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 Quarter Ended June 30, 2005 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, issued and outstanding as of July 20, 2005 is
27,801,000
Total of 33 Pages
INDEX
-----
PART I. FINANCIAL INFORMATION PAGE NO.
--------------------- --------
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets as of
June 30, 2005 and December 31, 2004 2
Consolidated Statements of Income for the Three Months Ended
June 30, 2005 and June 30, 2004
3
Consolidated Statements of Income for the Six Months Ended
June 30, 2005 and June 30, 2004 4
Consolidated Statements of Cash Flows for the Six Months
ended June 30, 2005 and June 30, 2004 5
Consolidated Statement of Stockholders' Equity for the Six
Months Ended June 30, 2005 6
Notes To Consolidated Financial Statements 7 - 13
Item 2. Management's Discussion and Analysis of Financial Condition
and Results Of Operations 13 - 26
Item 3. Quantitative and Qualitative Disclosure About Market Risk
Controls and Procedures 27
Item 4.
27
Part II. Other Information
-----------------
Item 1. Legal Proceedings 28
Item 2. Changes in Securities, Use of Proceeds
and Issuer Purchases of Equity Securities 28
Item 3. Defaults Upon Senior Securities 28
Item 4. Submission of Matters to a Vote of Security Holders 28
Item 5. Other Information 28
Item 6. Exhibits 28
Signatures 29
-1-
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2005 2004
----------------------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 82,533,000 $ 74,847,000
Accounts and notes receivable, less allowance for doubtful
accounts of $2,289,000 in 2005 and $1,869,000 in 2004 59,458,000 55,725,000
Prepaid income taxes 286,000 -
Inventories and supplies 11,375,000 11,015,000
Deferred income taxes 709,000 574,000
Prepaid expenses and other 3,871,000 3,110,000
------------- -------------
Total current assets 158,232,000 145,271,000
PROPERTY AND EQUIPMENT:
Laundry and linen equipment installations 2,352,000 2,329,000
Housekeeping and office equipment 14,855,000 13,987,000
Autos and trucks 80,000 80,000
------------- -------------
17,287,000 16,396,000
Less accumulated depreciation 12,501,000 11,592,000
------------- -------------
4,786,000 4,804,000
NOTES RECEIVABLE- long term portion, net of discount 3,853,000 5,557,000
DEFERRED COMPENSATION FUNDING 4,838,000 4,062,000
DEFERRED INCOME TAXES- long term portion 6,167,000 5,563,000
GOODWILL AND OTHER NONCURRENT ASSETS 1,708,000 1,707,000
------------- -------------
$ 179,584,000 $ 166,964,000
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 7,450,000 $ 7,272,000
Accrued payroll, accrued and withheld payroll taxes 5,428,000 6,110,000
Other accrued expenses 2,145,000 1,692,000
Income taxes payable - 1,016,000
Accrued insurance claims 4,670,000 4,169,000
------------- -------------
Total current liabilities 19,693,000 20,259,000
ACCRUED INSURANCE CLAIMS- long term portion 10,896,000 10,227,000
DEFERRED COMPENSATION LIABILITY 6,023,000 5,018,000
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value: 67,500,000 shares authorized,
28,389,000 shares issued in 2005 and 27,761,000 in 2004 284,000 277,000
Additional paid in capital 45,178,000 39,374,000
Retained earnings 106,660,000 101,279,000
Common stock in treasury, at cost, 1,411,000 shares in 2005 and
1,488,000 in 2004 (9,150,000) (9,470,000)
------------- -------------
Total stockholders' equity 142,972,000 131,460,000
------------- -------------
$ 179,584,000 $ 166,964,000
============= =============
See accompanying notes.
-2-
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
FOR THE THREE MONTHS ENDED JUNE 30,
-------------------------------------------
2005 2004
------------ ------------
Revenues $116,048,000 $110,489,000
Operating costs and expenses:
Costs of services provided 101,385,000 97,340,000
Selling, general and administrative 8,109,000 7,761,000
Other Income:
Investment and interest income 839,000 306,000
------------ ------------
Income before income taxes 7,393,000 5,694,000
Income taxes 2,809,000 2,164,000
------------ ------------
Net Income $ 4,584,000 $ 3,530,000
============ ============
Basic earnings per common share $ 0.17 $ 0.13
============ ============
Diluted earnings per common share $ 0.16 $ 0.13
============ ============
Cash dividends per common share $ 0.07 $ 0.04
============ ============
Basic weighted average number of
common shares outstanding 26,878,000 26,225,000
============ ============
Diluted weighted average number of
common shares outstanding 28,404,000 27,701,000
============ ============
See accompanying notes.
-3-
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30,
----------------------------------------------
2005 2004
------------- -------------
Revenues $ 230,743,000 $ 217,111,000
Operating costs and expenses:
Costs of services provided 201,155,000 190,789,000
Selling, general and administrative 16,538,000 15,775,000
Other Income:
Investment and interest income 1,219,000 500,000
------------- -------------
Income before income taxes 14,269,000 11,047,000
Income taxes 5,422,000 4,198,000
------------- -------------
Net Income $ 8,847,000 $ 6,849,000
============= =============
Basic earnings per common share $ 0.33 $ 0.26
============= =============
Diluted earnings per common share $ 0.31 $ 0.25
============= =============
Cash dividends per common share $ 0.13 $ 0.07
============= =============
Basic weighted average number of
common shares outstanding 26,750,000 26,226,000
============= =============
Diluted weighted average number of
common shares outstanding 28,221,000 27,679,000
============= =============
See accompanying notes.
