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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
(X) ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (FEE REQUIRED)
For the fiscal year ended December 31, 1998
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from to
Commission File No. 0-12015
HEALTHCARE SERVICES GROUP, INC.
(Exact name of registrant as specified in its charter)
Pennsylvania 232018365
- ------------------------------- ---------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporated or organization)
2643 Huntingdon Pike, Huntingdon Valley, Pennsylvania 19006
-----------------------------------------------------------
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (215) 938-1661
--------------
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Titles of Each Class on Which Registered
-------------------- -------------------
NONE
Securities registered pursuant to Section 12(g) of the Act:
Shares of Common Stock ($.01 par value)
---------------------------------------
Title of Class
Indicate by check mark whether the registrant (1) has filed all reports 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 the past 90 days.
YES X NO
---- ----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.
YES X NO
---- ----
The aggregate market value of voting stock (Common Stock, $.01 par value)
held by non-affiliates of the Registrant as of March 19, 1999 was
approximately $103,668,347. Indicate the number of shares outstanding of
each of the registrant's classes of common stock, as of the latest
practicable date: At March 19, 1999 there were outstanding 11,057,957 shares
of the Registrant's Common Stock, $.01 par value.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III of Form 10-K will be incorporated
by reference to certain portions of a definitive proxy statement which is
expected to be filed by the Registrant pursuant to Regulation 14A within 120
days after the close of its fiscal year.
PART I
References made herein to the Company or the Registrant include
Healthcare Services Group, Inc. and its wholly owned subsidiary HCSG Supply,
Inc., unless the context otherwise requires.
Item I. Business
- ------- --------
(a) General
Healthcare Services Group, Inc. (the "Company" or the "Registrant")
provides housekeeping, laundry, linen, facility maintenance and food services to
the health care industry, including nursing homes, retirement complexes,
rehabilitation centers and hospitals. The Company believes that it is the
largest provider of contractual housekeeping and laundry services to the
long-term care industry in the United States, rendering such services to
approximately 1,050 facilities in 43 states and Canada as of December 31, 1998.
(b) Not Applicable
(c) Description of Services
The Company provides management, administrative and operating expertise
and services to the housekeeping, laundry, linen, facility maintenance and food
service departments of the health care industry. The Company's labor force is
also interchangeable with respect to each of these services, with the exception
of food services. The Company believes that each service it performs is similar
in nature and each provides opportunity for growth.
Housekeeping services. Housekeeping services is the largest service
sector of the Company. It involves cleaning, disinfecting and sanitizing
resident areas in the facilities. In providing services to any given client
facility, the Company typically hires and trains the hourly employees who were
employed by such facility prior to the engagement of the Company. The Company
normally assigns two on-site managers to each facility to supervise and train
hourly personnel and to coordinate housekeeping and laundry with other facility
support functions. Such management personnel also oversee the execution of a
variety of quality and cost-control procedures including continuous training and
employee evaluation as well as on-site testing for infection control. The
on-site management team also assists the facility in complying with Federal,
state and local regulations.
Laundry and linen services. Laundry and linen services is the other
significant service sector of the Company. Laundry services involves laundering
and processing of the residents' personal clothing. The Company provides laundry
service to all of its housekeeping clients. Linen services involves providing,
laundering and processing the sheets, pillow cases, blankets, towels, uniforms
and assorted linen items used by the facilities. The hiring, training and
supervision of laundry and linen services' hourly employees are similar to, and
performed by the same management personnel as housekeeping services. Generally,
at most of the facilities that utilize the Company's linen services, the
equipment is either acquired and installed by the Company, or the existing
laundry installations are purchased from the facility and upgraded when
required. Each such installation generally requires initial capital outlays by
the Company of from $50,000 to $250,000 depending on the size of the facility,
installation and construction
1
cost and the amount of equipment required. The Company could incur relocation or
other costs in the event of the cancellation of a linen service agreement where
there was an investment by the Company in a corresponding laundry installation.
From January 1, 1996 through December 31, 1998, the Company's services
were cancelled by thirty-five facilities with respect to which the Company had
previously invested in a laundry installation. Laundry installations relating to
agreements cancelled in 1998 and 1997 resulted in the Company receiving
approximately $57,000 and $41,000 less, respectively than the net amount at
which these assets were recorded on its balance sheet. In 1996, laundry
installations, relating to clients who terminated their service agreements with
the Company, were sold to the Company's clients for an amount in excess of the
net amount recorded on the Company's balance sheet. Linen supplies, in some
instances are owned by the Company, and the Company maintains a sufficient
inventory of these items in order to ensure their availability. The Company
provides linen services to approximately twenty per cent of the facilities for
which it provides housekeeping services.
Facility maintenance, materials acquisition and consulting services.
Facility maintenance services consist of repair and maintenance of laundry
equipment, plumbing and electrical systems, as well as carpentry and painting.
In many instances, materials, equipment and supplies utilized by the Company in
the performance of maintenance services, as well as housekeeping, laundry and
linen services, are provided by the Company through its wholly owned subsidiary,
HCSG Supply, Inc.. The Company also provides consulting services to facilities
to assist them in updating their housekeeping, laundry and linen operations.
Food services. The Company commenced providing food services to a
limited number of clients in 1997. Food services consist of the development of a
menu that meets the residents' dietary needs, purchasing and preparing the food
to assure the residents receive an appetizing meal, and participation in
monitoring the residents' ongoing nutrition status. On-site management is
responsible for all daily food service activities, with regular support being
provided by a district manager specializing in food service, as well as a
registered dietitian. The Company also provides consulting services to
facilities to assist them in updating and cost containment in regards a client's
food service operation.
Laundry installations sales. The Company (as distributor of laundry
equipment) sells laundry installations to its clients which generally represent
the construction and installation of a turn-key operation. With regard to
laundry installation sales, the Company generally offers payment terms, ranging
from 36 to 60 months. There were no service agreement cancellations in 1998,
1997 or 1996 by clients who have purchased laundry installations from the
Company. During the years 1996 through 1998, laundry installation sales were not
material to the Company's operating results as the Company prefers to own such
laundry installations in connection with performance of its service agreements.
2
Operational-Management Structure
--------------------------------
By applying its professional management techniques, the Company is able
to contain certain housekeeping, laundry, linen, facility maintenance and food
service costs on a continuing basis. The Company provides its services through a
network of management personnel, as illustrated below.
Vice President - Operations
Divisional Vice President
(5 Divisions)
Regional Vice President/Manager
(18 Regions)
District Manager
(97 Districts)
Training Manager
Facility Manager and
Assistant Facility Manager
Each facility is managed by an on-site Facility Manager, an Assistant
Facility Manager, and if necessary, additional supervisory personnel. Districts,
typically consisting of from eight to twelve facilities, are supported by a
District Manager and a Training Manager. District Managers bear overall
responsibility for the facilities within their districts. They are generally
based within close proximity to each facility. These managers provide active
support to clients in addition to the support provided by the Company's on-site
management. Training Managers are responsible for the recruitment, training and
development of Facility Managers. At December 31, 1998, the Company maintained
18 regions within five divisions. A division consists of two to six regions
within a specific geographical area. A Divisional Vice President manages each
division. Additionally, two divisions, have a Divisional Vice President-Sales
who supports the Divisional Vice President by managing the marketing efforts of
the respective divisions. Each region is headed by a Regional Vice
President/Manager and a Regional Sales Director who assumes primary
responsibility for marketing the Company's services. Regional Vice
President/Managers report to Divisional Vice Presidents who in turn report to
the Vice President of Operations. With respect to the Food Service division, the
Divisional Vice President assumes primary responsibility for the marketing
efforts of his division. Such efforts are supplemented by the
3
Food Service division Regional Manager, as well as the other divisions' sales
and marketing personnel. The Company believes that its divisional, regional and
district organizational structure facilitates its ability to obtain new clients,
as well as its ability to sell new services to existing clients.
Market and Services
-------------------
The market for the Company's services consists of a large number of
facilities involved in various aspects of the health care industry, including,
nursing homes, retirement complexes, rehabilitation centers and hospitals. Such
facilities may be specialized or general, privately owned or public, profit or
not-for-profit, and may serve patients on a long-term or short-term basis. The
market for the Company's services is expected to continue to grow as the elderly
increase as a percentage of the United States and Canadian population and as
government reimbursement policies require increased cost control or containment
by constituents of its targeted market.
In 1998 the long-term care market consisted of approximately 23,000
facilities, according to estimates of the Department of Health and Human
Services. The facilities primarily range in size from small private facilities
with 65 beds to facilities with over 500 beds. The Company markets its services
primarily to facilities with 100 or more beds. The Company believes that less
than five percent of long-term care facilities use outside providers of
housekeeping and laundry services such as the Company.
