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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, 2003 Commission File Number 0-120152
HEALTHCARE SERVICES GROUP, INC.
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(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 April
25, 2003 is 11,200,421
Total of 23 Pages
INDEX
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PART I. FINANCIAL INFORMATION PAGE NO.
--------------------- --------
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets as of 2
March 31, 2003 and December 31, 2002
Consolidated Statements of Income for the Three Months 3
Ended March 31, 2003 and 2002
Consolidated Statements of Cash Flows for the Three Months 4
ended March 31, 2003 and 2002
Notes To Consolidated Financial Statements 5 - 9
Item 2. Management's Discussion and Analysis of Financial 10 - 15
Condition and Results Of Operations
Item 3. Quantitative and Qualitative Disclosure of 16 - 17
Market Risks
Part II. Other Information 17
-----------------
Exhibits - Certifications
18 - 21
Signatures 22
-1-
Balance Sheet
Consolidated Balance Sheets
(Unaudited)
March 31, December 31,
2003 2002
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 48,101,554 $ 48,320,098
Accounts and notes receivable, less allowance for doubtful
accounts of $4,816,000 in 2003 and $7,323,000 in 2002 52,077,992 51,750,225
Prepaid income taxes 202,741 883,282
Inventories and supplies 9,650,064 8,625,727
Deferred income taxes 2,006,568 3,021,724
Prepaid expenses and other 3,380,596 2,176,913
------------ ------------
Total current assets 115,419,515 114,777,969
PROPERTY AND EQUIPMENT:
Laundry and linen equipment installations 6,890,288 6,855,886
Housekeeping and office equipment 12,025,337 11,641,590
Autos and trucks 85,489 85,489
------------ ------------
19,001,114 18,582,965
Less accumulated depreciation 14,554,543 14,144,869
------------ ------------
4,446,571 4,438,096
COST IN EXCESS OF FAIR VALUE OF NET ASSETS ACQUIRED less
accumulated amortization of $1,743,155 in 2003 and 2002 1,612,322 1,612,322
DEFERRED INCOME TAXES 2,164,521 1,955,365
OTHER NONCURRENT ASSETS, principally notes receivable 11,653,176 11,512,558
------------ ------------
$135,296,105 $134,296,310
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 8,885,396 $ 7,201,543
Accrued payroll, accrued and withheld payroll taxes 6,654,458 11,162,342
Other accrued expenses 341,543 238,485
Accrued insurance claims 2,149,952 1,953,198
------------ ------------
Total current liabilities 18,031,349 20,555,568
ACCRUED INSURANCE CLAIMS 6,449,855 5,859,593
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value: 30,000,000 shares authorized,
11,631,430 shares issued in 2003 and 11,612,505 in 2002. 116,314 116,125
Additional paid in capital 29,861,123 29,675,341
Retained earnings 84,352,684 81,806,772
Common stock in treasury, at cost, 420,909 shares in 2003 and
445,050 in 2002 (3,515,220) (3,717,089)
------------ ------------
Total stockholders' equity 110,814,901 107,881,149
------------ ------------
$135,296,105 $134,296,310
============ ============
See accompanying notes.
