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 September 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 October 21, 2005
is 26,903,000
Total of 33 Pages
INDEX
-----
PART I. FINANCIAL INFORMATION PAGE NO.
--------------------- --------
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets as of
September 30, 2005 and December 31, 2004 2
Consolidated Statements of Income for the Three Months Ended September
30, 2005 and September 30, 2004
3
Consolidated Statements of Income for the Nine Months Ended September
30, 2005 and September 30, 2004 4
Consolidated Statements of Cash Flows for the Nine Months ended
September 30, 2005 and September 30, 2004 5
Consolidated Statement of Stockholders' Equity for the Nine Months
Ended September 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 - 27
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 28
and Issuer Purchases of Equity Securities
Item 3. Defaults Upon Senior Securities 28
Item 4. Submission of Matters to a Vote of Security 28
Holders
Item 5. Other Information 28
Item 6. Exhibits 28
Signatures 29
-1-
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
2005 2004
---------------------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 91,703,000 $ 74,847,000
Accounts and notes receivable, less allowance for
doubtful accounts of $2,488,000 in 2005 and $1,869,000 in 2004 59,315,000 55,725,000
Inventories and supplies 11,458,000 11,015,000
Deferred income taxes 669,000 574,000
Prepaid expenses and other 3,691,000 3,110,000
-------------- --------------
Total current assets 166,836,000 145,271,000
PROPERTY AND EQUIPMENT:
Laundry and linen equipment installations 2,391,000 2,329,000
Housekeeping and office equipment 14,789,000 13,987,000
Autos and trucks 80,000 80,000
-------------- --------------
17,260,000 16,396,000
Less accumulated depreciation 12,442,000 11,592,000
-------------- --------------
4,818,000 4,804,000
NOTES RECEIVABLE- long term portion, net of discount 4,084,000 5,557,000
DEFERRED COMPENSATION FUNDING 5,125,000 4,062,000
DEFERRED INCOME TAXES- long term portion 6,084,000 5,563,000
GOODWILL AND OTHER NONCURRENT ASSETS 1,708,000 1,707,000
-------------- --------------
$ 188,655,000 $ 166,964,000
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 7,814,000 $ 7,272,000
Accrued payroll, accrued and withheld payroll taxes 12,671,000 6,110,000
Other accrued expenses 2,413,000 1,692,000
Income taxes payable 1,151,000 1,016,000
Accrued insurance claims 4,487,000 4,169,000
-------------- --------------
Total current liabilities 28,536,000 20,259,000
ACCRUED INSURANCE CLAIMS- long term portion 10,471,000 10,227,000
DEFERRED COMPENSATION LIABILITY 6,375,000 5,018,000
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value: 67,500,000 shares authorized,
28,505,000 shares issued in 2005 and 27,761,000 in 2004 285,000 277,000
Additional paid in capital 46,760,000 39,374,000
Retained earnings 109,258,000 101,279,000
Common stock in treasury, at cost, 1,624,000 shares in
2005 and 1,488,000 in 2004 (13,030,000) (9,470,000)
-------------- --------------
Total stockholders' equity 143,273,000 131,460,000
-------------- --------------
$ 188,655,000 $ 166,964,000
============== ==============
See accompanying notes.
-2-
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
FOR THE THREE MONTHS ENDED SEPT 30,
2005 2004
------------- -------------
Revenues $ 117,684,000 $ 112,324,000
Operating costs and expenses:
Costs of services provided 102,884,000 98,644,000
Selling, general and administrative 8,024,000 7,967,000
Other Income:
Investment and interest income 923,000 293,000
------------- -------------
Income before income taxes 7,699,000 6,006,000
Income taxes 2,925,000 2,282,000
------------- -------------
Net Income $ 4,774,000 $ 3,724,000
============= =============
Basic earnings per common share $ 0.18 $ 0.14
============= =============
Diluted earnings per common share $ 0.17 $ 0.14
============= =============
Cash dividends per common share $ 0.08 $ 0.05
============= =============
Basic weighted average number of
common shares outstanding 27,079,000 26,090,000
============= =============
Diluted weighted average number of
common shares outstanding 28,414,000 27,520,000
============= =============
See accompanying notes.
