10-Q 1 ten-q.txt TEN-Q.TXT UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For Quarter Ended March 31, 2005 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 25, 2005 is 17,735,000 INDEX
PAGE NO. -------- PART I. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Consolidated Balance Sheets as of March 31, 2005 and December 31, 2004 2 Consolidated Statements of Income for the Three Months Ended March 31, 2005 and March 31, 2004 3 Consolidated Statements of Cash Flows for the Three Months ended March 31, 2005 and March 31, 2004 4 Consolidated Statement of Stockholders' Equity for the Three Months Ended March 31, 2005 5 Notes To Consolidated Financial Statements 6 - 11 Item 2. Management's Discussion and Analysis of Financial Condition and Results Of Operations 11 - 20 Item 3. Quantitative and Qualitative Disclosure About Market Risk 21 Item 4. Controls and Procedures 21 Part II. Other Information Item 1. Legal Proceedings 21 Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities 21 Item 3. Defaults Upon Senior Securities 21 Item 4. Submission of Matters to a Vote of Security 21 Holders 21 Item 5. Other Information 21 Item 6. Exhibits 21 - 22 Signatures 23
-1- CONSOLIDATED BALANCE SHEETS
(Unaudited) March 31, December 31, 2005 2004 -------------- -------------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 85,912,000 $ 74,847,000 Accounts and notes receivable, less allowance for doubtful accounts of $2,209,000 in 2005 and $1,869,000 in 2004 55,932,000 55,725,000 Inventories and supplies 11,396,000 11,015,000 Deferred income taxes 628,000 574,000 Prepaid expenses and other 3,959,000 3,110,000 -------------- -------------- Total current assets 157,827,000 145,271,000 PROPERTY AND EQUIPMENT: Laundry and linen equipment installations 2,329,000 2,329,000 Housekeeping and office equipment 14,427,000 13,987,000 Autos and trucks 80,000 80,000 -------------- -------------- 16,836,000 16,396,000 Less accumulated depreciation 12,054,000 11,592,000 -------------- -------------- 4,782,000 4,804,000 NOTES RECEIVABLE- long term portion, net of discount 5,005,000 5,557,000 DEFERRED COMPENSATION FUNDING 4,198,000 4,062,000 DEFERRED INCOME TAXES- long term portion 5,801,000 5,563,000 OTHER NONCURRENT ASSETS 1,707,000 1,707,000 -------------- -------------- $ 179,320,000 $ 166,964,000 ============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 8,281,000 $ 7,272,000 Accrued payroll, accrued and withheld payroll taxes 11,080,000 6,110,000 Other accrued expenses 1,849,000 1,692,000 Income taxes payable 1,030,000 1,016,000 Accrued insurance claims 4,533,000 4,169,000 -------------- -------------- Total current liabilities 26,773,000 20,259,000 ACCRUED INSURANCE CLAIMS- long term portion 10,577,000 10,227,000 DEFERRED COMPENSATION LIABILITY 5,330,000 5,018,000 COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Common stock, $.01 par value: 45,000,000 shares authorized, 18,673,000 shares issued in 2005 and 18,507,000 in 2004 187,000 185,000 Additional paid in capital 41,663,000 39,466,000 Retained earnings 103,951,000 101,279,000 Common stock in treasury, at cost, 948,000 shares in 2005 and 992,000 in 2004 (9,161,000) (9,470,000) -------------- -------------- Total stockholders' equity 136,640,000 131,460,000 -------------- -------------- $ 179,320,000 $ 166,964,000 ============== ==============
See accompanying notes. -2- CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) FOR THE THREE MONTHS ENDED MARCH 31, ------------------------------------ 2005 2004 -------------- --------------- Revenues $ 114,695,000 $ 106,622,000 Operating costs and expenses: Costs of services provided 99,770,000 93,397,000 Selling, general and administrative 8,429,000 8,015,000 Other Income : Investment and interest income 380,000 142,000 -------------- --------------- Income before income taxes 6,876,000 5,352,000 Income taxes 2,613,000 2,034,000 -------------- --------------- Net Income $ 4,263,000 $ 3,318,000 ============== =============== Basic earnings per common share $ 0.24 $ 0.19 ============== =============== Diluted earnings per common share $ 0.23 $ 0.18 ============== =============== Cash dividends per common share $ 0.09 $ 0.05 ============== =============== Basic weighted average number of common shares outstanding 17,748,000 17,476,000 ============== =============== Diluted weighted average number of common shares outstanding 18,691,000 18,429,000 ============== =============== -3- CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 