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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 September 30, 2003 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 (IRS Employer
of incorporation or organization) Identification 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 24, 2003
is 11,413,919
INDEX
PART I. FINANCIAL INFORMATION PAGE NO.
--------------------- --------
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets as of
September 30, 2003 and December 31, 2002 2
Consolidated Statements of Income for the Three Months
Ended September 30, 2003 and 2002 3
Consolidated Statements of Income for the Nine Months Ended
September 30, 2003 and 2002 4
Consolidated Statements of Cash Flows for the Nine Months
ended September 30, 2003 and 2002 5
Consolidated Statement of Stockholders' Equity as of
September 30, 2003 6
Notes To Consolidated Financial Statements 7 - 13
Item 2. Management's Discussion and Analysis of Financial
Condition and Results Of Operations 14 - 20
Item 3. Quantitative and Qualitative Disclosure of Market Risks 21
Item 4. Controls and Procedures 22
Part II. Other Information 23
- -------- -----------------
Signatures 24
Exhibits - Certifications 25 - 28
-1-
Consolidated Balance Sheets
(Unaudited)
September 30, December 31,
2003 2002
---------------------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 58,672,887 $ 48,320,098
Accounts and notes receivable, less allowance for doubtful
accounts of $4,641,000 in 2003 and $7,323,000 in 2002 52,099,661 51,554,373
Prepaid income taxes 883,282
Inventories and supplies 9,692,172 8,662,652
Deferred income taxes 2,310,626 3,021,724
Prepaid expenses and other 3,451,960 2,335,840
------------- -------------
Total current assets 126,227,306 114,777,969
PROPERTY AND EQUIPMENT:
Laundry and linen equipment installations 4,928,583 6,855,886
Housekeeping and office equipment 12,605,175 11,641,590
Autos and trucks 79,639 85,489
------------- -------------
17,613,397 18,582,965
Less accumulated depreciation 13,202,288 14,144,869
------------- -------------
4,411,109 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 2,772,663 1,955,365
OTHER NONCURRENT ASSETS, principally notes receivable 10,814,371 11,512,558
------------- -------------
$ 145,837,771 $ 134,296,310
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 8,665,022 $ 7,201,543
Accrued payroll, accrued and withheld payroll taxes 7,881,538 11,162,342
Other accrued expenses 640,463 238,485
Income taxes payable 699,937
Accrued insurance claims 2,542,472 1,953,198
------------- -------------
Total current liabilities 20,429,432 20,555,568
ACCRUED INSURANCE CLAIMS 7,627,415 5,859,593
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value: 30,000,000 shares authorized,
11,838,502 shares issued in 2003 and 11,612,505 in 2002. 118,385 116,125
Additional paid in capital 32,211,612 29,675,341
Retained earnings 89,129,615 81,806,772
Common stock in treasury, at cost, 435,283 shares in 2003 and
445,050 in 2002 (3,678,688) (3,717,089)
------------- -------------
Total stockholders' equity 117,780,924 107,881,148
------------- -------------
$ 145,837,771 $ 134,296,310
============= =============
See accompanying notes.
