10-Q 1 tenq.txt 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For Quarter Ended March 31, 2004 Commission File Number 0-120152 HEALTHCARE SERVICES GROUP, INC. ------------------------------- (Exact name of registrant as specified in its charter) Pennsylvania 23-2018365 ------------------------------- ---------------------------- (State or other jurisdiction of (IRS Employer Identification incorporation or organization) number) 3220 Tillman Drive-Suite 300, Bensalem, Pennsylvania 19020 --------------------------------------------------------------- (Address of principal executive office) (Zip code) Registrant's telephone number, including area code: 215-639-4274 ------------ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months ( or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for past 90 days. YES X NO ----- ----- Indicate by check mark whether the registrant is an Accelerated Filer ( as defined in Rule 12b-2 of the Exchange Act ) YES X NO ----- ----- Number of shares of common stock, issued and outstanding as of April 28, 2004 is 17,527,286 Total of 22 Pages
INDEX PART I. FINANCIAL INFORMATION PAGE NO. --------------------- -------- Item 1. Financial Statements (Unaudited) Consolidated Balance Sheets as of March 31, 2004 and December 31, 2003 2 Consolidated Statements of Income for the Three Months Ended March 31, 2004 and 2003 3 Consolidated Statements of Cash Flows for the Three Months ended March 31, 2004 and 2003 4 Consolidated Statement of Stockholders' Equity as of March 31, 2004 5 Notes To Consolidated Financial Statements 6 - 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results Of Operations 10 - 15 Item 3. Quantitative and Qualitative Disclosure About Market Risk 16 Item 4. Controls and Procedures 17 Part II. Other Information 17 ----------------- Signatures 19 Exhibits - Certifications 20 - 22
-1- Consolidated Balance Sheets
(Unaudited) March 31, December 31, 2004 2003 ---------------------------------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 67,343,847 $ 64,180,697 Accounts and notes receivable, less allowance for doubtful accounts of $3,987,000 in 2004 and $3,414,000 in 2003 55,052,808 58,145,440 Inventories and supplies 10,720,268 10,454,838 Deferred income taxes 2,268,698 2,016,798 Prepaid expenses and other 3,813,273 3,312,959 -------------- -------------- Total current assets 139,198,894 138,110,732 PROPERTY AND EQUIPMENT: Laundry and linen equipment installations 2,243,499 2,190,388 Housekeeping and office equipment 13,336,723 12,830,794 Autos and trucks 79,639 79,639 -------------- -------------- 15,659,861 15,100,821 Less accumulated depreciation 10,936,000 10,489,224 -------------- -------------- 4,723,861 4,611,597 NOTES RECEIVABLE- long term portion 7,930,505 7,904,195 DEFERRED COMPENSATION FUNDING 3,093,067 2,847,575 DEFERRED INCOME TAXES- long term portion 3,088,191 3,134,691 OTHER NONCURRENT ASSETS 1,719,342 1,719,342 -------------- -------------- $ 159,753,860 $ 158,328,132 ============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 6,368,432 $ 6,536,395 Accrued payroll, accrued and withheld payroll taxes 9,212,904 14,127,469 Other accrued expenses 2,133,919 874,523 Income taxes payable 656,418 178,862 Accrued insurance claims 3,060,711 2,978,974 -------------- -------------- Total current liabilities 21,432,384 24,696,223 ACCRUED INSURANCE CLAIMS- long term portion 9,182,135 8,936,921 DEFERRED COMPENSATION LIABILITY 3,805,532 3,496,810 COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Common stock, $.01 par value: 45,000,000 shares authorized, 18,081,616 shares issued in 2004 and 17,938,613 in 2003 180,816 179,386 Additional paid in capital 34,989,853 33,515,234 Retained earnings 93,565,654 91,178,370 Common stock in treasury, at cost, 603,907 shares in 2004 and 652,238 in 2003 (3,402,514) (3,674,812) -------------- -------------- Total stockholders' equity 125,333,809 121,198,178 -------------- -------------- $ 159,753,860 $ 158,328,132 ============== ==============
See accompanying notes. -2- CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 31, 2004 2003 ---------------- ---------------- Revenues $ 106,621,820 $ 89,531,352 Operating costs and expenses: Costs of services provided 93,396,926 78,690,855 Selling, general and administrative 8,014,901 6,796,788 Other Income : Investment and interest income 142,202 199,203 ------------- ------------ Income before income taxes 5,352,195 4,242,912 Income taxes 2,034,000 1,697,000 ------------- ------------ Net Income $ 3,318,195 $ 2,545,912 ============= ============ Basic earnings per common share $ 0.19 $ 0.15 ============= ============ Diluted earnings per common share $ 0.18 $ 0.15 ============= ============ Cash dividends per common share $ 0.053 $ -- ============= ============ Basic weighted average number of common shares outstanding 17,476,278 16,867,871 ============= ============ Diluted weighted average number of common shares outstanding 18,429,590 17,511,581 ============= ============