31, ---------------------------------- 2005 2004 --------------- --------------- Cash flows from operating activities: Net Income $ 4,263,000 $ 3,318,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 479,000 483,000 Bad debt provision 375,000 1,000,000 Deferred income taxes benefit (293,000) (205,000) Tax benefit of stock option transactions 746,000 428,000 Unrealized loss on deferred compensation fund investments 55,000 -- Changes in operating assets and liabilities: Accounts and notes receivable (582,000) 2,093,000 Inventories and supplies (381,000) (266,000) Notes receivable- long term portion 552,000 (26,000) Deferred compensation funding (190,000) (246,000) Accounts payable and other accrued expenses 1,166,000 1,091,000 Accrued payroll, accrued and withheld payroll taxes 5,611,000 (4,548,000) Accrued insurance claims 714,000 327,000 Deferred compensation liability 313,000 309,000 Income taxes payable 15,000 477,000 Prepaid expenses and other assets (849,000) (500,000) --------------- --------------- Net cash provided by operating activities 11,994,000 3,735,000 --------------- --------------- Cash flows from investing activities: Disposals of fixed assets 3,000 55,000 Additions to property and equipment (460,000) (650,000) --------------- --------------- Net cash used in investing activities (457,000) (595,000) --------------- --------------- Cash flows from financing activities: Acquisition of treasury stock (155,000) Dividends paid (1,591,000) (931,000) Reissuance of treasury stock pursuant to Dividend Reinvestment Plan 7,000 2,000 Proceeds from the exercise of stock options 1,267,000 952,000 --------------- --------------- Net cash provided by (used in) financing activities (472,000) 23,000 --------------- --------------- Net increase in cash and cash equivalents 11,065,000 3,163,000 Cash and cash equivalents at beginning of the period 74,847,000 64,181,000 --------------- --------------- Cash and cash equivalents at end of the period $ 85,912,000 $ 67,344,000 =============== =============== Supplementary Cash Flow Information: Issuance of 60,000 shares of Common Stock in 2005 and 48,000 shares of Common Stock in 2004 pursuant to Employee Stock Plans $ 643,000 $ 366,000 =============== ===============
See accompanying notes. -4- Consolidated Statements of Stockholders' Equity (unaudited)
For the Three Months Ended March 31, 2005 ------------------------------------------------------------------------------------------ Common Stock Additional Total --------------------------- Paid-in Retained Treasury Stockholders' Shares Amount Capital Earnings Stock Equity ------------ ------------ ------------- ------------- -------------- ------------- Balance, December 31, 2004 18,507,000 $ 185,000 $ 39,466,000 $ 101,279,000 $ (9,470,000) $ 131,460,000 Net income for the period 4,263,000 4,263,000 Exercise of stock options 155,000 1,000 1,266,000 1,267,000 Tax benefit arising from stock option transactions 746,000 746,000 Purchase of common stock for treasury (4,700 shares) (155,000) (155,000) Shares issued pursuant to Employee Stock Plans (60,000 shares) 11,000 1,000 181,000 461,000 643,000 Cash dividends - $.09 per common share (1,591,000) (1,591,000) Shares issued pursuant to Dividend Reinvestment Plan (356 shares) 4,000 3,000 7,000 ------------ ------------ ------------- ------------- -------------- ------------- Balance, March 31, 2005 18,673,000 $ 187,000 $ 41,663,000 $ 103,951,000 $ (9,161,000) $ 136,640,000 ============ ============ ============= ============= ============== =============
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 our opinion, 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 March 31, 2005 has been derived from, and does not include, all the disclosures contained in the financial statements for the year ended December 31, 2004. The financial statements should be read in conjunction with the financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2004. The results of operations for the quarter ended March 31, 2005 are not necessarily indicative of the results that may be expected for the full fiscal year. NOTE 2 - THREE-FOR-TWO STOCK SPLIT On April 19, 2005, our Board of Directors approved a three-for-two stock split in the form of a 50% common stock dividend which will be paid on May 2, 2005 to shareholders of record on April 29, 2005. Presented below are unaudited pro forma results for the three month periods ended March 31, 2005 and March 31, 2004 assuming the stock split occurred on January 1, 2004.