-2-
Consolidated Statements of Income
(Unaudited)
For the Three Months Ended September 30,
2003 2002
------------ -------------
Revenues $95,878,338 $83,044,730
Operating costs and expenses:
Costs of services provided 84,347,689 73,012,961
Selling, general and administrative 7,413,050 6,494,315
Other Income:
Interest Income 368,610 117,132
----------- -----------
Income before income taxes 4,486,209 3,654,586
Income taxes 1,683,000 1,444,000
----------- -----------
Net Income $ 2,803,209 $ 2,210,586
=========== ===========
Basic earnings per common share $ 0.25 $ 0.20
=========== ===========
Diluted earnings per common share $ 0.24 $ 0.19
=========== ===========
Dividends paid per common share $ 0.06 $ --
=========== ===========
See accompanying notes
-3-
Consolidated Statements of Income
(Unaudited)
For the nine months ended September 30,
2003 2002
----------- -----------
Revenues $278,215,404 $244,043,351
Operating costs and expenses:
Costs of services provided 244,674,740 215,310,120
Selling, general and administrative 21,285,724 18,593,605
Other income:
Interest income 758,692 500,198
----------- -----------
Income before income taxes 13,013,632 10,639,824
Income taxes 5,004,000 4,204,000
----------- -----------
Net income $ 8,009,632 $ 6,435,824
=========== ===========
Basic earnings per common share $ 0.71 $ 0.57
=========== ===========
Diluted earnings per common share $ 0.68 $ 0.55
=========== ===========
Dividends paid per common share $ 0.06 $ --
=========== ===========
See accompanying notes
-4-
Consolidated Statements of Cash Flows
(Unaudited)
For the Nine Months Ended
September 30,
--------------------------------
2003 2002
-------------- -------------
Cash flows from operating activities:
Net Income $ 8,009,632 $ 6,435,824
Adjustments to reconcile net income
to net cash used in operating activities:
Depreciation 1,427,521 1,533,881
Bad debt provision 3,800,000 4,950,000
Deferred income taxes (106,200) (2,222,700)
Tax benefit of stock option transactions 682,356 509,295
Unrealized (gain) loss on SERP Investments (132,655) 77,088
Changes in operating assets and liabilities:
Accounts and notes receivable (4,345,288) (2,345,156)
Prepaid income taxes 883,282 8,188
Inventories and supplies (1,029,520) (361,585)
Long-term notes receivable 1,553,653 1,167,765
Accounts payable and other accrued expenses 1,865,459 197,122
Accrued payroll, accrued and withheld payroll
taxes (3,075,605) (3,430,840)
Income taxes payable 699,937 937,250
Accrued insurance claims 2,357,096 1,328,731
Prepaid expenses and other assets (1,838,932) (829,050)
------------ ------------
Net cash provided by operating activities 10,750,736 7,955,813
------------ ------------
Cash flows from investing activities:
Proceeds from disposals of fixed assets 149,154 74,406
Additions to property and equipment (1,549,688) (1,371,038)
------------ ------------
Net cash used in investing activities (1,400,534) (1,296,632)
------------ ------------
Cash flows from financing activities:
Purchase of treasury stock (163,448) (342,157)
Proceeds from the exercise of stock options 1,852,402 1,716,755
Dividends paid (686,789) --
Reissuance of Treasury Stock 422 --
------------ ------------
Net cash provided by financing activities 1,002,587 1,374,598
------------ ------------
Net increase in cash and cash equivalents 10,352,789 8,033,779
Cash and cash equivalents at beginning of the year 48,320,098 34,259,334
------------ ------------
Cash and cash equivalents at end of the period $ 58,672,887 $ 42,293,113
============ ============
Supplementary Cash Flow Information:
Issuance of 24,141 shares of Common Stock in 2003 and
23,926 shares of Common Stock in 2002 pursuant to
Employee Stock Purchase Plan $ 205,199 $ 129,649
============ ============
See accompanying notes
-5-
Consolidated Statements of Stockholders' Equity
(Unaudited)
Additional Total
Common Stock Paid-in Retained Treasury Stockholders'
Shares Amount Capital Earnings Stock Equity
------ ------ ---------- -------- -------- ------------
Balance, December 31, 2002 11,612,505 $116,125 $29,675,341 $81,806,772 ($3,717,089) $107,881,149
Net income nine months ended September 30, 2003 8,009,632 $8,009,632
Exercise of stock options 225,997 2,260 1,850,142 $1,852,402
Tax benefit arising from stock transaction 682,356 $682,356
Purchase of common stock for treasury (14,400 shs) (163,448) ($163,448)
Issued pursuant to Employee Stock Purchase Plan 3,570 201,630 $205,200
Dividends paid (686,789) ($686,789)
Issued pursuant to Dividend Reinvestment Plan 203 219 $422
Balance, September 30, 2003 11,838,502 $118,385 $32,211,612 $89,129,615 ($3,678,688) $117,780,924
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 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 our
Annual Report on Form 10-K for the year ended December 31, 2002. The results of
operations for the quarters and nine month periods ended September 30, 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 January 31, 2005. The Company believes the line will be renewed at
that time. Amounts drawn under the line are payable upon demand. At both
September 30, 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 September
30, 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.