-3-
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
FOR THE NINE MONTHS ENDED SEPT 30,
2005 2004
------------- -------------
Revenues $ 348,426,000 $ 329,435,000
Operating costs and expenses:
Costs of services provided 304,039,000 289,433,000
Selling, general and administrative 24,562,000 23,742,000
Other Income:
Investment and interest income 2,142,000 792,000
------------- -------------
Income before income taxes 21,967,000 17,052,000
Income taxes 8,347,000 6,480,000
------------- -------------
Net Income $ 13,620,000 $ 10,572,000
============= =============
Basic earnings per common share $ 0.51 $ 0.40
============= =============
Diluted earnings per common share $ 0.48 $ 0.38
============= =============
Cash dividends per common share $ 0.21 $ 0.12
============= =============
Basic weighted average number of
common shares outstanding 26,861,000 26,180,000
============= =============
Diluted weighted average number of
common shares outstanding 28,286,000 27,625,000
============= =============
See accompanying notes.
-4-
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------------------
2005 2004
------------- -------------
Cash flows from operating activities:
Net Income $ 13,620,000 $ 10,572,000
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation 1,400,000 1,395,000
Bad debt provision 875,000 2,600,000
Deferred income taxes benefit (616,000) (599,000)
Tax benefit of stock option transactions 2,920,000 1,688,000
Unrealized loss on deferred compensation
fund investments (469,000) (74,000)
Changes in operating assets and liabilities:
Accounts and notes receivable (4,465,000) (1,748,000)
Prepaid income taxes -- (238,000)
Inventories and supplies (442,000) (312,000)
Notes receivable- long term portion 1,472,000 3,221,000
Deferred compensation funding (593,000) (628,000)
Accounts payable and other accrued expenses 1,263,000 814,000
Accrued payroll, accrued and withheld payroll taxes 7,203,000 (3,150,000)
Accrued insurance claims 561,000 1,401,000
Deferred compensation liability 1,358,000 1,034,000
Income taxes payable 136,000 (179,000)
Prepaid expenses and other assets (582,000) (1,276,000)
------------- -------------
Net cash provided by operating activities 23,641,000 14,521,000
Cash flows from investing activities:
Disposals of fixed assets 40,000 266,000
Additions to property and equipment (1,455,000) (1,885,000)
------------- -------------
Net cash used in investing activities (1,415,000) (1,619,000)
Cash flows from financing activities:
Treasury stock transactions in benefit plans (174,000) --
Dividends paid (5,641,000) (3,195,000)
Purchase of treasury stock (3,857,000) (5,999,000)
Reissuance of treasury stock pursuant to Dividend
Reinvestment Plan 24,000 6,000
Proceeds from the exercise of stock options 4,278,000 3,295,000
------------- -------------
Net cash used in financing activities (5,370,000) (5,893,000)
------------- -------------
Net increase in cash and cash equivalents 16,856,000 7,009,000
Cash and cash equivalents at beginning of the period 74,847,000 64,181,000
------------- -------------
Cash and cash equivalents at end of the period $ 91,703,000 $ 71,190,000
============= =============
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 Nine Months Ended September 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 13,620,000 13,620,000
Exercise of stock options 728,000 7,000 4,271,000 4,278,000
Tax benefit arising from stock option
transactions 2,920,000 2,920,000
Purchase of treasury stock (218,000 shares) (3,857,000) (3,857,000)
Shares purchased and shares sold in
employee Deferred Compensation Plan
and other benefit plans (9,000 shares) (174,000) (174,000)
Shares issued pursuant to Employee
Stock Plans (90,000 shares) 16,000 1,000 181,000 461,000 643,000
Cash dividends - $.21 per common share (5,641,000) (5,641,000)
Shares issued pursuant to Dividend
Reinvestment Plan (1,000 shares) 14,000 10,000 24,000
------------ --------- ------------ ------------- ------------ -------------
Balance, September 30, 2005 28,505,000 $ 285,000 $ 46,760,000 $ 109,258,000 ($ 13,030,000) $ 143,273,000
------------ --------- ------------ ------------- ------------ -------------
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 nine month period ended September 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 a $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 September 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 September 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 September 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 44 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 September 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. With respect to these assessments, we have recorded a reserve at
-7-
both September 30, 2005 and December 31, 2004 of $900,000 ($590,000 net of
federal income taxes). On October 6, 2005 we executed a closing agreement with a
state's revenue services department settling a $2,400,000 assessment (including
interest) resulting from the state's audit of our sales and use tax filings for
the period July 1, 1999 through June 30, 2003. The closing agreement settlement,
among other understandings, provides for a payment by us of $700,000 (including
interest) in connection with the audit assessment. Such payment when paid was
charged to the aforementioned reserve.