Marketing and Sales
-------------------
The Company's services are marketed at four levels of the Company's
organization: at the corporate level by the Chief Executive Officer, President
and the Vice President of Operations, at the divisional level by Divisional Vice
Presidents and Divisional Vice Presidents- Sales; at the regional level by the
Regional Vice Presidents/Managers and Regional Sales Directors; and at the
district level by District Managers. The Company provides incentive compensation
to its operational personnel based on achieving budgeted earnings and to its
Divisional Vice Presidents- Sales and Regional Sales Directors based on
achieving budgeted earnings and new business revenues.
The Company's services are marketed primarily through referrals and
in-person solicitation of target facilities. The Company also utilizes direct
mail campaigns and participates in industry trade shows, health care trade
associations and healthcare support services seminars that are offered in
conjunction with state or local health authorities in many of the states in
which the Company conducts its business. The Company's programs have been
approved for continuing education credits by state nursing home licensing boards
in certain states, and are typically attended by facility owners, administrators
and supervisory personnel, thus presenting a marketing opportunity for the
Company. Indications of interest in the Company's services arising from initial
marketing efforts are followed up with a presentation regarding the Company's
services and survey of the service requirements of the facility. Thereafter, a
formal proposal, including operational recommendations and recommendations for
proposed savings, is submitted to the prospective client. Once the prospective
client accepts the proposal and signs the service agreement, the Company can set
up its operations on-site within days.
Government Regulation of Clients
--------------------------------
The Company's clients are subject to governmental regulation. In August
1997, the President signed into law the Balanced Budget Act of 1997. The
legislation changes Medicare and Medicaid policy in a number of ways including
the phasing in of a Medicare prospective payment system ("PPS") for skilled
nursing facilities effective July 1, 1998. PPS will significantly change the
manner in which skilled nursing facilities are reimbursed for inpatient services
provided to Medicare beneficiaries. Unlike the old system, which relied solely
on cost reports submitted, PPS rates are based entirely on the
federallly-acuity-adjusted rate. Although there can be no assurance thereof, the
Company believes that while PPS will affect how clients are paid for certain
services, the Company's business should not be adversely impacted by this
legislation, as clients determine how to adjust to PPS. The Company does not
participate in any government reimbursement programs, therefore, all of the
Company's contractual relationships with its clients continue to determine the
clients' payment obligations to the Company. At this time, the Company has not
been able to fully assess the impact of PPS on its clients, due in part to
uncertainty as to the details of implementation by its clients.
4
Service Agreements
------------------
The Company offers two kinds of service agreements, a full service
agreement or a management agreement. In a full service agreement, the Company
assumes both management and payroll responsibility for the hourly housekeeping,
laundry, linen, facility maintenance and food service employees.
The Company typically adopts and follows the client's employee wage
structure, including its policy of wage rate increases, and passes through to
the client any labor cost increases associated with wage rate adjustments. Under
a management agreement, the Company provides management and supervisory services
while the client facility retains payroll responsibility for its hourly
employees. Substantially all of the Company's agreements are full service
agreements. These agreements typically provide for a one year term, cancelable
by either party upon 30 days' notice after the initial 90-day period. As of
December 31, 1998, the Company provided services to approximately 1,050 client
facilities.
Although the service agreements are cancelable on short notice, the
Company has historically had a favorable client retention rate and expects to be
able to continue to maintain satisfactory relationships with its clients. The
risk associated with short-term agreements have not materially affected either
the Company's linen services, which generally require a capital investment, or
laundry installation sales, which require the Company to finance the sales
price. Such risks are often mitigated by certain provisions set forth in the
agreements which are entered into by the Company. In cases where the Company has
purchased the laundry installation from its clients, many of the linen service
agreements require that in the event the Company's services are terminated, the
client becomes obligated to purchase the laundry installation from the Company
at a price no less than the value recorded on the Company's financial statements
at the time of termination. The laundry installation sales agreements obligate
the purchaser to pay for such installation upon terms independent of the
services rendered by the Company.
From time to time, the Company encounters difficulty in collecting
amounts due from certain of its clients, including 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 recorded bad debt
provisions of $2,339,515, $899,551 and $2,050,000 in the years ended December
31, 1998, 1997 and 1996, respectively. In making its 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.
Competition
-----------
The Company competes primarily with the in-house support service
departments of its potential clients. Most healthcare facilities perform their
own support service functions without relying upon outside management firms such
as the Company. In addition, a number of local firms compete with the Company in
the regional markets in which the Company conducts business. Several national
service firms are larger and have greater financial and marketing resources than
the Company, although historically, such firms have concentrated their marketing
efforts on hospitals rather than the long-term care facilities typically
serviced by the Company. Although the competition to provide service to health
care facilities is strong, the Company believes that it competes effectively for
new agreements, as well as
5
renewals of the existing agreements based upon the quality and dependability of
its services and the cost savings it can effect for the client.
Employees
---------
At December 31, 1998, the Company employed 2,040 management and
supervisory personnel. Of these employees, 206 held executive, regional/district
management and office support positions, and 1,834 of these salaried employees
were on-site management personnel. On such date, the Company employed
approximately 12,006 hourly employees. Many of the Company's hourly employees
were previous support employees of the Company's clients. In addition, the
Company manages hourly employees who remain employed by certain of its clients.
Approximately 12% of the Company's hourly employees are unionized.
These employees are subject to collective bargaining agreements that are
negotiated by individual facilities and are assented to by the Company so as to
bind the Company as an "employer" under the agreements. The Company may be
adversely affected by relations between its client facilities and the employee
unions. The Company is a party to negotiated collective bargaining agreements
with respect to approximately 90 employees at five facilities. The Company
believes its employee relations are satisfactory.
(d) Risk Factors - Certain matters discussed in this report may include
forward-looking statements that are subject to risks and uncertainties that
could cause actual results or objectives to differ materially from those
projected. Such risks and uncertainties include, but are not limited to, risks
arising from the Company providing its services exclusively to the health care
industry and credit and collection risks associated with this industry.
Additionally, the Company's operating results would be adversely effected if
unexpected increases in the costs of labor, materials supplies and equipment
used in performing its services could not be passed on to clients.
In addition, the Company believes that in order to improve its
financial performance it must continue to obtain service agreements with new
clients, as well as providing new services to existing clients, achieve modest
price increases on current service agreements with existing clients and maintain
internal cost reduction strategies at the various operational levels of the
Company. Furthermore, the Company believes that its ability to sustain the
internal development of managerial personnel is an important factor impacting
future operating results and successfully executing projected growth strategies.
(e) Financial Information About Foreign and Domestic Operations and Export
Sales
Not Applicable.
Item 2. Properties
- ------- ----------
The Company leases its corporate offices, located at 2643 Huntingdon
Pike, Huntingdon Valley, Pennsylvania 19006, which consists of 6,638 square
feet. The term of the lease expires on March 31, 2001. The Company also leases
office space at other locations in Pennsylvania, Massachusetts, Florida,
Illinois, California, Colorado, Georgia, Missouri and Texas, office sizes range
from approximately 1,000 to 2,500 square feet. These locations serve as
divisional or regional offices. In addition, the Company leases warehouse space
in Pennsylvania, Florida and Illinois. The warehouses in Pennsylvania, Florida
6
and Illinois consist of approximately 18,000, 10,000 and 3,500 square feet,
respectively. None of these leases is for more than a five-year term.
The Company is provided with office and storage space at each of its
client facilities. Management does not foresee any difficulties with regard to
the continued utilization of such premises.
The Company presently owns laundry equipment, office furniture and
equipment, housekeeping equipment and vehicles. Management believes that all of
such equipment is sufficient for the conduct of the Company's current
operations.
Item 3. Legal Proceedings.
- ---- ---------------------
As of December 31, 1998, there were no material pending legal
proceedings to which the Company was a party, or of which any of its property
was subject, other than routine litigation or claims believed to be adequately
covered by insurance.
Item 4. Submission of Matters to a Vote of Security Holders
- ------- ---------------------------------------------------
Not applicable.
7
PART II
Item 5. Market for Registrant's Common Stock and Related Security Holder
Matters
(a) Market Information
The Company's common stock, $.01 par value (the "Common Stock") is
traded on the NASDAQ National Market System. On December 31, 1998, there were
11,034,207 shares of Common Stock outstanding.
On August 5, 1998, the Board of Directors declared a three-for-two
stock split of the Company's Common Stock effected in the form of a 50% stock
dividend payable on August 27, 1998 to Common Stock stockholders of record on
August 17, 1998. An amount equal to the par value of the shares of Common Stock
issued was transferred from additional paid in capital to Common Stock in the
December 31, 1998 balance sheet. The effect of this action was to increase
shares of outstanding Common Stock at August 27, 1998 by approximately
3,693,432.
