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 June 30, 2003 Commission File Number 0-120152
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, 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 o 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
Indicate by check mark whether the registrant is an
Accelerated Filer o as defined in Rule 12b-2 of the
Exchange Act )
YES X NO
Number of shares of common stock, issued and outstanding as of July 25, 2003
is 11,323,921
INDEX
PART I. FINANCIAL INFORMATION PAGE NO.
Item 1. Financial Statements (Unaudited) Consolidated Balance Sheets as of June 30, 2003 and December 31, 2
2002
Consolidated Statements of Income for the Three Months Ended June 30, 2003 and 2002 3
Consolidated Statements of Income for the Six Months Ended June 30, 2003 and 2002 4
Consolidated Statements of Cash Flows for the Six Months ended June 30, 2003 and 2002 5
Notes To Consolidated Financial Statements 6 - 12
Item 2. Management's Discussion and Analysis of Financial Condition and Results Of Operations 13 - 19
Item 3. Quantitative and Qualitative Disclosure of Market Risks 19
Item 4. Controls and Procedures 20
Part II. OTHER INFORMATION 21
Exhibits - Certifications 22 - 26
Signatures 27
-1-
Consolidated Balance Sheets
(Unaudited)
June 30, December 31,
2003 2002
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 58,386,593 $ 48,320,098
Accounts and notes receivable, less allowance
for doubtful accounts of $4,587,000
in 2003 and $7,323,000 in 2002 50,912,920 51,554,372
Prepaid income taxes 883,282
Inventories and supplies 9,710,902 8,662,652
Deferred income taxes 2,115,075 3,021,724
Prepaid expenses and other 3,388,517 2,335,840
------------ ------------
Total current assets 124,514,007 114,777,968
PROPERTY AND EQUIPMENT:
Laundry and linen equipment installations 6,958,693 6,855,886
Housekeeping and office equipment 12,254,133 11,641,590
Autos and trucks 85,489 85,489
------------ ------------
19,298,315 18,582,965
Less accumulated depreciation 14,875,874 14,144,869
------------ ------------
4,422,441 4,438,096
COST IN EXCESS OF FAIR VALUE OF NET ASSETS
ACQUIRED less accumulated
amortization of $1,743,155 in 2003 and 2002 1,612,322 1,612,322
DEFERRED INCOME TAXES 2,479,114 1,955,365
OTHER NONCURRENT ASSETS, principally notes
receivable 11,435,053 11,512,558
------------ ------------
$144,462,937 $134,296,309
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 5,727,340 $ 7,201,543
Accrued payroll, accrued and withheld payroll
taxes 13,899,262 11,162,342
Other accrued expenses 500,857 238,485
Income taxes payable 528,500
Accrued insurance claims 2,338,577 1,953,198
------------ ------------
Total current liabilities 22,994,536 20,555,568
ACCRUED INSURANCE CLAIMS 7,015,731 5,859,593
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $0.1 par value: 30,000,000
shares authorized, 11,743,880 shares
issued in 2003 and 11,612,505 in 2002 117,439 116,125
Additional paid in capital 31,000,944 29,675,340
Retained earnings 87,013,195 81,806,772
Common stock in treasury, at cost, 435,309
shares in 2003 and 445,050 in 2002 (3,678,908) (3,717,089)
------------ ------------
Total stockholders' equity 114,452,670 107,881,148
------------ ------------
$144,462,937 $134,296,309
============ ============
See accompanying notes.
