing.
In accordance with the Company's previously announced authorizations to
purchase its outstanding common stock, the Company expended approximately
$342,000 to purchase 28,700 shares of its common stock during the nine month
period ended September 30, 2002 at an average price of $11.92 per common share.
Pursuant to previous Board of Directors' actions, the Company remains authorized
to purchase an additional 757,750.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT
MARKET RISK
The Company's exposure to market risk is not significant.
ITEM 4 - PROCEDURES AND CONTROLS
Within the 90 days prior to the date of this report, the Company
carried out an evaluation, under the supervision and with the participation of
the Company's management, including the Company's Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures pursuant to Exchange Act Rule
13a-14. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the Company's disclosure controls and
procedures are effective. There were no significant changes in the Company's
internal controls or in other factors that could significantly affect these
controls subsequent to the date of their evaluation.
Cautionary Statements Regarding Forward Looking Statements
Certain matters discussed include forward-looking statements that are
subject to risks and uncertainties that could cause actual results or objectives
to differ materially from those projected. The Company undertakes 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 the Company providing its
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 16% of revenue in 2002; the Company's claims experience
related to workers' compensation and general liability insurance; the effects of
changes in regulations governing the industry and risk factors described in the
Company's Form 10-K filed with the Securities and Exchange Commission for the
year ended December 31, 2001 in Part I thereof under "Government Regulation of
Clients", "Competition" and "Service Agreements/Collections". Many of the
Company's 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
Prospective Payment System ("PPS"). That change, and the lack of substantive
reimbursement funding rate reform legislation, as well as other trends in the
long-term care industry have resulted in certain of the Company's 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 effect on the Company's clients. These
factors, in addition to delays in payments from clients has resulted in and
could continue to result in significant additional bad debts in the near future.
Additionally, the Company's 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 its services could not be passed on to
clients.
In addition, the Company believes that to improve its financial
performance it 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 the various operational levels of the Company.
Furthermore, the Company believes that its ability to sustain the internal
development of managerial personnel is an important factor impacting future
operating results and successfully executing projected growth strategies.
Effects of Inflation
All of the Company's service agreements allow it to pass through to its
clients increases in the cost of labor resulting from new wage agreements. The
Company believes that it will be able to recover increases in costs attributable
to inflation by continuing to pass through cost increases to its clients.
PART II. Other Information
-----------------
Item 1. Legal Proceedings. Not Applicable
Item 2. Changes in Securities. Not Applicable
Item 3. Defaults under Senior Securities. Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders Not Applicable
Item 5. Other Information.
a) None
Item 6. Exhibits and Reports on Form 8-K.
a) Exhibits - Certifications
b) Reports on Form 8-K - None
Exhibit I
CERTIFICATIONS
- --------------
I, Daniel P. McCartney, Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Healthcare
Services Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the periods covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrants other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures ( as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and have;
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period this quarterly
report is prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's Board of Directors.
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: October 22, 2002
/s/ Daniel P. McCartney
-----------------------
Daniel P. McCartney
Chief Executive Officer
Exhibit II
I, James L. DiStefano, Chief Financial Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Healthcare
Services Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the periods covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrants other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures ( as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and have;
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period this quarterly
report is prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's Board of Directors.
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: October 22, 2002
/s/ James L. DiStefano
----------------------
James L. DiStefano
Chief Financial Officer
Exhibit III
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Sec 1350),
the undersigned, Daniel P. McCartney, Chief Executive Officer of Healthcare
Services Group, Inc., a Pennsylvania corporation (the "Company"), does hereby
certify, to his knowledge, that:
The Quarterly Report on Form 10-Q for the quarter ended September 30, 2002 of
the Company (the "Report") fully complies with the requirements of section 13(a)
or 15(d) of the Securities Exchange Act of 1934, and the information contained
in the Report fairly presents, in all material respects, the financial condition
and results of operations of the Company.
/s/ Daniel P. McCartney
-----------------------
Daniel P. McCartney
Chief Executive Officer
October 22, 2002
Exhibit IV
CERTIFICATION OF CHIEF FINANCIAL OFFICER
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Sec 1350),
the undersigned, James L. DiStefano, Chief Financial Officer of Healthcare
Services Group, Inc., a Pennsylvania corporation (the "Company"), does hereby
certify, to his knowledge, that:
The Quarterly Report on Form 10-Q for the quarter ended September 30, 2002 of
the Company (the "Report") fully complies with the requirements of section 13(a)
or 15(d) of the Securities Exchange Act of 1934, and the information contained
in the Report fairly presents, in all material respects, the financial condition
and results of operations of the Company.
/s/ James L. DiStefano
----------------------
James L. DiStefano
Chief Financial Officer
October 22, 2002
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.
October 22, 2002 /s/ Daniel P. McCartney
- -------------------- --------------------------------------
Date DANIEL P. McCARTNEY, Chief
Executive Officer
October 22, 2002 /s/ Thomas A. Cook
- -------------------- --------------------------------------
Date THOMAS A. COOK, President and
Chief Operating Officer
October 22, 2002 /s/ James L. DiStefano
- -------------------- --------------------------------------
Date JAMES L. DiSTEFANO, Chief Financial
Officer and Treasurer
October 22, 2002 /s/ Richard W. Hudson
- -------------------- --------------------------------------
Date RICHARD W. HUDSON, Vice
President-Finance, Secretary and Chief
Accounting Officer