-7-
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 which was confirmed by the Bankruptcy Court
on May 12, 2003. The Company estimates that it will receive approximately
$180,000 from this client group under such plan. The Company 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.
Note 3 - Segment Information
The Company manages and evaluates its operations in two reportable
operating segments: (i) housekeeping, laundry, linen and other services, and
(ii) 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.
The housekeeping, laundry, linen and other services' segment provides
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
-------------- -------- ------------- -----
Nine Months Ended
September 30, 2003
Revenues $234,243,575 $ 44,319,601 $ (347,772) $278,215,404
Income before income
taxes $ 17,939,821 $ 1,348,655 $ (6,274,844)(1) $ 13,013,632
Nine Months Ended
September 30, 2002
Revenues $206,571,578 $ 37,679,260 $ (207,487) $244,043,351
Income before income
taxes $ 16,826,225 $ 1,071,799 $ (7,258,200)(1) $ 10,639,824
-8-
Quarter Ended
September 30, 2003
Revenues $ 80,301,521 $ 16,457,117 $ (880,300) $ 95,878,338
Income before income
taxes $ 5,608,773 $ 317,527 $( 1,440,091)(1) $ 4,486,209
Quarter Ended
September 30, 2002
Revenues $ 70,182,650 $ 13,639,456 $ (777,376) $ 83,044,730
Income before income
taxes $ 5,489,371 $ 230,809 $ (2,065,594)(1) $ 3,654,586
(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 categories:
For the quarter ended September 30,
-----------------------------------
2003 2002
------------ ------------
Housekeeping services $ 55,628,692 $ 49,414,525
Laundry and linen services 23,708,141 19,924,367
Food Services 16,152,997 13,424,120
Maintenance services
and Other 388,508 281,718
------------ ------------
$ 95,878,338 $ 83,044,730
============ ============
For the nine months ended September 30,
---------------------------------------
2003 2002
------------ ------------
Housekeeping services $164,753,663 $146,421,798
Laundry and linen services 68,273,669 58,994,287
Food Services 44,061,512 37,319,217
Maintenance services
and Other 1,126,560 1,308,049
------------ ------------
$278,215,404 $244,043,351
============ ============
The Company has one client, a nursing home chain, which in the nine
months ended September 30, 2003 and September 30, 2002 accounted for
approximately 23% and 16%, respectively of consolidated revenues. With respect
to such client, the Company derived revenues from both operating segments.
Although 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.
-9-
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 September 30, 2003
--------------------------------
Weighted
Income Average Shares Per-share
(Numerator) (Denominator) Amount
----------- -------------- ---------
Net income $ 2,803,209
===========
Basic earnings per
common share $ 2,803,209 11,406,417 $ .25
Effect of dilutive securities:
Options 523,010 (.01)
----------- ---------- ---------
Diluted earnings per
Common share $ 2,803,209 11,929,427 $ .24
=========== ========== =========
Quarter Ended September 30, 2002
--------------------------------
Weighted
Income Average Shares Per-share
(Numerator) (Denominator) Amount
----------- -------------- ---------
Net income $ 2,210,586
===========
Basic earnings per
common share $ 2,210,586 11,317,662 $ .20
Effect of dilutive securities:
Options 528,232 (.01)
----------- ---------- --------
Diluted earnings per
Common share $ 2,210,586 11,845,894 $ .19
=========== ========== ========
Nine Months Ended September 30, 2003
------------------------------------
Weighted
Income Average Shares Per-share
(Numerator) (Denominator) Amount
----------- -------------- ---------
Net income $ 8,009,632
===========
Basic earnings per
common share $ 8,009,632 11,319,027 $ .71
Effect of dilutive securities:
Options 455,317 (.03)
----------- ---------- --------
Diluted earnings per
Common share $ 8,009,632 11,774,344 $ .68
=========== ========== ========
-10-
Nine Months Ended September 30, 2002
-----------------------------------------------
Weighted
Income Average Shares Per-share
(Numerator) (Denominator) Amount
----------- -------------- ---------
Net income $6,435,824
===========
Basic earnings per
common share $6,435,824 11,237,560 $ .57
Effect of dilutive securities:
Options 508,763 (.02)
----------- ---------- ----------
Diluted earnings per
Common share $6,435,824 11,746,323 $ .55
=========== ========== ==========
No outstanding options were excluded at either September 30, 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 the 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.