See accompanying notes. -3- CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 31, ----------------------------- 2004 2003 ------------- -------------- Cash flows from operating activities: Net Income $ 3,318,195 $ 2,545,912 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 482,961 500,093 Bad debt provision 1,000,000 1,500,000 Deferred income taxes (benefit) (205,400) 806,000 Tax benefit of stock option transactions 428,035 52,740 Changes in operating assets and liabilities: Accounts and notes receivable 2,092,632 (2,023,620) Prepaid income taxes 680,541 Inventories and supplies (265,430) (987,412) Notes Receivable--long-term (26,311) 89,828 Deferred compensation funding (245,492) (230,446) Accounts payable and other accrued expenses 1,091,433 1,503,629 Accrued payroll, accrued and withheld payroll taxes (4,548,387) (4,302,684) Deferred compensation liability 308,722 283,283 Income taxes payable 477,556 -- Accrued insurance claims 326,951 787,016 Prepaid expenses and other assets (500,314) (1,044,758) ------------- -------------- Net cash provided by operating activities 3,735,151 160,122 ------------- -------------- Cash flows from investing activities: Disposals of fixed assets 54,783 60,551 Additions to property and equipment (650,008) (569,119) ------------- -------------- Net cash used in investing activities (595,225) (508,568) ------------- -------------- Cash flows from financing activities: Dividends paid (930,911) -- Reissuance of treasury stock 1,534 -- Proceeds from the exercise of stock options 952,601 129,902 ------------- -------------- Net cash provided by financing activities 23,224 129,902 ------------- -------------- Net increase (decrease) in cash and cash equivalents 3,163,150 (218,544) Cash and cash equivalents at beginning of the period 64,180,697 48,320,098 ------------- -------------- Cash and cash equivalents at end of the period $ 67,343,847 $ 48,101,554 ============= ============== Supplementary Cash Flow Information: Issuance of 48,224 shares of Common Stock in 2004 and 36,212 shares of Common Stock in 2003 pursuant to Employee Stock Plans $ 366,177 $ 205,199 ============= ==============
See accompanying notes. -4- Consolidated Statements of Stockholders' Equity (Unaudited)
For the Three Months Ended March 31, 2004 ----------------------------------------- Additional Total Common Stock Paid-in Retained Treasury Stockholders' Shares Amount Capital Earnings Stock Equity ---------------- --------- ------------ ------------ ------------- -------------- Balance, December 31, 2003 17,938,613 $179,386 $33,515,234 $91,178,370 ($3,674,812) $121,198,178 Net income 3,318,195 3,318,195 Exercise of stock options 143,003 1,430 951,171 952,601 Tax benefit arising from stock option transactions 428,035 428,035 Shares issued pursuant to Employee Stock Plans (48,224 shares) 94,478 271,699 366,177 Cash dividends paid - $.053 per common share (930,911) (930,911) Shares issued pursuant to Dividend Reinvestment Plan (107 shares) 935 599 1,534 ---------------- --------- ------------ ------------ ------------- -------------- Balance, March 31, 2004 18,081,616 $180,816 $34,989,853 $93,565,654 ($3,402,514) $125,333,809 ================ ========= ============ ============ ============= ==============
See accompanying notes. -5- 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, 2003 has been derived from, and does not include, all the disclosures contained in the financial statements for the year ended December 31, 2003. The financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2003. The results of operations for the quarter ended March 31, 2004 are not necessarily indicative of the results that may be expected for the full fiscal year. NOTE 2 - THREE-FOR-TWO STOCK SPLIT On February 12, 2004, the Company's Board of Directors approved a three-for-two stock split in the form of a 50% common stock dividend which was paid on March 1, 2004 to shareholders of record on February 23, 2004. All share and per share information for all periods presented have been adjusted to reflect the three-for-two stock split. NOTE 3 - OTHER CONTINGENCIES 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 upon demand. At both March 31, 2004 and December 31, 2003, there were no borrowings under the line. However, at such dates, the Company had outstanding $15,925,000 and $14,500,000, respectively 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 $15,925,000 and $14,500,000 at March 31, 2004 and December 31, 2003, 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 affect on the Company's financial position or results of operations. The Balance Budget Act of 1997 changed Medicare policy in a number of ways, most notably the phasing in, effective July 1, 1998, of a Medicare Prospective Payment System for skilled nursing facilities which significantly changed the manner and the amounts of reimbursement they receive. Many of 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. -6- NOTE 4 - SEGMENT INFORMATION The Company manages and evaluates its operations in two reportable operating segments. The two operating segments are Housekeeping services (housekeeping, laundry, linen and other services), and Food service. Although both segments serve the same client base and share many operational similarities they are managed separately due to distinct differences in the type of service provided, as well as the specialized expertise required of the professional management personnel responsible for delivering the respective segments' services. The Company considers the various services provided within the Housekeeping 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 services' segment provides services in Canada, although essentially all of its revenues and net income, 99% in both categories, are earned in one geographic area, the United States.