The high and low bids for the Common Stock during the two years ended
December 31, 1998, ranged as follows (after giving effect to the three-for-two
stock split):
1998 High 1998 Low
--------- --------
1st Qtr. 9 15/16 8 1/3
2nd Qtr. 9 9/16 9 1/3
3rd Qtr. 11 11/16 9 3/16
4th Qtr. 9 7/8 8 3/8
1997 High 1997 Low
--------- --------
1st Qtr. 8 1/3 6 3/4
2nd Qtr. 8 1/3 6 2/3
3rd Qtr. 9 1/3 7 2/3
4th Qtr. 9 9/16 8 3/16
(b) Holders
As of March 19, 1999, there were approximately 320 holders of record of
the common stock, including stock held in nominee name by brokers or other
nominees. It is estimated that there are approximately 2,600 beneficial holders.
(c) Dividends
The Company has not paid any cash dividends on its Common Stock during
the last two years. Currently, it intends to continue this policy of retaining
all of its earnings, if any, to finance the development and expansion of its
business.
8
Items 6 through 8 - Selected Financial Data, Management's Discussion and
Analysis of Financial Condition and Results of Operations
and Financial Statements and Supplementary Data
The information called for herein is incorporated by reference to the
Company's Annual Report to Shareholders for the year ended December 31, 1998.
Selected Financial Data
The selected financial data presented below should be read in conjunction with,
and is qualified in its entirety by reference to, the Financial Statements and
Notes thereto.
(In thousands except for per share data and employees)
------------------------------------------------------
Years ended December 31:
------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Revenues $204,869 $181,359 $162,482 $148,747 $136,414
Net income $ 8,869 $ 5,894 $ 6,889 $ 3,941 $ 6,400
Basic earnings per common share $ .79 $ .52 $ .57 $ .32 $ .53
Diluted earnings per common share $ .77 $ .51 $ .56 $ .32 $ .53
Weighted average number of common
shares outstanding for basic EPS 11,188 11,354 12,156 12,210 12,044
Weighted average number of common
shares outstanding for diluted EPS 11,512 11,578 12,203 12,335 12,211
As of December 31:
Working Capital $ 62,009 $ 55,706 $ 57,434 $ 51,068 $ 46,146
Total Assets $ 93,109 $ 84,890 $ 86,446 $ 80,290 $ 75,815
Long-Term Obligations $ - $ - $ - $ - $ 300
Stockholders' Equity $ 80,192 $ 72,227 $ 74,938 $ 68,470 $ 62,124
Book Value Per Share $ 7.27 $ 6.52 $ 6.17 $ 5.61 $ 5.22
Employees 14,046 12,180 11,217 10,911 10,808
All share data has been adjusted to reflect the 3-for-2 stock split paid in the
form of a 50% stock dividend on August 27, 1998.
9
The following discussion and analysis should be read in conjunction with the
financial statements and notes thereto.
Management's Discussion and Analysis of
Financial Condition And Results of Operations
Results of Operations
From 1993 through 1998, the Company's revenues grew at a compound annual rate of
12.4%. This growth was achieved through obtaining new clients in both existing
market areas, as well as providing additional services to existing clients.
Although there can be no assurance thereof, the Company anticipates future
growth, although its compound growth rates will likely decrease as growth is
measured against the Company's increasing revenue base.
The following table sets forth for the years indicated the percentage which
certain items bear to revenues:
Relation to Total Revenues
--------------------------
Years Ended December 31,
------------------------
1998 1997 1996
Revenues 100.0% 100.0% 100.0%
Operating costs and expenses:
Costs of services provided 85.1 85.1 85.7
Selling, general and administrative 8.5 8.8 8.0
Interest income .6 .8 .7
Settlement of civil litigation
(Note 9) - (1.0) -
--- --- ---
Income before income taxes 7.0 5.9 7.0
Income taxes 2.7 2.6 2.8
--- --- ---
Net income 4.3% 3.3% 4.2%
=== === ===
1998 Compared with 1997
Revenues increased 13% to $204,869,023 in 1998 from $181,359,305 in 1997. The
following factors contributed to the increase in revenues: service agreements
with new clients increased revenues 22.7%; new services to existing clients
increased revenues 4.9%; and cancellations and other minor changes decreased
revenues by 14.6%.
Costs of services provided as a percentage of revenues in 1998 was 85.1%, the
same as in 1997. The primary factors affecting specific variations in the 1998
cost of services provided as a percentage of revenue are as follows: decrease in
workers' compensation, general liability and other insurance of .5%; decrease of
.3% in the cost of supplies consumed in performing services; decrease of .3% in
employee benefits; offsetting these decreases was an increase in allowance for
doubtful accounts of .6%.
Selling, general and administrative expenses as a percentage of revenue
decreased to 8.5% in 1998 from 8.8% in 1997. The decrease is primarily
attributable to the Company's ability to control these expenses while comparing
them to a greater revenue base.
10
1997 Compared with 1996
Revenues increased 12% to $181,359,305 in 1997 from $162,482,169 in 1996. The
following factors contributed to the increase in revenues: service agreements
with new clients in existing geographic areas increased revenues 16.8%; new
services to existing clients increased revenues 5.2%; and cancellations and
other minor changes decreased revenues by 10%.
Costs of services provided as a percentage of revenues decreased to 85.1% in
1997 from 85.7% in 1996. The primary factors affecting specific variations in
the 1997 cost of services provided as a percentage of revenue and their effects
on the .6% decrease are as follows: decrease in allowance for doubtful accounts
of .9%; decrease in workers' compensation, general liability and other insurance
of .7%; offsetting these decreases was an increase of 1.2% in the cost of
supplies consumed in performing services.
Selling, general and administrative expenses as a percentage of revenue
increased to 8.8% in 1997 from 8.0% in 1996. The increase is primarily a result
of the additional costs associated with the expansion of the Company's
divisional and regional staffs, as well as the costs of installing a new
computerized financial reporting system.
In the second quarter of 1997 the Company established a provision of
$1,800,000 for additional legal and related costs in connection with the
settlement of a civil lawsuit which was settled in July 1997 (see Note 9 -
Settlement of Civil Litigation).
Liquidity and Capital Resources
At December 31, 1998 the Company had working capital and cash of $62,009,010 and
$17,201,408 respectively, which represents an 11% increase and 3% decrease,
respectively, compared to December 31, 1997 working capital and cash of
$55,705,917 and $17,774,219. During 1998, the Company expended $3,496,000 for
open market purchases of 369,000 shares of its common stock. The Company's
current ratio at December 31, 1998 increased only slightly, to 6.8 to 1 from 6.7
to 1 at December 31, 1997.
The net cash provided by the Company's operating activities was $3,319,704
for the year ended December 31, 1998. The principal source of cash flows from
operating activities for 1998 was net income, charges to operations for bad debt
provisions, depreciation and amortization, and the timing of payments for
payroll and payroll related taxes. The operating activity that used the largest
amount of cash was a $10,215,917 net increase in accounts and current and long
term notes receivable, as well as a $871,915 decrease in accrued insurance
claims. The net increase in accounts and current and long term notes receivable
resulted primarily from the growth in the Company's revenues. The decrease in
accrued insurance claims is principally due to the estimated final payment on
expiring policies to the Company's insurance carrier.
The Company's principal use of cash in investing activities for the year
ended December 31, 1998 was the purchase of housekeeping equipment, computer
equipment and laundry equipment installations.
At December 31, 1997 the Company had working capital and cash of $55,705,917
and $17,774,219 respectively which represent decreases of 3% and 22%
respectively, compared to December 31, 1996 working capital and cash of
$57,434,314 and $22,677,290, respectively. The declines are primarily a result
of the Company's expending approximately $10,900,000 for open market purchases
of 942,500 shares of its common stock. As a result of the stock buy-back the
Company's current ratio at December 31, 1997 decreased to 6.7 to 1 from 7.6 to 1
at December 31, 1996.
The net cash provided by the Company's operating activities was $5,364,992
for the year ended December 31, 1997. The principal source of cash flows from
operating activities for 1997 was net income, depreciation and amortization,
charges to operations for bad debt provisions and the timing of payments for
payroll and payroll related taxes. The operating activity that used the largest
amount of cash was a $4,261,684 increase in accounts and current and long term
notes receivable, as well as a $506,560 increase in prepaid expenses and other
assets. The increase in accounts and current and long term notes receivable
resulted primarily from the growth in the Company's revenues. The increase in
prepaid expenses and other assets primarily resulted from payments made in
connection with laundry installations not complete as of December 31, 1997.
11
The Company's principal use of cash in investing activities for the year
ended December 31, 1997 was the purchase of housekeeping equipment and laundry
equipment installations.
The Company expends considerable effort to collect the amounts due for its
services on the terms agreed upon with its clients. Many of the Company's
clients participate in programs funded by federal and state governmental
agencies which historically have encountered delays in making payments to its
program participants. Whenever possible, when a client falls behind in making
agreed-upon payments, the Company converts the unpaid accounts receivable to
interest bearing promissory notes. The promissory notes receivable provide a
means by which to further evidence the amounts owed, provide a definitive
repayment plan and therefore may enhance the ultimate collectibility of the
amounts due. In some instances the Company obtains a security interest in
certain of the debtors' assets.