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 comply with the new disclosure requirements beginning with the
first quarter of its fiscal year ending December 31, 2003.
-11-
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:
Quarter Ended September 30,
----------------------------
2002 2003
---- ----
Net income
As reported $2,803,209 $2,210,586
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 $2,803,209 $2,210,586
========== ==========
Basic earnings per common share
As reported $ .25 $ .20
Pro forma $ .25 $ .20
Diluted earnings per common share
As reported $ .24 $ .19
Pro forma $ .24 $ .19
Nine Months Ended September 30,
-------------------------------
2002 2003
---- ----
Net income
As reported $8,009,632 $6,435,824
Deduct:
Total stock based employee
compensation expense determined
under fair value based method
for all awards, net of related
tax effects (1,382,884) (1,513,855)
---------- -----------
Pro forma net income $6,626,748 $4,921,969
========== ===========
Basic earnings per common share
As reported $ .71 $ .57
Pro forma $ .59 $ .44
Diluted earnings per common share
As reported $ .68 $ .55
Pro forma $ .56 $ .42
-12-
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 effect on the Company's financial statements.
In April 2003, the FASB issued Statement of Financial Accounting Standards No.
149 ("SFAS No. 149"), "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities," which amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts and for hedging activities under SFAS No. 133. SFAS
No. 149 is effective for contracts entered into or modified after June 30, 2003
except for the provisions that were cleared by the FASB in prior pronouncements.
The adoption of SFAS No. 149 did not have a material effect on its financial
position and results of operations.
In May 2003, the FASB issued Statement of Financial Accounting
Standards No. 150 ("SFAS No. 150"), "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity". SFAS 150
establishes standards for how an issuer classifies and measures in its statement
of financial position certain financial instruments with characteristics of both
liabilities and equity. In accordance with the standard, financial instruments
that embody obligations for the issuer are required to be classified as
liabilities. SFAS 150 is effective for financial instruments entered into or
modified after May 31, 2003. The adoption of SFAS No. 150 did not have a
material effect on the Company's financial position and results of operations.
-13-
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 Sept 30, For the Nine Months Ended Sept 30,
-------------------------------------------------------------------
2003 2002 2003 2002
---- ---- ---- ----
Revenues 100.0% 100.0% 100.0% 100.0%
Operating costs and expenses:
Costs of services provided 88.0 87.9 88.0 88.2
Selling, general and
administration 7.7 7.8 7.6 7.6
Interest income .4 .1 .3 .2
------ ------ ----- -----
Income before income taxes 4.7 4.4 4.7 4.4
------ ------ ----- -----
Income taxes 1.8 1.7 1.8 1.7
------ ------ ----- -----
Net income 2.9% 2.7% 2.9% 2.7%
====== ====== ===== =====
Revenues for the three and nine month periods ended September 30, 2003
increased 15.5% and 14.0%, respectively, compared to the corresponding 2002
periods. 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, in each period, 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 the nine
months ended September 30, 2003 and September 30, 2002 accounted for
approximately 23% and 16%, respectively of consolidated revenues. With respect
to such client, the Company derived revenues from both operating segments.