-4-
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE SIX MONTHS ENDED
JUNE 30,
----------------------------------------
2005 2004
-------------- -------------
Cash flows from operating activities:
Net Income $ 8,847,000 $ 6,849,000
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation 977,000 976,000
Bad debt provision 625,000 1,750,000
Deferred income taxes benefit (739,000) (331,000)
Tax benefit of stock option transactions 2,555,000 643,000
Unrealized loss on deferred compensation
fund investments (208,000) (83,000)
Changes in operating assets and liabilities:
Accounts and notes receivable (4,358,000) 2,007,000
Prepaid income taxes (286,000) -
Inventories and supplies (359,000) (378,000)
Notes receivable- long term portion 1,704,000 2,171,000
Deferred compensation funding (567,000) (527,000)
Accounts payable and other accrued expenses 631,000 2,211,000
Accrued payroll, accrued and withheld payroll taxes (40,000) 1,093,000
Accrued insurance claims 1,169,000 893,000
Deferred compensation liability 1,005,000 748,000
Income taxes payable (1,016,000) 217,000
Prepaid expenses and other assets (762,000) (438,000)
-------------- -------------
Net cash provided by operating activities 9,178,000 17,801,000
-------------- -------------
Cash flows from investing activities:
Disposals of fixed assets 33,000 119,000
Additions to property and equipment (992,000) (1,164,000)
-------------- -------------
Net cash used in investing activities (959,000) (1,045,000)
-------------- -------------
Cash flows from financing activities:
Treasury stock transactions in benefit plans (147,000) (5,617,000)
Dividends paid (3,466,000) (1,985,000)
Reissuance of treasury stock pursuant to Dividend
Reinvestment Plan 15,000 4,000
Proceeds from the exercise of stock options 3,065,000 1,388,000
-------------- -------------
Net cash used in financing activities (533,000) (6,210,000)
-------------- -------------
Net increase in cash and cash equivalents 7,686,000 10,546,000
Cash and cash equivalents at beginning of the period 74,847,000 64,181,000
-------------- -------------
Cash and cash equivalents at end of the period $ 82,533,000 $ 74,727,000
============== =============
Supplementary Cash Flow Information:
Issuance of 90,000 shares of Common Stock in 2005 and
72,000 shares of Common Stock in 2004 pursuant to
Employee Stock Plans $ 643,000 $ 366,000
============== =============
See accompanying notes.
-5-
Consolidated Statements of Stockholders' Equity
(Unaudited)
For the Six Months Ended June 30, 2005
--------------------------------------------------------------------------------------
Additional Total
Common Stock Paid-in Retained Treasury Stockholders'
Shares Amount Capital Earnings Stock Equity
---------- -------- ----------- ------------ ----------- ------------
Balance, December 31, 2004 27,761,000 $277,000 $39,374,000 $101,279,000 ($9,470,000) $131,460,000
Net income for the period 8,847,000 8,847,000
Exercise of stock options 612,000 6,000 3,059,000 3,065,000
Tax benefit arising from stock option
transactions 2,555,000 2,555,000
Shares purchased and shares sold in employee
Deferred Compensation Plan and other benefit
plans (4,000 shares) (147,000) (147,000)
Shares issued pursuant to Employee Stock
Plans (90,000 shares) 16,000 1,000 181,000 461,000 643,000
Cash dividends - $.13 per common share (3,466,000) (3,466,000)
Shares issued pursuant to Dividend
Reinvestment Plan (1,000 shares) 9,000 6,000 15,000
---------- -------- ----------- ------------ ----------- ------------
Balance, June 30, 2005 28,389,000 $284,000 $45,178,000 $106,660,000 ($9,150,000) $142,972,000
========== ======== =========== ============ =========== ============
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, 2004 has been derived from, and does not include,
all the disclosures contained in the financial statements for the year ended
December 31, 2004. 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, 2004. The results of operations for the
quarter and six month period ended June 30, 2005 are not necessarily indicative
of the results that may be expected for the full fiscal year.
NOTE 2 - THREE-FOR-TWO STOCK SPLIT
On April 19, 2005, our Board of Directors approved a three-for-two
stock split in the form of a 50% common stock dividend which was paid on May 2,
2005 to shareholders of record on April 29, 2005. All share and earnings per
common share information for all periods presented in this report have been
adjusted to reflect the three-for-two stock split.
NOTE 3 - OTHER CONTINGENCIES
We have an $22,000,000 bank line of credit on which we may draw to meet
short-term liquidity requirements in excess of internally generated cash flow.
Amounts drawn under the line of credit are payable on demand. At June 30, 2005
and December 31, 2004, there were no borrowings under the line of credit.
However, at such dates, we had outstanding $17,925,000 and $15,925,000,
respectively, of irrevocable standby letters of credit which relate to payment
obligations under our insurance programs. As a result of the letters of credit
issued, the amount available under the line of credit was reduced by $17,925,000
and $15,925,000 at June 30, 2005 and December 31, 2004, respectively. The line
of credit requires us to satisfy several financial covenants. We complied with
all financial covenants at both June 30, 2005 and December 31, 2004 and expect
to continue to remain in compliance with all such financial covenants. This line
of credit expires on June 30, 2006. We believe the line of credit will be
renewed at that time.
We provide our services in 43 states and we are subject to numerous
local taxing jurisdictions within those states. Consequently, the taxability of
our services is subject to various interpretations within these jurisdictions.
In the ordinary course of business, a jurisdiction may contest our reporting
positions with respect to the application of its tax code to our services, which
may result in additional tax liabilities. As of June 30, 2005 and December 31,
2004 we have unsettled tax assessments (including interest to date) from various
state taxing authorities of $2,900,000 ($1,900,000, net of federal income taxes)
and $2,800,000 ($1,800,000, net of federal income taxes), respectively. Although
we intend to vigorously defend our positions that the
-7-
assessments are without merit, we have recorded a reserve at both June 30, 2005
and December 31, 2004 of $900,000 ($590,000 net of federal income taxes), for
these assessments in cases where we could estimate that a tax settlement is
probable and the range of such settlement. In other tax matters, because of the
uncertainties related to both the probable outcome and amount of probable
assessment due, we are unable to make a reasonable estimate of a liability. We
do not expect the resolution of any of these matters, taken individually or in
the aggregate, to have a material adverse effect on our financial position or
results of operations.