March 31, March 31, 2005 2004 ---------------- ---------------- Net income $ 4,263,000 $ 3,318,000 Basic weighted average number of common shares outstanding as reported 17,748,000 17,476,000 Basic weighted average number of common shares outstanding pro forma (unaudited) 26,622,000 26,214,000 Basic earnings per common share as reported $ .24 $ .19 Basic earnings per common share pro forma (unaudited) $ .16 $ .13 Diluted weighted average number of common shares outstanding as reported 18,691,000 18,430,000 Diluted weighted average number of common shares outstanding pro forma (unaudited) 28,036,000 27,644,000 Diluted earnings per common share as reported $ .23 $ .18 Diluted earnings per common share pro forma (unaudited) $ .15 $ .12 Cash dividends per common share as reported $ .09 $ .05 Cash dividends per common share pro forma (unaudited) $ .06 $ .03
-6- Additionally, our Board of Directors has declared a $.07 per common share cash dividend to be paid on May 16, 2005 to shareholders of record as of May 4, 2005. Such cash dividend payment is after giving effect to the three-for-two stock split. NOTE 3- OTHER CONTINGENCIES We have an $18,000,000 bank line of credit on which we may draw to meet short-term liquidity requirements in excess of internally generated cash flow. Amounts drawn under the line of credit are payable on demand. At March 31, 2005 and December 31, 2004, there were no borrowings under the line of credit. However, at such dates, we had outstanding $17,925,000 and $15,925,000, respectively, of irrevocable standby letters of credit which relate to payment obligations under our insurance programs. As a result of the letters of credit issued, the amount available under the line of credit was reduced by $17,925,000 and $15,925,000 at March 31, 2005 and December 31, 2004, respectively. The line of credit requires us to satisfy several financial covenants. We complied with all financial covenants at both March 31, 2005 and December 31, 2004 and expect to continue to remain in compliance with all such financial covenants. This line of credit expires on June 30, 2005. We believe the line of credit will be renewed at that time. We provide our services in 42 states and numerous local taxing jurisdictions within those states. Consequently, the taxability of our services is subject to various interpretations within these jurisdictions. In the ordinary course of business, a jurisdiction may contest our application and reporting requirements of its tax code to our services, which may result in additional tax liabilities. As of March 31, 2005 and December 31, 2004 we have unsettled tax assessments (including interest to date) from various state taxing authorities of $2,900,000 ($1,900,000, net of federal income taxes) and $2,800,000 ($1,800,000, net of federal income taxes), respectively. Although we intend to vigorously defend our positions that the assessments are without merit, we have recorded a reserve at both March 31, 2005 and December 31, 2004 of $900,000 ($590,000, net of federal income taxes), for these assessments in cases where we could estimate that a tax settlement is probable and the range of such settlement. In other tax matters, because of the uncertainties related to both the probable outcome and amount of probable assessment due, we are unable to make a reasonable estimate of a liability. We do not expect the resolution of any of these matters, taken individually or in the aggregate, to have a material adverse effect on our financial position or results of operations. We are involved in miscellaneous claims and litigation arising in the ordinary course of business. We believe that these matters, taken individually or in the aggregate, would not have a material adverse affect on our 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 our 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 our clients filing for bankruptcy -7- 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. NOTE 4 - SEGMENT INFORMATION REPORTABLE OPERATING SEGMENTS We manage and evaluate our operations in two reportable operating segments. The two reportable operating segments are Housekeeping (housekeeping, laundry, linen and other services), and Food. 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. We consider the various services provided within the Housekeeping 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 our consolidated financial statements relate primarily to corporate level transactions, as well as transactions between reportable segments and our warehousing and distribution subsidiary. The subsidiary's transactions with reportable segments are made on a basis intended to reflect the fair market value of the goods transferred. Additionally, included in the differences between the reportable segments' operating results and other disclosed data are amounts from our investment holding company subsidiary. This subsidiary does not transact any business with the reportable segments. Segment amounts reported are prior to any elimination entries made in consolidation. The Housekeeping 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. Food services are provided solely in the United States.
Housekeeping Food Corporate and services services eliminations Total ---------------- ---------------- ---------------- ---------------- Quarter Ended March 31, 2005 Revenues $ 91,090,000 $ 22,615,000 $ 990,000 $ 114,695,000 Income before income taxes $ 8,282,000 $ 644,000 $ (2,050,000)(1) $ 6,876,000 Quarter Ended March 31, 2004 Revenues $ 87,792,000 $ 18,855,000 $ (25,000) $ 106,622,000 Income before income taxes $ 7,800,000 $ 497,000 $ (2,945,000)(1) $ 5,352,000
(1) represents primarily corporate office cost and related overhead, as well as consolidated subsidiaries' operating expenses that are not allocated to the reportable segments. -8- TOTAL REVENUES FROM CLIENTS The following revenues earned from clients differ from segment revenues reported above due to the inclusion of adjustments used for segment reporting purposes by management. We earned revenues from clients in the following service categories: For the quarter ended March 31, ----------------------------------- 2005 2004 ---------------- ---------------- Housekeeping services $ 64,459,000 $ 61,651,000 Laundry and linen services 27,092,000 26,073,000 Food Services 22,437,000 18,420,000 Maintenance services and Other 707,000 478,000 ---------------- ---------------- $ 114,695,000 $ 106,622,000 ================ ================ MAJOR CLIENT We have one client, a nursing home chain, which in the three month periods ended March 31, 2005 and 2004 accounted for 19% and 21%, respectively, of total revenues. In the three month period ended March 31, 2005, we derived 18% and 26%, respectively, of the Housekeeping and Food