Housekeeping Food Corporate and services services eliminations Total -------- -------- ------------ ----- Quarter Ended March 31, 2004 ---------------------------- Revenues $ 87,791,789 $ 18,854,548 $ (24,517) $ 106,621,820 Income before income taxes $ 7,799,548 $ 497,071 $ (2,944,424)(1) $ 5,352,195 Quarter Ended March 31, 2003 ---------------------------- Revenues $ 75,579,077 $ 13,420,908 $ 531,367 $ 89,531,352 Income before income taxes $ 6,085,650 $ 471,715 $ (2,314,453)(1) $ 4,242,912
(1) represents primarily corporate office cost and related overhead, as well as certain operating expenses that are not allocated to the service segments. -7- The Company earned revenue in the following service categories: For the quarter ended March 31, ------------------------------- 2004 2003 ---- ---- Housekeeping services $ 61,651,194 $ 53,805,771 Laundry and linen services 26,073,253 21,828,640 Food Services 18,419,879 13,546,960 Maintenance services and Other 477,494 349,981 ------------- ------------ $ 106,621,820 $ 89,531,352 ============= ============ The Company has one client, a nursing home chain, which in 2004 and 2003 accounted for approximately 21% and 22%, respectively of consolidated revenues. The Company derived approximately 19% and 29%, respectively of the Housekeeping services and Food services' segments' 2004 revenues from such client. 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. NOTE 5 - EARNINGS PER COMMON SHARE A reconciliation of the numerator and denominator of basic and diluted earnings per common share is as follows:
Quarter Ended March 31, 2004 ---------------------------- Income Shares Per-share (Numerator) (Denominator) Amount ----------- ------------- ------ Net income $3,318,195 ========== Basic earnings per common share $3,318,195 17,476,278 $ .19 Effect of dilutive securities: Options 953,312 (.01) ----------- ------------- ----- Diluted earnings per Common share $3,318,195 18,429,590 $ .18 =========== ============= ===== Quarter Ended March 31, 2003 ---------------------------- Income Shares Per-share (Numerator) (Denominator) Amount ----------- ------------- ------ Net income $2,545,912 ========== Basic earnings per common share $2,545,912 16,867,871 $ .15 Effect of dilutive securities: Options 643,710 ----------- ------------- ----- Diluted earnings per Common share $2,545,912 17,511,581 $ .15 =========== ============= =====
-8- No outstanding options were excluded at either March 31, 2004 or March 31, 2003 as none have an exercise price in excess of the average market value of the Company's Common Stock at such dates. NOTE 6 - STOCK BASED COMPENSATION At both March 31, 2004 and December 31, 2003, the Company has stock based compensation plans. As permitted by the Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation", the Company accounts for stock-based compensation arrangements in accordance with provisions of Accounting Principles Board ("APB") Opinion No. 25 "Accounting for Stock Issued to Employees". Compensation expense for stock options issued to employees is based on the difference on the date of grant, between the fair value of the Company's stock and the exercise price of the option. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock at the date of grant. The Company accounts for equity instruments issued to nonemployees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force ("EITF") Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction With Selling, or in Conjunction With Selling Goods or Services". All transactions in which goods or services are the consideration received for the issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable. 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 March 31, ----------------------- 2004 2003 ---- ---- Net Income As reported $3,318,195 $2,545,912 Deduct: Total stock based employee compensation expense determined under fair value based method for all awards, net of related tax effects (767,000) (748,000) ---------- ---------- Pro forma net income $2,551,195 $1,797,912 ========== ========== Basic Earnings Per Common Share As reported $ .19 $ .15 Pro forma $ .15 $ .11 Diluted Earnings Per Common Share As reported $ .18 $ .15 Pro forma $ .14 $ .10
-9- PART I. ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, the percentage which certain items bear to revenues: Relation to Total Revenues For the Quarter Ended March 31, ------------------------------- 2004 2003 ---- ---- Revenues 100.0% 100.0% Operating costs and expenses: Costs of services provided 87.6 87.9 Selling, general and administration 7.5 7.6 Investment and interest income .1 .2 ----- ----- Income before income taxes 5.0 4.7 Income taxes 1.9 1.9 ----- ----- Net income 3.1% 2.8% ===== ===== Revenues increased 19.1% to $106,621,820 in the quarter ended March 31, 2004 compared to $89,531,352 in the corresponding 2003 period. Housekeeping services' segment revenues increased to $87,791,789, an increase of approximately 15.9% from first quarter 2003 segment revenues of $75,759,077. This segment's growth