UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004 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 ( 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 (as
defined in Rule 12b-2 of the Exchange Act)
YES X NO
----- -----
Number of shares of common stock outstanding as of July 26, 2004 is 17,198,305
INDEX
PART I. FINANCIAL INFORMATION PAGE NO.
--------------------- --------
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets as of
June 30, 2004 and December 31, 2003 2
Consolidated Statements of Income for the Three
Months Ended June 30, 2004 and 2003 3
Consolidated Statements of Income for the Six
Months Ended June 30, 2004 and 2003 4
Consolidated Statements of Cash Flows for the Six
Months ended June 30, 2004 and 2003 5
Consolidated Statement of Stockholders' Equity
for the Six Months ended June 30, 2004 6
Notes To Consolidated Financial Statements 7 - 12
Item 2. Management's Discussion and Analysis of
Financial Condition and Results Of Operations 13 - 21
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 21
Item 4. Controls and Procedures 22
PART II. OTHER INFORMATION
-----------------
Item 1. Legal Proceedings 23
Item 2. Changes in Securities, Use of Proceeds
And Issuer Purchases of Equity Securities 23
Item 3. Defaults Upon Senior Securities 23
Item 4. Submission of Matters to a Vote of Security
Holders 23
Item 5. Other Information 24
Item 6. Exhibits and Reports on Form 8-K 24
Signatures 25
-1-
PART I- FINANCIAL INFORMATION
---------------------
ITEM 1.- FINANCIAL STATEMENTS
Consolidated Balance Sheets
(Unaudited)
June 30, December 31,
2004 2003
-------------------------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 74,726,696 $ 64,180,697
Accounts and notes receivable, less allowance for doubtful
accounts of $2,784,000 in 2004 and $3,414,000 in 2003 54,388,779 58,145,440
Inventories and supplies 10,832,419 10,454,838
Deferred income taxes 1,811,603 2,016,798
Prepaid expenses and other 3,750,894 3,312,959
------------- -------------
Total current assets 145,510,391 138,110,732
PROPERTY AND EQUIPMENT:
Laundry and linen equipment installations 2,199,450 2,190,388
Housekeeping and office equipment 13,637,507 12,830,794
Autos and trucks 79,639 79,639
------------- -------------
15,916,596 15,100,821
Less accumulated depreciation 11,235,557 10,489,224
------------- -------------
4,681,039 4,611,597
NOTES RECEIVABLE- long term portion, net 5,733,094 7,904,195
DEFERRED COMPENSATION FUNDING 3,458,286 2,847,575
DEFERRED INCOME TAXES- long term portion 3,670,486 3,134,691
OTHER NONCURRENT ASSETS 1,719,342 1,719,342
------------- -------------
$ 164,772,638 $ 158,328,132
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 7,128,272 $ 6,536,395
Accrued payroll, accrued and withheld payroll taxes 14,854,321 14,127,469
Other accrued expenses 2,493,999 874,523
Income taxes payable 396,191 178,862
Accrued insurance claims 3,202,278 2,978,974
------------- -------------
Total current liabilities 28,075,061 24,696,223
ACCRUED INSURANCE CLAIMS- long term portion 9,606,833 8,936,921
DEFERRED COMPENSATION LIABILITY 4,244,521 3,496,810
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value: 45,000,000 shares authorized,
18,154,000 shares issued in 2004 and 17,938,613 in 2003 181,540 179,386
Additional paid in capital 35,641,165 33,515,234
Retained earnings 96,042,074 91,178,370
Common stock in treasury, at cost, 963,565 shares in 2004 and
652,238 in 2003 (9,018,556) (3,674,812)
------------- -------------
Total stockholders' equity 122,846,223 121,198,178
------------- -------------
$ 164,772,638 $ 158,328,132
============= =============
See accompanying notes.
-2-
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
FOR THE THREE MONTHS ENDED JUNE 30,
2004 2003
-------------- -------------
Revenues $ 110,489,485 $ 92,805,714
Operating costs and expenses:
Costs of services provided 97,340,454 81,636,195
Selling, general and administrative 7,760,779 7,075,887
Other Income:
Investment and interest income 306,057 190,878
------------- ------------
Income before income taxes 5,694,309 4,284,510
Income taxes 2,164,000 1,624,000
------------- ------------
Net Income $ 3,530,309 $ 2,660,510
============= ============
Basic earnings per common share $ 0.20 $ 0.16
============= ============
Diluted earnings per common share $ 0.19 $ 0.15
============= ============
Cash dividends per common share $ 0.06 $ --
============= ============
Basic weighted average number of
common shares outstanding 17,483,148 16,956,909
============= ============
Diluted weighted average number of
common shares outstanding 18,467,080 17,577,611
============= ============
See accompanying notes.
-3-
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30,
2004 2003
---------------- --------------
Revenues $ 217,111,305 $ 182,337,066
Operating costs and expenses:
Costs of services provided 190,788,869 160,327,050
Selling, general and administrative 15,775,680 13,872,674
Other Income:
Investment and interest income 499,747 390,081
------------- ------------
Income before income taxes 11,046,503 8,527,423
Income taxes 4,198,000 3,321,000
------------- ------------
Net Income $ 6,848,503 $ 5,206,423
============= =============
Basic earnings per common share $ 0.39 $ 0.31
============= =============
Diluted earnings per common share $ 0.37 $ 0.30
============= =============
Cash dividends per common share $ 0.11 $ --
============= =============
Basic weighted average number of
common shares outstanding 17,483,836 16,912,637
============= =============
Diluted weighted average number of
common shares outstanding 18,452,458 17,544,844
============= =============
See accompanying notes.