We are involved in miscellaneous claims and litigation arising in the
ordinary course of business. We believe that these matters, taken individually
or in the aggregate, would not have a material adverse effect 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 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
REPORTABLE SEGMENTS
-------------------
We manage and evaluate our operations in two reportable segments. The
two reportable segments are Housekeeping (housekeeping, laundry, linen and other
services), and Food (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 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
segments and our warehousing and distribution subsidiary. The 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 reported are prior to any elimination entries made in consolidation.
The Housekeeping 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.
-8-
Housekeeping Food Corporate and
services services eliminations Total
------------- ------------ --------------- ------------
Quarter Ended June 30, 2005
- ---------------------------
Revenues $ 93,275,000 $ 22,924,000 $( 151,000) $116,048,000
Income before income taxes $ 8,152,000 $ 785,000 $( 1,544,000)(1) $ 7,393,000
Quarter Ended June 30, 2004
- ---------------------------
Revenues $ 88,773,000 $ 21,795,000 $( 79,000) $110,489,000
Income before income taxes $ 7,547,000 $ 779,000 $( 2,632,000)(1) $ 5,694,000
Six Months Ended June 30, 2005
- ------------------------------
Revenues $184,365,000 $ 45,539,000 $ 839,000 $230,743,000
Income before income taxes $ 16,433,000 $ 1,430,000 $( 3,594,000)(1) $ 14,269,000
Six Months Ended June 30, 2004
- ------------------------------
Revenues $176,565,000 $ 40,649,000 $( 103,000) $217,111,000
Income before income taxes $ 15,347,000 $ 1,276,000 $( 5,576,000)(1) $ 11,047,000
(1) represents primarily corporate office cost and related overhead, as well as
consolidated subsidiaries' operating expenses that are not allocated to the
reportable segments.
TOTAL REVENUES FROM CLIENTS
---------------------------
The following revenues earned from clients differ from segment revenues
reported above due to the inclusion of adjustments used for segment reporting
purposes by management. We earned total revenues from clients in the following
service categories:
For the Quarter Ended June 30,
---------------------------------------
2005 2004
------------ ------------
Housekeeping services $ 65,485,000 $ 61,961,000
Laundry and linen services 27,367,000 26,314,000
Food Services 22,631,000 21,690,000
Maintenance services
and Other 565,000 524,000
------------ ------------
$116,048,000 $110,489,000
============ ============
-9-
For the Six Months Ended June 30,
---------------------------------------
2005 2004
------------ ------------
Housekeeping services $129,944,000 $123,612,000
Laundry and linen services 54,459,000 52,387,000
Food Services 45,068,000 40,110,000
Maintenance services
and Other 1,272,000 1,002,000
------------ ------------
$230,743,000 $217,111,000
============ ============
MAJOR CLIENT
------------
We have one client, a nursing home chain, which in the six month
periods ended June 30, 2005 and 2004 accounted for 19% and 21%, respectively, of
consolidated revenues. In the six month period ended June 30, 2005, we derived
18% and 26%, respectively, of the Housekeeping and Food segment's revenues from
such client. During 2005, this client's Board of Directors voted to conduct an
auction to sell the company, which is anticipated to be completed by year-end.
Although we expect to continue our relationship with this client, the loss of
such client would have a material adverse effect on the results of operations of
our two operating segments.
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, 2005
---------------------------------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
----------- ------------- ----------
Net income $4,584,000
==========
Basic earnings per
common share $4,584,000 26,878,000 $ .17
Effect of dilutive securities:
Options 1,526,000 (.01)
---------- ---------- -------
Diluted earnings per
common share $4,584,000 28,404,000 $ .16
========== ========== =======
Quarter Ended June 30, 2004
---------------------------------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
----------- ------------- ----------
Net income $3,530,000
==========
Basic earnings per
common share $3,530,000 26,225,000 $ .13
Effect of dilutive securities:
Options 1,476,000
---------- ---------- -------
Diluted earnings per
common share $3,530,000 27,701,000 $ .13
========== ========== =======
-10-
Six Months Ended June 30, 2005
---------------------------------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
----------- ------------- ----------
Net income $8,847,000
==========
Basic earnings per
common share $8,847,000 26,750,000 $ .33
Effect of dilutive securities:
Options 1,471,000 (.02)
---------- ---------- -------
Diluted earnings per
common share $8,847,000 28,221,000 $ .31
========== ========== =======
Six Months Ended June 30, 2004
---------------------------------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
----------- ------------- ----------
Net income $6,849,000
==========
Basic earnings per
common share $6,849,000 26,226,000 $ .26
Effect of dilutive securities:
Options 1,453,000 (.01)
---------- ---------- -------
Diluted earnings per
common share $6,849,000 27,679,000 $ .25
========== ========== =======
No outstanding options were excluded from the computation of diluted earnings
per common share for either of the three or six month period ended June 30, 2005
or June 30, 2004 as none have an exercise price in excess of the average market
value of our common stock during such periods.
NOTE 6 - STOCK BASED COMPENSATION
At June 30, 2005, we had stock based compensation plans. As permitted
by the Statement of Financial Accounting Standards No. 123 ("SFAS 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 market value of our stock and
the exercise price of the option. No stock based employee compensation cost is
reflected in net income, as all options granted under our 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.