-2-
Consolidated Statements of Income
(Unaudited)
For the Three Months Ended March 31,
2003 2002
----------- -----------
Revenues $89,531,352 $78,932,055
Operating costs and expenses:
Costs of services provided 78,690,855 69,722,745
Selling, general and administrative 6,796,788 6,039,413
Other income:
Interest income 199,203 186,654
----------- -----------
Income before income taxes 4,242,912 3,356,551
Income taxes 1,697,000 1,326,000
----------- -----------
Net income $ 2,545,912 $ 2,030,551
=========== ===========
Basic earnings per common share $ 0.23 $ 0.18
=========== ===========
Diluted earnings per common share $ 0.22 $ 0.18
=========== ===========
See Accompanying Notes
-3-
Consolidated Statements of Cash Flows
(Unaudited)
For the Three Months Ended March 31,
2003 2002
----------- -----------
Cash flows from operating activities:
Net income $ 2,545,912 $ 2,030,551
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization 500,093 535,455
Bad debt provision 1,500,000 1,500,000
Deferred income taxes (benefits) 806,000 (267,000)
Tax benefit of stock option transactions 52,740 127,690
Changes in operating assets and liabilities:
Accounts and notes receivable (2,023,620) (1,359,541)
Prepaid income taxes 680,541 8,188
Inventories and supplies (987,412) (98,894)
Long term notes receivable 89,828 777,840
Accounts payable and other accrued expenses 1,786,912 (415,878)
Accrued payroll, accrued and withheld
payroll taxes (4,302,684) (3,896,805)
Accrued insurance claims 787,015 346,316
Income taxes payable 508,727
Prepaid expenses and other assets (1,275,203) (805,222)
----------- -----------
Net cash used in operating activities (160,122) (1,008,573)
Cash flows from investing activities:
Disposals of fixed assets 60,551 9,554
Additions to property and equipment (569,119) (363,616)
----------- -----------
Net cash used in investing activities (508,568) (354,062)
Cash flows from financing activities:
Proceeds from the exercise of stock options 129,902 581,157
----------- -----------
Net cash provided by investing activities 129,902 581,157
----------- -----------
Net decrease in cash and cash equivalents (218,544) (781,478)
Cash and cash equivalents at beginning of
the year 48,320,098 34,259,334
----------- -----------
Cash and cash equivalents at end of period $48,101,554 $33,477,856
=========== ===========
Supplementary Cash Flow Information:
Issuance of 24,141 and 23,926 shares of Common
Stock in 2003 and 2002, respectively pursuant
to Employee Stock Purchase Plan $ 205,199 $ 129,649
=========== ===========
See accompanying notes
-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 (consisting of normal recurring adjustments)
considered necessary for a fair presentation have been included. The balance
sheet shown in this report as of December 31, 2002 has been derived from, and
does not include, all the disclosures contained in the financial statements for
the year ended December 31, 2002. The financial statements should be read in
conjunction with the financial statements and notes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2002. The
results of operations for the quarters ended March 31, 2003 and 2002 are not
necessarily indicative of the results that may be expected for the full fiscal
year.
Note 2 - Other Contingencies
The Company has an $18,000,000 bank line of credit under which it may
draw to meet short-term liquidity requirements or for other purposes, that
expires on September 30, 2003. The Company believes the line will be renewed at
that time. Amounts drawn under the line are payable upon demand. At both March
31, 2003 and December 31, 2002, there were no borrowings under the line.
However, at such dates, the Company had outstanding $14,500,000 of irrevocable
standby letters of credit, which relate to payment obligations under the
Company's insurance program. As a result of the letters of credit issued, the
amount available under the line was reduced by $14,500,000 at both March 31,
2003 and December 31, 2002.
The Company is also involved in miscellaneous claims and litigation
arising in the ordinary course of business. The Company believes that these
matters, taken individually or in the aggregate, would not have a material
adverse affect on the Company's financial position or results of operations.
The Balance Budget Act of 1997 ("BBA") changed Medicare policy
in a number of ways, most notably the phasing in, effective July 1, 1998, of a
Medicare Prospective Payment System ("PPS") for skilled nursing facilities which
significantly changed the manner and the amounts of reimbursement they receive.
Many of the Company's clients revenues are highly contingent on Medicare and
Medicaid reimbursement funding rates. Therefore, they have been and continue to
be adversely affected by changes in applicable laws and regulations, as well as
other trends in the long-term care industry. This has resulted in certain of the
Company's clients filing for bankruptcy protection. Others may follow. These
factors, in addition to delays in payments from clients have resulted in and
could continue to result in significant additional bad debts in the near future.
-5-
At December 31, 2002, the Company had receivables of approximately
$4,000,000 ($1,500,000, net of reserves) from a client group currently in
Chapter 11 bankruptcy proceedings. During the first quarter of 2003, this client
group filed a plan of reorganization with the Bankruptcy Court. The Company
estimates that it will receive approximately $180,000 from this client group
under such plan. The Company has increased its bad debt provision and
charged-off to the Allowance for Doubtful Accounts approximately $3,820,000 of
such receivables during the first quarter of 2003.