The Company encounters difficulty in collecting amounts due from certain of
its clients, including those in bankruptcy, those which have terminated service
agreements and slow payers experiencing financial difficulties. In order to
provide for these collection problems and the general risk associated with the
granting of credit terms, the Company has recorded bad debt provisions of
$2,339,515, $899,551 and $2,050,000 in the years ended December 31, 1998, 1997
and 1996 respectively. In making its evaluation, in addition to analyzing, and
anticipating, where possible, the specific cases described above, management
considers the general collection risk associated with trends in the long-term
care industry.
The Company has a $13,000,000 bank line of credit on which it may draw to
meet short-term liquidity requirements in excess of internally generated cash
flow, that expires on September 30, 1999. Amounts drawn under the line are
payable on demand. At December 31, 1998, there were no borrowings under the
line. However, at such date, the line was fully utilized as a result of
contingent liabilities of the Company to the lender relating to letters of
credit issued for the Company (see Note 8 of Notes to Financial Statements).
At December 31, 1998, the Company had $17,201,408 of cash and cash
equivalents, which it views as its principal measure of liquidity.
The level of capital expenditures by the Company is generally dependent on
the number of new clients obtained. Such capital expenditures primarily consist
of housekeeping equipment and laundry and linen equipment installations.
Although the Company has no specific material commitments for capital
expenditures through the end of calendar year 1999, 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 hardware and software
expenditures relating to the implementation of a new computerized financial
reporting system. The Company believes that its cash from operations, existing
balances and credit line will be adequate for the foreseeable future to satisfy
the needs of its operations and to fund its continued growth. However, if the
need arose, the Company would seek to obtain capital from such sources as
long-term debt or equity financing.
In accordance with the Company's previously announced authorizations to
purchase its outstanding common stock, the Company expended $3,496,000 to
purchase 369,000 shares of its common stock during 1998 at an average price of
$9.47 per share. The Company remains authorized to purchase 469,950 shares
pursuant to previous Board of Directors action (in each case after giving effect
to the 50% stock dividend described below).
The Company's Board of Director's declared a three-for-two stock split in the
form of a 50% stock dividend payable August 27, 1998, to the owners of its
Common Stock of record at the close of business August 17, 1998. The effect of
this action was to increase shares outstanding by 3,693,432. The three-for-two
stock split has been reflected in the December 31, 1998 balance sheet.
12
Effect of Recently Issued Accounting Pronouncements
Accounting for Derivative Instruments and Hedging Activities
- ------------------------------------------------------------
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which is effective for fiscal years
beginning after June, 1999. SFAS No. 133 requires all entities to recognize all
derivative instruments on their balance sheet as either assets or liabilities
measured at fair value. SFAS No. 133 also specifies new methods of accounting
for hedging transactions, prescribes the items and transactions that may be
hedged, and specifies detailed criteria to be met to qualify for hedge
accounting.
Adoption of SFAS No. 133 is not expected to have a material effect on the
Company's consolidated financial statements.
Other Matters - Year 2000 Compliance
The Company has implemented new operating and application software which has
become operational during 1998. The Company has been notified by the software
manufacturer, as well as the firm providing installation support, that the new
applications have functionality for the year 2000. Therefore, the Company does
not believe it will incur any material expense, beyond the new systems
installation costs, with respect to year 2000 issues. Additionally, the Company
utilizes an independent service bureau for the processing and payment of payroll
and payroll related taxes. The Company has been notified by its payroll
processing company that all of its systems will be fully compliant with year
2000 requirements. Many of the Company's clients participate in programs funded
by federal and state governmental agencies which may be affected by year 2000
issues. Any failure by the Company, its outside processing company, its clients
or the federal and state governmental agencies to effectively monitor, implement
or improve the above referenced operational, financial, management and technical
support systems could have a material adverse effect on the Company's business
and consolidated results of operations.
Cautionary Statements Regarding Forward Looking Statements
Certain matters discussed may include forward-looking statements that are
subject to risks and uncertainties that could cause actual results or objectives
to differ materially from those projected. Such risks and uncertainties include,
but are not limited to, risks arising from the Company providing its services
exclusively to the health care industry, primarily providers of long-term care,
and credit and collection risks associated with this industry. Additionally, the
Company's operating results would be adversely effected if unexpected increases
in the costs of labor, materials, supplies and equipment used in performing its
services could not be passed on to its clients.
In addition, the Company believes that to improve its future 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 in respect to successfully executing projected growth
strategies.
Effects of Inflation
All of the Company's service agreements allow it to pass through to its clients
increases in the cost of labor resulting from new wage agreements. The Company
believes that it will be able to recover increases in costs attributable to
inflation by continuing to pass through cost increases to its clients.
13
Consolidated Balance Sheets
Assets December 31,
-------------------------
Current Assets: 1998 1997
- --------------- ---- ----
Cash and cash equivalents $17,201,408 $17,774,219
Accounts and notes receivable, less allowance for
doubtful accounts of $3,449,000 in 1998 and
$3,663,000 in 1997 45,066,828 36,560,661
Prepaid income taxes - 366,712
Inventories and supplies 7,803,437 7,339,928
Deferred income taxes (Note 4) 324,054 567,119
Prepaid expenses and other 2,318,285 2,859,133
----------- -----------
Total current assets 72,714,012 65,467,772
Property and Equipment:
Laundry and linen equipment installations 8,985,945 10,993,558
Housekeeping and office equipment 8,482,207 8,731,042
Autos and trucks 51,110 157,611
----------- -----------
17,519,262 19,882,211
Less accumulated depreciation 11,416,214 14,245,071
----------- -----------
6,103,048 5,637,140
COSTS IN EXCESS OF FAIR VALUE OF
NET ASSETS ACQUIRED
less accumulated amortization of $1,420,284 in 1998
and $1,312,660 in 1997 (Note 1) 1,935,193 2,042,817
DEFERRED INCOME TAXES (Note 4) 2,131,535 1,067,670
OTHER NONCURRENT ASSETS (Note 1) 10,225,439 10,674,340
----------- -----------
$93,109,227 $84,889,739
=========== ===========
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts payable $ 4,366,015 $4,275,902
Accrued payroll, accrued and withheld payroll taxes 5,147,634 3,770,310
Other accrued expenses (Note 9) 319,333 944,501
Income taxes payable (Note 4) 283,980 -
Accrued insurance claims (Notes 1 and 10) 588,040 771,142
----------- -----------
Total current liabilities 10,705,002 9,761,855
ACCRUED INSURANCE CLAIMS
(Notes 1 and 10) 2,212,151 2,900,964
COMMITMENTS AND CONTINGENCIES (Notes 2 and 8)
STOCKHOLDERS' EQUITY: (Note 3)
Common stock, $.01 par value: 15,000,000 shares
authorized, 11,034,207 shares issued in 1998 and
7,386,863 in 1997 110,342 73,869
Additional paid in capital 25,064,832 26,005,004
Retained earnings 55,016,900 46,148,047
----------- -----------
Total stockholders' equity 80,192,074 72,226,920
----------- -----------
$93,109,227 $84,889,739
=========== ===========
See accompanying notes.
14
Consolidated Statements of Income
Years Ended December 31,
------------------------
1998 1997 1996
---- ---- ----
Revenues $204,869,023 $181,359,305 $162,482,169
Operating costs and expenses:
Cost of services provided 174,431,075 154,417,984 139,178,736
Selling, general and administrative 17,447,639 15,859,083 12,967,523
Other income (expense):
Settlement of civil litigation (Note 9) (1,800,000)
Interest income 1,400,544 1,412,096 1,143,162
------------ ----------- ------------
Income before income taxes 14,390,853 10,694,334 11,479,072
Income taxes (Note 4) 5,522,000 4,800,000 4,590,000
------------ ----------- ------------
Net income $ 8,868,853 $ 5,894,334 $ 6,889,072
============ ============ ============
Basic earnings per common share
(Notes 1 and 7) $ .79 $ .52 $ .57
============ ============ ============
Diluted earnings per common share
(Notes 1 and 7) $ .77 $ .51 $ .56
============ ============ ============
All per share data has been adjusted to reflect the 3-for-2 stock split paid in
the form of a 50% stock dividend on August 27, 1998.
See accompanying notes.