With respect to other remaining outstanding assessments of $500,000
($325,000 net of federal income taxes), we intend to vigorously defend our
positions that the assessments are without merit. 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. Additionally, included
in the differences between the reportable segments' operating results and other
disclosed data are amounts attributable to our investment holding company
-8-
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.
Housekeeping Food Corporate and
services services eliminations Total
------------- -------- -------------- -----
Quarter Ended Sept 30,
2005
- ----------------------
Revenues $ 95,155,000 $23,772,000 $(1,243,000) $117,684,000
Income before income
taxes $ 7,738,000 $ 477,000 $ (516,000)(1) $ 7,699,000
Quarter Ended Sept 30,
2004
- ----------------------
Revenues $ 90,190,000 $23,228,000 $(1,094,000) $112,324,000
Income before income
taxes $ 7,113,000 $ 234,000 $(1,341,000)(1) $ 6,006,000
Nine months Ended
Sept 30, 2005
- -----------------
Revenues $279,519,000 $69,310,000 $ (403,000) $348,426,000
Income before income
taxes $ 24,171,000 $ 1,907,000 $(4,111,000)(1) $ 21,967,000
Nine Months Ended
Sept 30, 2004
- -----------------
Revenues $266,755,000 $63,877,000 $(1,197,000) $329,435,000
Income before income
taxes $ 22,459,000 $ 1,510,000 $(6,917,000)(1) $ 17,052,000
(1) represents primarily corporate office cost and related overhead, as well as
consolidated subsidiaries' operating expenses that are not allocated to the
reportable segments.
-9-
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 September 30,
-----------------------------------------------
2005 2004
---- ----
Housekeeping services $ 66,291,000 $ 62,688,000
Laundry and linen services 27,588,000 26,465,000
Food Services 23,245,000 22,596,000
Maintenance services
and Other 560,000 575,000
------------ ------------
$117,684,000 $112,324,000
============ ============
For the Nine Months Ended September 30,
------------------------------------------------
2005 2004
---- ----
Housekeeping services $196,235,000 $186,300,000
Laundry and linen services 82,047,000 78,852,000
Food Services 68,312,000 62,706,000
Maintenance services
and Other 1,832,000 1,577,000
------------ ------------
$348,426,000 $329,435,000
============ ============
MAJOR CLIENT
------------
We have one client, a nursing home chain, which in the nine month
periods ended September 30, 2005 and 2004 accounted for 19% and 20%,
respectively, of consolidated revenues. In the nine month period ended September
30, 2005, we derived 18% and 26%, respectively, of the Housekeeping and Food
segment's revenues from such client. According to public filings, during 2005,
this client's Board of Directors agreed to conduct an auction to sell the
company. The auction was completed and the client entered into a merger
agreement on August 16, 2005. At the present time, the purchaser has not met all
of its financing commitments and was given an extension to November 18, 2005 to
meet such commitments. The client has the right to explore other strategic
options until the purchaser meets its financial commitments. In the event the
sale to this purchaser is not completed, the client's Board of Directors will
continue to pursue a sale of the company. Although we expect to continue our
relationship with this client or its successor, there can be no assurance
thereof, and the loss of such client would have a material adverse effect on the
results of operations of our two operating segments.