The Company indemnifies its officers and directors against all
reasonable costs and expenses related to shareholder and other claims pertaining
to actions taken in their capacity as officers and directors which are not
covered by the Company's directors and officers insurance policy. This
indemnification is ongoing and does not include a limit on the maximum potential
future payments, nor are there any recourse provisions or collateral that may
offset the cost. As of March 31, 2003, the Company has not recorded a liability
for any obligations arising as a result of these indemnifications.
Note 3 - Segment Information
The Company manages and evaluates its operations in two reportable
operating segments. The two operating segments are housekeeping, laundry, linen
and other services, and food service. Although both segments serve the same
client base and share many operational similarities, they are managed separately
due to distinct differences in the type of service provided, as well as the
specialized expertise required of the professional management personnel
responsible for delivering the respective segments' services. The Company
considers the various services provided within the housekeeping, laundry, linen
and other services' segment to be one reportable operating segment since such
services are rendered pursuant to a single service agreement and the delivery of
such services is managed by the same management personnel.
Differences between the reportable segments' operating results and
other disclosed data, and the Company's consolidated financial statements relate
primarily to corporate level transactions, as well as transactions between
reportable operating segments and the Company's warehousing and distribution
subsidiary. The subsidiary's transactions with reportable segments are
immaterial and are made on a basis intended to reflect the fair market value of
the goods transferred. Segment amounts disclosed are prior to any elimination
entries made in consolidation.
-6-
The housekeeping, laundry, linen and other services' segment of the Company does
provide services in Canada, although essentially all of its revenues and net
income, 99% in each operating segments, are earned in one geographic area, the
United States.
Housekeeping,
laundry, linen
and other Food Corporate and
services services eliminations Total
----------- ----------- ------------ -----------
Quarter Ended March 31,
2003
Revenues $75,579,077 $13,420,908 $ 531,367 $89,531,352
Income before income
taxes $ 6,085,650 $ 471,715 $(2,314,453)(1) $ 4,242,912
Quarter Ended March 31,
2002
Revenues $66,843,373 $11,408,253 $ 680,429 $78,932,055
Income before income
taxes $ 5,481,424 $ 505,330 $(2,630,203)(1) $ 3,356,551
(1) represents primarily corporate office cost and related overhead, as well as
certain operating expenses that are not allocated to the service operating
segments.
The Company earned revenue in the following service business categories:
For the quarter ended March 31,
--------------------------------
2003 2002
---- ----
Housekeeping services $53,805,771 $47,654,743
Laundry and linen services 21,828,640 19,230,715
Food Services 13,546,960 11,422,809
Maintenance services
and Other 349,981 623,788
----------- -----------
$89,531,352 $78,932,055
=========== ===========
The Company has one client, a nursing home chain, which in 2003 and
2002 accounted for approximately 22% and 16%, respectively of consolidated
revenues. In respect to such client, the Company derived revenues from both
operating segments. While the Company expects to continue its relationship with
this client, the loss of such client would adversely affect the operations of
the Company's two operating segments.
-7-
Note 4 - Earnings Per Common Share
A reconciliation of the numerator and denominator of basic and diluted earnings
per common share is as follows:
Quarter Ended March 31, 2003
----------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
---------- ------------ ---------
Net income $2,545,912
==========
Basic earnings per
common share $2,545,912 11,245,247 $ .23
Effect of dilutive securities:
Options 429,140 (.01)
---------- ---------- ---------
Diluted earnings per
Common share $2,545,912 11,674,387 $ .22
========== ========== =========
Quarter Ended March 31, 2002
----------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
---------- ------------ ---------
Net income $2,030,551
==========
Basic earnings per
common share $2,030,551 11,169,039 $ .18
Effect of dilutive securities:
Options 403,106 -
---------- ---------- ---------
Diluted earnings per
Common share $2,030,551 11,572,145 $ .18
========== ========== =========
No outstanding options were excluded at either March 31, 2003 or 2002 as none
have an exercise price in excess of the average market value of the Company's
Common Stock at such dates.
Note 5 - Stock Based Compensation
As permitted by the Statement of Financial Accounting Standards No. 123,
"Accounting for Stock Based Compensation", the Company accounts for stock-based
compensation arrangements in accordance with provisions of Accounting Principles
Board ("APB") Opinion No. 25 "Accounting for Stock Issued to Employees".