15
Consolidated Statements of Cash Flows
Years Ended December 31,
------------------------
1998 1997 1996
---- ---- ----
Cash flows from operating activities:
Net Income $ 8,868,853 $ 5,894,334 $ 6,889,072
Adjustments to reconcile net
income to net cash provided
by operating activities:
Depreciation and amortization 2,080,823 2,119,053 2,212,570
Bad debt provision 2,339,515 899,551 2,050,000
Deferred income taxes (benefits)
(Note 4) (820,800) 258,000 660,797
Tax benefit of stock option
transactions 571,985 120,826 2,821
Changes in operating assets and liabilities:
Accounts and notes receivable (10,845,682) (4,141,482) (2,905,442)
Prepaid income taxes 366,712 (366,712) 1,466,184
Inventories and supplies (463,509) 52,579 (192,474)
Changes to long term
notes receivable 629,765 (120,202) (786,737)
Accounts payable and other
accrued expenses (Note 9) (535,055) 303,524 (1,407,510)
Accrued payroll, accrued and
withheld payroll taxes 1,377,324 816,211 641,193
Accrued insurance claims
(Notes 1 and 10) (871,915) 89,009 400,161
Income taxes payable 283,980 (53,139) 53,139
Prepaid expenses and other assets 337,708 (506,560) (184,564)
----------- ----------- -----------
Net cash provided by operating
activities 3,319,704 5,364,992 8,899,210
----------- ----------- -----------
Cash flows from investing activities:
Disposals of fixed assets 400,165 212,721 251,211
Additions to property and equipment (2,816,996) (1,754,111) (2,386,017)
----------- ----------- -----------
Net cash used in investing activities (2,416,831) (1,541,390) (2,134,806)
----------- ----------- -----------
Cash flows from financing activities:
Purchase of treasury stock (3,496,000) (10,923,679) (528,975)
Proceeds from the exercise of stock
options 2,020,316 2,197,006 105,975
----------- ----------- -----------
Net cash used in financing activities (1,475,684) (8,726,673) (423,000)
----------- ----------- -----------
Net increase (decrease) in cash and
cash equivalents (572,811) (4,903,071) 6,341,404
Cash and cash equivalents at
beginning of the year 17,774,219 22,677,290 16,335,886
----------- ----------- -----------
Cash and cash equivalents at end of
the year $17,201,408 $17,774,219 $22,677,290
=========== =========== ===========
See accompanying notes.
16
Consolidated Statements of Stockholders' Equity
Years Ended December 31, 1998, 1997 and 1996
--------------------------------------------
Additional Total
Common Stock Paid-in Retained Treasury Stockholders'
Shares Amount Capital Earnings Stock Equity
------ ------ ------- -------- ----- ------
Balance, December 31, 1995 8,143,063 $ 81,431 $35,023,468 $33,364,641 $ -- $68,469,540
Net income for the year 6,889,072 6,889,072
Exercise of stock options 12,600 126 105,849 105,975
Tax benefit arising from
stock transactions 2,821 2,821
Purchase of common
stock for treasury
(65,000 shares) (528,975) (528,975)
Treasury stock retired (65,000) (650) (528,325) 528,975
---------- -------- ----------- ----------- ----------- -----------
Balance, December 31, 1996 8,090,663 80,907 34,603,813 40,253,713 -- 74,938,433
Net income for year 5,894,334 5,894,334
Exercise of stock options 238,700 2,387 2,194,619 2,197,006
Tax benefit arising from
stock transactions 120,826 120,826
Purchase of common
stock for treasury
(942,500 shares) (10,923,679) (10,923,679)
Treasury stock retired (942,500) (9,425) (10,914,254) 10,923,679
---------- -------- ----------- ----------- ----------- -----------
Balance, December 31, 1997 7,386,863 73,869 26,005,004 46,148,047 -- 2,226,920
Three-for-two stock split 3,693,432 36,934 (36,934)
Net income for year 8,868,853 8,868,853
Exercise of stock options 322,912 3,229 2,017,087 2,020,316
Tax benefit arising from
stock transactions 571,985 571,985
Purchase of common stock
for treasury (369,000 shares) (3,496,000) (3,496,000)
Treasury stock retired (369,000) (3,690) (3,492,310) 3,496,000
---------- -------- ----------- ----------- ----------- -----------
Balance, December 31, 1998 11,034,207 $110,342 $25,064,832 $55,016,900 $ -- $80,192,074
========== ======== =========== =========== =========== ===========
See accompanying notes.
17
Notes to Consolidated Financial Statements
Note 1--Summary of Significant Accounting Policies
General
- -------
The Company provides housekeeping, laundry, linen, facility maintenance and food
services exclusively to the healthcare industry such as nursing homes,
rehabilitation centers, retirement facilities and hospitals.
Principles of Consolidation
- ---------------------------
The consolidated financial statements include the accounts of Healthcare
Services Group, Inc. and its wholly-owned subsidiary, HCSG Supply, Inc. after
elimination of intercompany transactions.
Cash and cash equivalents
- -------------------------
Cash and cash equivalents consist of short-term, highly liquid investments with
a maturity of three months or less at time of purchase.
Impaired notes receivable
- -------------------------
In the event that a promissory note receivable is impaired, it is accounted for
in accordance with FAS 114 and FAS 118; that is, they are valued at the present
value of expected cash flows or market value of related collateral. The Company
evaluates its notes receivable for impairment quarterly and on an individual
client basis. Notes receivable considered impaired are generally attributable to
clients that are either in bankruptcy, have been turned over to collection
attorneys or those slow payers that are experiencing severe financial
difficulties.
At December 31, 1998, the Company had notes receivable aggregating $5,300,000
that are impaired. During 1998, the Company increased its reserve against these
notes by $3,250,000 and charged the reserve $50,000 resulting in a reserve
balance at December 31, 1998 of $4,100,000. During 1998, the average outstanding
balance of these notes receivable was $3,500,000 and no interest income was
recognized.
At December 31, 1997, the Company had notes receivable aggregating $1,600,000
that are impaired. During 1997, the Company reduced its reserve against these
notes by 1,100,000 and charged the reserve $600,000 resulting in a reserve
balance at December 31, 1997, of $900,000. During 1997, the average outstanding
balance of these notes receivable was $2,400,000 and no interest was recognized.
At December 31, 1996, the Company had notes receivable aggregating $3,300,000
that are impaired. During 1996, the Company increased its reserve against these
notes by $1,200,000 and charged the reserve $1,100,000 resulting in a reserve
balance at December 31, 1996 of $2,600,000. During 1996, the average outstanding
balance of these notes receivable was $3,800,000 and no interest income was
recognized.
The Company follows an income recognition policy on all notes receivable that
does not recognize interest income until cash payments are received. This policy
was established for conservative reasons, recognizing the environment of the
long-term care industry, and not because such notes are impaired. The difference
between income recognition on a full accrual basis and cash basis, for notes
that are not considered impaired, is not material. For impaired notes, interest
income is recognized on a cost recovery basis only.
Inventories and supplies
- ------------------------
Inventories and supplies include housekeeping and laundry supplies, as well as
food service provisions which are valued at the lower of cost or market. Cost is
determined on a first-in, first-out (FIFO) basis. Linen supplies are included in
inventory and are amortized over a 24 month period.
Property and equipment
- ----------------------
Property and equipment are stated at cost. Additions, renewals and improvements
are capitalized, while maintenance and repair costs are expensed. When assets
are retired or otherwise disposed of, the cost and related accumulated
depreciation are removed from the respective accounts and any resulting gain or
loss is included in income. Depreciation is provided by the straight-line method
over the following estimated useful lives: laundry and linen equipment
installations -- 3 to 7 years; housekeeping equipment and office equipment -- 3
to 7 years; autos and trucks -- 3 Years.
18
Revenue recognition
- -------------------
Revenues from service agreements are recognized as services are performed. The
Company (as a distributor of laundry equipment since 1981) occasionally makes
sales of laundry installations to certain clients. The sales in most cases
represent the construction and installation of a turn-key operation and are for
payment terms ranging from 36 to 60 months. The Company's accounting policy for
these sales is to recognize the gross profit over the life of the original
payment terms associated with the financing of the transactions by the Company.
During 1998, 1997 and 1996, laundry installation sales were not material.
Income taxes
- ------------
Deferred income taxes result from temporary differences between tax and
financial statement recognition of revenue and expense. These temporary
differences arise primarily from differing methods used for financial and tax
purposes to calculate insurance expense, certain receivable reserves, other
provisions which are not currently deductible for tax purposes, and revenue
recognized on laundry installation sales.
Income taxes paid were approximately $5,120,000, $5,481,000 and $1,936,000
during 1998, 1997 and 1996, respectively.
Earnings per common share
- -------------------------
Basic earnings per common share is computed by dividing income available to
common shareholders by the weighted-average common shares outstanding for the
period. Diluted earnings per common share reflects the weighted-average common
shares outstanding and dilutive potential common shares, such as stock options.
Earnings per common share has been adjusted to reflect the 3-for-2 stock split
described in Note 3.