in revenues is primarily a result of a net increase in service agreements entered into with new clients. The Food service's segment revenues increased approximately 40.5% to $18,854,548 as compared to first quarter 2003 segment revenues of $13,420,908. The Food service's segment revenue growth is a result of providing this service to existing Housekeeping service's segment clients. Although there can be no assurance thereof, the Company believes that in 2004 both Housekeeping services, and Food services' revenues, as a percentage of total revenues, will remain approximately the same as their respective 2003 percentages. The Company has one client, a nursing home chain, which in 2004 and 2003 accounted for approximately 21% and 22%, respectively of consolidated revenues. The Company derived approximately 19% and 29%, respectively of the Housekeeping services and Food services' segments' 2004 revenues from such client. 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. -10- Cost of services provided as a percentage of revenues decreased to 87.6% for the first quarter of 2004 from 87.9 % in the corresponding 2003 quarter. The primary factors affecting the .3% decrease are as follows: decrease of .8% in labor costs which is primarily a result of efficiencies achieved in managing the Housekeeping segment's labor and a .7% decrease in bad debt provision. Offsetting these decreases was an increase of 1.6% in the cost of supplies consumed in providing services which was primarily attributable to increased costs associated with the Food service segment. Selling, general and administrative expenses as a percentage of revenue remained essentially unchanged at 7.5% compared to 7.6% in the 2003 first quarter. As a result of the matters discussed above, net income for the 2004 first quarter increased to 3.1% as a percentage of revenue compared to 2.8% in the 2003 first quarter. CRITICAL ACCOUNTING POLICIES The two 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, 2003 which contain accounting policies and other disclosures required by generally accepted accounting principles. Allowance for Doubtful Accounts ------------------------------- The allowance for doubtful accounts is established as losses are estimated to have occurred through a provision for bad debts charged to earnings. The allowance for doubtful accounts is evaluated based on management's periodic review of accounts and notes receivable and is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The Company has had varying collection experience with respect to its accounts and notes receivable. When contractual terms are not met, the Company generally encounters difficulty in collecting amounts due from certain of its clients. Therefore, the Company has sometimes been required to extend the period of payment for certain clients beyond contractual terms. These clients include -11- those in bankruptcy, those who have terminated service agreements and slow payers experiencing financial difficulties. In making credit evaluations, in addition to analyzing and anticipating, where possible, the specific cases described above, management considers the general collection risks associated with trends in the long-term care industry. The Company also establishes credit limits and performs 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. The reserve is based upon management estimates of ultimate collectibility. 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, 2003 in Part I thereof under "Government Regulation of Clients" and "Service Agreements/Collections", change in such a manner as to negatively impact the cash flows of its clients. 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. Accrued Insurance Claims ------------------------ 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, open claims and actuarial analysis done by an independent insurance 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 amounts to be paid for known claims. Management regularly evaluates its claims' pay-out experience, present value factor and other factors related to the nature of specific claims in arriving at the basis for its accrued insurance claims' estimate. Management evaluations are based primarily on current information derived from reviewing the Company's claims' experience and industry trends. In the event that the Company's claims' experience and/or industry trends result in an unfavorable change, it could have an adverse affect on the Company's results of operations and financial condition. -12- LIQUIDITY AND CAPITAL RESOURCES At March 31, 2004 the Company had cash and cash equivalents of $67,343,847 and working capital of $117,766,510 compared to December 31, 2003 cash and cash equivalents, and working capital of $64,180,697 and $113,414,509, respectively. Management views the Company's cash and cash equivalents of $67,343,847 at March 31, 2004 as its principal measure of liquidity. The Company's current ratio at March 31, 2004 increased to 6.5 to 1 from 5.6 to 1 at December 31, 2003. The net cash provided by the Company's operating activities was $3,735,151 for the three month period ended March 31, 2004. The principal sources of net cash flows from operating activities for the three month period ended March 31, 2004 were net income, including