Compensation expense for stock options issued to employees is based on the
difference on the date of grant, between the fair value of the Company's stock
and the exercise price of the option. No stock-based employee compensation cost
is reflected in net income, as all options granted under those plans had an
exercise price equal to the market value of the underlying common stock at the
date of grant. The Company accounts for equity instruments issued to
nonemployees in accordance with the provisions of SFAS No. 123 and Emerging
Issues Task Force ("EITF") Issue No. 96-18, "Accounting for Equity Instruments
That Are Issued to Other Than Employees for Acquiring, or in Conjunction With
Selling, or in Conjunction With Selling Goods or Services". All transactions in
which goods or services are the consideration received for the issuance of
equity instruments are accounted for based on the fair value of the
consideration received or the fair value of the equity instrument issued,
whichever is more reliably measurable.
-8-
In December 2002, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure, an amendment of FASB Statement No. 123. " SFAS No. 148 amends SFAS
No. 123, "Accounting for Stock-Based Compensation, " to provide alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, SFAS No. 148
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosure in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. The provisions of SFAS No. 148 are effective for
fiscal years ending after December 15, 2002 and the interim disclosure
provisions are effective for interim periods beginning after December 15, 2002.
The Company continues to apply the intrinsic-value based method to account for
stock options and complies with the new disclosure requirements beginning with
the first quarter of its fiscal year ending December 31, 2003.
The following table illustrates the effect on net income and earnings per share
if the company had applied the fair value recognition provisions of SFAS No. 123
to stock based compensation:
(in thousands except per share data)
Quarter ended March 31,
-------------------------
2003 2002
------ ------
Net Income
As reported $2,546 $2,031
Deduct:
Total stock based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects (748) (735)
------ ------
Pro forma net income $1,798 $1,296
====== ======
Basic Earnings Per Common Share
As reported $ .23 $ .18
Pro forma $ .16 $ .12
Diluted Earnings Per Common Share
As reported $ .22 $ .18
Pro forma $ .15 $ .11
Note 6 - Recent Accounting Pronouncements
In June 2002, the Financial Accounting Standards Board issued SFAS No. 146,
"Accounting for Exit or Disposal Activities". SFAS No. 146 requires that the
liability for costs associated with an exit or disposal activity be recognized
at their fair values when the liabilities are incurred. Under previous guidance,
liabilities for certain exit costs were recognized at the date that management
committed to an exit plan, which is generally before the actual liabilities are
incurred. As SFAS No. 146 is effective only for exit or disposal activities
initiated after December 31, 2002, the adoption of this statement did not have a
material impact on its financial statements.
-9-
PART I.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated the percentage which
certain items bear to revenues:
Relation to Total Revenues
For the Quarter Ended March 31,
2003 2002
----- ----
Revenues 100.0% 100.0%
Operating costs and expenses:
Costs of services provided 87.9 88.3
Selling, general and
administration 7.6 7.6
Interest income .2 .2
----- -----
Income before income taxes 4.7 4.3
Income taxes 1.9 1.7
----- -----
Net income 2.8% 2.6%
===== =====
Revenues for the first quarter of 2003 increased 13.4% compared to the
corresponding 2002 quarter. The growth in revenues is primarily a result of a
net increase in service agreements entered into with new clients, as well as
providing additional services to existing clients. Approximately 80% of the
revenue growth resulted from the Company's housekeeping, laundry and linen, and
other services segment, with the remaining revenue growth being generated from
the Company's food service segment. The Company believes that in 2003 both
housekeeping, laundry, linen and other services, and food services' revenues, as
a percentage of total revenues, will remain approximately the same as their
respective 2002 percentages.
The Company has one client, a nursing home chain, which in 2003 and
2002 accounted for approximately 22% and 16%, respectively of consolidated
revenues. In respect to such client, the Company derived revenues from both
operating segments. While the Company expects to continue its relationship with
this client, the loss of such client would adversely affect the operations of
the Company's two operating segments.
Cost of services provided as a percentage of revenues decreased to 87.9
% for the first quarter of 2003 from 88.3 % in the corresponding 2002 quarter.
The primary factors affecting specific variations in the 2003 cost of services
provided as a percentage of revenue and its effect on the .4% decrease are as
follows: a decrease of .7% in health insurance and employee benefits; offsetting
this decrease were increases of .3% each in labor costs and the cost of supplies
consumed in providing services. The increase cost of supplies was attributable
to increase costs associated with the food service segment.