Costs in excess of fair value of net assets
- -------------------------------------------
Costs in excess of the fair value of net assets of businesses acquired are
amortized on a straight-line basis over periods not exceeding forty years. All
of the carrying value at December 31, 1998 resulted from a 1985 acquisition
which is being amortized over a thirty-one year period. Amortization charged to
earnings was $107,624 per year for the years 1998, 1997 and 1996, respectively.
On an ongoing basis, management reviews the valuation and amortization of
costs in excess of fair value of net assets acquired. As part of this review,
the Company estimates the value and future benefits of the net income generated
by the related service agreements to determine that no impairment has occurred.
Other noncurrent assets
- -----------------------
Other noncurrent assets consist of:
1998 1997
----------- -----------
Long-term notes receivable $ 9,748,210 $10,377,975
Other 477,229 296,365
----------- -----------
$10,225,439 $10,674,340
=========== ===========
Long-term notes receivable primarily represent trade receivables that were
converted to notes to enhance collection efforts. Interest income is only
recognized as cash payments are received. Amounts shown are net of allowance for
doubtful accounts of $2,777,580 and $336,500 in 1998 and 1997, respectively.
Reclassification
- ----------------
Certain reclassifications to 1997 reported amounts have been made in the
financial statements to conform to 1998 presentation.
19
Concentrations of Credit Risk
- -----------------------------
Statement of Financial Accounting Standards No. 105 (SFAS No. 105) requires the
disclosure of significant concentrations of credit risk, regardless of the
degree of such risk. Financial instruments, as defined by SFAS No. 105, which
potentially subject the Company to concentrations of credit risk, consist
principally of cash and cash equivalents and accounts and notes receivable. At
December 31, 1998 and 1997, substantially all of the Company's cash and cash
equivalents were invested with one financial institution. The Company's clients
are concentrated in the health care industry, primarily providers of long-term
care. The clients are comprised of many companies with a wide geographical
dispersion within the United States. However, recent industry trends indicate
consolidation of nursing home ownership into chains, which can lead to a client
concentration. At December 31, 1998, no single client or nursing home chain
accounted for more than 10% of total revenue.
Fair Value of Financial Instruments
- -----------------------------------
The carrying value of financial instruments (principally consisting of cash and
cash equivalents, accounts and notes receivable and accounts payable)
approximate fair value.
Use of Estimates in Financial Statements
- ----------------------------------------
In preparing financial statements in conformity with generally accepted
accounting principles, management makes estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosures of contingent
assets and liabilities at the date of the financial statements, as well as the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
Note 2--Lease Commitments
The Company leases office facilities and autos under operating leases expiring
on various dates through 2003 (see Note 5). The following is a schedule, by
calendar years, of future minimum lease payments under operating leases having
remaining terms in excess of one year as of December 31, 1998:
Operating
Year Leases
--------
1999 ................................................. $480,011
2000 ................................................. 331,464
2001 ................................................. 110,426
2002 ................................................. 44,325
2003 ................................................. 23,590
--------
Total minimum lease payments ......................... $989,816
========
Total expense for all operating leases was $861,245, $813,719 and $698,041 for
the years ended December 31, 1998, 1997 and 1996, respectively.
Note 3--Stockholders' Equity
On August 5, 1998, the Board of Directors declared a three-for-two stock split
of the Company's Common Stock effected in the form of a 50% stock dividend
payable on August 27, 1998 to Common Stock stockholders of record on August 17,
1998. An amount equal to the par value of the shares of Common Stock issued was
transferred from additional paid in capital to common stock in the December 31,
1998 balance sheet. All stock options, share and per share disclosures have been
adjusted to reflect the 3-for-2 stock split.
As of December 31, 1998, 1,127,354 shares of common stock were reserved under
the incentive stock option plans, including 331,999 shares which were available
for future grant. The Stock Option Committee is responsible for determining the
individuals who will be granted options, the number of options each individual
will receive, the option price per share, and the exercise period of each
option. The incentive stock option price will not be less than the fair market
value of the common stock on the date the option is granted. No option will have
a term in excess of ten years and are exercisable commencing six months from the
option date. As to any stockholder who owns 10% or more of the common stock, the
option price per share will be no less than 110% of the fair market value of the
common stock on the date the options are granted and such options shall not have
a term in excess of five years.
20
On December 6, 1996, the Stock Option Committee extended to December 18, 2001
the expiration date of 139,200 Incentive Stock Options which were due to expire
on December 18, 1996. Such options were extended at their original grant price
which was greater than the fair market value on the date of the extension.
As of December 31, 1998, options outstanding, under the Incentive Stock
Option Plans, for 626,186 shares were exercisable at prices ranging from $5.56
to $9.90, and the weighted average remaining contractual life was 5.1 years. The
weighted average fair value of incentive options granted during 1998, 1997 and
1996 was $3.74, $1.17 and $1.73, respectively.
A summary of incentive stock option activity is as follows:
Incentive Stock Options
----------------------------------------------------------------------
1998 1997 1996
--------------------- ------------------- --------------------
Average Number Average Number Average Number
Price of Shares Price of Shares Price of Shares
----- --------- ----- --------- ----- ---------
Beginning of period $7.11 914,076 $6.78 928,818 $7.09 764,474
Granted 8.43 169,169 7.72 197,696 6.25 237,620
Cancelled 5.70 (17,326) 6.68 (23,738) 8.50 (66,376)
Exercised 6.48 (270,564) 6.20 (188,700) 5.65 (6,900)
----- -------- ----- -------- ----- -------
End of period $7.63 795,355 $7.11 914,076 $6.78 928,818
===== ======= ===== ======= ===== =======
Exercisable at end of period 626,186 716,380 732,846
======= ======= =======
The Company has granted non-qualified stock options primarily to employees
and directors under either the Company's 1995 Incentive and Non-Qualified Stock
Option Plan for key employees and the Company's 1996 Non-Employee Director's
Stock Option Plan. Amendments to the 1995 Plan, as well as the 1996 Plan were
adopted on March 6, 1996 and approved by shareholders on June 4, 1996. Pursuant
to the terms of the 1996 Non-Employee Director's Stock Option Plan, each
eligible non-employee director receives an automatic grant based on a prescribed
formula on the fixed annual grant date. The non-qualified options were granted
at option prices which were not less than the fair market value of the common
stock on the date the options were granted. The options are exercisable over a
five to ten year period, commencing six months from the option date.
As of December 31, 1998, non-qualified options outstanding, under the above
mentioned plans, for 426,540 shares were exercisable at prices ranging from
$5.67 to $9.21, and the weighted average remaining contractual life was 4.3
years. The weighted average fair value of non-qualified options granted during
1998, 1997 and 1996 was $5.53, $4.97 and $1.68, respectively.