-2-
Consolidated Statements of Income
(Unaudited)
For the Three Months
Ended June 30,
2003 2002
----------- -----------
Revenues $92,805,714 $82,066,566
Operating costs and expenses:
Costs of services provided 81,636,195 72,574,414
Selling, general and administrative 7,075,887 6,059,877
Other Income :
Interest Income 190,878 196,412
----------- -----------
Income before income taxes 4,284,510 3,628,687
Income taxes 1,624,000 1,434,000
----------- -----------
Net Income $ 2,660,510 $ 2,194,687
=========== ===========
Basic earnings per common share $ 0.24 $ 0.20
=========== ===========
Diluted earnings per common share $ 0.23 $ 0.19
=========== ===========
See accompanying notes
-3-
Consolidated Statements of Income
(Unaudited)
For the Six Months Ended
June 30,
2003 2002
------------ ------------
Revenues $182,337,066 $160,998,622
Operating costs and expenses:
Costs of services provided 160,327,050 142,297,159
Selling, general and administrative 13,872,674 12,099,290
Other income :
Interest income 390,081 383,066
------------ ------------
Income before income taxes 8,527,423 6,985,239
Income taxes 3,321,000 2,760,000
============ ============
Net income $ 5,206,423 $ 4,225,239
============ ============
Basic earnings per common share $ 0.46 $ 0.38
============ ============
Diluted earnings per common share $ 0.45 $ 0.36
============ ============
See accompanying notes
-4-
Consolidated Statements of Cash Flows
(Unaudited)
For the Six Months Ended
June 30,
-------------------------
2003 2002
----------- -----------
Cash flows from operating activities:
Net income $ 5,206,423 $ 4,225,239
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization 1,016,865 1,090,803
Bad debt provision 2,950,000 3,250,000
Deferred income taxes (benefits) 382,900 (1,251,900)
Tax benefit of stock option transactions 326,485 342,074
Unrealized (gain) loss on SERP investments 30,712 (4,174)
Changes in operating assets and liabilities:
Accounts and notes receivable (2,308,548) (3,954,767)
Prepaid income taxes 883,282 (343,219)
Inventories and supplies (1,048,250) (281,953)
Long term notes receivable 532,560 1,055,094
Accounts payable and other accrued expenses 1,248,176 (624,641)
Accrued payroll, accrued and withheld payroll
taxes 482,112 291,082
Accrued insurance claims 1,541,517 1,007,609
Income taxes payable 528,500 --
Prepaid expenses and other assets (1,538,445) (988,627)
----------- -----------
Net cash provided by operating activities 10,234,289 3,812,620
Cash flows from investing activities:
Disposals of fixed assets 112,929 27,708
Additions to property and equipment (1,114,138) (986,468)
----------- -----------
Net cash used in investing activities (1,001,209) (958,760)
Cash flows from financing activities:
Purchase of Treasury stock (163,448) --
Proceeds from the exercise of stock options 996,863 1,225,489
----------- -----------
Net cash provided by investing activities 833,415 1,225,489
----------- -----------
Net increase in cash and cash equivalents 10,066,495 4,079,349
Cash and cash equivalents at beginning of the year 48,320,098 34,259,334
----------- -----------
Cash and cash equivalents at end of period $58,386,593 $38,338,683
=========== ===========
Supplementary Cash Flow Information:
Issuance of 24,141 and 23,926 shares of Common
Stock in 2003 and 2002, respectively pursuant to
Employee Stock Purchase Plan $ 205,199 $ 129,649
=========== ===========
See accompanying notes
-5-
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 Healthcare Services Group, Inc. ("we", "us", "our" or 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, 2002 has been derived from, and
does not include, all the disclosures contained in the financial statements
for the year ended December 31, 2002. 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, 2002. The results
of operations for the quarters and six month periods ended June 30, 2003 and
2002 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 believes the line will be renewed at that
time. Amounts drawn under the line are payable upon demand. At both June 30,
2003 and December 31, 2002, there were no borrowings under the line. However,
at such dates, 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 both June 30, 2003 and
December 31, 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 affect 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 manner 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. 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.
-6-
At December 31, 2002, the Company had receivables of approximately
$4,000,000 ($1,500,000, net of reserves) from a client group currently in
Chapter 11 bankruptcy proceedings. This client group filed a plan of
reorganization which was confirmed by the Bankruptcy Court on May 12, 2003.
The Company estimates that it will receive approximately $180,000 from this
client group under such plan. The Company increased its bad debt provision and
charged-off to the Allowance for Doubtful Accounts approximately $3,820,000 of
such receivables during the first quarter of 2003.
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. 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.
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 each operating segments, are earned in one
geographic area, the United States.