-10-
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 September 30, 2005
---------------------------------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
----------- ------------- --------
Net income $4,774,000
==========
Basic earnings per
common share $4,774,000 27,079,000 $ .18
Effect of dilutive securities:
Options 1,335,000 (.01)
---------- ---------- ----------
Diluted earnings per
common share $4,774,000 28,414,000 $ .17
========== ========== ==========
Quarter Ended September 30, 2004
---------------------------------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
----------- ------------- --------
Net income $3,724,000
==========
Basic earnings per
common share $3,724,000 26,090,000 $ .14
Effect of dilutive securities:
Options 1,430,000
---------- ---------- ----------
Diluted earnings per
common share $3,724,000 27,520,000 $ .14
========== ========== ==========
Nine Months Ended September 30, 2005
---------------------------------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
----------- ------------- --------
Net income $ 13,620,000
============
Basic earnings per
common share $ 13,620,000 26,861,000 $ .51
Effect of dilutive securities:
Options 1,425,000 (.03)
------------ ---------- ----------
Diluted earnings per
common share $ 13,620,000 28,286,000 $ .48
============ ========== ==========
Nine Months Ended September 30, 2004
---------------------------------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
Net income $10,572,000
Basic earnings per
common share $10,572,000 26,180,000 $ .40
Effect of dilutive securities:
Options 1,445,000 (.02)
------------ ---------- ----------
Diluted earnings per
common share $10,572,000 27,625,000 $ .38
============ ========== ==========
-11-
No outstanding options were excluded from the computation of diluted
earnings per common share for either of the three or nine month period ended
September 30, 2005 or September 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 September 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 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.
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 September 30,
-------------------------------------
2005 2004
---- ----
Net Income
As reported $4,774,000 $3,724,000
Deduct:
Total stock based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects (-0-) (-0-)
Pro forma net income $4,774,000 $3,724,000
========== ==========
Basic Earnings Per Common Share
As reported $ .18 $ .14
Pro forma $ .18 $ .14
Diluted Earnings Per Common Share
As reported $ .17 $ .14
Pro forma $ .17 $ .14
-12-
Nine Months Ended September 30,
------------------------------------
2005 2004
---- ----
Net Income
As reported $13,620,000 $10,572,000
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 $11,921,000 $ 9,293,000
=========== ===========
Basic Earnings Per Common Share
As reported $ .51 $ .40
Pro forma $ .44 $ .35
Diluted Earnings Per Common Share
As reported $ .48 $ .38
Pro forma $ .42 $ .34
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 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 affect 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 nine month period ended September 30, 2005
(such client's Board of Directors is pursuing a sale of the company, which sale
could be completed by year-end- see Note 4, "Major Client" above); our claims
experience related to workers' compensation and general liability insurance; the
-13-
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.
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 be helpful in understanding our financial statements including the changes
in certain key items in comparing financial statements period to period. We also
intend to provide the primary factors that accounted for those changes, as well
as a summary of how certain accounting principles affect our financial
statements. In addition, we are providing information about the financial
results of our two operating segments to further assist in understanding how
these segments and their results affect our results of operations. This
discussion should be read in conjunction with our financial statements as of
September 30, 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 44 states as of September 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 the management and
hourly employees located at our clients' facilities. We also provide services on
-14-
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.