21
A summary of non-qualified stock option activity is as follows:
Non Qualified Stock Options
----------------------------------------------------------------------
1998 1997 1996
--------------------- ------------------- --------------------
Average Number Average Number Average Number
Price of Shares Price of Shares Price of Shares
----- --------- ----- --------- ----- ---------
Beginning of period $6.84 495,525 $6.47 581,391 $6.48 476,180
Granted 8.60 52,156 7.89 89,484 6.30 117,211
Cancelled - - - - - -
Exercised 6.19 (68,985) 6.13 (175,350) 5.58 (12,000)
----- -------- ----- -------- ----- -------
End of period $7.13 478,696 $6.84 495,525 $6.47 581,391
===== ======= ===== ======= ===== =======
Exercisable at end of period 426,540 406,041 491,533
======= ======= =======
The Company applies APB Opinion 25 in measuring stock compensation. Accordingly,
no compensation cost has been recorded for options granted to employees or
directors in the years ended December 31, 1998, 1997 and 1996. The fair value of
each option granted has been estimated on the grant date using the Black-Scholes
Option Valuation Model. The following assumptions were made in estimating fair
value:
1998 1997 1996
--------------- --------------- -------
Risk-Free Interest-Rate 4.53% and 4.94% 5.69% and 6.54% 5.83%
Expected Life 5 and 10 years 1 and 10 years 2 years
Expected Volatility 42.0% and 49.3% 32.0% and 49.5% 42.2%
Had compensation cost been determined under fasb Statement No. 123, net income
and earnings per share would have been reduced as follows:
(in thousands)
Year Ended December 31,
--------------------------------
1998 1997 1996
---- ---- ----
Net Income
As reported $8,869 $5,894 $6,889
Pro forma $8,682 $5,174 $6,516
Basic Earnings Per Common Share
As reported $ .79 $ .52 $ .57
Pro forma $ .78 $ .46 $ .54
Diluted Earnings Per Common Share
As reported $ .77 $ .51 $ .56
Pro forma $ .75 $ .45 $ .53
22
Note 4--Income Taxes
The provision for income taxes consists of:
Year Ended December 31,
-------------------------------------
1998 1997 1996
---- ---- ----
Current:
Federal $4,789,900 $3,361,900 $2,923,800
State 1,552,900 1,180,100 1,005,400
---------- ---------- ----------
6,342,800 4,542,000 3,929,200
---------- ---------- ----------
Deferred:
Federal (631,700) 194,500 498,000
State (189,100) 63,500 162,800
---------- ---------- ----------
(820,800) 258,000 660,800
---------- ---------- ----------
Tax Provision $5,522,000 $4,800,000 $4,590,000
========== ========== ==========
Under FAS 109, deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amount used for income tax purposes. Significant
components of the Company's federal and state deferred tax assets and
liabilities are as follows:
Year Ended December 31,
-----------------------
1998 1997
---- ----
Net current deferred assets:
Allowance for doubtful accounts $1,431,335 $1,487,424
Accrued insurance claims- current 244,037 313,084
Expensing of housekeeping supplies (1,351,318) (1,233,389)
---------- ----------
$ 324,054 $ 567,119
========== ==========
Net noncurrent deferred tax assets:
Deferred profit on laundry installation sales $ 188,063 $ 182,719
Non-deductible reserves 1,722,076 479,126
Depreciation of property and equipment (715,594) (901,975)
Accrued insurance claims- noncurrent 918,043 1,177,791
Other 18,947 130,009
---------- ----------
$2,131,535 $1,067,670
========== ==========
23
A reconciliation of the provision for income taxes and the amount computed by
applying the statutory federal income tax rate (34%) to income before income
taxes is as follows:
Year Ended December 31,
-----------------------------------
1998 1997 1996
---- ---- ----
Tax expense computed at
statutory rate $4,892,900 $3,636,100 $3,902,900
Increases (decreases) resulting
from:
State income taxes, net of
federal tax benefit 900,100 820,700 771,000
Tax exempt interest (400) (268,800) (222,100)
Nondeductible reserves 416,500
Amortization of costs in
excess of fair value of
net assets acquired 36,600 37,100 36,600
Other, net (307,200) 158,400 101,600
-------- ------- -------
$5,522,000 $4,800,000 $4,590,000
========== ========== ==========
Note 5--Related Party Transactions
The Company leases its corporate offices from a partnership in which the chief
executive officer of the Company is a general partner. The rental payments made
during the years ended December 31, 1998, 1997 and 1996 were $88,617 per year.
The Company made no leasehold improvements in 1998, 1997 or 1996. A director of
the Company has an ownership interest in several client facilities which have
entered into service agreements with the Company.
During the years ended December 31, 1998, 1997 and 1996 the agreements with
the client facilities which the director has an ownership interest resulted in
Company revenues of approximately $2,931,000, $2,957,000 and $2,838,704
respectively.
Note 6--Segment Information
The Company provides housekeeping, laundry, linen, facility maintenance and food
services to the healthcare industry. The Company considers its business to
consist of one reportable operating segment, based on the service business
categories, provided to a client facility, sharing similar economic
characteristics in the nature of the service provided, method of delivering
service and client base. Although the Company does provide services in Canada,
essentially all of its revenue and net income, approximately 99%, are earned in
one geographic area, the United States.
The Company earned revenue in the following service business categories:
Year Ended December 31,
----------------------------------------
1998 1997 1996
---- ---- ----
Housekeeping services $134,727,000 $127,255,000 $120,687,000
Laundry & linen services 53,066,000 43,372,000 39,955,000
Food services 13,374,000 8,085,000 -
Maintenance services &
other 3,702,000 2,647,000 1,840,000
------------ ------------ ------------
$204,869,000 $181,359,000 $162,482,000
============ ============ ============
24
Note 7--Earnings Per Common Share
A reconciliation of the numerator and denominators of basic and diluted earnings
per common share (after giving effect to the August 27, 1998 three-for-two stock
split) is as follows:
Year Ended December 31, 1998
------------------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
----------- ------------- ---------
Net Income $8,868,853
Basic earnings per
common share 8,868,853 11,187,615 $ .79
Effect of dilutive
securities:
Options 324,582
---------- ---------- ------
Diluted earnings per
common share $8,868,853 11,512,197 $ .77
========== ========== ======
Year Ended December 31, 1997
------------------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
----------- ------------- ---------
Net Income $5,894,334
Basic earnings per
common share 5,894,334 11,353,602 $ .52
Effect of dilutive
securities:
Options 224,538
---------- ---------- ------
Diluted earnings per
common share $5,894,334 11,578,140 $ .51
========== ========== ======
Year Ended December 31, 1996
------------------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
----------- ------------- ---------
Net Income $6,889,072
Basic earnings per
common share 6,889,072 12,155,572 $ .57
Effect of dilutive
securities:
Options 47,678
---------- ---------- ------
Diluted earnings per
common share $6,889,072 12,203,250 $ .56
========== ========== ======
Options to purchase 27,215, 321,450 and 659,700 shares of common stock at an
average exercise price of $9.78, $8.39 and $7.72 for the years ended December
31, 1998, 1997 and 1996, respectively were outstanding during such years but not
included in the computation of diluted earnings per share because the options'
exercise prices were greater than the average market value of the common shares.
25
Note 8--Other Contingencies
The Company has a $13,000,000 bank line of credit under which it may draw to
meet short-term liquidity requirements or for other purposes, that expires on
September 30, 1999. Amounts drawn under the line are payable upon demand. At
both December 31, 1998 and 1997, there were no borrowings under the line. At
December 31, 1998 and 1997, the Company had outstanding approximately
$13,000,000 and $11,200,000, respectively of irrevocable standby letters of
credit, which primarily relate to payment obligations under the Company's
insurance program. As a result of letters of credit issued, the amount available
under the line was reduced by approximately $13,000,000 and $11,200,000 at
December 31, 1998 and December 31, 1997, respectively.
The Company is also involved in miscellaneous claims and litigation arising
in the ordinary course of business. The Company believes that these matters,
taken individually or in the aggregate, would not have a material adverse impact
on the Company's financial position or results of operations.
Note 9--Settlement of Civil Litigation
On July 24, 1997 the Company and the U.S. Attorney for the Eastern District of
Pennsylvania reached a settlement of the civil litigation commenced by the
United States Attorney on or about May 24, 1996. This litigation was a result of
and arose from (1) payments made by the Company for supplies which were
allegedly furnished to clients of the Company and the actions of the Company
after the payments were made and (2) payments made to certain clients of the
Company in connection with the purchase of laundry installations from those
clients. All claims described in the complaint were settled through the payment
in July, 1997 of $1,225,000 to the United States government. The Company and its
officers denied all allegations, and all allegations against the Company and its
officers were dismissed with prejudice. The monetary impact of this settlement
plus estimated related legal costs of $575,000, amounting to approximately
$1,800,000 was accrued at June 30, 1997 and reduced the net income for the year
ended December 31, 1997 by $1,577,000 or $.14 per basic common share and $.13
per diluted common share (after effect of the August 27, 1998 three-for-two
stock split). The Company has not recorded an income tax benefit in the
accompanying financial statements for the settlement payment of $1,225,000 and
therefore the effective tax rate of 44.9% for the year ended December 31, 1997
is in excess of the statutory rate.
Note 10--Accrued Insurance Claims
For years 1996 through 1998, the Company 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 company. The accrued
insurance claims were reduced by approximately $2,200,000, $2,353,000 and
$2,956,000 at December 31, 1998, 1997 and 1996, respectively in order to record
the estimated present value at the end of each year using an 8% interest factor.
For general liability insurance, the Company records a reserve for the estimated
ultimate amounts to be paid for known claims.
26
Market Makers
As of the end of 1998, the following firms were making a market in the shares of
Healthcare Services Group, Inc.:
Salomon Smith Barney Inc.
C. L. King & Associates
Prudential Securities, Inc.
Troster Singer Corp.
Wedbush Morgan Securities, Inc.
Mayer & Schweitzer Inc.
Herzog, Heine, Geduld, Inc.
About Your Shares
Healthcare Services Group, Inc.'s common stock is traded on the NASDAQ National
Market System of the over-the-counter market. On December 31, 1998 there was
11,034,207 of the Company's common shares issued and outstanding. As of March 1,
1999 there were approximately 320 holders of record of the common stock,
including holders whose stock was held in nominee name by brokers or other
nominees. It is estimated that there are approximately 2,600 beneficial holders.
Price quotations (after giving effect to the August 27, 1998 three-for-two stock
split) during the two years ended December 31, 1998, ranged as follows:
1998 High 1998 Low
--------- --------
1st Qtr. ....................................... 9 15/16 8 1/3
2nd Qtr. ....................................... 9 9/16 9 1/3
3rd Qtr. ....................................... 11 11/16 8 3/16
4th Qtr. ....................................... 9 7/8 8 3/8
1997 High 1997 Low
--------- --------
1st Qtr. ....................................... 8 1/3 6 3/4
2nd Qtr. ....................................... 8 1/3 6 2/3
3rd Qtr. ....................................... 9 1/3 7 2/3
4th Qtr. ....................................... 9 9/16 8 3/16
27
Report Of Independent Certified Public Accountants
The Stockholders and Board of Directors
Healthcare Services Group, Inc.