Housekeeping,
laundry, linen
and other Food Corporate and
services services eliminations Total
-------------- ----------- ------------- ------------
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
Six Months Ended June 30, 2002
------------------------------
Revenues $136,388,928 $24,039,804 $ 569,890 $160,998,622
-7-
Income before income taxes $11,354,747 $ 823,097 $(5,192,605)(1) $ 6,985,239
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 $(2,520,301)(1) $ 4,284,510
Quarter Ended June 30, 2002
Revenues $69,545,555 $12,631,551 $ (110,540) $82,066,566
Income before income taxes $ 5,873,323 $ 317,767 $(2,562,403)(1) $ 3,628,687
(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 business categories:
For the quarter ended
June 30,
-------------------------
2003 2002
----------- -----------
Housekeeping services $55,319,200 $49,352,530
Laundry and linen services 22,736,888 19,839,205
Food Services 14,361,554 12,472,287
Maintenance services and Other 388,072 402,544
----------- -----------
$92,805,714 $82,066,566
=========== ===========
For the six months ended
June 30,
---------------------------
2003 2002
------------ ------------
Housekeeping services $109,124,971 $ 97,007,274
Laundry and linen services 44,565,528 39,069,920
Food Services 27,908,515 23,895,097
Maintenance services and Other 738,052 1,026,331
------------ ------------
$182,337,066 $160,998,622
============ ============
The Company has one client, a nursing home chain, which in the six months
ended June 30, 2003 and June 30, 2002 accounted for approximately 23% and 16%,
respectively of consolidated revenues. With respect to such client, the
Company derived revenues from both
-8-
operating segments. Although the Company expects to continue its relationship
with this client, the loss of such client would adversely affect the
operations of the Company's two 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 June 30, 2003
-----------------------------------------
Weighted
Income Average Shares Per-share
(Numerator) (Denominator) Amount
----------- -------------- ---------
Net income $2,660,510
===========
Basic earnings per common share $ 2,660,510 11,304,606 $ .24
Effect of dilutive securities:
Options 413,801 (.01)
----------- ---------- -----
Diluted earnings per Common share $ 2,660,510 11,718,407 $ .23
=========== ========== =====
Quarter Ended June 30, 2002
-----------------------------------------
Weighted
Income Average Shares Per-share
(Numerator) (Denominator) Amount
----------- -------------- ---------
Net income $2,194,687
==========
Basic earnings per common share $2,194,687 11,224,347 $ .20
Effect of dilutive securities:
Options 594,460 (.01)
---------- ---------- -----
Diluted earnings per Common share $2,194,687 11,818,807 $ .19
========== ========== =====
Six Months Ended June 30, 2003
-----------------------------------------
Weighted
Income Average Shares Per-share
(Numerator) (Denominator) Amount
----------- -------------- ---------
Net income $5,206,423
==========
Basic earnings per common share $5,206,423 11,275,091 $ .46
Effect of dilutive securities:
Options 421,471 (.01)
---------- ---------- -----
Diluted earnings per Common share $5,206,423 11,696,562 $ .45
========== ========== =====
-9-
Six Months Ended June 30, 2002
-----------------------------------------
Weighted
Income Average Shares Per-share
(Numerator) (Denominator) Amount
----------- -------------- ---------
Net income $4,225,239
==========
Basic earnings per common share $4,225,239 11,196,845 $ .38
Effect of dilutive securities: Options 499,029 (.02)
---------- ---------- -----
Diluted earnings per Common share $4,225,239 11,695,874 $ .36
========== ========== =====
No outstanding options were excluded at either June 30, 2003 or 2002 as none
have an exercise price in excess of the average market value of the Company's
Common Stock at such dates.
Note 5 - Stock Based Compensation
As permitted by the Statement of Financial Accounting Standards No. 123,
"Accounting for Stock Based Compensation", the Company accounts for stock-
based compensation arrangements in accordance with provisions of Accounting
Principles Board ("APB") Opinion No. 25 "Accounting for Stock Issued to
Employees". Compensation expense for stock options issued to employees is
based on the difference on the date of grant, between the fair value of the
Company's 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. The Company accounts for equity instruments
issued to nonemployees in accordance with the provisions of SFAS No. 123 and
Emerging Issues Task Force ("EITF") Issue No. 96-18, "Accounting for Equity
Instruments That Are Issued to Other Than Employees for Acquiring, or in
Conjunction With Selling, or in Conjunction With Selling Goods or 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.
