================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For Quarter Ended March 31, 1998 Commission File Number 0-12015 HEALTHCARE SERVICES GROUP, INC. ------------------------------- (Exact name of registrant as specified in its charter) Pennsylvania 23-2018365 - ------------------------------- ---------------------------- (State or other jurisdiction of (IRS Employer Identification incorporation or organization) number) 2643 Huntingdon Pike, Huntingdon Valley, Pennsylvania 19006 ------------------------------------------------------------------------ (Address of principal executive office) (Zip code) Registrant's telephone number, including area code: 215-938-1661 ---------------- Indicate mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months ( or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for past 90 days. YES X NO ___ --- Number of shares of common stock, issued and outstanding as of April 30, 1998 is 7,471,913 Total of 13 Pages INDEX ----- PART I. FINANCIAL INFORMATION PAGE NO. --------------------- -------- Consolidated Balance Sheets as of March 31, 1998 and 2 December 31, 1997 Consolidated Statements of Income for the Three Months 3 Ended March 31, 1998 and 1997 Consolidated Statements of Cash Flows for the Three Months 4 ended March 31, 1998 and 1997 Notes To Consolidated Financial Statements 5 Management's Discussion and Analysis of Financial 7 - 11 Condition and Results Of Operations Part II. Other Information 12 ----------------- Signatures 13 -1- HEALTHCARE SERVICES GROUP, INC. Consolidated Balance Sheets March 31, December 31, 1998 1997 (Unaudited) (Audited) ------------------------------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 19,664,072 $ 17,774,219 Accounts and notes receivable, less allowance for doubtful accounts of $3,822,000 in 1998 and $3,663,000 in 1997 39,113,614 36,560,661 Prepaid income taxes - 366,712 Inventories and supplies 7,516,060 7,339,928 Deferred income taxes 636,763 567,119 Prepaid expenses and other 2,781,391 2,859,133 ------------------------------- Total current assets 69,711,900 65,467,772 ------------------------------- PROPERTY AND EQUIPMENT: Laundry and linen equipment installations 10,992,338 10,993,558 Housekeeping equipment and office furniture 8,965,351 8,731,042 Autos and trucks 157,611 157,611 ------------------------------- 20,115,300 19,882,211 Less accumulated depreciation 14,707,501 14,245,071 ------------------------------- 5,407,799 5,637,140 COST IN EXCESS OF FAIR VALUE OF NET ASSETS ACQUIRED less accumulated amortization of $1,339,566 in 1998 and $1,312,660 in 1997 2,015,911 2,042,817 DEFERRED INCOME TAXES 1,471,234 1,067,670 OTHER NONCURRENT ASSETS 10,415,251 10,674,340 ------------------------------- $ 89,022,095 $ 84,889,739 =============================== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 2,569,003 $ 4,275,902 Accrued payroll, accrued and withheld payroll taxes 6,009,417 3,770,310 Other accrued expenses 753,621 944,501 income taxes payable 958,375 Accrued insurance claims 783,679 771,142 ------------------------------- Total current liabilities 11,074,095 9,761,855 ACCRUED INSURANCE CLAIMS 2,948,126 2,900,964 COMMITMENTS AND CONTINGENCIES ( Note 2 STOCKHOLDERS' EQUITY: Common stock, $.01 par value: 15,000,000 shares authorized, 7,457,763 shares issued and outstanding in 1998 and 7,386,863 in 1997 74,578 73,869 Additional paid in capital 26,677,004 26,005,004 Retained earnings 48,248,292 46,148,047 ------------------------------- Total stockholders' equity 74,999,874 72,226,920 ------------------------------- $ 89,022,095 $ 84,889,739 =============================== See accompanying notes. -2- Healthcare Services Group, Inc. Consolidated Income Statements (Unaudited) For the Three Months Ended March 31 1998 1997 ---------------------------------------- Revenues $ 47,767,127 $ 41,414,490 Operating costs and expenses: Costs of services provided 40,596,844 35,271,313 Selling general and administrative 3,949,148 3,507,038 Other Income: Interest Income 338,111 481,224 ---------------- -------------- Income before income taxes 3,559,246 3,117,363 Income taxes 1,459,000 1,265,000 ---------------- -------------- Net Income $ 2,100,246 $ 1,852,363 ================ ============== Basic earnings per common share $ .28 $ .23 ================ ============== Diluted earnings per common share $ .28 $ .23 ================ ============== Basic weighted average number of common shares outstanding 7,423,302 8,099,595 ================ ============== Diluted weighted average number of common shares outstanding 7,636,704 8,201,542 ================ ============== See accompanying notes -3- Healthcare Services Group, Inc. Consolidated Statements of Cash Flows (Unaudited) For the Three Months Ended March 31, 1998 1997 ---------------------------------------- Cash flows from operating activities: Net Income $ 2,100,246 $ 1,852,363 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 496,852 465,806 Bad debt provision 550,000 375,000 Deferred income tax benefits (473,208) (203,488) Tax benefit of stock option transactions 115,624 2,807 Changes in operating assets and liabilities: Accounts and notes receivable (3,103,380) (2,447,075) Prepaid income taxes 366,712 Inventories and supplies (176,132) (23,044) Changes to long term notes receivable 516,261 (279,856) Accounts payable and other accrued expenses (1,897,779) (2,645,764) Accrued payroll, accrued and withheld payroll taxes 2,239,107 2,016,963 Accrued insurance claims 59,699 506,325 Income taxes payable 958,375 1,425,781 Prepaid expenses and other assets (179,004) (248,114) ---------------------------------------- Net cash provided by operating activities 1,573,373 797,704 ---------------------------------------- Cash flows from investing activities: Disposals of fixed assets 30,525 69,730 Additions