-4-
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE SIX MONTHS ENDED
JUNE 30,
----------------------------------------------
2004 2003
--------------------- ---------------------
Cash flows from operating activities:
Net Income $ 6,848,503 $ 5,206,423
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation 975,785 1,016,865
Bad debt provision 1,750,000 2,950,000
Deferred income taxes (benefit) (330,600) 382,900
Tax benefit of stock option transactions 642,912 326,485
Unrealized (gain) loss on deferred compensation
fund investments (83,382) 30,712
Changes in operating assets and liabilities:
Accounts and notes receivable 2,006,661 (2,308,548)
Prepaid income taxes -- 883,282
Inventories and supplies (377,581) (1,048,250)
Notes receivable- long term 2,171,100 532,560
Deferred compensation funding (527,329) (485,767)
Accounts payable and other accrued expenses 2,211,353 682,539
Accrued payroll, accrued and withheld payroll taxes 1,093,030 482,112
Deferred compensation liability 747,711 565,637
Income taxes payable 217,329 528,500
Accrued insurance claims 893,216 1,541,517
Prepaid expenses and other assets (437,935) (1,052,678)
------------- -------------
Net cash provided by operating activities 17,800,773 10,234,289
------------- -------------
Cash flows from investing activities:
Disposals of fixed assets 118,872 112,929
Additions to property and equipment (1,164,099) (1,114,138)
------------- -------------
Net cash used in investing activities (1,045,227) (1,001,209)
------------- -------------
Cash flows from financing activities:
Dividends paid (1,984,799) --
Purchase of treasury stock (5,617,004) (163,448)
Reissue of treasury stock pursuant to Dividend
Reinvestment Plan 3,684 --
Proceeds from the exercise of stock options 1,388,572 996,863
------------- -------------
Net cash provided by (used in) financing activities (6,209,547) 833,415
------------- -------------
Net increase in cash and cash equivalents 10,545,999 10,066,495
Cash and cash equivalents at beginning of the period 64,180,697 48,320,098
------------- -------------
Cash and cash equivalents at end of the period $ 74,726,696 $ 58,386,593
============= =============
Supplementary Cash Flow Information:
Issuance of 48,224 shares of Common Stock in 2004 and
36,212 shares of Common Stock in 2003 pursuant to
Employee Stock Plans $ 366,177 $ 205,199
============= =============
See accompanying notes.
Consolidated Statements of Stockholders' Equity
(Unaudited)
For the Six Months Ended June 30, 2004
--------------------------------------
Additional Total
Common Stock Paid-in Retained Treasury Stockholders'
Shares Amount Capital Earnings Stock Equity
------ ------ ---------- -------- -------- -------------
Balance, December 31, 2003 17,938,613 $179,386 $33,515,234 $91,178,370 ($3,674,812) $121,198,178
Net income 6,848,503 6,848,503
Exercise of stock options 215,387 2,154 1,386,418 1,388,572
Tax benefit arising from stock option transactions 642,912 642,912
Purchase of common stock for treasury
(359,798 shares) (5,617,004) (5,617,004)
Shares issued pursuant to Employee Stock Plans
(48,224 shares) 94,478 271,699 366,177
Cash dividends paid - $.11 per common share (1,984,799) (1,984,799)
Shares issued pursuant to Dividend Reinvestment
Plan (247 shares) 2,123 1,561 3,684
---------- -------- ----------- ----------- ----------- ------------
Balance, June 30, 2004 18,154,000 $181,540 $35,641,165 $96,042,074 ($9,018,556) $122,846,223
========== ======== =========== =========== =========== ============
See accompanying notes.
-6-
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 our
opinion, all adjustments (consisting of normal recurring adjustments) considered
necessary for a fair presentation have been included. The balance sheet shown in
this report as of December 31, 2003 has been derived from, and does not include,
all the disclosures contained in the financial statements for the year ended
December 31, 2003. The financial statements should be read in conjunction with
the financial statements and notes thereto included in our Annual Report on Form
10-K for the year ended December 31, 2003. The results of operations for the
three and six month periods ended June 30, 2004 and 2003 are not necessarily
indicative of the results that may be expected for the full fiscal year.
NOTE 2 - THREE-FOR-TWO STOCK SPLIT
On February 12, 2004, our Board of Directors approved a three-for-two
stock split in the form of a 50% common stock dividend which was paid on March
1, 2004 to shareholders of record on February 23, 2004. All share and earnings
per common share information for all periods presented have been adjusted to
reflect the three-for-two stock split.
NOTE 3 - OTHER CONTINGENCIES
We have an $18,000,000 bank line of credit on which we may draw to meet
short-term liquidity requirements in excess of internally generated cash flow.