-10-
Selling, general and administrative expenses as a percentage of revenue
remained unchanged at 7.6% in 2003 compared to 2002.
As a result of the matters discussed above, 2003 net income increased
to 2.8% as a percentage of revenue compared to 2.6% in 2002.
Critical Accounting Policies
The policies discussed below are considered by the Company's management to be
critical to an understanding of the Company's financial statements because their
application places the most significant demands on management's judgment.
Therefore, it should be noted that financial reporting results rely on
estimating the effect of matters that are inherently uncertain. Specific risks
for these critical accounting policies are described in the following
paragraphs. For these policies, management cautions that future events rarely
develop exactly as forecast, and the best estimates routinely require
adjustment.
The two policies discussed are not intended to be a comprehensive list of all of
our accounting policies. In many cases, the accounting treatment of a particular
transaction is specifically dictated by generally accepted accounting
principles, with no need for management's judgment in their application. There
are also areas in which management's judgment in selecting another available
alternative would not produce a materially different result. See our audited
consolidated financial statements and notes thereto which are included in our
Annual Report for the year ended December 31, 2002 which contain accounting
policies and other disclosures required by generally accepted accounting
principles.
Allowance for Doubtful Accounts
- -------------------------------
The allowance for doubtful accounts is established as losses are
estimated to have occurred through a provision for bad debts charged to
earnings. The allowance for doubtful accounts is evaluated based on management's
periodic review of accounts and notes receivable and is inherently subjective as
it requires estimates that are susceptible to significant revision as more
information becomes available.
The Company has had varying collection experience with respect to its
accounts and notes receivable. When contractual terms are not met, the Company
generally encounters difficulty in collecting amounts due from certain of its
clients. Therefore, the Company has sometimes been required to extend the period
of payment for certain clients beyond contractual terms. These clients have
included those in bankruptcy, those who have terminated service agreements and
slow payers experiencing financial difficulties. In making its credit
evaluations, in addition to analyzing and anticipating, where possible, the
specific cases described above, management considers the general collection
risks associated with trends in the long-term care industry. The Company also
establishes credit limits, as well as performing ongoing credit evaluation and
account monitoring procedures to minimize the risk of loss.
-11-
In accordance with the risk of extending credit, the Company regularly
evaluates its accounts and notes receivable for impairment or loss of value and
when appropriate will provide in its Allowance for Doubtful Accounts for such
receivables. The Company generally follows a policy of reserving for receivables
from clients in bankruptcy, as well as clients with which the Company is in
litigation for collection. Correspondingly, once the Company's recovery of a
receivable is determined through either litigation, bankruptcy proceedings or
negotiation at less than the recorded amount on its balance sheet, it will
charge-off the applicable amount to the Allowance for Doubtful Accounts.
Notwithstanding the Company's efforts to minimize its credit risk
exposure, the Company's clients could be adversely affected if future industry
trends, as more fully discussed under Liquidity and Capital Resources below and
as further described in the Company's Form 10-K filed with Securities and
Exchange Commission for the year ended December 31, 2002 in Part I thereof under
"Government Regulation of Clients" and "Service Agreements/Collections", change
in such a manner as to negatively impact their cash flows. If the Company's
clients experience such significant impact in their cash flows, it could have a
material adverse affect on the Company's results of operations and financial
condition.
At December 31, 2002, the Company had receivables of approximately
$4,000,000 ($1,500,000, net of reserves) from a client group currently in
Chapter 11 bankruptcy proceedings. During the first quarter of 2003, this client
group filed a plan of reorganization with the Bankruptcy Court. The Company
estimates that it will receive approximately $180,000 from this client group
under such plan. The Company has increased its bad debt provision and
charged-off to the Allowance for Doubtful Accounts approximately $3,820,000 of
such receivables during the first quarter of 2003.
Accrued Insurance Claims
- ------------------------
The Company currently has a Paid Loss Retrospective Insurance Plan for
general liability and workers' compensation insurance. Under these plans,
pre-determined loss limits are arranged with an insurance company to limit both
the Company's per occurrence cash outlay and annual insurance plan cost.