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 Sept 30, For the Nine Months Ended Sept 30,
-----------------------------------------------------------------
2005 2004 2005 2004
---- ---- ---- ----
Revenues 100.0% 100.0% 100.0% 100.0%
Operating costs and expenses:
Costs of services provided 87.4 87.8 87.3 87.8
Selling, general and
administration 6.8 7.1 7.0 7.2
Investment and interest income .8 .2 .6 .2
---- ---- ---- ----
Income before income taxes 6.6 5.3 6.3 5.2
Income taxes 2.5 2.0 2.4 2.0
---- ---- ---- ----
Net income 4.1% 3.3% 3.9% 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 nine month period
ended September 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 nine month
period ended September 30, 2005. Food segment revenues represented approximately
20% of consolidated revenues for both the quarter and nine month period ended
September 30, 2005.
-15-
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.
2005 THIRD QUARTER COMPARED WITH 2004 THIRD QUARTER
---------------------------------------------------
The following table sets forth 2005 third 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 third quarter amounts.
Reportable Segments
-----------------------------------------------
Percent Corporate and Housekeeping Food
Consolidated increase eliminations Amount %incr Amount %incr
------------ -------- -------------- ----------- ----- ----------- -----
Revenues $117,684,000 4.8% $(1,243,000) $95,155,000 5.5% $23,772,000 2.3%
Cost of services provided 102,884,000 4.3 (7,828,000) 87,417,000 5.2 23,295,000 1.3
Selling, general and
administrative expense 8,024,000 .7 8,024,000 -- --
Income before income taxes 7,699,000 28.2 (516,000) 7,738,000 8.8 477,000 103.7
REVENUES
- --------
Consolidated
------------
Consolidated revenues increased 4.8% to $117,684,000 in the 2005 third
quarter compared to $112,324,000 in the 2004 third 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 third quarter and the 2004 third quarter accounted for 19% and 20%,
respectively, of consolidated revenues. According to public filings, during
2005, this client's Board of Directors agreed to conduct an auction to sell the
company. The auction was completed and the client entered into a merger
agreement on August 16, 2005. At the present time, the purchaser has not met all
of its financing commitments and was given an extension to November 18, 2005 to
meet such commitments. The client has the right to explore other strategic
options until the purchaser meets its financial commitments. In the event the
sale to this purchaser is not completed, the client's Board of Directors will
continue to pursue a sale of the company. Although we expect to continue our
relationship with this client or its successor, there can be no assurance
thereof, and the loss of such client would have a material adverse effect on our
results of operations.
-16-
Reportable Segments
-------------------
The Housekeeping segment's 5.5% 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 2.3% net growth in reportable segment revenues is a
result of providing this service to an increasing number of existing
Housekeeping segment clients.
We derived 17% and 26%, respectively, of the Housekeeping and Food
segments' 2005 third quarter revenues from the Significant Client. Additionally,
at both September 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 2005 third quarter decreased to 87.4 % from 87.8 %
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 % Incr (Decr) %
---------------------------------------- ------ ------ -------------
Bad debt provision .2 .8 (.6)
Workers' compensation and general
liability insurance 3.6 3.1 .5
The decrease in bad debt provision resulted primarily from improved
collection experience. The increase in workers' compensation and general
liability insurance is primarily a result of increased payments to claimants.
Reportable Segments
-------------------
Cost of services provided for the Housekeeping segment, as a percentage
of Housekeeping segment revenues, for the 2005 third quarter decreased to 91.9%
from 92.1% in the corresponding 2004 quarter. Cost of services provided for the
Food segment, as a percentage of Food segment revenues, for the 2005 third
quarter decreased to 98.0% from 99.0% 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 82.9 83.0 (.1)
Housekeeping segment supplies 5.7 5.3 .4
Food labor and other labor costs 55.7 55.5 .2
Food segment supplies 37.5 39.3 (1.8)
The minor decrease in Housekeeping segment labor and other labor costs,
as a percentage of Housekeeping segment revenues, resulted primarily from
efficiencies achieved. The increase in Housekeeping segment supplies resulted
primarily from vendor price increases.