segments' revenues from such client. Although we expect to continue our relationship with this client, the loss of such client would have a material adverse affect on the operations of our 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, 2005 --------------------------------------------- Income Shares Per-share (Numerator) (Denominator) Amount -------------- -------------- ---------- Net income $ 4,263,000 ============== Basic earnings per common share $ 4,263,000 17,748,000 $ .24 Effect of dilutive securities: Options 943,000 (.01) -------------- -------------- ---------- Diluted earnings per common share $ 4,263,000 18,691,000 $ .23 ============== ============== ========== -9- Quarter Ended March 31, 2004 --------------------------------------------- Income Shares Per-share (Numerator) (Denominator) Amount -------------- -------------- ---------- Net income $ 3,318,000 ============== Basic earnings per common share $ 3,318,000 17,476,000 $ .19 Effect of dilutive securities: Options 953,000 (.01) -------------- -------------- ---------- Diluted earnings per common share $ 3,318,000 18,429,000 $ .18 ============== ============== ========== No outstanding options were excluded from the computation of diluted earnings per common share for either the three month period ended March 31, 2005 or March 31, 2004 as none have an exercise price in excess of the average market value of our common stock during such periods. NOTE 6 - STOCK BASED COMPENSATION At March 31, 2005, we had stock based compensation plans. As permitted by the Statement of Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock Based Compensation", we account 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 market value of our stock and the exercise price of the option. No stock based employee compensation cost is reflected in net income, as all options granted under our plans had an exercise price equal to the market value of the underlying common stock at the date of grant. We account for equity instruments issued to non-employees 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. -10- The following table illustrates the effect on net income and earnings per common share if we had applied the fair value recognition provisions of SFAS No. 123 to stock based compensation: Quarter Ended March 31, ---------------------------- 2005 2004 -------------- ----------- Net Income As reported $ 4,263,000 $ 3,318,000 Deduct: Total stock based employee compensation expense determined under fair value based method for all awards, net of related tax effects (1,020,000) (767,000) -------------- ----------- Pro forma net income $ 3,243,000 $ 2,551,000 ============== =========== Basic Earnings Per Common Share As reported $ .24 $ .19 Pro forma $ .18 $ .15 Diluted Earnings Per Common Share As reported $ .23 $ .18 Pro forma $ .17 $ .14 NOTE 7 - RECENT ACCOUNTING PRONOUNCEMENTS In December 2004, the Financial Accounting Standards Board (the "FASB") issued a revision of Financial Accounting Standards No. 123 ("SFAS 123R") which requires all share-based payments to employees to be recognized in the income statement based on their fair values. Our option grants to employees, non-employees and directors, as well as common stock shares issued pursuant to our Employee Stock Purchase Plan will represent share-based payments. We expect to calculate the fair value of share-based payments under SFAS 123R on a basis substantially consistent with the fair value approach of SFAS 123. We plan to adopt SFAS 123R in our fiscal year beginning January 1, 2006. We expect the adoption of SFAS 123R will have a material impact on our financial statements in that fiscal year, but we cannot reasonably estimate the impact of adoption because we expect certain assumptions that can materially affect the calculation of the value of share-based payments to recipients to change between now and the time of adoption. -11- PART I. ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS This report includes forward-looking statements that are subject to risks and uncertainties that could cause actual results or objectives to differ materially from those projected. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Such risks and uncertainties include, but are not limited to, risks arising from our providing services exclusively to the health care industry, primarily providers of long-term care; credit and collection risks associated with this industry; one client accounting for approximately 19% of revenues in the three month period ended March 31, 2005; our claims experience related to workers' compensation and general liability insurance; the effects of changes in, or interpretations of laws and regulations governing the industry, including state and local regulations pertaining to the taxability of our services; and the risk factors described in our Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2004 in Part I thereof under "Government Regulation of Clients", "Competition" and "Service Agreements/Collections". Many of our clients' revenues are highly contingent on Medicare and Medicaid reimbursement funding rates, which have been and continue to be adversely affected by the change in Medicare payments under the 1997 enactment of the Medicare Prospective Payment System. That change, and the lack of substantive reimbursement funding rate reform legislation, as well as other trends in the long-term care industry have resulted in certain of our clients filing for bankruptcy protection. Others may follow. Any decisions by the government to discontinue or adversely modify legislation related to reimbursement funding rates will have a material adverse affect on our clients. These factors, in addition to delays in payments from clients have resulted in and could continue to result in significant additional bad debts in the near future. Additionally, our operating results would be adversely affected if unexpected increases in the costs of labor and labor related costs, materials, supplies and equipment used in performing services could not be passed on to our clients. In addition, we believe that to improve our financial performance we must continue to obtain service agreements with new clients, provide new services to existing clients, achieve modest price increases on current service agreements with existing clients and maintain internal cost reduction strategies at our various operational levels. Furthermore, we believe that our ability to sustain the internal development of managerial personnel is an important factor impacting future operating results and successfully executing projected growth strategies. RESULTS OF OPERATIONS The following discussion is intended to provide the reader with information that will assist them in understanding our financial