In December 2002, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure, an amendment of FASB Statement No. 123. " SFAS No. 148 amends SFAS
No. 123, "Accounting for Stock-Based Compensation, " to provide alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, SFAS No. 148
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosure in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on
-10-
reported results. The provisions of SFAS No. 148 are effective for fiscal
years ending after December 15, 2002 and the interim disclosure provisions are
effective for interim periods beginning after December 15, 2002. The Company
continues to apply the intrinsic-value based method to account for stock
options and complies with the new disclosure requirements beginning with the
first quarter of its fiscal year ending December 31, 2003.
The following table illustrates the effect on net income and earnings per
share if the Company had applied the fair value recognition provisions of SFAS
No. 123 to stock based compensation:
(in thousands
except per
share data)
Quarter Ended
June 30,
---------------
2003 2002
------ ------
Net income
As reported $2,661 $2,195
Deduct:
Total stock based employee compensation expense determined
under fair value based method for all awards, net of
related tax effects (553) (605)
------ ------
Pro forma net income $2,108 $1,590
====== ======
Basic earnings per common share
As reported $ .24 $ .20
Pro forma $ .19 $ .14
Diluted earnings per common share
As reported $ .23 $ .19
Pro forma $ .18 $ .13
Six Months Ended
June 30,
-----------------
2003 2002
------- -------
Net income
As reported $ 5,206 $ 4,225
Deduct:
Total stock based employee compensation expense
determined under fair value based method for all awards,
net of related tax effects (1,383) (1,514)
------- -------
Pro forma net income $ 3,823 $ 2,711
======= =======
Basic earnings per common share
As reported $ .46 $ .38
Pro forma $ .34 $ .24
Diluted earnings per common share
As reported $ .45 $ .36
Pro forma $ .33 $ .23
-11-
Note 6 - Recent Accounting Pronouncements
In June 2002, the Financial Accounting Standards Board issued SFAS No. 146,
"Accounting for Exit or Disposal Activities". SFAS No. 146 requires that the
liability for costs associated with an exit or disposal activity be recognized
at their fair values when the liabilities are incurred. Under previous guidance,
liabilities for certain exit costs were recognized at the date that management
committed to an exit plan, which is generally before the actual liabilities are
incurred. As SFAS No. 146 is effective only for exit or disposal activities
initiated after December 31, 2002, the adoption of this statement did not have a
material impact on its financial statements.
In April 2003, the FASB issued Statement of Financial Accounting Standards No.
149 ("SFAS No. 149"), "Amendment of Statement 133 on Derivative Instruments
and Hedging Activities," which amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts and for hedging activities under SFAS No. 133.
SFAS No. 149 is effective for contracts entered into or modified after June
30, 2003 except for the provisions that were cleared by the FASB in prior
pronouncements. The Company believes that the adoption of SFAS No. 149 will
not have a material effect on its financial position and results of
operations.
In May 2003, the FASB issued Statement of Financial Accounting Standards No.
150 ("SFAS No. 150"), "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity." This statement establishes
standards for how an issuer classifies and measures in its statement of
financial position certain financial instruments with characteristics of both
liabilities and equity. In accordance with the standard, financial instruments
that embody obligations for the issuer are required to be classified as
liabilities. This Statement is effective for financial instruments entered
into or modified after May 31, 2003. The adoption of SFAS No. 150 had no
material effect on the Company's financial position and results of operations.
-12-
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 For the Six
Quarter Ended Months Ended
June 30, June 30,
------------- -------------
2003 2002 2003 2002
----- ----- ----- -----
Revenues 100.0% 100.0% 100.0% 100.0%
Operating costs and expenses:
Costs of services provided 88.0 88.4 87.9 88.4
Selling, general and
administration 7.6 7.4 7.6 7.5
Interest income .2 .2 .2 .2
----- ----- ----- -----
Income before income taxes 4.6 4.4 4.7 4.3
Income taxes 1.7 1.7 1.8 1.7
----- ----- ----- -----
Net income 2.9% 2.7% 2.9% 2.6%
===== ===== ===== =====
Revenues for the three and six month periods ended June 30, 2003 increased
13.1% and 13.3%, respectively compared to the corresponding 2002 periods. The
growth in revenues is primarily a result of a net increase in service
agreements entered into with new clients, as well as providing additional
services to existing clients. Approximately 80% of the revenue growth, in each
period, resulted from the Company's housekeeping, laundry and linen, and other
services segment, with the remaining revenue growth being generated from the
Company's food service segment. The Company believes that in 2003 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 2002 percentages.