non-cash charges to operations for bad debt provisions and depreciation. Additionally, operating activities' cash flows were increased by the timing of payments for accounts payable and other accrued expenses, as well as, a $2,066,321 net decrease in accounts and notes receivable and long term notes receivable. The operating activity that used the largest amount of cash during the three month period ended March 31, 2004 was a decrease of $4,548,387 in accrued payroll, accrued and withheld payroll taxes resulting from the timing of such payments. The Company's principal use of cash in investing activities in the three month period ended March 31, 2004 was the purchase of housekeeping equipment and computer software and equipment. On February 12, 2004, the Company's Board of Directors approved a three-for-two stock split in the form of a 50% common stock dividend which was paid on March 1, 2004 to shareholders of record on February 23, 2004. 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 March 31, 2004 balance sheet. All share and earnings per common share information presented in this report have been adjusted to reflect the three-for-two stock split. The effect of this action was to increase shares outstanding at March 1, 2004 by 6,016,799 to 17,646,172. On February 14, 2004, the Company paid to shareholders of record as of January 31, 2004, regular cash dividends in the aggregate of $930,911 ($.053 per common share as adjusted for the three-for-two stock split). Additionally, on April 20, 2004, the Company's Board of Directors declared a regular cash dividend of $.06 per common share to be paid on May 14, 2004 to shareholders of record as of April 30, 2004. -13- Accounts and Notes Receivable ----------------------------- 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 changed Medicare policy in a number of ways, most notably the phasing in, effective July 1, 1998 of a Medicare Prospective Payment System for skilled nursing facilities which significantly changed the reimbursement procedures and the amounts of reimbursement 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 March 31, 2004 and December 31, 2003, the Company had approximately, net of reserves, $12,782,000 and $12,638,000, respectively of such notes outstanding. In some instances the Company obtains a security interest in certain of the debtors' assets. Additionally, the Company considers restructuring service agreements from full service to management-only service in the case of certain clients experiencing financial difficulties. The Company believes that the restructuring provides it with a means to maintain a relationship with the client while at the same time minimizing collection exposure. The Company has had varying collection experience with respect to its accounts and notes receivable. When contractual terms are not met, the Company generally encounters difficulty in collecting amounts due from certain of its clients. Therefore, the Company has sometimes been required to extend the period of payment for certain clients beyond contractual terms. These clients include those in bankruptcy, those who have terminated service agreements and slow payers experiencing financial difficulties. In order to provide for these collection problems and the general risk associated with the granting of credit terms, the Company has recorded bad debt provisions (in an Allowance for Doubtful Accounts) of $1,000,000 and $1,500,000 in the three month periods ended March 31, 2004 and 2003, respectively. These provisions represent approximately .9% and 1.7%, 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, performs ongoing credit evaluation and monitors accounts to minimize the risk of loss. Notwithstanding the Company's efforts to minimize its credit risk exposure, the Company's clients could be adversely affected if future industry trends change in such a manner as to negatively impact their cash flows. If the Company's clients experience such significant impact in their cash flows, it could have a material adverse effect on the Company's results of operations and financial condition. -14- Insurance Programs ------------------ 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, open claims and actuarial analysis done by an independent insurance 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 amounts to be paid for known claims. Management regularly evaluates its claims' 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. Line of Credit -------------- 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 March 31, 2004 there were no borrowings under the line. However, at such date, the Company had outstanding $15,925,000 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 $15,925,000 at March 31, 2004. Capital Expenditures -------------------- 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 2004, 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. -15- Material Off-Balance Sheet Arrangements --------------------------------------- The Company has not entered into any material off-balance sheet arrangements. ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The Company's exposure to market risk is not significant. CAUTIONARY STATEMENTS REGARDING FORWARD LOOKING STATEMENTS Certain matters discussed include forward-looking statements that are subject to risks and uncertainties that could cause actual results or objectives to differ materially from those projected. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Such risks and uncertainties include, but are not limited to, risks arising from the Company providing its services exclusively to the health care industry, primarily providers of long-term care; credit and collection risks associated with this industry; one client accounting for approximately 21% of revenues in 2004; 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 the Company's Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2003 in Part I thereof under "Government Regulation of Clients", "Competition" and "Service Agreements/Collections". Many of the Company's clients' revenues are highly contingent on Medicare and Medicaid reimbursement funding rates, which have been and continue to be adversely affected by the change in Medicare payments under the 1997 enactment of Prospective Payment System. That change, and lack of substantive reimbursement funding rate reform legislation, as well as other trends in the long-term care industry have resulted in certain of the Company's clients filing for bankruptcy protection. Others may follow. Any decisions by the government to discontinue or adversely modify legislation related to reimbursement funding rates will have a material adverse affect on the Company's clients. These factors, in addition to delays in payments from clients have resulted in and could continue to result in significant additional bad debts in the near future. Additionally, the Company's operating results would be adversely affected if unexpected increases in the costs of labor and labor related costs, materials, supplies and equipment used in performing its services could not be passed on to clients. In addition, the Company believes that to improve its financial performance it must continue to obtain service agreements with new clients, provide new services to existing clients, achieve modest price increases on current service agreements with existing clients and maintain internal cost reduction strategies at the various operational levels of the Company. Furthermore, the Company believes that its ability to sustain the internal development of managerial personnel is an important factor impacting future operating results and successfully executing projected growth strategies. -16- EFFECTS OF INFLATION The Company believes in most instances it will be able to recover increases in costs attributable to inflation by passing through such cost increases to its clients. ITEM 4. CONTROLS AND PROCEDURES The Company maintains "disclosure controls and procedures", as such term is defined in Rules 13a-15e of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), that are designed to ensure that information required to be disclosed in its reports, pursuant to the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to its management, including its Chief Executive Officer and Principal Accounting Officer, as appropriate, to allow timely decisions regarding the required disclosures. In designing and evaluating the disclosure controls and procedures, management has recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurances of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the cost benefit relationship of possible controls and procedures. The Company's Chief Executive Officer and Principal Accounting Officer (its Principal Executive Officer and Principal Accounting Officer, respectively) have evaluated the effectiveness of its "disclosure controls and procedures" as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on their evaluation, the Principal Executive Officer and Principal Financial Officer concluded that its disclosure controls and procedures are effective. There were no significant changes in its internal controls or in other factors that could significantly affect these controls subsequent to the date the controls were evaluated. PART II. Other Information ----------------- Item 1. Legal Proceedings. Not Applicable Item 2. Changes in Securities. Not Applicable Item 3. Defaults under Senior Securities. Not Applicable Item 4. Submission of Matters to a Vote of Security Not Applicable Holders Item 5. Other Information. a) None Item 6. Exhibits and Reports on Form 8-K. a) Exhibits - 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 -17- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant had duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HEALTHCARE SERVICES GROUP, INC. ------------------------------- April 30, 2004 /s/ Daniel P. McCartney ---------------------------- -------------------------------------- Date DANIEL P. McCARTNEY, Chief Executive Officer April 30, 2004 /s/ Thomas A. Cook ---------------------------- -------------------------------------- Date THOMAS A. COOK, President and Chief Operating Officer April 30, 2004 /s/ James L. DiStefano ---------------------------- -------------------------------------- Date JAMES L. DiSTEFANO, Chief Financial Officer and Treasurer April 30, 2004 /s/ Richard W. Hudson ---------------------------- -------------------------------------- Date RICHARD W. HUDSON, Vice President-Finance, Secretary and Chief Accounting Officer -18-