-17-
The minor increase in Food segment labor and other labor costs, as a
percentage of Food segment revenues, resulted primarily from labor
inefficiencies. The decrease in Food segment supplies, as a percentage of Food
segment revenues, is a result of price decreases in vendor purchasing
agreements.
CONSOLIDATED SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
- --------------------------------------------------------
Consistent with our 4.8% growth in consolidated revenues, selling,
general and administrative expenses increased by .7% or $57,000. However, as a
percentage of total consolidated revenues, these expenses decreased to 6.8% in
the 2005 third quarter as compared to 7.1% in the 2004 third quarter. The
decrease is primarily attributable to our ability to control these expenses and
comparing them to a greater revenue base in the current period.
INCOME BEFORE INCOME TAXES
- --------------------------
Consolidated
------------
As a result of the growth in revenues and expenses discussed above,
consolidated income before income taxes for the 2005 third quarter increased to
6.6 %, as a percentage of consolidated revenues, compared to 5.3% in the 2004
third quarter.
Reportable Segments
-------------------
Housekeeping's 8.8% 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 5.5% increase in reportable
segment revenues.
Food segment income before income taxes increased over 103% on a
reportable segment basis which is primarily attributable to an improvement in
the gross profit earned at the client facility level and the gross profit earned
on the 2.3% increase in reportable segment revenues.
CONSOLIDATED INVESTMENT AND INTEREST INCOME
- -------------------------------------------
Investment and interest income, as a percentage of consolidated
revenues, was .8% in the 2005 third quarter compared to .2% in the 2004 third
quarter. The increase is attributable to improved rates of return on the higher
cash and cash equivalents' average balance and the increase in market value of
the investments held in our Deferred Compensation Fund.
CONSOLIDATED INCOME TAXES
- -------------------------
Our effective tax rate at both September 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 third 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.
-18-
CONSOLIDATED NET INCOME
As a result of the matters discussed above, consolidated net income for
the 2005 third quarter increased to 4.1%, as a percentage of consolidated
revenues, compared to 3.3% in the 2004 third quarter.
2005 NINE MONTH PERIOD COMPARED WITH 2004 NINE MONTH PERIOD
The following table sets forth, for the nine month period ended September 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 nine month period ended September
30, 2004 amounts.
Reportable Segments
-----------------------------------------------
Percent Corporate and Housekeeping Food
Consolidated increase eliminations Amount %incr Amount %incr
------------ -------- ------------- ------ ----- ------ -----
Revenues $348,426,000 5.8% $ (403,000) $279,519,000 4.8% $69,310,000 8.5%
Cost of services provided 304,039,000 5.0 (18,712,000) 255,348,000 4.5 67,403,000 8.1
Selling, general and
administrative expense 24,562,000 3.5 24,562,000 -- --
Income before income taxes 21,967,000 28.8 (4,111,000) 24,171,000 7.6 1,907,000 26.2
REVENUES
- --------
Consolidated
------------
Consolidated revenues increased 5.8% to $348,426,000 in the nine month
period ended September 30, 2005 compared to $329,435,000 in the same 2004 period
as a result of the factors discussed below under Reportable Segments.
In the nine month periods ended September 30, 2005 and 2004 our
Significant Client accounted for 19% and 20%, respectively, of consolidated
revenues.
Reportable Segments
-------------------
The Housekeeping segment's net 4.8% 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 8.5% 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 nine month period ended September 30, 2005 from our
Significant Client. Additionally, at both September 30, 2005 and December 31,
2004, amounts due from such client represented less than 1% of our accounts
receivable balances.
-19-
COSTS OF SERVICES PROVIDED
- --------------------------
Consolidated
------------
Cost of services provided, on a consolidated basis, as a percentage of
consolidated revenues for the nine month period ended September 30, 2005
decreased to 87.3 % from 87.8 % 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
Cost of Services Provided-Key Indicators 2005 % 2004 % Incr (Decr) %
---------------------------------------- ------ ------ -------------
Bad debt provision .3 .8 (.5)
Workers' compensation and general
liability insurance 4.1 3.9 .2
The decrease in bad debt provision resulted primarily from improved
collection experience. The increase in workers' compensation and general
liability insurance is primarily a result of increased payments to claimants.