Although 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 remained
essentially unchanged at 88.0 % for the third quarter of 2003 compared to 87.9 %
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 .1% change are as follows: increases of 1.3% and .7% in the
cost of supplies consumed in providing services and workers' compensation
insurance, respectively. The increase in cost of supplies was primarily
attributable to price increases. The increase in workers' compensation insurance
resulted primarily from the effect of the acceleration in the timing of
settlements made with, as well as increased payments to claimants under the
plan; offsetting these increases was a decrease of 1.2% in bad debt provision;
-14-
Cost of services provided as a percentage of revenues decreased to
88.0% for the nine month period ended September 30, 2003 from 88.2% in the
corresponding 2002 period. The primary factors affecting specific variations in
the 2003 cost of services provided as a percentage of revenue and its effect on
the .2% decrease are as follows: decreases of .7% and .6% in the bad debt
provision, and health insurance and employee benefits, respectively; offsetting
these decreases were increases of .9% and .5% in the cost of supplies consumed
in providing services, and workers' compensation insurance. The increase in cost
of supplies was primarily attributable to price increases. The increase in
workers' compensation insurance resulted primarily from the effect of the
acceleration in the timing of settlements made with, as well as increased
payments to claimants under the plan.
Selling, general and administrative expenses as a percentage of revenue
remained essentially unchanged at 7.7% and 7.6% in the third quarter and nine
month period ended September 30, 2003, respectively, compared to 7.8% and 7.6%
in the third quarter and nine month period ended September 30, 2002,
respectively.
As a result of the matters discussed above, net income for both the
third quarter and nine month period ended September 30, 2003 increased to 2.9%
as a percentage of revenue compared to 2.7% in both of the comparable 2002
periods.
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.
-15-
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.
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) due from a client group currently in
Chapter 11 bankruptcy proceedings. During the first quarter of 2003, this client
group filed a plan of reorganization which was confirmed by the Bankruptcy Court
on May 12, 2003. The Company estimates that it will receive approximately
$180,000 from this client group under such plan. The Company 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.
-16-
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, 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 affect on the Company's results of operations
and financial condition.
Liquidity and Capital Resources
At September 30, 2003 the Company had working capital and cash of
$105,797,874 and $58,672,887, respectively, which represent increases of 12% and
22%, respectively in working capital and cash as compared to December 31, 2002
working capital and cash of $94,222,400 and $48,320,098, respectively. The
Company's current ratio at September 30, 2003 increased to 6.2 to 1 from 5.6 to
1 at December 31, 2002.
Management views the Company's cash and cash equivalents of $58,672,887
at September 30, 2003 as its principal measure of liquidity.
The net cash provided by the Company's operating activities was
$10,750,736 for the nine month period ended September 30, 2003. The principal
sources of net cash flows from operating activities for the nine month periods
ended 2003 was net income which has been reduced as a result of noncash charges
to operations for bad debt provisions and depreciation. Additionally, operating
activities' cash flows were increased by the timing of payments for accrued
insurance claims and accounts payable and other accrued expenses of $2,357,096
and $1,865,459, respectively. The operating activities that used the largest
amount of cash during the nine month periods ended September 30, 2003 were net
increases in accounts and notes receivable and long term notes receivable of
$2,791,635. The net increases in these amounts resulted primarily from the
growth in the Company's revenues, as well as the timing of collections from
clients. Additionally, operating cash flows in the nine month period ended
September 30, 2003 were negatively impacted by a $3,075,605 increase in accrued
payroll, accrued and withheld payroll taxes, as well as a $1,838,932 increase in
prepaid expenses and other assets. These cash flows' decreases were primarily
the result of the timing of such payments.
-17-
The net cash provided by the Company's operating activities was
$7,955,813 for the nine month period ended September 30, 2002. The principal
sources of net cash flows from operating activities for the nine month period
ended September 30, 2002 was net income which has been reduced as a result of
noncash charges to operations for bad debt provisions and depreciation.