statements including the changes in certain key items in comparing financial statements period to period. We also intend to provide the primary factors that accounted for those changes, as well as a summary of how certain accounting principles affect our financial statements. In addition, we are providing information about the financial results of our two operating segments to further assist in understanding how these segments and their results affect our results of operations. This discussion should be read in conjunction with -12- our financial statements as of March 31, 2005 and December 31, 2004 and the notes accompanying those financial statements. OVERVIEW We provide housekeeping, laundry, linen, facility maintenance and food services to the health care industry, including nursing homes, retirement complexes, rehabilitation centers and hospitals located throughout the United States. We believe that we are the largest provider of housekeeping and laundry services to the long-term care industry in the United States, rendering such services to approximately 1,700 facilities in 42 states as of March 31, 2005. Although we do not directly participate in any government reimbursement programs, our clients' reimbursements are subject to government regulation. Therefore, they are directly affected by any legislation relating to Medicare and Medicaid reimbursement programs. We provide our services primarily pursuant to full service agreements with our clients. In such agreements, we are responsible for our management and hourly employees located at our clients' facilities. We also provide services on the basis of a management agreement for a very limited number of clients. Our agreements with clients typically provide for a one year service term, cancelable by either party upon 30 to 90 days notice after the initial 90-day period. Additionally, we operate two wholly-owned subsidiaries. HCSG Supply, Inc. purchases, warehouses and distributes the supplies and equipment used in providing our Housekeeping segment services. Huntingdon Holdings, Inc. invests our cash and cash equivalents. CONSOLIDATED OPERATIONS The following table sets forth, for the periods indicated, the percentage which certain items bear to total revenues: Relation to Total Revenues For the Quarter Ended March 31, ----------------------------------- 2005 2004 ---------------- ---------------- Revenues 100.0% 100.0% Operating costs and expenses: Costs of services provided 87.0 87.6 Selling, general and administration 7.3 7.5 Investment and interest income .3 .1 ---------------- ---------------- Income before income taxes 6.0 5.0 Income taxes 2.3 1.9 ---------------- ---------------- Net income 3.7% 3.1% ================ ================ Subject to the factors noted in the Cautionary Statement Regarding Forward Looking Statements included in this report, we anticipate our financial performance for the remainder of 2005 to be comparable to the quarter ended March 31, 2005 percentages presented in the above table as they relate to total revenues. -13- Although there can be no assurance thereof, we believe that for the remainder of 2005 both the Housekeeping and Food segments' revenues, as a percentage of total revenues, will remain approximately the same as their respective percentages noted in the discussion below. Furthermore, we expect the sources of growth for the remainder of 2005 for the respective business segments will be primarily the same as historically experienced. That is the growth in the Food segment is expected to come from our current Housekeeping segment's client base, while growth in the Housekeeping segment will primarily come from obtaining new clients. We are organized into two operating segments; housekeeping, laundry, linen and other services ("Housekeeping"), and food services ("Food"). Housekeeping is our largest and core operating segment, representing 80.4% or $92,258,000 of total first quarter 2005 revenues. The services provided by this segment consist primarily of the cleaning, disinfecting and sanitizing of patient rooms and common areas of a client's facility, as well as the laundering and processing of the personal clothing belonging to the facility's patients. Also within the scope of this segment's service is the laundering and processing of the bed linens, uniforms and other assorted linen items utilized by a client facility. The Food segment, which began operations in 1997, consists of providing for the development of a menu that meets the patient's dietary needs, and the purchasing and preparing of the food for delivery to the patients. Food segment revenues represented approximately 19.6% or $22,437,000 of total first quarter 2005 revenues. 2005 FIRST QUARTER COMPARED WITH 2004 FIRST QUARTER The following table sets forth 2005 first quarter revenues, income before income taxes, and percentage increases of each compared to 2004 first quarter amounts. Revenues and income before income taxes are shown in total and on a reportable segment basis.
Reportable Segments -------------------------------------------------- Housekeeping Food Percent Corporate and ----------------------- ----------------------- Total increase eliminations Amount %incr Amount %incr -------------- -------- -------------- -------------- ----- -------------- ----- Revenues $ 114,695,000 7.6% $ 990,000 $ 91,090,000 3.8% $ 22,615,000 19.9% Income before income taxes 6,876,000 28.5 (2,050,000) 8,282,000 6.2 644,000 29.6
Total revenues increased 7.6% to $114,695,000 in the 2005 first quarter compared to $106,622,000 in the same 2004 period. The Housekeeping segment's 3.8% growth in revenues is primarily a result of a net increase in service agreements entered into with new clients. Housekeeping's 6.2% increase in income before income taxes, on an operating segment basis, is attributable to both a modest improvement in the gross profit earned at the client facility level and the gross profit earned on the 3.8% increase in reportable segment revenues. The improvement in gross profit is primarily a result of a .6% reduction, as a percentage of reportable segment revenues, in total labor costs. The reduction is attributable to our ability to have managed these costs more efficiently. The Food segment's 19.9% revenue growth is a result of providing this service to an increasing number of existing Housekeeping segment clients. Food segment income before income taxes increased 29.6% on a reportable segment basis which is attributable to both a -14- modest improvement in gross profit earned at the client facility level and the gross profit earned on the 19.9% increase in reportable segment revenues. We have one client, a nursing home chain, which in the three month periods ended March 31, 2005 and March 31, 2004 accounted for 19% and 21%, respectively, of total revenues. We derived 18% and 26%, respectively, of the Housekeeping and Food segments' 2005 first quarter revenues from such client. Additionally, at both March 31, 2005 and December 31, 2004, amounts due from such client represented less than 1% of our accounts receivable balances. Although we expect the relationship with this client to continue, the loss of such client would have a material adverse affect on our results of operations. Cost of services provided, on a consolidated basis, as a percentage of total revenues for the 2005 first quarter decreased to 87.0 % from 87.6 % in the corresponding 2004 quarter. The following table provides a comparison, as a percentage of total revenues (unless otherwise noted), of the key indicators of our financial performance in respect to our cost of services provided:
Cost of Services Provided Key Indicators 2005 % 2004 % Incr (Decr) % -------------------------------------------------- -------- -------- -------------- Labor and costs of labor 65.9% 66.7% (.8)% Workers' compensation and general liability insurance 4.3 4.1 .2 Bad debt provision .3 .9 (.6) Health insurance and employee benefits 2.1 2.7 (.6) Housekeeping segment supplies (as a percentage of Housekeeping segment revenues) 4.6 4.8 (.2) Food segment supplies ( as a percentage of Food segment revenues) 42.4 41.2 1.2
The following is an explanation of significant increases and decreases of key indicators of cost of services provided in comparing the 2005 first quarter to the 2004 first quarter. The decrease in labor and costs of labor is primarily attributable to efficiencies achieved in managing the Housekeeping segment's labor. The decrease in bad debt provision resulted primarily from improved collection experience. The decrease in health insurance and employee benefits is a result of fewer employees participating in our health insurance programs. The decrease in Housekeeping segment supplies, as a percentage of Housekeeping segment revenues, resulted primarily from our ability to limit price increases from the vendors of housekeeping supplies. The increase in Food segment supplies, as a percentage of Food segment revenues, is a result of price increases from vendors. The increase in workers' compensation and general liability insurance is primarily a result of the increase in the cost to settle claims. Consistent with our 7.6% growth in total revenues, selling, general and administrative expenses increased by $414,000. However, as a percentage of total revenues, these expenses decreased to 7.3% in the 2005 first quarter as compared to 7.5% in the 2004 first quarter. The decrease is primarily attributable to our ability to control these expenses and comparing them to a greater revenue base in the current year. -15- Investment and interest income, as a percentage of total revenues, was .3% in the 2005 first quarter compared to .1% in the 2004 first quarter. The increase is primarily attributable to higher cash balances, as well as increased rates of return. Our effective tax rate at both March 31, 2005 and 2004 was 38%. Absent any significant change in federal, or state and local tax laws, we expect our effective tax rate for the remainder of 2005 to be approximately the same as realized in the 2005 first quarter. Our 38% effective tax rate differs from the federal income tax statutory rate principally because of the effect of state and local income taxes. As a result of the matters discussed above, net income for the 2005 first quarter increased to 3.7%, as a percentage of total revenues, compared to 3.1% in the 2004 first quarter. CRITICAL ACCOUNTING POLICIES We consider the two policies discussed below to be critical to an understanding of our financial statements because their application places the most significant demands on our 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, we caution that future events rarely develop exactly as forecasted, and the best estimates routinely require adjustment. Any such adjustments or revisions to estimates could result in material differences to previously reported amounts. 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 our judgment in their application. There are also areas in which our 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, 2004 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 our 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. We have had varying collection experience with respect to our accounts and notes receivable. When contractual terms are not met, we generally encounter difficulty in collecting amounts due from certain of our clients. Therefore, we have sometimes been required to extend the period of payment for certain clients beyond contractual terms. These clients include 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 -16- cases described above, we consider the general collection risks associated with trends in the long-term care industry. We also establish credit limits, perform ongoing credit evaluation, and monitor accounts to minimize the risk of loss. In accordance with the risk of extending credit, we regularly evaluate our accounts and notes receivable for impairment or loss of value and when appropriate will provide in our Allowance for Doubtful Accounts for such receivables. We generally follow a policy of reserving for receivables from clients in bankruptcy, clients with which we are in litigation for collection and other slow paying clients. The reserve is based upon our estimates of ultimate collectibility. Correspondingly, once our recovery of a receivable is determined through either litigation, bankruptcy proceedings or negotiation to be less than the recorded amount on our balance sheet, we will charge-off the applicable amount to the Allowance for Doubtful Accounts. At March 31, 2005, we identified accounts totaling $3,887,000 that require an Allowance for Doubtful Accounts based on potential impairment or loss of value. An Allowance for Doubtful Accounts totaling $2,209,000 was provided for these accounts at March 31, 2005. Actual collections of these accounts could differ from that which we currently estimate. If our actual collection experience is 5% less than our estimate, the related increase to our Allowance for Doubtful Accounts would decrease net income by $62,000. Notwithstanding our efforts to minimize credit risk exposure, our clients could be adversely affected if future industry trends, as more fully discussed under Liquidity and Capital Resources below, and as further described in our Form 10-K filed with Securities and Exchange Commission for the year ended December 31, 2004 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 our clients. If our clients experience a negative impact in their cash flows, it would