to property and equipment (271,131) (300,713) ---------------------------------------- Net cash used in investing activities (240,606) (230,983) ---------------------------------------- Cash flows from financing activities: Purchase of treasury stock (174,744) Proceeds from the exercise of stock options 557,086 139,111 ---------------------------------------- Net cash provided by (used in) financing activities 557,086 (35,633) ---------------------------------------- Net increase in cash and cash equivalents 1,889,853 531,088 Cash and cash equivalents at beginning of the period 17,774,219 22,677,290 ---------------------------------------- Cash and cash equivalents at end of the period $19,664,072 $ 23,208,378 ======================================== See accompanying notes. -4- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------ (Unaudited) Note 1 - Basis of Reporting The accompanying financial statements are unaudited and do not include certain information and note disclosures required by generally accepted accounting principles for complete financial statements. However, in the opinion of the Company, all adjustments considered necessary for a fair presentation have been included. The balance sheet shown in this report as of December 31, 1997 has been derived from, and does not include, all the disclosures contained in the financial statements for the year ended December 31, 1997. The financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 1997. The results of operations for the three month periods ended March 31, 1998 and 1997 are not necessarily indicative of the results that may be expected for the full fiscal year. Note 2 - Other Contingencies The Company has a $13,000,000 bank line of credit on which it may draw to meet short-term liquidity requirements or for other purposes, that expires on September 30, 1998. Amounts drawn under the line are payable upon demand. At both March 31, 1998 and December 31, 1997, there were no borrowings under the line. At March 31, 1998 and December 31, 1997, the Company had outstanding approximately $12,600,000 and $11,200,000, respectively of irrevocable standby letters of credit, which primarily relate to payment obligations under the Company's insurance program. As a result of letters of credit issued, the amount available under the line was reduced by approximately $12,600,000 and $11,200,000 at March 31, 1998 and December 31, 1997, respectively. The Company is also involved in miscellaneous claims and litigation arising in the ordinary course of business. The Company believes that these matters, taken individually or in the aggregate, would not have a material adverse impact on the Company's financial position or results of operations. Note 3 - Earnings per common share In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128 (SFAS No. 128) Earnings per Share, which is effective for financial statements for periods ending after December 15, 1997 and requires that all prior period earnings per share data be restated. The Company's financial statements reflect this adoption. The new standard eliminates primary and fully diluted earnings per common share and requires presentation of basic and, if applicable, diluted earnings per common share. Basic earnings per common share is computed by dividing income available to common shareholders by the weighted-average common shares outstanding for the period. Diluted earnings per common share reflects the weighted-average common shares outstanding and dilutive potential common shares, such as stock options. -5- Note 4 - Effect of Recently Issued Accounting Pronouncements Reporting Comprehensive Income In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income", which is effective for fiscal years beginning after December 15, 1997. The Statement addresses the reporting and displaying of comprehensive income and its components. Adoption of SFAS No. 130 relates to disclosure within the financial statements and did not impact the Company's financial statements. Disclosures about Segments of an Enterprise and Related Information In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" which is effective for fiscal years beginning after December 15, 1997. The Statement changes the way public companies report information about segments of their business in their annual financial statements and requires them to report selected segment information in their quarterly reports on a comparative basis beginning with the Company's quarter ending March 31, 1999. Adoption of SFAS No. 131 is not expected to have a material effect on the Company's financial statements. -6- PART I. ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the financial statements and notes thereto. RESULTS OF OPERATIONS Revenues for the first quarter of 1998 increased by 15.3% over revenues in the corresponding 1997 quarter. The following factors contributed to the increase in 1998 first quarter revenues as compared to the corresponding 1997 quarter: service agreements with new clients increased revenues by 17.3%; providing new services to existing clients increased revenues 7.7% ; and cancellations and other minor changes decreased revenues 9.7%. Cost of services provided as a percentage of revenues decreased slightly to 85.0% for the first quarter of 1998 from 85.2% in the corresponding 1997 quarter. The primary factors affecting specific variations in the 1998 first quarter as compared to the 1997 first quarter cost of services provided as a percentage of revenue and their effects on the .2% decrease are as follows: decrease of 1.6% in labor costs; decrease of .5% in workers' compensation, general liability and other insurance; decrease of .4% in payroll related taxes; offsetting these decreases was an increase of 2.6% in the cost of supplies consumed in performing services. Selling, general