-11-
The following table illustrates the effect on net income and earnings
per common share if we had applied the fair value recognition provisions of SFAS
No. 123 to stock based compensation:
Quarter Ended June 30,
------------------------------------
2005 2004
---------- ----------
Net Income
As reported $4,584,000 $3,530,000
Deduct:
Total stock based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects ( 680,000) ( 512,000)
---------- ----------
Pro forma net income $3,904,000 $3,018,000
========== ==========
Basic Earnings Per Common Share
As reported $ .17 $ .13
Pro forma $ .15 $ .11
Diluted Earnings Per Common Share
As reported $ .16 $ .13
Pro forma $ .14 $ .11
Six Months Ended June 30,
------------------------------------
2005 2004
---------- ----------
Net Income
As reported $8,847,000 $6,849,000
Deduct:
Total stock based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects (1,699,000) (1,279,000)
---------- -----------
Pro forma net income $7,147,000 $ 5,570,000
========== ===========
Basic Earnings Per Common Share
As reported $ .33 $ .26
Pro forma $ .27 $ .21
Diluted Earnings Per Common Share
As reported $ .31 $ .25
Pro forma $ .25 $ .20
-12-
NOTE 7 - RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board (the "FASB") issued a
revision of Financial Accounting Standards No. 123 ("SFAS 123R") which requires
all share-based payments to employees to be recognized in the income statement
based on their fair values. Our option grants to employees, non-employees and
directors, as well as common stock shares issued pursuant to our Employee Stock
Purchase Plan will represent share-based payments. We expect to calculate the
fair value of share-based payments under SFAS 123R on a basis substantially
consistent with the fair value approach of SFAS 123. We plan to adopt SFAS 123R
in our fiscal year beginning January 1, 2006. We expect the adoption of SFAS
123R will have a material impact on our financial statements in that fiscal
year, but we cannot reasonably estimate the impact of adoption because we expect
certain assumptions that can materially effect the calculation of the value of
share-based payments to recipients to change between now and the time of
adoption.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS
---------------------------------------------------------
This report 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 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 19% of revenues in the six month period ended June 30, 2005 (such
client's Board of Directors voted to conduct an auction to sell the company,
which is anticipated to be completed by year-end); our claims experience related
to workers' compensation and general liability insurance; the effects of changes
in, or interpretations of laws and regulations governing the industry, including
state and local regulations pertaining to the taxability of our services; and
the risk factors described in our Form 10-K filed with the Securities and
Exchange Commission for the year ended December 31, 2004 and 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 the lack
of substantive reimbursement funding rate reform legislation, as well as other
trends in the long-term care industry have resulted in certain of 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 effect 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 our
clients.
-13-
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.
RESULTS OF OPERATIONS
The following discussion is intended to provide the reader with information that
will assist them in understanding our financial statements including the changes
in certain key items in comparing financial statements period to period. We also
intend to provide the primary factors that accounted for those changes, as well
as a summary of how certain accounting principles affect our financial
statements. In addition, we are providing information about the financial
results of our two operating segments to further assist in understanding how
these segments and their results affect our results of operations. This
discussion should be read in conjunction with our financial statements as of
June 30, 2005 and December 31, 2004 and the notes accompanying those financial
statements.
OVERVIEW
--------
We provide housekeeping, laundry, linen, facility maintenance and food
services to the health care industry, including nursing homes, retirement
complexes, rehabilitation centers and hospitals located throughout the United
States. We believe that we are the largest provider of housekeeping and laundry
services to the long-term care industry in the United States, rendering such
services to approximately 1,700 facilities in 43 states as of June 30, 2005.
Although we do not directly participate in any government reimbursement
programs, our clients' reimbursements are subject to government regulation.
Therefore, they are directly affected by any legislation relating to Medicare
and Medicaid reimbursement programs.
We provide our services primarily pursuant to full service agreements
with our clients. In such agreements, we are responsible for our management and
hourly employees located at our clients' facilities. We also provide services on
the basis of a management-only agreement for a very limited number of clients.
Our agreements with clients typically provide for a one year service term,
cancelable by either party upon 30 to 90 days notice after the initial 90-day
period.
We are organized into two reportable segments; housekeeping, laundry,
linen and other services ("Housekeeping"), and food services ("Food").
The services provided by the Housekeeping segment consist primarily of
the cleaning, disinfecting and sanitizing of patient rooms and common areas of a
client's facility, as well as the laundering and processing of the personal
clothing belonging to the facility's patients. Also within the scope of this
segment's service is the laundering and processing of the bed linens, uniforms
and other assorted linen items utilized by a client facility.
The Food segment, which began operations in 1997, consists of providing
for the development of a menu that meets the patient's dietary needs, and the
purchasing and preparing of the food for delivery to the patients.
-14-
Additionally, we operate two wholly-owned subsidiaries, HCSG Supply,
Inc. ("Supply") and Huntingdon Holdings, Inc. ("Huntingdon"). Supply purchases,
warehouses and distributes the supplies and equipment used in providing our
Housekeeping segment services. Huntingdon invests our cash and cash equivalents.
CONSOLIDATED OPERATIONS
- -----------------------
The following table sets forth, for the periods indicated, the
percentage which certain items bear to consolidated revenues:
Relation to Consolidated Revenues
--------------------------------------------------------------------
For the Quarter Ended June 30, For the Six Months Ended June 30,
------------------------------ ---------------------------------
2005 2004 2005 2004
---- ---- ---- ----
Revenues 100.0% 100.0% 100.0% 100.0%
Operating costs and expenses:
Costs of services provided 87.3 88.1 87.2 87.9
Selling, general and administration 7.0 7.0 7.1 7.3
Investment and interest income .7 .3 .5 .3
---- ---- ---- ----
Income before income taxes 6.4 5.2 6.2 5.1
Income taxes 2.4 2.0 2.4 1.9
---- ---- ---- ----
Net income 4.0% 3.2% 3.8% 3.2%
==== ==== ==== ====
Subject to the factors noted in the Cautionary Statement Regarding
Forward Looking Statements included in this report, we anticipate our financial
performance for the remainder of 2005 to be comparable to the six month period
ended June 30, 2005 percentages presented in the above table as they relate to
consolidated revenues.
Housekeeping is our largest and core reportable segment, representing
approximately 80% of consolidated revenues for both the quarter and six month
period ended June 30, 2005. Food segment revenues represented approximately 20%
of consolidated revenues for both the quarter and six month period ended June
30, 2005.
Although there can be no assurance thereof, we believe that for the
remainder of 2005 each the Housekeeping and Food segments' revenues, as a
percentage of consolidated revenues, will remain approximately the same as their
respective percentages noted above. Furthermore, we expect the sources of growth
for the remainder of 2005 for the respective operating segments will be
primarily the same as historically experienced. Accordingly, although there can
be no assurance thereof, the growth in the Food segment is expected to come from
our current Housekeeping segment's client base, while growth in the Housekeeping
segment will primarily come from obtaining new clients.