have a material adverse affect on our results of operations and financial condition. ACCRUED INSURANCE CLAIMS We currently have a Paid Loss Retrospective Insurance Plan for general liability and workers' compensation insurance, which comprise approximately 35% of our liabilities at March 31, 2005. Our accounting for this plan is affected by various uncertainties because we must make assumptions and apply judgment to estimate the ultimate cost to settle reported claims and claims incurred but not reported as of the balance sheet date. We address these uncertainties by regularly evaluating our claims pay-out experience, present value factor and other factors related to the nature of specific claims in arriving at the basis for our accrued insurance claims estimate. Our evaluations are based primarily on current information derived from reviewing our claims experience and industry trends. In the event that our claims experience and/or industry trends result in an unfavorable change, it would have a material adverse effect on our results of operations and financial condition. Under these plans, pre-determined loss limits are arranged with an insurance company to limit both our per occurrence cash outlay and annual insurance plan cost. For workers' compensation, we record a reserve based on the present value of future payments, including an estimate of claims incurred but not reported, that are developed as a -17- result of a review of our historical data and open claims. The present value of the payout is determined by applying an 8% discount factor against the estimated value of the claims over the estimated remaining pay-out period. Reducing the discount factor by 1% would reduce net income by approximately $62,000. Additionally, reducing the estimated payout period by six months would result in an approximate $118,000 reduction in net income. For general liability, we record a reserve for the estimated ultimate amounts to be paid for known claims. LIQUIDITY AND CAPITAL RESOURCES At March 31, 2005, we had cash and cash equivalents of $85,912,000 and working capital of $131,054,000 compared to December 31, 2004 cash and cash equivalents, and working capital of $74,847,000 and $125,012,000, respectively. We view our cash and cash equivalents of $85,912,000 at March 31, 2005 as our principal measure of liquidity. Our current ratio at March 31, 2005 decreased to 5.9 to 1 compared to 7.2 to 1 at December 31, 2004. This decrease resulted primarily from the timing of payments for accrued payroll, accrued and withheld payroll taxes. On an historical basis, our operations have generally produced consistent cash flow and have required limited capital resources. We believe our current and near term cash flow positions will enable us to fund our continued growth. OPERATING ACTIVITIES The net cash provided by our operating activities was $11,994,000 for the three month period ended March 31, 2005. The principal sources of net cash flows from operating activities for the three month period ended March 31, 2005 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 accrued payroll, accrued and withheld payroll taxes of $5,611,000 and $1,166,000 for accounts payable and other accrued expenses. The operating activity that used the largest amount of cash during the three month period ended March 31, 2005 was an increase of $849,000 in prepaid expenses and other assets resulting from the timing of such payments. INVESTING ACTIVITIES Our principal use of cash in investing activities for the three month period ended March 31, 2005 was $460,000 for the purchase of housekeeping equipment, computer software and equipment, and laundry equipment installations. Under our current plans, which are subject to revision upon further review, it is our intention to spend an aggregate of $1,500,000 to $2,000,000 during the remainder of 2005 for such capital expenditures. FINANCING ACTIVITIES On February 11, 2005, we paid, in the aggregate $1,591,000, to shareholders of record as of January 28, 2005 regular cash dividends of $.09 per common share ($.06 per common share after giving effect to the May 2, 2005 three-for-two stock split). Additionally, on April 19, 2005, our Board of Directors declared a three-for-two stock split in the form of a 50% stock dividend payable on May 2, 2005 to shareholders of record on April 29, 2005, and a regular cash dividend of $.07 per common share to be paid on May 16, 2005 to shareholders of record as of May 4, 2005. -18- The cash dividend payment is after giving effect to the three-for-two stock split. Our Board of Directors reviews our dividend policy on a quarterly basis. Although there can be no assurance that we will continue to pay dividends or the amount of the dividend, we expect to continue to pay a regular quarterly cash dividend. In connection with the establishment of our dividend policy, we adopted a Dividend Reinvestment Plan in 2003. On April 19, 2005, the Board of Directors also authorized the repurchase of up to 1,000,000 shares of our common stock pursuant to our share repurchase program. During the 2005 first quarter, we received proceeds of $1,267,000 from the exercise of stock options by employees. Additionally, 4,700 shares of our common stock at an aggregate value of $155,000 were purchased by certain employees within their deferred compensation accounts which are considered an acquisition of treasury stock. LINE OF CREDIT We have an $18,000,000 bank line of credit on which we may draw to meet short-term liquidity requirements in excess of internally generated cash flow. Amounts drawn under the line of credit are payable upon demand. At March 31, 2005 and December 31, 2004, there were no borrowings under the line. However, at such dates, we had outstanding $17,925,000 and $15,925,000, respectively of irrevocable standby letters of credit, which relate to payment obligations under our insurance programs. As a result of the letters of credit issued, the amount available under the line of credit was reduced by $17,925,000 and $15,925,000 at March 31, 2005 and December 31, 2004, respectively. The line of credit requires us to satisfy several financial covenants. Such covenants, and their respective status at March 31, 2005, are as follows:
Covenant Description and Requirement Status at March 31, 2005 --------------------------------------------- ----------------------------------- Commitment coverage ratio: cash and cash Commitment coverage is 7.5. equivalents, and eligible receivables must equal or exceed outstanding obligations under the line of credit a multiple of 2. Tangible net worth: must exceed $105,000,000. Tangible net worth is $134,000,000. Fixed charge coverage ratio: EBITDA must Fixed charge coverage ratio is 1.6. exceed fixed charges by 1.5 times.