For workers' compensation, the Company records a reserve based on the
present value of future payments, including an estimate of claims incurred but
not reported, that are developed as a result of a review of the Company's
historical data and actuarial analysis done by an independent specialist. The
present value of the payout is determined by applying an 8% discount factor
against the estimated remaining pay-out period.
For general liability, the Company records a reserve for the estimated
ultimate amounts to be paid for known claims.
Management regularly evaluates its claim pay-out experience, present
value factor and other factors related to the nature of specific claims in
arriving at the basis for its accrued insurance claims' estimate. Management
evaluations are based primarily on current information derived from reviewing
the Company's claims' experience and industry trends. In the event that the
Company's claims' experience and/or industry trends result in an unfavorable
change, it could have an adverse affect on the Company's results of operations
and financial condition.
-12-
Liquidity and Capital Resources
At March 31, 2003 the Company had working capital and cash of
$97,388,166 and $48,101,554, respectively compared to December 31, 2002 working
capital and cash of $94,222,399 and $48,320,098, respectively. The Company's
current ratio at March 31, 2003 increased to 6.4 to 1 from 5.6 to 1 at December
31, 2002 primarily as a result of the timing of payments for payroll and payroll
taxes.
Management views the Company's cash and cash equivalents of $48,101,554
at March 31, 2003 as its principal measure of liquidity.
The net cash used in the Company's operating activities was $45,077 for
the quarter ended March 31, 2003 as compared to net cash used in operating
activities of $1,008,573 in the same 2002 quarter. The principal sources of net
cash flows from operating activities for the quarter ended March 31, 2003 and
2002 were net income which has been reduced for noncash charges to operations
for bad debt provisions. Additionally, operating activities' cash flows were
increased by the timing of payments for accounts payable of $1,786,912 in the
quarter ended March 31, 2003. The operating activities that used the largest
amount of cash during the quarters ended March 31, 2003 and 2002 were decreases
in payroll and payroll related taxes of $4,507,883 and $3,896,805, respectively.
Additionally, in the quarter ended March 31, 2003 a $1,275,203 increase in
prepaid expenses and other assets, which was the result of the timing of
payments. Additionally, operating activities' cash flows in the first quarter of
2003 were negatively impacted by a $1,933,792 net increase in accounts and notes
receivable and long term notes receivable. The net increase in these amounts
resulted primarily from the growth in the Company's revenues, as well as the
timing of collections from clients.
The Company's principal use of cash in investing activities in each of
the quarters ended March 31, 2003 and 2002, respectively was the purchase of
housekeeping equipment and computer software and equipment.
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. The Balance Budget Act of 1997 ("BBA") changed Medicare
policy in a number of ways, most notably the phasing in, effective July 1, 1998
of a Medicare Prospective Payment System ("PPS") for skilled nursing facilities
which significantly changed the reimbursement procedures and the amounts of
reimbursement they receive. Many of the Company's clients' revenues are highly
contingent on Medicare and Medicaid reimbursement funding rates. Therefore, they
have been and continue to be adversely affected by changes in applicable laws
and regulations, as well as other trends in the long-term care industry. This
has resulted in certain of the Company's clients filing for bankruptcy
protection. Others may follow.
-13-
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, 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 and provide a definitive
repayment plan and therefore may ultimately enhance the Company's ability to
collect the amounts due. At March 31, 2003 and December 31, 2002, the Company
had approximately, net of reserves, $15,229,000 and $14,385,000, respectively of
such notes outstanding. In some instances the Company obtains a security
interest in certain of the debtors' assets. Additionally, the Company considers
restructuring service agreements from full service to management-only service in
the case of certain clients experiencing financial difficulties. The Company
believes that the restructuring provides it with a means to maintain a
relationship with the client while at the same time minimizing collection
exposure.