-15-
2005 SECOND QUARTER COMPARED WITH 2004 SECOND QUARTER
-----------------------------------------------------
The following table sets forth 2005 second quarter income statement key
components that we use to evaluate our financial performance on a consolidated
and reportable segment basis, as well as the percentage increases of each
compared to 2004 second quarter amounts.
Reportable Segments
-------------------------------------------------
Housekeeping Food
Percent Corporate and ----------------------- ----------------------
Consolidated increase eliminations Amount %incr Amount %incr
------------ -------- ------------- ------------ ------ ---------- -------
Revenues $116,048,000 5.0% $ (151,000) $93,275,000 5.1% $22,924,000 5.2%
Cost of services provided 101,385,000 4.2 (5,877,000) 85,123,000 4.8 22,139,000 5.3
Selling, general and
administrative expense 8,109,000 4.5 8,109,000 -- --
Income before income taxes 7,393,000 29.8 (1,544,000) 8,152,000 8.0 785,000 .8
REVENUES
- --------
Consolidated
------------
Consolidated revenues increased 5.0% to $116,048,000 in the 2005 second
quarter compared to $110,489,000 in the 2004 second quarter as a result of the
factors discussed below under Reportable Segments.
We have one client, a nursing home chain ("Significant Client"), which
in the 2005 second quarter and the 2004 second quarter accounted for 19% and
21%, respectively, of consolidated revenues. During 2005, this client's Board of
Directors voted to conduct an auction to sell the company, which is anticipated
to be completed by year-end. Although we expect the relationship with this
client to continue, the loss of such client would have a material adverse effect
on our results of operations.
Reportable Segments
-------------------
The Housekeeping segment's 5.1% net growth in reportable segment
revenues is primarily a result of an increase in service agreements entered into
with new clients.
The Food segment's 5.2% net growth in reportable segment revenues is a
result of providing this service to an increasing number of existing
Housekeeping segment clients.
We derived 18% and 26%, respectively, of the Housekeeping and Food
segments' 2005 second quarter revenues from the Significant Client.
Additionally, at both June 30, 2005 and December 31, 2004, amounts due from such
client represented less than 1% of our accounts receivable balances. During
2005, this client's Board of Directors voted to conduct an auction to sell the
company, which is anticipated to be completed by year-end. Although we expect
the relationship with this client to continue, the loss of such client would
have a material adverse effect on our results of operations.
-16-
COSTS OF SERVICES PROVIDED
- --------------------------
Consolidated
-------------
Cost of services provided, on a consolidated basis, as a percentage of
consolidated revenues for the 2005 second quarter decreased to 87.3 % from 88.1
% in the corresponding 2004 quarter. The following table provides a comparison
of the primary cost of services provided-key indicators that we manage on a
consolidated basis in evaluating our financial performance
Cost of Services Provided-Key Indicators 2005 % 2004 % (Decr) %
---------------------------------------- ------ ------ --------
Bad debt provision .2 .7 (.5)
Workers' compensation and general
liability insurance 4.3 4.4 (.1)
The decrease in bad debt provision resulted primarily from improved
collection experience. The slight decrease in workers' compensation and general
liability insurance is primarily a result of a small reduction in the current
year's average claim cost.
Reportable Segments
-------------------
Cost of services provided for the Housekeeping segment, as a percentage
of Housekeeping segment revenues, for the 2005 second quarter decreased to 91.3%
from 91.5% in the corresponding 2004 quarter. Cost of services provided for the
Food segment, as a percentage of Food segment revenues, for the 2005 second
quarter increased to 96.6% from 96.4% in the corresponding 2004 quarter.
The following table provides a comparison of the primary cost of
services provided-key indicators, as a percentage of the respective segment's
revenues, that we manage on a reportable segment basis in evaluating our
financial performance:
Cost of Services Provided-Key Indicators 2005 % 2004 % Incr (Decr) %
----------------------------------------- ------ ------ -------------
Housekeeping labor and other labor costs 82.4 82.5 (.1)
Housekeeping segment supplies 5.7 5.3 .4
Food labor and other labor costs 54.4 54.3 .1
Food segment supplies 37.3 37.1 .2
The minor decrease in Housekeeping segment labor and other labor costs,
as a percentage of Housekeeping segment revenues, resulted primarily from
efficiencies achieved in managing such costs. The increase in Housekeeping
segment supplies resulted primarily from vendor price increases.
The minor increase in Food segment labor and other labor costs, as a
percentage of Food segment revenues, resulted primarily from labor
inefficiencies. The minor increase in Food segment supplies, as a percentage of
Food segment revenues, is a result of vendor price increases.
-17-
CONSOLIDATED SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
- --------------------------------------------------------
Consistent with our 5.0% growth in consolidated revenues, selling,
general and administrative expenses increased by 4.5% or $348,000. However, as a
percentage of total consolidated revenues, these expenses remained constant at
7.0% in the 2005 second quarter as compared to the 2004 second quarter.
INCOME BEFORE INCOME TAXES
- --------------------------
Consolidated
------------
As a result of the discussion above related to consolidated revenues,
costs of services provided and selling, general and administrative expenses,
consolidated income before income taxes for the 2005 second quarter increased to
6.4%, as a percentage of consolidated revenues, compared to 5.2% in the 2004
second quarter.
Reportable Segments
-------------------
Housekeeping's 8.0% increase in income before income taxes is
attributable to the improvement in the gross profit earned at the client
facility level and the gross profit earned on the 5.1% increase in reportable
segment revenues.
Food segment income before income taxes increased .8% on a reportable
segment basis which is attributable to both a modest improvement in gross profit
earned at the client facility level and the gross profit earned on the 5.2%
increase in reportable segment revenues.