The credit facility contains several financial covenants that we are required to
meet. We are in compliance with all financial covenants at both June 30, 2004
and December 31, 2003 and expect to continue to remain in compliance. This
facility expires on January 31, 2005. We believe the line of credit will be
renewed at that time. Amounts drawn under the line of credit are payable upon
demand. At both June 30, 2004 and December 31, 2003, there were no borrowings
under the line of credit. However, at such dates, we had outstanding $15,925,000
and $14,500,000, respectively of irrevocable standby letter of credit which
relate to payment obligations under our insurance program. As a result of the
letter of credit issued, the amount available under the line of credit was
reduced by $15,925,000 and $14,500,000 at June 30, 2004 and December 31, 2003,
respectively.
We are also involved in miscellaneous claims and litigation arising in
the ordinary course of business. We believe that these matters, taken
individually or in the aggregate, will not have a material adverse affect on our
financial position or results of operations.
The Balance Budget Act of 1997 changed Medicare policy in a number of
ways, most notably the phasing in, effective July 1, 1998, of a Medicare
Prospective Payment System for skilled nursing facilities which significantly
changed the manner and the amounts of reimbursement they receive. Many of the
-7-
our clients' revenues are highly contingent on Medicare and Medicaid
reimbursement funding rates. Therefore, they have been and continue to be
adversely affected by changes in applicable laws and regulations, as well as
other trends in the long-term care industry. This has resulted in certain of our
clients filing for bankruptcy protection. Others may follow. These factors, in
addition to delays in payments from clients, have resulted in and could continue
to result in significant additional bad debts in the near future.
NOTE 4 - SEGMENT INFORMATION
We manage and evaluate our operations in two reportable operating
segments. The two operating segments are Housekeeping services (housekeeping,
laundry, linen and other services), and Food services. Although both segments
serve the same client base and share many operational similarities they are
managed separately due to distinct differences in the type of service provided,
as well as the specialized expertise required of the professional management
personnel responsible for delivering the respective segment's services. We
consider the various services provided within the Housekeeping services segment
to be one reportable operating segment since such services are rendered pursuant
to a single service agreement and the delivery of such services is managed by
the same management personnel.
Differences between the reportable segments' operating results and
other disclosed data, and our consolidated financial statements relate primarily
to corporate level transactions, as well as transactions between reportable
operating segments and our warehousing and distribution subsidiary. This
subsidiary's transactions with reportable segments are made on a basis intended
to reflect the fair market value of the goods transferred. Additionally,
included in the differences between the reportable segments' operating results
and other disclosed data are amounts from our investment holding company
subsidiary. This subsidiary does not transact any business with the reportable
segments. Segment amounts disclosed are prior to any elimination entries made in
consolidation.
The Housekeeping services segment provides services in Canada, although
essentially all of its revenues and net income, 99% in both categories, are
earned in one geographic area, the United States. Food services are provided
solely in the United States.
Housekeeping Food Corporate and
services services eliminations Total
------------ -------- -------------- ------
Quarter Ended June 30, 2004
- ---------------------------
Revenues $ 88,773,502 $ 21,794,596 $( 78,613) $110,489,485
Income before income
taxes $ 7,546,850 $ 779,251 $( 2,631,792)(1) $ 5,694,309
Quarter Ended June 30, 2003
- ---------------------------
Revenues $ 78,363,077 $ 14,441,576 $ 1,061 $ 92,805,714
Income before income
taxes $ 6,245,398 $ 559,413 $( 3,520,301)(1) $ 4,284,510
(1) represents primarily corporate office cost and related overhead, as well as
certain consolidated subsidiaries' operating expenses that are not allocated
to the service segments.
-8-
Housekeeping Food Corporate and
services services eliminations Total
------------ -------- -------------- ------
Six Months Ended June 30, 2004
- ------------------------------
Revenues $ 176,565,291 $ 40,649,144 $( 103,130) $217,111,305
Income before income
taxes $ 15,346,398 $ 1,276,322 $( 5,576,217)(1) $ 11,046,503
Six Months Ended June 30, 2003
- ------------------------------
Revenues $ 153,942,154 $ 27,862,484 $ 532,428 $182,337,066
Income before income
taxes $ 12,331,048 $ 1,031,128 $( 4,834,753)(1) $ 8,527,423
(1) represents primarily corporate office cost and related overhead, as well as
certain consolidated subsidiaries' operating expenses that are not allocated
to the service segments.
We earned revenue in the following service categories:
For the quarter ended June 30,
------------------------------
2004 2003
---- ----
Housekeeping services $ 61,961,274 $55,319,200
Laundry and linen services 26,313,529 22,736,888
Food services 21,690,477 14,361,554
Maintenance services
and Other 524,205 388,072
------------ -----------
$110,489,485 $92,805,714
============ ===========
For the quarter ended June 30,
------------------------------
2004 2003
---- ----
Housekeeping services $123,612,468 $109,124,971
Laundry and linen services 52,386,782 44,565,528
Food services 40,110,356 27,908,515
Maintenance services
and Other 1,001,699 738,052
------------ ------------
$217,111,305 $182,337,066
============ ============
We have one client, a nursing home chain, which in the six month
periods ended June 30, 2004 and June 30, 2003 accounted for approximately 21%
and 23%, respectively of consolidated revenues. In the six month period ended
June 30, 2004, we derived approximately 19% and 27%, respectively of the
Housekeeping services and Food services segments' revenues from such client.