As noted above, we complied with all financial covenants at March 31, 2005 and expect to continue to remain in compliance with all such financial covenants. This line of credit expires on June 30, 2005. We believe the line of credit will be renewed at that time. -19- ACCOUNTS AND NOTES RECEIVABLE We expend considerable effort to collect the amounts due for our services on the terms agreed upon with our clients. Many of our 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 our clients receive. Many of our 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 our 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, we convert 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 our ability to collect the amounts due. At March 31, 2005 and December 31, 2004, we had $8,192,000 and $8,942,000, net of reserves, respectively, of such promissory notes outstanding. Additionally, we consider restructuring service agreements from full service to management service in the case of certain clients experiencing financial difficulties. We believe that such restructuring may provide us with a means to maintain a relationship with the client while at the same time minimizing collection exposure. We have had varying collection experience with respect to our accounts and notes receivable. When contractual terms are not met, we generally encounter difficulty in collecting amounts due from certain of our clients. Therefore, we have sometimes been required to extend the period of payment for certain clients beyond contractual terms. These clients include 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, we have recorded bad debt provisions (in an Allowance for Doubtful Accounts) of $375,000 and $1,000,000 in the three month periods ended March 31, 2005 and 2004, respectively. These provisions represent approximately .3% and .9%, as a percentage of total revenues for such respective periods. In making our credit evaluations, in addition to analyzing and anticipating, where possible, the specific cases described above, we consider the general collection risk associated with trends in the long-term care industry. We also establish credit limits, perform ongoing credit evaluation and monitor accounts to minimize the risk of loss. Notwithstanding our efforts to minimize credit risk exposure, our clients could be adversely affected if future industry trends change in such a manner as to negatively impact their cash flows. If our clients experience a negative impact in their cash flows, it would have a material adverse effect on our results of operations and financial condition. -20- INSURANCE PROGRAMS We have 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 our per occurrence cash outlay and annual insurance plan cost. For workers' compensation, we record 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 our historical data and open claims. The present value of the payout is determined by applying an 8% discount factor against the estimated value of the claims over the estimated remaining pay-out period. For general liability, we record a reserve for the estimated ultimate amounts to be paid for known claims. We regularly evaluate our claims' pay-out experience, present value factor and other factors related to the nature of specific claims in arriving at the basis for our accrued insurance claims' estimate. Our evaluation is based primarily on current information derived from reviewing our claims experience and industry trends. In the event that our claims experience and/or industry trends result in an unfavorable change, it would have an adverse effect on our results of operations and financial condition. CAPITAL EXPENDITURES The level of capital expenditures is generally dependent on the number of new clients obtained. Such capital expenditures primarily consist of housekeeping equipment purchases, laundry and linen equipment installations, and computer hardware and software. Although we have no specific material commitments for capital expenditures through the end of calendar year 2005, we estimate that for the remainder of 2005 we will have capital expenditures of approximately $1,500,000 to $2,000,000 in connection with housekeeping equipment purchases and laundry and linen equipment installations in our clients' facilities, as well as expenditures relating to internal data processing hardware and software requirements. We believe that our cash from operations, existing cash and cash equivalents balance and credit line will be adequate for the foreseeable future to satisfy the needs of our operations and to fund our continued growth. However, should these sources not be sufficient, we would, if necessary, seek to obtain necessary working capital from such sources as long-term debt or equity financing. MATERIAL OFF-BALANCE SHEET ARRANGEMENTS We have no material off-balance sheet arrangements, other than our irrevocable standby letter of credit previously discussed. EFFECTS OF INFLATION Although there can be no assurance thereof, we believe that in most instances we will be able to recover increases in costs attributable to inflation by passing through such cost increases to our clients. -21- ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Our exposure to market risk is not significant. ITEM 4. CONTROLS AND PROCEDURES EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES Disclosure controls are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports under the Securities Exchange Act of 1934 (the "Exchange Act"), such as this Form 10-Q, is reported in accordance with the Securities and Exchange Commission's (the "SEC") rules. Disclosure controls are also designed with the objective of ensuring that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. As of the March 31, 2005 (the "Evaluation Date"), we carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rules 13a-15(e) and 15d-15(e). Based upon our evaluation, at the Evaluation Date, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to insure that information required to be disclosed in the reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and regulations. CHANGES IN INTERNAL CONTROLS There were no significant changes in our internal controls or to our knowledge, in other factors that could significantly affect our disclosure controls and procedures subsequent to the Evaluation Date. CERTIFICATIONS Certifications of the Principal Executive Officer and Principal Financial Officer regarding, among other items, disclosure controls and procedures are included as exhibits to this Form 10-Q. 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 -22- a) Exhibits - 31.1 Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 -23- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant had duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HEALTHCARE SERVICES GROUP, INC. April 25, 2005 /s/ Daniel P. McCartney Date ---------------------------------------- DANIEL P. McCARTNEY, Chief Executive Officer April 25, 2005 /s/ Thomas A. Cook Date ---------------------------------------- THOMAS A. COOK, President and Chief Operating Officer April 25, 2005 /s/ James L. DiStefano Date ---------------------------------------- JAMES L. DiSTEFANO, Chief Financial Officer and Treasurer April 25, 2005 /s/ Richard W. Hudson Date ---------------------------------------- RICHARD W. HUDSON, Vice President-Finance, Secretary and Chief Accounting Officer -24-