CONSOLIDATED INVESTMENT AND INTEREST INCOME
- -------------------------------------------
Investment and interest income, as a percentage of consolidated
revenues, was .7% in the 2005 second quarter compared to .3% in the 2004 second
quarter. The increase is primarily attributable to higher average cash balances,
as well as increased rates of return.
CONSOLIDATED INCOME TAXES
- -------------------------
Our effective tax rate at both June 30, 2005 and 2004 was 38%. Absent
any significant change in federal, or state and local tax laws, we expect our
effective tax rate for the remainder of 2005 to be approximately the same as
realized in the 2005 second quarter. Our 38% effective tax rate differs from the
federal income tax statutory rate principally because of the effect of state and
local income taxes.
CONSOLIDATED NET INCOME
- -----------------------
As a result of the matters discussed above, consolidated net income for
the 2005 second quarter increased to 4.0%, as a percentage of consolidated
revenues, compared to 3.2% in the 2004 second quarter.
-18-
2005 SIX MONTH PERIOD COMPARED WITH 2004 SIX MONTH PERIOD
---------------------------------------------------------
The following table sets forth, for the six month period ended June 30, 2005,
income statement key components that we use to evaluate our financial
performance on a consolidated and reportable segment basis, as well as the
percentage increases of each compared to the six month period ended June 30,
2004 amounts.
Reportable Segments
----------------------------------------------------
Housekeeping Food
Percent Corporate and ------------------------ ----------------------
Consolidated increase eliminations Amount %incr Amount %incr
------------ -------- -------------- ------------- ----- ----------- -------
Revenues $230,743,000 6.3% $ 839,000 $184,365,000 4.4% $45,539,000 12.0%
Cost of services provided 201,155,000 5.4 (10,886,000) 167,932,000 4.2 44,109,000 12.0
Selling, general and
administrative expense 16,538,000 4.8 16,538,000 -- --
Income before income taxes 14,269,000 29.2 ( 3,594,000) 16,433,000 7.1 1,430,000 12.0
REVENUES
- --------
Consolidated
------------
Consolidated revenues increased 6.3% to $230,743,000 in the six month
period ended June 30, 2005 compared to $217,111,000 in the same 2004 period as a
result of the factors discussed below under Reportable Segments.
In the six month periods ended June 30, 2005 and 2004 our Significant
Client accounted for 19% and 21%, respectively, of consolidated revenues.
Reportable Segments
-------------------
The Housekeeping segment's net 4.4% growth in reportable segment
revenues is primarily a result of an increase in service agreements entered into
with new clients.
The Food segment's net 12.0% growth in reportable segment revenues is a
result of providing this service to an increasing number of existing
Housekeeping segment clients.
We derived 18% and 26%, respectively, of the Housekeeping and Food
segments' revenues for the six month period ended June 30, 2005 from the
Significant Client noted above. Additionally, at both June 30, 2005 and December
31, 2004, amounts due from such client represented less than 1% of our accounts
receivable balances.
COSTS OF SERVICES PROVIDED
- --------------------------
Consolidated
------------
Cost of services provided, on a consolidated basis, as a percentage of
consolidated revenues for the six month period ended June 30, 2005 decreased to
87.2 % from 87.9 % in the corresponding 2004 period. The following table
provides a comparison of the primary cost of services provided-key indicators
that we manage on a consolidated basis in evaluating our financial performance
-19-
Cost of Services Provided-Key Indicators 2005 % 2004 % Incr (Decr) %
---------------------------------------- ------ ------ -------------
Bad debt provision .3 .8 (.5)
Workers' compensation and general
liability insurance 4.3 4.2 .1
The decrease in bad debt provision resulted primarily from improved
collection experience. The slight increase in workers' compensation and general
liability insurance is primarily a result of a increased payments to plan
claimants.
Reportable Segments
-------------------
Cost of services provided for the Housekeeping segment, as a percentage
of Housekeeping segment revenues, for the six month period ended June 30, 2005
decreased to 91.1% from 91.3% in the corresponding 2004 period. Cost of services
provided for the Food segment, as a percentage of Food segment revenues was
96.9% for both the six month periods ended June 30, 2005 and 2004.
The following table provides a comparison of the primary cost of
services provided-key indicators, as a percentage of the respective segment's
revenues, that we manage on a reportable segment basis in evaluating our
financial performance:
Cost of Services Provided-Key Indicators 2005 % 2004 % Incr (Decr) %
---------------------------------------- ------ ------ -------------
Housekeeping labor and other labor costs 82.1 82.3 (.2)
Housekeeping segment supplies 5.2 5.1 .1
Food labor and other labor costs 54.3 54.1 .2
Food segment supplies 39.7 38.5 1.2
The decrease in Housekeeping segment labor and other labor costs, as a
percentage of Housekeeping segment revenues, resulted primarily from
efficiencies achieved in managing such costs. The slight increase in
Housekeeping segment supplies resulted primarily from vendor price increases.
The increase in Food segment labor and other labor costs, as a
percentage of Food segment revenues, resulted primarily from labor
inefficiencies. The increase in Food segment supplies, as a percentage of Food
segment revenues, is a result of vendor price increases. The increases in these
key indicators were offset by decreases in the Food segment's other operating
costs, resulting in cost of services provided, as a percentage of Food segment
revenues, of 96.9% for both the six month periods ended June 30, 2005 and 2004
CONSOLIDATED SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
- --------------------------------------------------------
Although we achieved a 6.3% growth in consolidated revenues, selling,
general and administrative expenses increased by only 4.8% or $763,000. However,
as a percentage of consolidated revenues, these expenses decreased to 7.1% in
the six month period ended June 30, 2005 as compared to 7.3% in the same 2004
period. The decrease is primarily attributable to our ability to control these
expenses and comparing them to a greater revenue base in the current year.
-20-
INCOME BEFORE INCOME TAXES
- --------------------------
Consolidated
------------
As a result of the discussion above related to consolidated revenues,
costs of services provided and selling, general and administrative expenses,
consolidated income before income taxes for the six month period ended June 30,
2005 increased to 6.2%, as a percentage of consolidated revenues, compared to
5.1% in the same 2004 period.