Although we expect to continue our relationship with this client, the loss of
such client would adversely affect the operations of our two operating segments.
-9-
NOTE 5 - 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, 2004
---------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
----------- ------------- ---------
Net income $3,530,309
==========
Basic earnings per
common share $3,530,309 17,483,148 $ .20
Effect of dilutive securities:
Options -- 983,932 (.01)
---------- ------------- ---------
Diluted earnings per
Common share $3,530,309 18,467,080 $ .19
========== ============= =========
Quarter Ended June 30, 2003
---------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
----------- ------------- ---------
Net income $2,660,510
==========
Basic earnings per
common share $2,660,510 16,956,909 $ .16
Effect of dilutive securities:
Options -- 620,702 (.01)
---------- ------------- ---------
Diluted earnings per
Common share $2,660,510 17,577,611 $ .15
========== ============= =========
Six Months Ended June 30, 2004
------------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
----------- ------------- ---------
Net income $6,848,503
==========
Basic earnings per
common share $6,848,503 17,483,836 $ .39
Effect of dilutive securities:
Options -- 968,622 (.02)
---------- ------------- ---------
Diluted earnings per
Common share $6,848,503 18,452,458 $ .37
========== ============= =========
-10-
Six Months Ended June 30, 2003
------------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
----------- ------------- ---------
Net income $5,206,423
==========
Basic earnings per
common share $5,206,423 16,912,637 $ .31
Effect of dilutive securities:
Options 632,207 (.01)
---------- ------------- ---------
Diluted earnings per
Common share $5,206,423 17,544,844 $ .30
========== ============= =========
No outstanding options were excluded for any of the reported periods ended
June 30, 2004 or June 30, 2003, as none have an exercise price in excess of the
average market value of our Common Stock at such dates.
NOTE 6 - STOCK BASED COMPENSATION
At both June 30, 2004 and December 31, 2003, we had and continue to
have stock based compensation plans. As permitted by the Statement of Financial
Accounting Standards No. 123, "Accounting for Stock Based Compensation", we
account 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 our
common stock and the exercise price of the option. No stock-based employee
compensation cost is reflected in net income, as all options granted under those
plans had an exercise price equal to the market value of the underlying common
stock at the date of grant.
We account for equity instruments issued to non-employees in accordance
with the provisions of SFAS No. 123 and Emerging Issues Task Force ("EITF")
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. There were
no such equity instruments issued during the six month periods ended June 30,
2004 or June 30, 2003.
-11-
The following table illustrates the effect on net income and earnings
per share if we had applied the fair value recognition provisions of SFAS No.
123 to stock based compensation:
Quarter Ended June 30,
----------------------
2004 2003
---- ----
Net Income
As reported $3,530,309 $2,660,510
Deduct:
Total stock based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects ( 512,000) ( 553,000)
---------- ----------
Pro forma net income $3,018,309 $2,107,510
========== ==========
Basic Earnings Per Common Share
As reported $ .20 $ .16
Pro forma $ .17 $ .12
Diluted Earnings Per Common Share
As reported $ .19 $ .15
Pro forma $ .16 $ .12
Six Months Ended June 30,
-------------------------
2004 2003
---- ----
Net Income
As reported $6,848,503 $5,206,423
Deduct:
Total stock based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects (1,279,000) (1,383,000)
---------- ----------
Pro forma net income $5,569,503 $3,823,423
========== ==========
Basic Earnings Per Common Share
As reported $ .39 $ .31
Pro forma $ .32 $ .23
Diluted Earnings Per Common Share
As reported $ .37 $ .30
Pro forma $ .30 $ .22
-12-
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Cautionary Statements Regarding Forward Looking Statements
This quarterly report on Form 10-Q includes forward-looking statements
that are subject to risks and uncertainties that could cause actual results or
objectives to differ materially from those projected. We undertake no obligation
to publicly update or revise any forward-looking statements, whether as a result
of new information, future events or otherwise. Such risks and uncertainties
include, but are not limited to, risks arising from providing our services
exclusively to the health care industry, primarily providers of long-term care;
credit and collection risks associated with this industry; one client accounting
for approximately 21% of revenues in 2004; 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, 2003 in Part I thereof under "Government Regulation of Clients",
"Competition" and "Service Agreements/Collections". Many of our clients'
revenues are highly contingent on Medicare and Medicaid reimbursement funding
rates, which have been and continue to be adversely affected by the change in
Medicare payments under the 1997 enactment of the Medicare Prospective Payment
System. That change, and lack of substantive reimbursement funding rate reform
legislation, as well as other trends in the long-term care industry have
resulted in certain of our clients filing for bankruptcy protection. Others may
follow. Any decisions by the government to discontinue or adversely modify
legislation related to reimbursement funding rates will have a material adverse
affect on our clients. These factors, in addition to delays in payments from
clients have resulted in and could continue to result in significant additional
bad debts in the near future. Additionally, our operating results would be
adversely affected if unexpected increases in the costs of labor and labor
related costs, materials, supplies and equipment used in performing our services
could not be passed on to our clients.
In addition, we believe that to improve our financial performance we
must continue to obtain service agreements with new clients, provide new
services to existing clients, achieve modest price increases on current service
agreements with existing clients and maintain internal cost reduction strategies
at our various operational levels. Furthermore, we believe that our ability to
sustain the internal development of managerial personnel is an important factor
impacting future operating results and successfully executing projected growth
strategies.