The Company has one client, a nursing home chain, which in the six months
ended June 30, 2003 and June 30, 2002 accounted for approximately 23% and 16%,
respectively of consolidated revenues. With respect to such client, the
Company derived revenues from both operating segments. Although the Company
expects to continue its relationship with this client, the loss of such client
would adversely affect the operations of the Company's two operating segments.
Cost of services provided as a percentage of revenues decreased to 88.0 %
for the second
-13-
quarter of 2003 from 88.4 % in the corresponding 2002 quarter. The primary
factors affecting specific variations in the 2003 cost of services provided as
a percentage of revenue and its effect on the .4% decrease are as follows:
decrease of .9% in health insurance and employee benefits, as well as
decreases of .6% each in bad debt provision and labor costs; offsetting these
decreases were increases of 1.0% and .7% in the cost of supplies consumed in
providing services and workers' compensation insurance, respectively. The
increase in cost of supplies was attributable to increase costs associated
with the food service segment, whereas the increase in workers' compensation
insurance resulted primarily from the effect of the acceleration in the timing
of settlements made with, as well as increased payments to claimants under the
plan.
Cost of services provided as a percentage of revenues decreased to 87.9 %
for the six month period ended June 30, 2003 from 88.4 % in the corresponding
2002 period. The primary factors affecting specific variations in the 2003
cost of services provided as a percentage of revenue and its effect on the .5%
decrease are as follows: decreases of .8% and .4% in health insurance and
employee benefits, and bad debt provision, respectively; offsetting these
decreases was an increase of .7% in the cost of supplies consumed in providing
services. The increase in cost of supplies was attributable to increase costs
associated with the food service segment.
Selling, general and administrative expenses as a percentage of revenue
remained essentially unchanged at 7.6% in both the second quarter and six
month period ended June 30, 2003 compared to 7.4% and 7.5% respectively, in
the second quarter and six month period ended June 30, 2002.
As a result of the matters discussed above, net income for both the second
quarter and six month periods ended June 30, 2003 increased to 2.9% as a
percentage of revenue compared to 2.7% and 2.6%, respectively in the
comparable 2002 periods.
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 these policies, management cautions 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 management's judgment in their
application. There are also areas in which management's 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, 2002 which
contain accounting policies and other disclosures required by generally
accepted accounting principles.
-14-
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
have included 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, 2002 in Part I thereof
under "Government Regulation of Clients" 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 affect on the Company's results of operations
and financial condition.
At December 31, 2002, the Company had receivables of approximately
$4,000,000 ($1,500,000, net of reserves) due from a client group currently in
Chapter 11 bankruptcy proceedings. This client group filed a plan of
reorganization which was confirmed by the Bankruptcy Court on May 12, 2003.
The Company estimates that it will receive approximately $180,000 from this
client group under such plan. The Company increased its bad debt provision and
charged-off to the Allowance for Doubtful Accounts approximately $3,820,000 of
such receivables during the first quarter of 2003.
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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 specialist. The
present value of the payout is determined by applying an 8% discount factor
against the estimated remaining pay-out period.
For general liability, the Company records a reserve for the estimated
ultimate amounts to be paid for known claims.
Management regularly evaluates its claim 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
the Company's 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.
Liquidity and Capital Resources
At June 30, 2003 the Company had working capital and cash of $101,519,471
and $58,386,593, respectively, compared to December 31, 2002 working capital
and cash of $94,222,400 and $48,320,098, respectively. The Company's current
ratio at June 30, 2003 decreased slightly to 5.4 to 1 from 5.6 to 1 at
December 31, 2002 primarily as a result of the timing of payments for payroll
and payroll taxes.
Management views the Company's cash and cash equivalents of $58,386,593 at
June 30, 2003 as its principal measure of liquidity.