The Company has had varying collection experience with respect to its
accounts and notes receivable. When contractual terms are not met, the Company
generally encounters difficulty in collecting amounts due from certain of its
clients. Therefore, the Company has sometimes been required to extend the period
of payment for certain clients beyond contractual terms. These clients include
those in bankruptcy, those who have terminated service agreements and slow
payers experiencing financial difficulties. In order to provide for these
collection problems and the general risk associated with the granting of credit
terms, the Company has recorded bad debt provisions (in an Allowance for
Doubtful Accounts) of $1,500,000 in the each of the quarters ended March 31,
2003 and 2002. These provisions represent approximately 1.7% and 1.9%, as a
percentage of revenue for such respective periods. In making its credit
evaluations, in addition to analyzing and anticipating, where possible, the
specific cases described above, management considers the general collection risk
associated with trends in the long-term care industry. The Company also
establishes credit limits, as well as performing ongoing credit evaluation and
account monitoring procedures to minimize the risk of loss. Notwithstanding the
Company's efforts to minimize its credit risk exposure, the Company's clients
could be adversely affected if future industry trends change in such a manner as
to negatively impact their cash flows. If the Company's clients experience such
significant impact in their cash flows, it could have a material adverse effect
on the Company's results of operations and financial condition.
At December 31, 2002, the Company had receivables of approximately
$4,000,000 ($1,500,000, net of reserves) from a client group currently in
Chapter 11 bankruptcy proceedings. During the first quarter of 2003, this client
group filed a plan of reorganization with the Bankruptcy Court. The Company
estimates that it will receive approximately $180,000 from this client group
under such plan. The Company has increased its bad debt provision and
charged-off to the Allowance for Doubtful Accounts approximately $3,820,000 of
such receivables during the first quarter of 2003.
-14-
The Company currently has a Paid Loss Retrospective Insurance Plan for
general liability and workers' compensation insurance. Under these plans,
pre-determined loss limits are arranged with an insurance company to limit both
the Company's per occurrence cash outlay and annual insurance plan cost.
For workers' compensation, the Company records a reserve based on the
present value of future payments, including an estimate of claims incurred but
not reported, that are developed as a result of a review of the Company's open
claims and actuarial analysis done by an independent specialist. The present
value of the payout is determined by applying an 8% discount factor against the
estimated remaining pay-out period.
For general liability, the Company records a reserve for the estimated
ultimate amounts to be paid for known claims.
Management regularly evaluates its claim pay-out experience, present
value factor and other factors related to the nature of specific claims in
arriving at the basis for its accrued insurance claims' estimate. Management
evaluations are based primarily on current information derived from reviewing
the Company's claims' experience and industry trends. In the event that the
Company's claims' experience and/or industry trends result in an unfavorable
change, it could have an adverse effect on the Company's results of operations
and financial condition.
The Company has an $18,000,000 bank line of credit on which it may draw
to meet short-term liquidity requirements in excess of internally generated cash
flow. This facility expires on September 30, 2003. The Company believes the line
will be renewed at that time. Amounts drawn under the line are payable on
demand. At March 31, 2003, there were no borrowings under the line. However, at
such date, the Company had outstanding $14,500,000 of irrevocable standby
letters of credit, which relate to payment obligations under the Company's
insurance program. As a result of the letters of credit issued, the amount
available under the line was reduced by $14,500,000 at March 31, 2003.
The level of capital expenditures by the Company is generally dependent
on the number of new clients obtained. Such capital expenditures primarily
consist of housekeeping equipment and laundry and linen equipment installations.
Although the Company has no specific material commitments for capital
expenditures through the end of calendar year 2003, it estimates that it will
incur capital expenditures of approximately $2,500,000 during this period in
connection with housekeeping equipment and laundry and linen equipment
installations in its clients' facilities, as well as expenditures relating to
internal data processing hardware and software requirements. The Company
believes that its cash from operations, existing balances and credit line will
be adequate for the foreseeable future to satisfy the needs of its operations
and to fund its continued growth. However, should cash flows from current
operations not be sufficient, the Company would utilize its existing working
capital and if necessary seek to obtain necessary working capital from such
sources as long-term debt or equity financing.
At March 31, 2003, the Company remains authorized to purchase up to
603,900 shares of its outstanding common stock pursuant to previous Board of
Directors' action. Although the Company did not make any such purchases during
the quarter ended March 31, 2003, it purchased during April, 2003, 14,400 shares
at an average price of $11.34 per common share.
-15-
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company's exposure to market risk is not significant.