-13-
RESULTS OF OPERATIONS
Revenues for the quarter ended June 30, 2004 increased 19.1% or
$17,683,771 to $110,489,485 as compared to $92,805,714 in the corresponding 2003
quarter.
The Housekeeping services segment's 2004 second quarter revenues
increased to $88,773,502, or 13.3% as compared to the second quarter of 2003
segment revenues of $78,363,077. This growth is primarily a result of a net
increase in service agreements entered into with new clients.
The Food service segment's 2004 second quarter revenues increased
approximately 51.0% to $21,794,596 as compared to the second quarter of 2003
revenues of $14,441,576. This growth is a result of providing this service to
additional existing Housekeeping services segment's clients.
Revenues for the six month period ended June 30, 2004 increased 19.1%
or $34,774,239 to $217,111,305 as compared to $182,337,066 in the corresponding
2003 period.
The Housekeeping services segment's 2004 six months period revenues
increased to $176,565,291, or 14.7% from the comparable 2003 period's revenues
of $153,942,154. This growth is primarily a result of a net increase in service
agreements entered into with new clients.
The Food services segment's 2004 six months period revenues increased
approximately 45.9% to $40,649,144 from the comparable 2003 period's revenues of
$27,862,484. This growth is a result of providing this service to additional
existing Housekeeping service's segment clients.
Although there can be no assurance thereof, we believe that during the
remainder of 2004 the revenue growth from both Housekeeping services and Food
services, as a percentage of total revenues, will approximate their respective
2004 six month percentages.
The following table sets forth, for the periods indicated, the
percentage which certain items bear to revenues:
Relation to Total Revenues
For the Quarter Ended June 30, For the Six Months Ended June 30,
------------------------------ ---------------------------------
2004 2003 2004 2003
---- ---- ---- ----
Revenues 100.0% 100.0% 100.0% 100.0%
Operating costs and expenses:
Costs of services provided 88.1 88.0 87.9 87.9
Selling, general and
administration 7.0 7.6 7.3 7.6
Investment and interest income .3 .2 .3 .2
----- ----- ----- -----
Income before income taxes 5.2 4.6 5.1 4.7
Income taxes 2.0 1.7 1.9 1.8
----- ----- ----- -----
Net income 3.2% 2.9% 3.2% 2.9%
===== ===== ===== =====
-14-
Major client
We have one client, a nursing home chain, which in the six months
periods ended June 30, 2004 and June 30, 2003 accounted for approximately 21%
and 23%, respectively of consolidated revenues. In the six months ended June 30,
2004 we derived approximately 19% and 27%, respectively, of the Housekeeping
services and Food services segments' revenues from such client. Although we
expect to continue our relationship with this client, the loss of such client
would adversely affect the operations of our two operating segments.
2004 Second Quarter Compared with 2003 Second Quarter
Cost of services provided as a percentage of revenues remained
essentially unchanged at 88.1% for the second quarter of 2004 compared to 88.0%
in the corresponding 2003 quarter. The primary factors affecting this slight
increase are as follows: an increase of 1.6% in the cost of supplies consumed in
providing services which was primarily attributable to increased costs
associated with the Food services segment's growth. Offsetting this increase
were decreases of .9% in bad debt provision, .6% in workers compensation
insurance, and a .5% decrease in labor costs which is primarily a result of
efficiencies achieved in managing the Housekeeping services segment's labor.
Although there can be no assurance thereof, we believe that the cost of services
provided as a percentage of revenues for the remainder of 2004 will approximate
the same percentage as recognized in the first six months of 2004.
Selling, general and administrative expenses as a percentage of revenue
decreased to 7.0% in the 2004 second quarter compared to 7.6% in the 2003 second
quarter. This is primarily attributable to our ability to control these expenses
and comparing these expenses to a greater revenue base in the current quarter.
Our effective income tax rate remained unchanged at 38% comparing the
2004 second quarter to the 2003 second quarter. Our effective income tax rate
differs from the federal income tax statutory rate principally because of the
effect of state and local income taxes.
As a result of the matters discussed above, net income for the three
month period ended June 30, 2004 increased to 3.2% as a percentage of revenue,
compared to 2.9% in the 2003 comparable three month period.
2004 Six Month Period Compared with 2003 Six Month Period
Cost of services provided as percentage of revenues remain unchanged at
87.9% in the 2004 six month period compared with the 2003 six month period. Even
though the percentage of cost of services remained unchanged, certain components
of the cost of services did change. The primary components that changed when
comparing the two six month periods were an increase of 1.6% in the cost of
supplies consumed in providing services, which was primarily attributable to
increased costs associated with the Food services segment's growth, which was
offset by decreases of .8% and .6% in bad debt provision and labor costs,
respectively. The decrease in labor costs resulted primarily from efficiencies
achieved in managing the Housekeeping services segment's labor.
-15-
Selling, general and administrative expenses as a percentage of
revenue decreased in the six month period ended June 30, 2004 to 7.3% from 7.6%
in the comparable 2003 period. This is primarily attributable to our ability to
control these expenses and comparing these expenses to a greater revenue base in
the current six month period.