The net cash provided by the Company's operating activities was $10,234,289
for the six month period ended June 30, 2003 as compared to net cash provided by
operating activities of $3,812,620 in the same 2002 six month period. The
principal sources of net cash flows from operating activities for the six month
periods ended June 30, 2003 and 2002 were net income which has been reduced as a
result of noncash charges to operations for bad debt provisions and depreciation
and amortization. Additionally, in the six month period ended June 30, 2003
operating activities' cash flows were increased by the timing of payments for
accrued insurance claims and accounts payable and other accrued expenses of
$1,541,517 and $1,248,176, respectively. The operating activities that used the
largest amount of cash during the six month periods ended June 30, 2003 and 2002
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were net increases in accounts and notes receivable and long term notes
receivable of $1,775,988 and $2,899,673, respectively. The net increases in
these amounts resulted primarily from the growth in the Company's revenues, as
well as the timing of collections from clients. Additionally, operating cash
flows in the six month period ended June 30, 2003 were negatively impacted by a
$1,538,445 increase in prepaid expenses and other assets. These cash flows were
the result of the timing of such payments. Operating activities' cash flows in
the six month period ended June 30, 2002 were reduced as a result of an increase
of $988,627 in prepaid expenses and other assets, and a decrease of $624,639 in
accounts payable and other accrued expenses. The respective uses of cash
resulted primarily from the timing of such payments.
The Company's principal use of cash in investing activities in each of the
six month periods ended June 30, 2003 and 2002, respectively was the purchase
of housekeeping equipment and computer software and equipment.
We expend considerable effort to collect the amounts due for our services
on the terms agreed upon with our clients. Many of the 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 ("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 our 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 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 our ability to collect the amounts
due. At June 30, 2003 and December 31, 2002, we had approximately, net of
reserves, $13,984,000 and $14,385,000, respectively of such notes outstanding.
In some instances we obtain a security interest in certain of the debtors'
assets. 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 it with a
means to maintain a relationship with the client while at the same time
minimizing collection exposure.
We have had varying collection experience with respect to its accounts and
notes receivable. When contractual terms are not met, we generally encounters
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
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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
$2,950,000 and $3,250,000 in the six month periods ended June 30, 2003 and
2002, respectively. These provisions represent approximately 1.6% and 1.8%, as
a percentage of revenue for such respective periods. In making its credit
evaluations, 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. We also
establishes credit limits, as well as performing ongoing credit evaluation and
account monitoring procedures 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 could have a material adverse effect on our results of
operations and financial condition.
At December 31, 2002, the Company had receivables of approximately
$4,000,000 ($1,500,000, net of reserves) from a client group currently in
Chapter 11 bankruptcy proceedings. This client group filed a plan of
reorganization which was confirmed by the Bankruptcy Court on May 12, 2003.
The Company estimates that it will receive approximately $180,000 from this
client group under such plan. The Company increased its bad debt provision and
charged-off to the Allowance for Doubtful Accounts approximately $3,820,000 of
such receivables during the first quarter of 2003.
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 specialist. The present
value of the payout is determined by applying an 8% discount factor against
the estimated remaining pay-out period.
For general liability, the Company records a reserve for the estimated
ultimate amounts to be paid for known claims.
Management regularly evaluates its claim 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
the Company's 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.
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
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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 June 30,
2003, 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 June 30, 2003.
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, laundry and linen equipment installations,
and computer hardware and software. Although the Company has no specific
material commitments for capital expenditures through the end of calendar year
2003, 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
utilize its existing working capital and if necessary seek to obtain necessary
working capital from such sources as long-term debt or equity financing.
During the 2003 second quarter, the Company purchased on the open market
14,400 shares of its common stock at an average price of $11.34 per common
share. At June 30, 2003, the Company remains authorized to purchase up to
589,500 shares of its outstanding common stock pursuant to previous Board of
Directors' action.
ITEM 3. - QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company's exposure to market risk is not significant.
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. 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 our
providing 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 23% of revenues in the six
month period ended June 30, 2003; our claims experience related to 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, 2002 in Part I thereof under "Government Regulation of Clients",
"Competition" and "Service Agreements/Collections". Many of our clients'
revenues
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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 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 services could not be passed on to 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 the various operational levels of the Company. 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.