and administrative expenses as a percentage of revenue decreased slightly in the first quarter of 1998 to 8.3% as compared to 8.5% in the corresponding 1997 three month period. The decrease in comparing the three month periods' selling, general and administrative expenses is primarily attributable to the Company's ability to control certain selling, general and administrative expenses while also comparing them to a greater revenue base. Interest income decreased in the three month period ending March 31, 1998 compared to the same 1997 period principally due to lower average cash balances. The lower average cash balances in the 1998 first quarter as compared to 1997 primarily resulted from the Company's expenditure of approximately $10,900,000 for a common stock buy-back which occurred during 1997. Liquidity and Capital Resources At March 31, 1998 the Company had working capital and cash of $58,637,805 and $19,664,072 respectively which represents a 5% and 11% increase as compared to December 31, 1997 working capital and cash of $55,705,917 and -7- $17,774,219, respectively. The Company's current ratio at March 31, 1998 decreased to 6.3 to 1 compared to 6.7 to 1 at December 31, 1997. The net cash provided by the Company's operating activities was $1,573,373 for the three month period ended March 31, 1998 as compared to $797,704 in the same 1997 period. The principle sources of cash flows from operating activities for the three month periods ended March 31, 1998 and 1997 was net income and the timing of payments for payroll, payroll related taxes and income taxes. The operating activity that used the largest amount of cash was a $2,587,119 and $2,726,931 net increase in accounts and current and long term notes receivable at March 31, 1998 and 1997, respectively. The increase in these amounts resulted primarily from the growth in the Company's revenues. Additionally, operating activities' cash flows for the three month periods ending March 31, 1998 and 1997 were decreased by $1,897,779 and $2,645,764, respectively which resulted from the timing of payments to vendors. The Company's principle use of cash in investing activities for the three month periods ended March 31, 1998 and 1997 is the purchase of housekeeping equipment and laundry equipment installations. The Company expends considerable effort to collect the amounts due for its services on the terms agreed upon with its clients. Many of the Company's clients participate in programs funded by federal and state governmental agencies which historically have encountered delays in making payments to its program participants. Whenever possible, when a client falls behind in making agreed-upon payments, the Company converts the unpaid accounts receivable to interest bearing promissory notes. The promissory notes receivable provide a means by which to further evidence the amounts owed, provide a definitive repayment plan and therefore may enhance the ultimate collectibility of the amounts due. In some instances the Company obtains a security interest in certain of the debtors' assets. The Company encounters difficulty in collecting amounts due from certain of its clients, including those in bankruptcy, those turned over to collection attorneys, those which have terminated service agreements and slow payers experiencing financial difficulties. In order to provide for these collection problems and the general risk associated with the granting of credit terms, the Company has increased its bad debt provision by approximately $550,000 in the three month period ending March 31, 1998. In making its evaluation, in addition to analyzing and anticipating, where possible, the specific cases described above, management considers the general collection risk associated with trends in the long-term care industry. The Company has a $13,000,000 bank line of credit on which it may draw to meet short-term liquidity requirements in excess of internally generated cash flow, that expires on September 30, 1998. The Company anticipates that this credit line will be continued. Amounts drawn under the line are payable on demand. At March 31, 1998, there were no borrowings under the line. However, at such date, the amount available under the line had been reduced by approximately $12,600,000 as a result of contingent liabilities of the Company to the lender relating to letters of credit issued for the Company (See Note 2 of Notes to Financial Statements). -8- At March 31, 1998, the Company had $19,664,072 of cash and cash equivalents, which it views as its principal measure of liquidity. The level of capital expenditures by the Company is generally dependent on the number of new clients obtained. Such capital expenditures primarily consist of housekeeping equipment and laundry and linen equipment installations. Although the Company has no specific material commitments for capital expenditures during calendar year 1998, it estimates that it will incur capital expenditures of approximately $2,000,000 during this year in connection with housekeeping equipment and laundry and linen equipment installations in its clients' facilities, as well as hardware and software expenditures relating to the implementation of a new computerized financial reporting system. The Company believes that its cash from operations, existing balances and available credit line will be adequate for the foreseeable future to satisfy the needs of its operations and to fund its continued growth. However, if the need arose, the Company would seek to obtain capital from such sources as long-term debt or equity financing. In accordance with the Company's previously announced authorizations to purchase its outstanding common stock, the Company expended approximately $10,900,000 to purchase 942,500 shares of its common stock during 1997 at an average price