Our 2004 second quarter effective income tax rate decreased slightly to
38.0% from 39.0% in the 2003 second quarter. The decrease primarily results from
a reduction in our state and local tax liability. The effective income tax rate
differs from the federal income tax statutory rate principally because of the
effect of state and local income taxes.
As a result of the matters discussed above, net income for the six
month period ended June 30, 2004 increased to 3.2% as a percentage of revenue
compared to 2.9% in the comparable 2003 six month period.
CRITICAL ACCOUNTING POLICIES
We consider the two policies discussed below to be critical to an
understanding of our financial statements because their application places the
most significant demands on our judgment. Therefore, it should be noted that
financial reporting results rely on estimating the effect of matters that are
inherently uncertain. Specific risks for these critical accounting policies are
described in the following paragraphs. For these policies, we caution that
future events rarely develop exactly as forecast, and the best estimates
routinely require adjustment.
The two policies discussed are not intended to be a comprehensive list
of all of our accounting policies. In many cases, the accounting treatment of a
particular transaction is specifically dictated by generally accepted accounting
principles, with no need for our judgment in their application. There are also
areas in which our judgment in selecting another available alternative would not
produce a materially different result. See our audited consolidated financial
statements and notes thereto which are included in our Annual Report for the
year ended December 31, 2003 which contain accounting policies and other
disclosures required by generally accepted accounting principles.
Allowance for Doubtful Accounts
The allowance for doubtful accounts is established as losses are
estimated to have occurred through a provision for bad debts charged to
earnings. The allowance for doubtful accounts is evaluated based on our periodic
review of accounts and notes receivable and is inherently subjective as it
requires estimates that are susceptible to significant revision as more
information becomes available.
We have had varying collection experience with respect to our accounts
and notes receivable. When contractual terms are not met, we generally encounter
difficulty in collecting amounts due from certain of our clients. Therefore, we
have sometimes been required to extend the period of payment for certain clients
beyond contractual terms. These clients include those in bankruptcy, those who
have terminated service agreements and slow payers experiencing financial
difficulties. In making credit evaluations, in addition to analyzing and
anticipating, where possible, the specific cases described above, we consider
the general collection risks associated with trends in the long-term care
industry. We also establish credit limits, perform ongoing credit evaluation,
and monitor accounts to minimize the risk of loss.
-16-
In accordance with the risk of extending credit, we regularly evaluate
our accounts and notes receivable for impairment or loss of value and when
appropriate will provide in our Allowance for Doubtful Accounts for such
receivables. We generally follow a policy of reserving for receivables from
clients in bankruptcy, as well as clients with which we are in litigation for
collection. The reserve is based upon our estimates of ultimate collectibility.
Correspondingly, once our recovery of a receivable is determined through either
litigation, bankruptcy proceedings or negotiation at less than the recorded
amount on our balance sheet, we will charge-off the applicable amount to the
Allowance for Doubtful Accounts.
Notwithstanding our efforts to minimize credit risk exposure, our
clients could be adversely affected if future industry trends, as more fully
discussed under Liquidity and Capital Resources below, and as further described
in our Form 10-K filed with the Securities and Exchange Commission for the year
ended December 31, 2003 in Part I thereof under "Government Regulation of
Clients" and "Service Agreements/Collections", change in such a manner as to
negatively impact the cash flows of our clients. If our clients experience a
negative impact in their cash flows, it would have a material adverse affect on
our results of operations and financial condition.
Accrued Insurance Claims
We have a Paid Loss Retrospective Insurance Plan for general liability
and workers' compensation insurance. Under these plans, pre-determined loss
limits are arranged with an insurance company to limit both our per occurrence
cash outlay and annual insurance plan cost.
For workers' compensation, we record a reserve based on the present
value of future payments, including an estimate of claims incurred but not
reported, that are developed as a result of a review of our historical data,
open claims and actuarial analysis done by an independent insurance specialist.
The present value of the payout is determined by applying an 8% discount factor
over the estimated remaining pay-out period.
For general liability, we record a reserve for the estimated amounts to
be paid for known claims.
We regularly evaluate our claims' pay-out experience, present value
factor and other factors related to the nature of specific claims in arriving at
the basis for our accrued insurance claims' estimate. Our evaluations are based
primarily on current information derived from reviewing our claims' experience
and industry trends. In the event that our claims' experience and/or industry
trends result in an unfavorable change, it would have an adverse affect on our
results of operations and financial condition.
-17-
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2004 we had cash and cash equivalents of $74,726,696 and
working capital of $117,435,330 compared to December 31, 2003 cash and cash
equivalents, and working capital of $64,180,697 and $113,414,509, respectively.
We view our cash and cash equivalents of $74,726,696 at June 30, 2004 as our
principal measure of liquidity. Our current ratio at June 30, 2004 decreased
slightly to 5.2 to 1 from 5.6 to 1 at December 31, 2003.
The net cash provided by our operating activities was $17,800,773 for
the six month period ended June 30, 2004. The principal sources of net cash
flows from operating activities for the six month period ended June 30, 2004
were net income, including non-cash charges to operations for depreciation and
bad debt provisions. Additionally, operating activities' cash flows were
increased by the timing of payments for accounts payable and other accrued
expenses, as well as, a $4,177,761 net decrease in accounts and notes receivable
and long term notes receivable due primarily to improved collections experience.