Reportable Segments
-------------------
Cost of services provided for the Housekeeping segment, as a percentage
of Housekeeping segment revenues, for the nine month period ended September 30,
2005, decreased to 91.4% from 91.6% in the corresponding 2004 period. Cost of
services provided for the Food segment, as a percentage of Food segment revenues
decreased to 97.2% from 97.6% in the corresponding 2004 nine month period.
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 82.3 82.5 (.2)
Housekeeping segment supplies 5.3 5.1 .2
Food labor and other labor costs 55.0 54.8 .2
Food segment supplies 38.9 38.8 .1
The decrease in Housekeeping segment labor and other labor costs, as a
percentage of Housekeeping segment revenues, resulted primarily from
efficiencies achieved. 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 Food
segment key indicators were offset by decreases in other Food segment operating
costs, resulting in a net .4% decrease in its cost of services provided, as a
percentage of Food segment revenues, in comparing the nine month periods ended
September 30, 2005 and 2004.
-20-
CONSOLIDATED SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
- --------------------------------------------------------
Although we achieved a 5.8% growth in consolidated revenues, selling,
general and administrative expenses increased by only 3.5% or $820,000. However,
as a percentage of consolidated revenues, these expenses decreased to 7.0% in
the nine month period ended September 30, 2005 as compared to 7.2% 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.
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 nine month period ended
September 30, 2005 increased to 6.3%, as a percentage of consolidated revenues,
compared to 5.2% in the same 2004 period.
Reportable Segments
-------------------
Housekeeping's 7.6% 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 4.8%
increase in reportable segment revenues.
Food segment income before income taxes increased 26.2% on a reportable
segment basis as a result of the improvement in gross profit earned at the
client facility level and the gross profit earned on the 8.5% increase in
reportable segment revenues.
CONSOLIDATED INVESTMENT AND INTEREST INCOME
- -------------------------------------------
Investment and interest income, as a percentage of consolidated
revenues, was .6% in the nine month period ended September 30, 2005 compared to
..2% in the same 2004 period. The increase is attributable to improved rates of
return on the higher cash and cash equivalents' average balance and the increase
in market value of the investments held in our Deferred Compensation Fund.
CONSOLIDATED INCOME TAXES
- -------------------------
Our effective tax rate at both September 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 nine month period ended September 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 nine month period ended September 30, 2005 increased to 3.9%, as a
percentage of consolidated revenues, compared to 3.2% in the same 2004 period.
-21-
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.
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.
-22-
At September 30, 2005, we identified accounts totaling $3,683,000 that
require an Allowance for Doubtful Accounts based on potential impairment or loss
of value. An Allowance for Doubtful Accounts totaling $2,488,000 was provided
for these accounts at September 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 $37,000.
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 33%
of our liabilities at September 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 $40,000. Additionally, reducing the estimated payout
period by six months would result in an approximate $100,000 reduction in net
income.
For general liability, we record a reserve for the estimated ultimate
amounts to be paid for known claims.
-23-
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2005, we had cash and cash equivalents of $91,703,000
and working capital of $138,300,000 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 September 30, 2005 decreased to 5.8 to 1 compared to 7.2 to 1
at December 31, 2004. This decrease resulted primarily from the timing of
payments for accrued payroll, accrued and withheld payroll taxes. 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.