of $11.59 per common share. The Company remains authorized to purchase approximately 559,000 shares pursuant to previous Board of Directors' action. Other Matters The Company is in the process of implementing new operating and application software which it believes will be fully operational during 1998. The Company has been notified by the software manufacturer, as well as the firm providing installation support, that the new applications have functionality for the year 2000. Therefore, the Company does not believe it will incur any material expense, beyond the new systems installation costs, with respect to year 2000 issues. Additionally, the Company utilizes an independent service bureau for the processing of payroll and payroll tax related operations. Many of the Company's clients participate in programs funded by federal and state governmental agencies which may be affected by year 2000 issue. The Company has been notified by its payroll processing company that all of its systems will be fully compliant with year 2000 requirements. Any failure by the Company, its outside processing company, its clients and the federal and state governmental agencies to effectively monitor, implement or improve the above referenced operational, financial, management and technical support systems could have a material adverse effect on the Company's business and consolidated results of operations. Effect of Recently Issued Accounting Pronouncements Earnings per Common Share In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128 (SFAS No. 128) Earnings per -9- Share, which is effective for financial statements for periods ending after December 15, 1997 and requires that all prior period earnings per share data be restated. The Company's financial statements reflect this adoption. The new standard eliminates primary and fully diluted earnings per common share and requires presentation of basic and, if applicable, diluted earnings per common share. Basic earnings per common share is computed by dividing income available to common shareholders by the weighted-average common shares outstanding for the period. Diluted earnings per common share reflects the weighted-average common shares outstanding and dilutive potential common shares, such as stock options. Reporting Comprehensive Income In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income", which is effective for fiscal years beginning after December 15, 1997. The Statement addresses the reporting and displaying of comprehensive income and its components. Adoption of SFAS No. 130 relates to disclosure within the financial statements and did not impact the Company's financial statements. Disclosures about Segments of an Enterprise and Related Information In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" which is effective for fiscal years beginning after December 15, 1997. The Statement changes the way public companies report information about segments of their business in their annual financial statements and requires them to report selected segment information in their quarterly reports on a comparative basis beginning with the Company's quarter ending March 31, 1999. Adoption of SFAS No. 131 is not expected to have a material effect on the Company's financial statements. Effects of Inflation All of the Company's service agreements allow it to pass through to its clients increases in the cost of labor resulting from new wage agreements. The Company believes that it will be able to recover increases in costs attributable to inflation by continuing to pass through cost increases to its clients. Cautionary Statements Regarding Forward Looking Statements Certain matters discussed may include forward-looking statements that are subject to risks and uncertainties that could cause actual results or objectives to differ materially from those projected. Such risks and uncertainties include, but are not limited to, risks arising from the Company providing its services exclusively to the healthcare industry, credit and collection risks associated with this industry. Additionally, the Company's operating results would be adversely effected if unexpected increases in the costs of labor, materials, supplies and equipment used in performing its services could not be passed on to clients. -10- In addition, the Company believes that in order to improve its financial performance it must continue to obtain service agreements with new clients, as well as providing new services to existing clients, achieve modest price increases on current service agreements with existing clients and maintain internal cost reduction strategies at the various operational levels of the Company. Furthermore, the Company believes that its ability to sustain the internal development of managerial personnel is an important factor impacting future operating results and successfully executing projected growth strategies. -11- 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 Not Applicable Holders Item 5. Other Information. a) None Item 6. Exhibits and Reports on Form 8-K. a) Exhibits - 27 - Financial data schedule b) Reports on Form 8-K - None -12- 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. May 6, 1998 /s/ Daniel P. McCartney - -------------------------- ------------------------------- Date DANIEL P. McCARTNEY, Chief Executive Officer May 6, 1998 /s/ Thomas A. Cook - -------------------------- ------------------------------- Date THOMAS A. COOK, President and Chief Operating Officer May 6, 1998 /s/ James L. DiStefano - -------------------------- ------------------------------- Date JAMES L. DiSTEFANO, Chief Financial Officer and Treasurer May 6, 1998 /s/ Richard W. Hudson - -------------------------- ------------------------------ Date RICHARD W. HUDSON, Vice President-Finance, Secretary and Chief Accounting Officer -13-