The operating activity that used the largest amount of cash during the six month
period ended June 30, 2004 was an increase of $527,329 in the funding of our
deferred compensation plan.
Our principal use of cash in investing activities in the six month
period ended June 30, 2004 was the purchase of housekeeping equipment and
computer software and equipment.
On February 12, 2004, our Board of Directors approved a three-for-two
stock split in the form of a 50% common stock dividend which was paid on March
1, 2004 to shareholders of record on February 23, 2004. An amount equal to the
par value of the shares of Common Stock issued was transferred from Additional
Paid In Capital to Common Stock in the March 31, 2004 balance sheet. All share
and earnings per common share information presented in this report have been
adjusted to reflect the three-for-two stock split. The effect of this action was
to increase shares outstanding at March 1, 2004 by 6,016,799 to 17,646,172.
During the six month period ended June 30, 2004, we have expended
$5,617,004 for open market purchases of 359,798 shares of our common stock. We
remain authorized to purchase 524,452 shares pursuant to previous Board of
Directors' actions.
During the six month period ended June 30, 2004, we issued 215,387
shares of common stock and received proceeds of $1,388,572 from the exercise of
stock options by employees and directors.
We paid regular quarterly dividends since the second quarter of 2003.
In the six month period ended June 30, 2004 we paid regular quarterly dividends
totaling $1,984,799. Such regular quarterly dividends paid were $.05 and $.06
per common share on February 14, 2004 and May 14, 2004, respectively. Such
payments were made to shareholders of record as of January 31, 2004 and April
30, 2004, respectively. Additionally, on July 20, 2004, our Board of Directors
declared a regular cash dividend of $.07 per common share to be paid on August
13, 2004 to shareholders of record as of July 30, 2004.
-18-
Accounts and Notes Receivable
We expend considerable effort to collect the amounts due for our
services on the terms agreed upon with our clients. Many of our clients
participate in programs funded by federal and state governmental agencies which
historically have encountered delays in making payments to its program
participants. The Balance Budget Act of 1997 changed Medicare policy in a number
of ways, most notably the phasing in, effective July 1, 1998 of a Medicare
Prospective Payment System for skilled nursing facilities which significantly
changed the reimbursement procedures and the amounts of reimbursement they
receive. Many of our clients' revenues are highly contingent on Medicare and
Medicaid reimbursement funding rates. Therefore, they have been and continue to
be adversely affected by changes in applicable laws and regulations, as well as
other trends in the long-term care industry. This has resulted in certain of our
clients filing for bankruptcy protection. Others may follow.
These factors, in addition to delays in payments from clients have
resulted in and could continue to result in significant additional bad debts in
the near future. Whenever possible, when a client falls behind in making
agreed-upon payments, we convert the unpaid accounts receivable to interest
bearing promissory notes. The promissory notes receivable provide a means by
which to further evidence the amounts owed and provide a definitive repayment
plan and therefore may ultimately enhance our ability to collect the amounts
due. At June 30, 2004 and December 31, 2003, we had approximately $10,985,000
and $12,638,000, net of reserves, respectively of such notes outstanding.
Additionally, we consider restructuring service agreements from full service to
management-only service in the case of certain clients experiencing financial
difficulties. We believe that the restructuring provides us with a means to
maintain a relationship with the client while at the same time minimizing
collection exposure.
-19-
We have had varying collection experience with respect to our accounts
and notes receivable. When contractual terms are not met, we generally encounter
difficulty in collecting amounts due from certain of our clients. Therefore, we
have sometimes been required to extend the period of payment for certain clients
beyond contractual terms. These clients include those in bankruptcy, those who
have terminated service agreements and slow payers experiencing financial
difficulties. In order to provide for these collection problems and the general
risk associated with the granting of credit terms, we have recorded bad debt
provisions (in an Allowance for Doubtful Accounts) of $1,750,000 and $2,950,000
in the six month periods ended June 30, 2004 and June 30, 2003, respectively.
These provisions represent approximately .8% and 1.6%, as a percentage of
revenue for such respective periods. In making credit evaluations, in addition
to analyzing and anticipating, where possible, the specific cases described
above, we consider the general collection risks associated with trends in the
long-term care industry. We also establish credit limits, perform ongoing credit
evaluation and monitor accounts to minimize the risk of loss. Notwithstanding
our efforts to minimize credit risk exposure, our clients could be adversely
affected if future industry trends change in such a manner as to negatively
impact their cash flows. If our clients experience such significant impact in
their cash flows, it would have a material adverse effect on our results of
operations and financial condition.
Insurance Programs
We have a Paid Loss Retrospective Insurance Plan for general liability
and workers' compensation insurance. Under these plans, pre-determined loss
limits are arranged with an insurance company to limit both our per occurrence
cash outlay and annual insurance plan cost.
For workers' compensation, we record a reserve based on the present
value of future payments, including an estimate of claims incurred but not
reported, that are developed as a result of a review of our historical data,
open claims and actuarial analysis done by an independent insurance specialist.
The present value of the payout is determined by applying an 8% discount factor
over the estimated remaining pay-out period.
For general liability, we record a reserve for the estimated amounts to
be paid for known claims.