We have audited the accompanying consolidated balance sheets of Healthcare
Services Group, Inc. as of December 31, 1998 and 1997, and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the three years in the period ended December 31, 1998. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
consolidated financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Healthcare Services Group, Inc. at December 31, 1998 and 1997 and the
consolidated results of their operations and their consolidated cash flows for
each of the three years in the period ended December 31, 1998, in conformity
with generally accepted accounting principles.
Parsippany, New Jersey
February 17, 1999
28
Transfer Agent Auditors
American Stock Transfer & Trust Co. Grant Thornton LLP
99 Wall St. 9 Campus Drive
New York, NY 10005 Parsippany, NJ 07054
Corporate Counsel Corporate Offices
Olshan Grundman Frome Healthcare Services Group, Inc.
Rosenzweig & Wolosky LLP 2643 Huntingdon Pike
505 Park Ave. Huntingdon Valley, PA 19006
New York, NY 10022 215-938-1661
Stock Listing Annual Stockholders' Meeting
Listed on the NASDAQ Date - May 18, 1999
National Market System Symbol - "HCSG" Time - 10:00 A.M.
Place - The Radisson Hotel of Bucks County
2400 Old Lincoln Highway
Trevose, PA 19047
Officers and Corporate Management
Daniel P. McCartney Nicholas R. Marino
Chief Executive Officer Human Resources Director
Thomas A. Cook Michael E. McBryan
President & Chief Operating Officer Mid-Atlantic Divisional Vice President - Sales
Alan L. Crowell Bryan D. McCartney
Vice President - Food Service Division Mid-Atlantic Divisional Vice President
James L. DiStefano Joseph F. McCartney
Chief Financial Officer and Treasurer Northeastern Divisional Vice President
Michael Harder James P. O'Toole
Vice President - Credit Administration Mid-Atlantic Regional Vice President
Richard W. Hudson Brian M. Waters
Vice President - Finance and Secretary Vice President - Operations
John D. Kelly Michael L. Wyse
Western Divisional Vice President Western Divisional Vice President - Sales
Directors
Daniel P. McCartney Robert L. Frome, Esq.
Chairman & Chief Executive Officer Senior Partner - Olshan Grundman Frome
Rosenzweig & Wolosky LLP
Thomas A. Cook
President & Chief Operating Officer Robert J. Moss, Esq.
Executive Director - Alzheimer's Association of
Joseph F. McCartney South Central Pennsylvania
Northeastern Divisional Vice President
John M. Briggs, CPA
Barton D. Weisman Partner - Briggs, Bunting & Dougherty LLP
President & CEO-H.B.A. Corp.
W. Thacher Longstreth
Vice Chairman - Packard Press
Availability of Form 10-K
A copy of Healthcare Services Group, Inc.'s 1998 Annual Report on Form 10-K, as
filed with the Securities and Exchange Commission, will be provided without
charge to each shareholder making a written request to the Investor Relations
Department of the Company at its Corporate Offices.
29
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosures
Not Applicable
PART III
--------
Item 10. Directors and Executive Officers of the Registrant
The information regarding Directors and executive officers is
incorporated herein by reference to the Company's definitive proxy statement to
be mailed to its shareholders in connection with its 1999 Annual Shareholders'
Meeting and to be filed within 120 days of the close of the year ended December
31, 1998.
Directors holding approximately 13.7% of the outstanding voting stock
of the Registrant have been deemed to be "affiliates" solely for the purpose of
calculating the aggregate market value of the voting stock held by
non-affiliates set forth on the cover page of this Report.
Item 11. Executive Compensation
The Information regarding executive compensation is incorporated herein
by reference to the Company's proxy statement to be mailed to shareholders in
connection with its 1999 Annual Shareholders Meeting and to be filed within 120
days of the close of the fiscal year ended December 31, 1998.
Item 13. Certain Relationships and Related Transactions
The information regarding certain relationship and related transactions
is incorporated herein by reference to the Company's proxy statement mailed to
shareholders in connection with its 1999 Annual Shareholders Meeting and to be
filed within 120 days of the close of the fiscal year ended December 31, 1998.
30
PART IV
-------
Item 14. Exhibits, Financial Statements Schedules and Reports on Form 8-K
(a) 1. Financial Statements
The documents shown below are contained in the Company's
Annual Report to Shareholders for 1998 and are incorporated herein by
reference.
Report of Independent Certified Public Accountants.
Balance Sheets as of December 31, 1998 and 1997.
Statements of Income for the three years ended December 31, 1998, 1997
and 1996.
Statements of Stockholders Equity for the three years ended
December 31, 1998, 1997 and 1996.
Statements of Cash Flows for the three years ended December 31, 1998,
1997 and 1996.
Notes to Financial Statements.
2. Financial Statement Schedules Included in Part IV of this
report:
Consent of Independent Certified Public Accountants.
Report of Independent Certified Public Accountants.
Schedule II - Valuation and Qualifying Accounts for the three years
ended December 31, 1998, 1997 and 1996.
Financial Data Schedule.
All other schedules are omitted since they are not required, not
applicable or the information has been included in the Financial Statements or
notes thereto.
31
3. Exhibits
The following Exhibits are filed as part of this Report
(references are to Reg. S-K Exhibit Numbers):
Exhibit
Number Title
- ------ -----
3.1 Articles of Incorporation of the Registrant, as amended, are
incorporated by reference to Exhibit 4.1 to the Company's
Registration Statement on Form S-2 (File No. 33-35798).
3.2 Amended By-Laws of the Registrant as of July 18, 1990, are
incorporated by reference to Exhibit 4.2 to the Company's
Registration Statement on Form S-2 (File No. 33-35798).
4. Specimen Certificate of the Common Stock, $.01 par value, of
the Registrant is incorporated by reference to Exhibit 4.1 of
Registrant's Registration Statement on Form S-18 (Commission
File No. 2-87625-W).
10.1 Incentive Stock Option Plan adopted on August 31, 1983,
amended and readopted on April 30, 1991 is incorporated by
reference to Exhibit 10.1 of Registrant's Registration
Statement on Form S-18 (Commission File No. 2-87625-W), as
well as by reference to the Company's definitive proxy
statement dated April 30, 1991.
10.2 1995 Incentive and Non-Qualified Stock Option Plan, as amended
(incorporated by reference to Exhibit 4(d) of the Form S-8
filed by the Registrant on July 31, 1996).
10.3 1996 Non-Employee Directors' Stock Option Plan, Amended and
Restated as of October 28, 1997 (incorporated by reference to
Exhibit 10.6 of Form 10-Q Report filed by Registrant on
November 14, 1997)
10.4 1995 Non-Qualified Stock Option Plan for Directors
(incorporated by reference to the Company's Definitive Proxy
Statement dated April 21, 1995.)
10.5 Form of Non-Qualified Stock Option Agreement granted to
certain Directors is incorporated by reference to Exhibit 10.9
of Registrant's Registration Statement on Form S-1 (Commission
File No. 2-98089).
23. Consent of Independent Certified Public Accountants
27. Financial Data Schedule
(b) Reports on Form 8-K
None
32
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities
and Exchange Act of 1934, the Registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
Dated: March 26, 1999 HEALTHCARE SERVICES GROUP, INC.
(Registrant)
By: /s/ Daniel P. McCartney
--------------------------------
Daniel P. McCartney
Chief Executive Officer and
Chairman of the Board
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed below by the following persons and in the
capacities and on the date indicated:
Signature Title Date
--------- ----- ----
/s/ Daniel P. McCartney Chief Executive Officer and March 26, 1999
- ----------------------- Chairman
Daniel P. McCartney
/s/ Joseph F. McCartney Director and Vice President March 26, 1999
- -----------------------
Joseph F. McCartney
/s/ Thacher Longstreth Director March 26, 1999
- -----------------------
Thacher Longstreth
/s/ Barton D. Weisman Director March 26, 1999
- ---------------------
Barton D. Weisman
/s/ Robert L. Frome Director March 26, 1999
- -------------------
Robert L. Frome
/s/ Thomas A. Cook Director and President March 26, 1999
- ------------------
Thomas A. Cook
/s/ John M. Briggs Director March 26, 1999
- ------------------
John M. Briggs
/s/ Robert J. Moss Director March 26, 1999
- ------------------
Robert J. Moss
/s/ James L. DiStefano Chief Financial Officer and March 26, 1999
- ---------------------- Treasurer
James L. DiStefano
/s/ Richard W. Hudson Vice President-Finance and March 26, 1999
- --------------------- Secretary
Richard W. Hudson
33