OPERATING ACTIVITIES
--------------------
The net cash provided by our operating activities was $23,641,000 for
the nine month period ended September 30, 2005. The principal sources of net
cash flows from operating activities for the nine month period ended September
30, 2005 were net income, including non-cash charges to operations for bad debt
provisions and depreciation. Additionally, operating activities' cash flows
increased by $7,203,000 as a result of the timing of payments for accrued
payroll, accrued and withheld payroll taxes, as well as $1,263,000 resulting
from the timing of payments for accounts payable and other accrued expenses. The
operating activity that used the largest amount of cash during the nine month
period ended September 30, 2005 was a net increase of $2,993,000 in accounts and
notes receivable and long-term notes receivable resulting primarily from the
5.8% growth in the Company's nine month period revenues.
INVESTING ACTIVITIES
--------------------
Our principal use of cash in investing activities for the nine month
period ended September 30, 2005 was $1,455,000 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 $500,000 to $1,000,000 during the
remainder of 2005 for such capital expenditures.
FINANCING ACTIVITIES
--------------------
During 2005 we paid to shareholders regular cash dividends of
$5,641,000 in the aggregate, equal to $.06, $.07 and $.08 per common share on
February 11, 2005, May 16 and August 12, 2005, respectively. Additionally, on
October 18, 2005, our Board of Directors declared a regular cash dividend of
$.09 per common share to be paid on November 14, 2005 to shareholders of record
as of October 31, 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.
During the nine month period ended September 30, 2005, we expended
$3,857,000 for the repurchase of 218,000 shares of our common stock. We remain
authorized to purchase 1,282,000 shares pursuant to previous Board of Directors'
actions.
-24-
During 2005, we received proceeds of $4,278,000 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 September 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
September 30, 2005 and December 31, 2004, respectively.
The line of credit requires us to satisfy several financial covenants.
Such covenants, and their respective status at September 30, 2005, were as
follows:
Covenant Description and Requirement Status at September 30, 2005
------------------------------------ ----------------------------
Commitment coverage ratio: cash and cash Commitment coverage is 5.1
equivalents must equal or exceed outstanding
obligations under the line of credit by a multiple of 2.
Tangible net worth: must exceed $110,000,000. Tangible net worth is $142,000,000
As noted above, we complied with all financial covenants at September
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 September 30, 2005
and December 31, 2004, we had $7,074,000 and $8,942,000, net of reserves,
respectively, of such promissory notes outstanding. Additionally, we consider
-25-
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 $875,000 and $2,600,000 in the nine month
periods ended September 30, 2005 and 2004, respectively. These provisions
represent approximately .3% and .8%, as a percentage of total revenues for such
respective 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.
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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 $500,000 to $1,000,000 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.
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 Securities and Exchange Commission ("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 September 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.
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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.
PART II. Other Information
-----------------
Item 1. Legal Proceedings. Not Applicable
Item 2. Changes in Securities.
(a) (b) (c) (d)
Total number of Maximum
shares purchased as number of shares
part of publicly that may yet be
Total number of Average price announced plans purchased under the
2005 Period Shares purchased paid per share or programs plans or programs
- ----------- ----------------- --------------- ------------------- --------------------
July 1 to
July 31 No transactions
August 1 to
August 31 196,000 $17.80 196,000 1,304,000
September 1 to
September 30 22,000 $16.47 22,000 1,282,000
Item 3. Defaults under Senior Securities. Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders Not Applicable
Item 5. Other Information.
a) None
Item 6. Exhibits
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.
October 21, 2005 /s/ Daniel P. McCartney
- ------------------------ --------------------------------
Date DANIEL P. McCARTNEY, Chief
Executive Officer
October 21, 2005 /s/ Thomas A. Cook
- ------------------------ --------------------------------
Date THOMAS A. COOK, President and
Chief Operating Officer
October 21, 2005 /s/ James L. DiStefano
- ------------------------ --------------------------------
Date JAMES L. DiSTEFANO, Chief Financial
Officer and Treasurer
October 21, 2005 /s/ Richard W. Hudson
- ------------------------ --------------------------------
Date RICHARD W. HUDSON, Vice
President-Finance, Secretary and Chief
Accounting Officer
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