We regularly evaluate our claims' pay-out experience, present value
factor and other factors related to the nature of specific claims in arriving at
the basis for our accrued insurance claims' estimate. Our evaluation is based
primarily on current information derived from reviewing our claims' experience
and industry trends. In the event that our claims' experience and/or industry
trends result in an unfavorable change, it would have an adverse effect on our
results of operations and financial condition.
-20-
Line of Credit
We have an $18,000,000 bank line of credit on which we may draw to meet
short-term liquidity requirements in excess of internally generated cash flow.
The line of credit contains several financial covenants that we are required to
meet. We are in compliance with all financial covenants at both June 30, 2004
and December 31, 2003 and expect to continue to remain in compliance. This line
of credit expires on January 31, 2005. We believe the line of credit will be
renewed at that time. Amounts drawn under the line of credit are payable on
demand. At June 30, 2004 there were no borrowings under the line of credit.
However, at such date, we had outstanding $15,925,000 of an irrevocable standby
letter of credit, which relate to payment obligations under our insurance
program. As a result of the letter of credit issued, the amount available under
the line of credit was reduced by $15,925,000 at June 30, 2004.
Capital Expenditures
Our level of capital expenditures is generally dependent on the number
of new clients obtained. Such capital expenditures primarily consist of
housekeeping equipment, laundry and linen equipment installations, and computer
hardware and software. Although we have no specific material commitments for
capital expenditures through the end of calendar year 2004, we estimate that we
will incur capital expenditures of approximately $2,500,000 during all of 2004
in connection with housekeeping equipment and laundry and linen equipment
installations in our clients' facilities, as well as expenditures relating to
internal data processing hardware and software requirements. We believe that
cash from operations, existing cash balances and available credit line will be
adequate for the foreseeable future to satisfy the needs of our operations and
to fund our continued growth. However, should cash flows from current operations
not be sufficient, we would utilize our existing working capital and if
necessary seek to obtain necessary working capital from such sources as
long-term debt or equity financing.
Material Off-Balance Sheet Arrangements
We have not entered into any material off-balance sheet arrangements.
Effects of Inflation
We believe in most instances we will be able to recover increases in
costs attributable to inflation by passing through such cost increases to our
clients.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Our exposure to market risk is not significant.
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ITEM 4. CONTROLS AND PROCEDURES
Disclosure controls are procedures that are designed with the objective
of ensuring that information required to be disclosed in our reports under the
Securities Exchange Act of 1934, such as this Form 10-Q, is reported in
accordance with the Securities and Exchange Commission's (the "SEC") rules.
Disclosure controls are also designed with the objective of ensuring that such
information is accumulated and communicated to management, including the Chief
Executive Officer and Chief Financial Officer as appropriate to allow timely
decisions regarding required disclosure.
As of the end of the period covered by this Form 10-Q, we carried out
an evaluation under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Securities Exchange Act Rules 13a-15(e) and 15d-15(e).
Based upon that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that our disclosure controls and procedures are effective to
insure that information required to be disclosed in the reports that we file
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified by the SEC's rules and regulations. There were no
significant changes in our internal controls or in other factors that could
significantly affect these controls subsequent to the date of their evaluation.
Certifications of the Chief Executive Officer and Chief Financial
Officer regarding, among other items, disclosure controls and procedures are
included as exhibits to this Form 10-Q.
-22-
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS Not Applicable.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND
ISSUER PURCHASES OF EQUITY SECURITIES
2004 (a) (b) (c) (d)
Period Total Average Total Maximum
Number Price Number of Shares Number of
Shares Paid per Purchased as Part Shares that
Purchased Share of Publicly Announced May Yet Be
Plans or Programs Purchased
Under the Plans
Or Programs
--------- -------- --------------------- ---------------
April 1 to
April 30 9,960 $15.4710 9,960 874,290
May 1 to
May 31 141,814 $15.6273 141,814 732,476
June 1 to
June 30 208,024 $15.6076 208,024 524,452
On July 18, 2001 our Board of Directors authorized a plan to purchase up to
900,000 shares (adjusted for the March 1, 2004 3-for-2 stock split) of its
common stock on the open market. Such repurchase plan does not have an
expiration date.
ITEM 3. DEFAULTS UNDER SENIOR SECURITIES Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our Annual Meeting of Shareholders was held on May 25, 2004. The
results are as follows:
(1) All of management's nominees for directors were elected as follows:
Shares Voted Withheld
"FOR"
11,002,819 5,409,228
(2) 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, 2004 as approved as
follows.
Shares Voted Shares Voted Shares
"FOR" "AGAINST" "ABSTAINING"
11,321,801 84,406 5,839
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ITEM 5. OTHER INFORMATION
a) None.
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.
-24-
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 26, 2004 /s/ Daniel P. McCartney
------------------------------------
Date DANIEL P. McCARTNEY, Chief
Executive Officer
July 26, 2004 /s/ Thomas A. Cook
------------------------------------
Date THOMAS A. COOK, President and
Chief Operating Officer
July 26, 2004 /s/ James L. DiStefano
------------------------------------
Date JAMES L. DiSTEFANO, Chief Financial
Officer and Treasurer
July 26, 2004 /s/ Richard W. Hudson
------------------------------------
Date RICHARD W. HUDSON, Vice
President-Finance, Secretary and
Chief Accounting Officer
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