Effects of Inflation
We believe that it will be able to recover increases in costs attributable
to inflation by passing through such cost increases to its clients.
ITEM 4 - CONTROLS AND PROCEDURES
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 in timely alerting them to material information,
relating to the Company (including its consolidated subsidiaries), required
to be included in the Company's periodic Securities and Exchange Commission
filings. No significant changes were made in the Company's internal controls
or in other factors that could significantly affect these controls subsequent
to the date of their evaluation.
Disclosure controls and procedures are those controls and other procedures
that are designed to ensure that information required to be disclosed by the
Company in the reports that it files or submits under the Exchange Act is
recorded, processed, summarized and reported, within the time periods
specified in the Securities and Exchange Commission's rules and forms.
Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required to be disclosed by the
Company in the reports that it files or
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submits under the Exchange Act is accumulated and communicated to the
Company's management, including the Company's principal executive officer and
principal financial officer, as appropriate to allow timely decisions
regarding disclosure.
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
c) The Company's Annual Meeting of Shareholders was held on May
27, 2003. The results are as follows:
(1) All of management's nominees for directors were elected
as follows:
Shares Voted Withheld
"FOR"
7,386,578 1,744,858
(2) Proposal to approve and adopt an amendment to the
Company's 2002 Stock Option Plan was approved as
follows:
Shares Voted Shares Voted Shares
"FOR" "AGAINST" "ABSTAINING"
7,692,422 1,431,828 7,186
(3) Proposal to approve and ratify selection of Grant
Thornton LLP as the independent certified public
accountants of the Company for its current fiscal year
ending December 31, 2003as approved as follows.
Shares Voted Shares Voted Shares
"FOR" "AGAINST" "ABSTAINING"
9,095,069 33,535 2,832
Item 5. Other Information.
a) None
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Item 6. Exhibits and Reports on Form 8-K.
a) Exhibits -
31.1 Certification of Chief Executive Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
b) Reports on Form 8-K - None
CERTIFICATIONS
Exhibit 31.1
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, or
caused such disclosure controls and procedures to be
designed under our supervision, 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 in
which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's
disclosure controls and procedures and presented in this
quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end
of the period covered by this report based on such
evaluation and;
c) disclosed in this report any change in the registrant's
internal control over financial reporting that occurred
during the registrant's most recent fiscal quarter that
has materially affected, or is reasonably likely to
materially affect, the registrant's internal control
over financial reporting; and
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.
-22-
a) all significant deficiencies and material weaknesses in
the design or operation of internal control over
financial reporting which are reasonably likely to
adversely affect the registrant's ability to record,
process, summarize and report financial information; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal control over financial
reporting
Date: July 25, 2003
/s/ Daniel P.McCartney
Daniel P.McCartney
Chief Executive Officer
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Exhibit 31.2
I, James L. DiStefano, Chief Financial Officer, certify that:
6. I have reviewed this quarterly report on Form 10-Q of Healthcare
Services Group, Inc.;
7. 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;
8. 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;
9. 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, or caused
such disclosure controls and procedures to be designed under
our supervision, 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 in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this quarterly report
our conclusions about the effectiveness of the disclosure
controls and procedures, as of the end of the period covered by
this report based on such evaluation and;
c) disclosed in this report any change in the registrant's
internal control over financial reporting that occurred during
the registrant's most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
10. 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 and material weaknesses in the
design or operation of internal control over financial
reporting which are reasonably likely to adversely affect the
registrant's ability to record, process, summarize and report
financial information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting
Date: July 25, 2003
/s/ James L. DiStefano
James L. DiStefano
Chief Financial Officer
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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.
July 25, 2003 /s/ Daniel P. McCartney
Date DANIEL P. McCARTNEY, Chief
Executive Officer
July 25, 2003 /s/ Thomas A. Cook
Date THOMAS A. COOK, President and
Chief Operating Officer
July 25, 2003 /s/ James L. DiStefano
Date JAMES L. DiSTEFANO, Chief Financial
Officer and Treasurer
July 25, 2003 /s/ Richard W. Hudson
Date RICHARD W. HUDSON, Vice
President-Finance, Secretary and Chief
Accounting Officer
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