Cautionary Statements Regarding Forward Looking Statements
Certain matters discussed include forward-looking statements that are
subject to risks and uncertainties that could cause actual results or objectives
to differ materially from those projected. The Company undertakes 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 the Company providing its
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 22% of revenues in 2003; the Company's
claims experience related to workers' compensation and general liability
insurance; the effects of changes in laws and regulations governing the industry
and risk factors described in the Company's Form 10-K filed with the Securities
and Exchange Commission for the year ended December 31, 2002 in Part I thereof
under "Government Regulation of Clients", "Competition" and "Service
Agreements/Collections". Many of the Company's 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 Prospective Payment System ("PPS"). That change, and lack
of substantive reimbursement funding rate reform legislation, as well as other
trends in the long-term care industry have resulted in certain of the Company's
clients filing for bankruptcy protection. Others may follow. Any decisions by
the government to discontinue or adversely modify legislation related to
reimbursement funding rates will have a material adverse affect on the Company's
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, the Company's 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 its services
could not be passed on to clients.
In addition, the Company believes that to improve its financial
performance it must continue to obtain service agreements with new clients,
provide new services to existing clients, achieve modest price increases on
current service agreements with existing clients and maintain internal cost
reduction strategies at the various operational levels of the Company.
Furthermore, 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.
-16-
Effects of Inflation
The Company believes that it will be able to recover increases in costs
attributable to inflation by passing through such cost increases to its clients.
Item 4. Controls and Procedures
Within the 90 days prior to the date of this report, the Company
carried out an evaluation, under the supervision and with the participation of
the Company's management, including the Company's Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures pursuant to Exchange Act Rule
13a-14. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the Company's disclosure controls and
procedures are effective in timely alerting them to material information,
relating to the Company ( including its consolidated subsidiaries ), required to
be included in the Company's periodic Securities and Exchange Commission
filings. No significant changes were made in the Company's internal controls or
in other factors that could significantly affect these controls subsequent to
the date of their evaluation.
Disclosure controls and procedures are those controls and other
procedures that are designed to ensure that information required to be disclosed
by the Company in the reports that it files or submits under the Exchange Act is
recorded, processed, summarized and reported, within the time periods specified
in the Securities and Exchange Commission's rules and forms. Disclosure controls
and procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed by the Company in the reports
that it files or submits under the Exchange Act is accumulated and communicated
to the Company's management, including the Company's principal executive officer
and principal financial officer, as appropriate to allow timely decisions
regarding disclosure.
PART II. Other Information
-----------------
Item 1. Legal Proceedings. Not Applicable
Item 2. Changes in Securities. Not Applicable
Item 3. Defaults under Senior Securities. Not Applicable
Item 4. Submission of Matters to a Vote of Security Not Applicable
Holders
Item 5. Other Information.
a) None
Item 6. Exhibits and Reports on Form 8-K.
a) Exhibits -
99.1 Certification of Chief Executive Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
99.2 Certification of Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
b) Reports on Form 8-K - None
-17-
CERTIFICATIONS
- --------------
I, Daniel P. McCartney, Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Healthcare Services
Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the periods
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrants other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures ( as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have;
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period this quarterly
report is prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's Board of Directors.
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: April 25, 2003
/s/ Daniel P. McCartney
-----------------------
Daniel P. McCartney
Chief Executive Officer
-18-
I, James L. DiStefano, Chief Financial Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Healthcare Services
Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the periods
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrants other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures ( as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have;
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period this quarterly
report is prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's Board of Directors.
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: April 25, 2003
/s/ James L. DiStefano
-----------------------
James L. DiStefano
Chief Financial Officer
-19-
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.
-------------------------------
April 25, 2003 /s/ Daniel P. McCartney
- ------------------------------ --------------------------------------
Date DANIEL P. McCARTNEY, Chief
Executive Officer
April 25, 2003 /s/ Thomas A. Cook
- ------------------------------ --------------------------------------
Date THOMAS A. COOK, President and
Chief Operating Officer
April 25, 2003 /s/ James L. DiStefano
- ------------------------------ --------------------------------------
Date JAMES L. DiSTEFANO, Chief Financial
Officer and Treasurer
April 25, 2003 /s/ Richard W. Hudson
- ------------------------------ --------------------------------------
Date RICHARD W. HUDSON, Vice
President-Finance, Secretary and Chief
Accounting Officer
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