Reportable Segments
-------------------
Housekeeping's 7.1% increase in income before income taxes, on a
reportable segment basis, is attributable to the improvement in the gross profit
earned at the client facility level and the gross profit earned on the 4.4%
increase in reportable segment revenues.
Food segment income before income taxes increased 12.0% on a reportable
segment basis as a result of a modest improvement in gross profit earned at the
client facility level and the gross profit earned on the 12.0% increase in
reportable segment revenues.
CONSOLIDATED INVESTMENT AND INTEREST INCOME
- -------------------------------------------
Investment and interest income, as a percentage of consolidated
revenues, was .5% in the six month period ended June 30, 2005 compared to .3% in
the same 2004 period. The increase is primarily attributable to higher average
cash balances, as well as increased rates of return.
CONSOLIDATED INCOME TAXES
- -------------------------
Our effective tax rate at both June 30, 2005 and 2004 was 38%. Absent
any significant change in federal, or state and local tax laws, we expect our
effective tax rate for the remainder of 2005 to be approximately the same as
realized in the six month period ended June 30, 2005. Our 38% effective tax rate
differs from the federal income tax statutory rate principally because of the
effect of state and local income taxes.
CONSOLIDATED NET INCOME
- -----------------------
As a result of the matters discussed above, consolidated net income for
the six month period ended June 30, 2005 increased to 3.8%, as a percentage of
consolidated revenues, compared to 3.2% in the same 2004 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 forecasted, and the best estimates
routinely require adjustment. Any such adjustments or revisions to estimates
could result in material differences to previously reported amounts.
-21-
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, 2004, 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 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.
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, clients with which we are in litigation for collection
and other slow paying clients. The reserve is based upon our estimates of
ultimate collectibility. Correspondingly, once our recovery of a receivable is
determined through either litigation, bankruptcy proceedings or negotiation to
be less than the recorded amount on our balance sheet, we will charge-off the
applicable amount to the Allowance for Doubtful Accounts.
At June 30, 2005, we identified accounts totaling $3,671,000 that
require an Allowance for Doubtful Accounts based on potential impairment or loss
of value. An Allowance for Doubtful Accounts totaling $2,289,000 was provided
for these accounts at June 30, 2005. Actual collections of these accounts could
differ from that which we currently estimate. If our actual collection
experience is 5% less than our estimate, the related increase to our Allowance
for Doubtful Accounts would decrease net income by $43,000.
-22-
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 Securities and Exchange Commission for the year
ended December 31, 2004 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 effect on
our results of operations and financial condition.
ACCRUED INSURANCE CLAIMS
------------------------
We currently have a Paid Loss Retrospective Insurance Plan for general
liability and workers' compensation insurance, which comprise approximately 43%
of our liabilities at June 30, 2005. Our accounting for this plan is affected by
various uncertainties because we must make assumptions and apply judgment to
estimate the ultimate cost to settle reported claims and claims incurred but not
reported as of the balance sheet date. We address these uncertainties by
regularly evaluating 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 a material adverse effect on our results of
operations and financial condition. 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 and
open claims. The present value of the payout is determined by applying an 8%
discount factor against the estimated value of the claims over the estimated
remaining pay-out period. Reducing the discount factor by 1% would reduce net
income by approximately $50,000. Additionally, reducing the estimated payout
period by six months would result in an approximate $103,000 reduction in net
income.
For general liability, we record a reserve for the estimated ultimate
amounts to be paid for known claims.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2005, we had cash and cash equivalents of $82,533,000 and
working capital of $138,539,000 compared to December 31, 2004 cash and cash
equivalents and working capital of $74,847,000 and $125,012,000, respectively.
We view our cash and cash equivalents as our principal measure of liquidity. Our
current ratio at June 30, 2005 increased to 8.0 to 1 compared to 7.2 to 1 at
December 31, 2004. This increase resulted primarily from higher cash and cash
equivalents balances. On an historical basis, our operations have generally
produced consistent cash flow and have required limited capital resources. We
believe our current and near term cash flow positions will enable us to fund our
continued anticipated growth.
-23-
OPERATING ACTIVITIES
--------------------
The net cash provided by our operating activities was $9,178,000 for
the six month period ended June 30, 2005. The principal sources of net cash
flows from operating activities for the six month period ended June 30, 2005
were net income, including non-cash charges to operations for bad debt
provisions and depreciation. Additionally, operating activities' cash flows were
increased by the timing of payments under our various insurance plans of
$1,169,000.The operating activity that used the largest amount of cash during
the six month period ended June 30, 2005 was a net increase of $2,654,000 in
accounts and notes receivable and long-term notes receivable resulting primarily
from the 6.3% growth in the Company's six month period revenues.
INVESTING ACTIVITIES
--------------------
Our principal use of cash in investing activities for the six month
period ended June 30, 2005 was $992,000 for the purchase of housekeeping
equipment, computer software and equipment, and laundry equipment installations.
Under our current plans, which are subject to revision upon further review, it
is our intention to spend an aggregate of $1,000,000 to $1,500,000 during the
remainder of 2005 for such capital expenditures.
FINANCING ACTIVITIES
--------------------
During 2005 we paid to shareholders regular cash dividends of
$3,466,000 in the aggregate, equal to $.06 and $.07 per common share on February
11, 2005 and May 16, 2005, respectively. Additionally, on July 19, 2005, our
Board of Directors declared a regular cash dividend of $.08 per common share to
be paid on August 12, 2005 to shareholders of record as of July 29, 2005.
Our Board of Directors reviews our dividend policy on a quarterly
basis. Although there can be no assurance that we will continue to pay dividends
or the amount of the dividend, we expect to continue to pay a regular quarterly
cash dividend. In connection with the establishment of our dividend policy, we
adopted a Dividend Reinvestment Plan in 2003.