Additionally, cash flows in the nine month period ended September 30, 2002 were
increased by the timing of payments for accrued insurance claims of $1,328,731.
Operating activities' cash flows were reduced in the 2002 period as a result of
an increase of $3,430,840 in accrued payroll, accrued and withheld payroll
taxes, as a result from the timing of such payments.
The Company's principal use of cash in investing activities in each of
the nine month periods ended September 30, 2003 and 2002, respectively was the
purchase of housekeeping equipment and computer software and equipment.
Although, there were no purchases by the Company of its common stock
during the third quarter of 2003, the Company has purchased 14,400 shares of its
common stock at an average price of $11.35 per common share for the nine month
period ended September 30, 2003. At September 30, 2003, the Company remains
authorized to purchase up to 589,500 shares of its outstanding common stock
pursuant to previous Board of Directors' action.
On September 29, 2003, the Company paid a cash dividend of $.06 per
common share, $686,789 in the aggregate, to shareholders of record on September
15, 2003.
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.
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 September 30, 2003 and December 31, 2002, the
Company had approximately, net of reserves, $13,050,000 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 such restructuring provides it with a means to maintain a
relationship with the client while at the same time minimizing collection
exposure.
-18-
The Company has had varying collection experience with respect to our
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 approximately $3,800,000 and $4,950,000 in the nine month
periods ended September 30, 2003 and 2002, respectively. These provisions
represent approximately 1.4% and 2.0%, 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 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 which was confirmed by the Bankruptcy Court
on May 12, 2003. The Company estimates that it will receive approximately
$180,000 from this client group under such plan. The Company 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 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, 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.
-19-
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 January 31, 2005. The Company believes the line
will be renewed at that time. Amounts drawn under the line are payable on
demand. At September 30, 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 September 30, 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, laundry and linen equipment installations,
and computer hardware and software. 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.
-20-
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. 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 23% of revenues in the nine month period ended September 30,
2003; our claims experience related to workers' compensation and general
liability insurance; the effects of changes in laws and regulations governing
the industry and risk factors described in our Form 10-K filed with the
Securities and Exchange Commission for the year ended December 31, 2002 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 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 our clients
filing for bankruptcy protection. Others may follow. Any decisions by the
government to discontinue or adversely modify legislation related to
reimbursement funding rates will have a material adverse affect on our clients.
These factors, in addition to delays in payments from clients have resulted in
and could continue to result in significant additional bad debts in the near
future. Additionally, our operating results would be adversely affected if
unexpected increases in the costs of labor and labor related costs, materials,
supplies and equipment used in performing services could not be passed on to
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 the various operational levels of the Company. 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.
Effects of Inflation
The Company believes that we will be able to recover increases in costs
attributable to inflation by passing through such cost increases to its clients.
-21-
ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this quarterly 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.
-22-
PART II. Other Information
Item 1. Legal Proceedings. Not Applicable.
Item 2. Changes in Securities. Not Applicable.
Item 3. Defaults under Senior Securities. Not Applicable.
Item 4. Submission of Matters to a Vote of Security
Holders - None.
Item 5. Other Information.
a) None.
Item 6. Exhibits and Reports on Form 8-K.
a) Exhibits -
31.1 Certification of Chief Executive
Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer
pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive
Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer
pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
b) Reports on Form 8-K - None
-23-
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 27, 2003 /s/ Daniel P. McCartney
- ------------------- ----------------------------
Date DANIEL P. McCARTNEY, Chief
Executive Officer
October 27, 2003 /s/ Thomas A. Cook
- ------------------- ----------------------------
Date THOMAS A. COOK, President and
Chief Operating Officer
October 27, 2003 /s/ James L. DiStefano
- ------------------- ----------------------------
Date JAMES L. DiSTEFANO, Chief Financial
Officer and Treasurer
October 27, 2003 /s/ Richard W. Hudson
- ------------------- ----------------------------
Date RICHARD W. HUDSON, Vice
President-Finance, Secretary and
Chief Accounting Officer
-24-