On April 19, 2005, the Board of Directors also authorized the
repurchase of up to 1,000,000 shares of our common stock pursuant to our share
repurchase program.
During 2005, we received proceeds of $3,065,000 from the exercise of
stock options by employees and directors.
LINE OF CREDIT
--------------
We have an $22,000,000 bank line of credit on which we may draw to meet
short-term liquidity requirements in excess of internally generated cash flow.
Amounts drawn under the line of credit are payable upon demand. At June 30, 2005
and December 31, 2004, there were no borrowings under the line. However, at such
dates, we had outstanding $17,925,000 and $15,925,000, respectively, of
irrevocable standby letters of credit, which relate to payment obligations under
our insurance programs. As a result of the letters of credit issued, the amount
available under the line of credit was reduced by $17,925,000 and $15,925,000 at
June 30, 2005 and December 31, 2004, respectively.
-24-
The line of credit requires us to satisfy several financial covenants.
Such covenants, and their respective status at June 30, 2005, were as follows:
Covenant Description and Requirement Status at June 30, 2005
- ----------------------------------------------------------- -----------------------------------
Commitment coverage ratio: cash and cash Commitment coverage is 4.6.
equivalents must equal or exceed outstanding
obligations under the line of credit by a multiple of 2.
Tangible net worth: must exceed $107,000,000. Tangible net worth is $141,000,000.
As noted above, we complied with all financial covenants at June 30,
2005 and expect to continue to remain in compliance with all such financial
covenants. This line of credit expires on June 30, 2006. We believe the line of
credit will be renewed at that time.
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 our
clients 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, 2005 and
December 31, 2004, we had $7,493,000 and $8,942,000, net of reserves,
respectively, of such promissory 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
such restructurings may provide us 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 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 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 $625,000 and $1,750,000 in the six month
periods ended June 30, 2005 and 2004, respectively. These provisions represent
approximately .3% and .9%, as a percentage of total revenues for such respective
-25-
periods. In making our credit evaluations, in addition to analyzing and
anticipating, where possible, the specific cases described above, we consider
the general collection risk 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 a negative 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 and
open claims. The present value of the payout is determined by applying an 8%
discount factor against the estimated value of the claims over the estimated
remaining pay-out period.
For general liability, we record a reserve for the estimated ultimate
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.
CAPITAL EXPENDITURES
--------------------
The level of capital expenditures is generally dependent on the number
of new clients obtained. Such capital expenditures primarily consist of
housekeeping equipment purchases, 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 2005, we
estimate that for the remainder of 2005 we will have capital expenditures of
approximately $1,000,000 to $1,500,000 in connection with housekeeping equipment
purchases 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 our cash from operations,
existing cash and cash equivalents balance and credit line will be adequate for
the foreseeable future to satisfy the needs of our operations and to fund our
continued growth. However, should these sources not be sufficient, we would, if
necessary, seek to obtain necessary working capital from such sources as
long-term debt or equity financing.
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MATERIAL OFF-BALANCE SHEET ARRANGEMENTS
---------------------------------------
We have no material off-balance sheet arrangements, other than our
irrevocable standby letter of credit previously discussed.
EFFECTS OF INFLATION
--------------------
Although there can be no assurance thereof, we believe that in most
instances we will be able to recover increases in costs attributable to
inflation by passing through such cost increases to our clients.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Our exposure to market risk is not significant.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE 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 (the "Exchange Act"), 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 June 30, 2005 (the "Evaluation Date"), 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 Exchange Act Rules 13a-15(e) and 15d-15(e). Based upon
our evaluation, at the Evaluation Date, 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.
CHANGES IN INTERNAL CONTROLS
----------------------------
There were no significant changes in our internal controls or to our
knowledge, in other factors that could significantly affect our disclosure
controls and procedures subsequent to the Evaluation Date.
CERTIFICATIONS
--------------
Certifications of the Principal Executive Officer and Principal
Financial Officer regarding, among other items, disclosure controls and
procedures are included as exhibits to this Form 10-Q.
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PART II. Other Information
-----------------
Item 1. Legal Proceedings. Not Applicable
Item 2. Changes in Securities. Not Applicable
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 24, 2005. The results were as follows.
(1) All of management's nominees for directors were elected as follows:
Shares Voted
Director "FOR" Withheld
------------------- ------------ ----------
Daniel P. McCartney 8,423,977 5,203,754
Barton D. Weisman 12,845,425 782,306
Joseph F. McCartney 8,040,889 5,586,842
Robert L. Frome 8,041,987 5,585,744
Thomas A. Cook 8,335,032 5,292,699
Robert J. Moss 12,534,461 1,093,270
John M. Briggs 12,843,493 784,238
(2) Proposal to approve an amendment to the Company's 2002 Stock Option Plan was
approved as follows:
Shares Voted Shares Voted Shares Broker
"FOR" "AGAINST" "ABSTAINING" Non-vote
------------ ------------ ------------ ---------
8,428,015 1,263,999 11,467 3,924,249
(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, 2005 was approved as follows.
Shares Voted Shares Voted Shares Broker
"FOR" "AGAINST" "ABSTAINING" Non-vote
------------ ------------ ------------ ---------
13,446,963 172,790 7,978 -0-
Item 5. Other Information.
a) None
Item 6. Exhibits
a) Exhibits -
31.1 Certification of Principal Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Principal Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Principal Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of Principal Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
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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 22, 2005 /s/ Daniel P. McCartney
- --------------- ------------------------------------------
Date DANIEL P. McCARTNEY,
Chief Executive Officer
July 22, 2005 /s/ Thomas A. Cook
- --------------- ------------------------------------------
Date THOMAS A. COOK, President and
Chief Operating Officer
July 22, 2005 /s/ James L. DiStefano
- --------------- ------------------------------------------
Date JAMES L. DiSTEFANO, Chief Financial
Officer and Treasurer
July 22, 2005 /s/ Richard W. Hudson
- --------------- ------------------------------------------
Date RICHARD W. HUDSON, Vice President-Finance,
Secretary and Chief Accounting Officer
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