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, 2006 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 Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such returns), (2) has been subject to such filing requirements
for the past 90 days.
YES _X_ NO ___
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer. See definition of "accelerated
filer" and "large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one) Large accelerated filer ___ Accelerated filer _X_ Non-accelerated filer ___
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). YES___ NO _X_
Number of shares of common stock, issued and outstanding as of April 20, 2006 is
27,260,000
Total of 32 Pages
INDEX
-----
PART I. FINANCIAL INFORMATION PAGE NO.
--------------------- --------
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets as of
March 31, 2006 and December 31, 2005 2
Consolidated Statements of Income for the Three Months Ended March 31,
2006 and March 31, 2005 3
Consolidated Statements of Cash Flows for the Three Months ended March
31, 2006 and March 31, 2005 4
Consolidated Statement of Stockholders' Equity for the Three Months
Ended March 31, 2006 5
Notes To Consolidated Financial Statements 6 - 12
Item 2. Management's Discussion and Analysis of Financial Condition and
Results Of Operations 13 - 24
Item 3. Quantitative and Qualitative Disclosure About Market Risk 25
Item 4. Controls and Procedures 25
Part II. Other Information
Item 1. Legal Proceedings 26
Item 1A. Risk Factors 26
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 26
Item 3. Defaults Upon Senior Securities 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 5. Other Information 26
Item 6. Exhibits 26
Signatures 27
-1-
---
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(Unaudited)
March 31, December 31,
2006 2005
---------------------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 97,396,000 $ 91,005,000
Accounts and notes receivable, less allowance for doubtful
accounts of $2,485,000 in 2006 and $2,275,000 in 2005 62,777,000 59,197,000
Inventories and supplies 11,949,000 11,729,000
Deferred income taxes 484,000 355,000
Prepaid expenses and other 3,950,000 3,330,000
------------- -------------
Total current assets 176,556,000 165,616,000
PROPERTY AND EQUIPMENT:
Laundry and linen equipment installations 2,148,000 2,416,000
Housekeeping equipment and office equipment 15,211,000 15,141,000
Autos and trucks 80,000 79,000
------------- -------------
17,439,000 17,636,000
Less accumulated depreciation 12,713,000 12,892,000
------------- -------------
4,726,000 4,744,000
COSTS IN EXCESS OF FAIR VALUE OF NET ASSETS ACQUIRED- Less
accumulated amortization of $1,743,000 in 2006 and 2005 1,612,000 1,612,000
NOTES RECEIVABLE- long term portion, net of discount 4,329,000 4,555,000
DEFERRED COMPENSATION FUNDING 6,151,000 5,626,000
DEFERRED INCOME TAXES- long term portion 6,370,000 6,181,000
OTHER NONCURRENT ASSETS 89,000 96,000
------------- -------------
TOTAL ASSETS $ 199,833,000 $ 188,430,000
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 8,201,000 $ 8,760,000
Accrued payroll, accrued and withheld payroll taxes 12,556,000 7,792,000
Other accrued expenses 1,632,000 657,000
Income taxes payable 1,901,000 1,467,000
Accrued insurance claims 4,445,000 4,405,000
------------- -------------
Total current liabilities 28,735,000 23,081,000
ACCRUED INSURANCE CLAIMS- long term portion 10,372,000 10,277,000
DEFERRED COMPENSATION LIABILITY 7,693,000 6,909,000
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value: 67,500,000 shares authorized,
28,817,000 shares issued in 2006 and 28,677,000 in 2005 288,000 287,000
Additional paid in capital 50,538,000 48,603,000
Retained earnings 115,360,000 112,299,000
Common stock in treasury, at cost, 1,581,000 shares in 2006 and
1,616,000 in 2005 (13,153,000) (13,026,000)
------------- -------------
Total stockholders' equity 153,033,000 148,163,000
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 199,833,000 $ 188,430,000
============= =============
See accompanying notes.
-2-
---
PART I. ITEM I. FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 31,
2006 2005
------------ ------------
Revenues $118,918,000 $114,695,000
Operating costs and expenses:
Costs of services provided 102,182,000 99,770,000
Selling, general and administrative 8,891,000 8,429,000
Other Income:
Investment and interest income 1,347,000 380,000
------------ ------------
Income before income taxes 9,192,000 6,876,000
Income taxes 3,401,000 2,613,000
------------ ------------
Net Income $ 5,791,000 $ 4,263,000
============ ============
Basic earnings per common share $ 0.21 $ 0.16
============ ============
Diluted earnings per common share $ 0.20 $ 0.15
============ ============
Cash dividends per common share $ 0.10 $ 0.06
============ ============
Basic weighted average number of
common shares outstanding 27,320,000 26,622,000
============ ============
Diluted weighted average number of
common shares outstanding 28,620,000 28,036,000
============ ============
See accompanying notes.
-3-
---
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE THREE MONTHS ENDED
MARCH 31,
----------------------------------
2006 2005
--------------- ----------------
Cash flows from operating activities:
Net Income $ 5,791,000 $ 4,263,000
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation 473,000 479,000
Bad debt provision 375,000 375,000
Deferred income taxes benefits (318,000) (293,000)
Unrealized (gain) loss on deferred compensation
fund investments (434,000) 55,000
Changes in operating assets and liabilities:
Accounts and notes receivable (3,955,000) (582,000)
Inventories and supplies (220,000) (381,000)
Notes receivable- long term portion 226,000 552,000
Deferred compensation funding (91,000) (190,000)
Accounts payable and other accrued expenses 416,000 1,166,000
Accrued payroll, accrued and withheld payroll taxes 5,493,000 5,611,000
Accrued insurance claims 135,000 714,000
Deferred compensation liability 783,000 313,000
Income taxes payable 434,000 15,000
Prepaid expenses and other assets (613,000) (849,000)
--------------- ----------------
Net cash provided by operating activities 8,495,000 11,248,000
--------------- ----------------
Cash flows from investing activities:
Disposals of fixed assets 32,000 3,000
Additions to property and equipment (487,000) (460,000)
--------------- ----------------
Net cash used in investing activities (455,000) (457,000)
--------------- ----------------
Cash flows from financing activities:
Treasury stock transactions in benefit plans (37,000) --
Dividends paid (2,730,000) (1,591,000)
Acquisition of treasury stock (613,000) (155,000)
Reissuance of treasury stock pursuant to Dividend
Reinvestment Plan 9,000 7,000
Proceeds from the exercise of stock options 1,209,000 1,267,000
Tax benefit of stock option transactions 513,000 746,000
--------------- ----------------
Net cash provided by (used in) financing activities (1,649,000) 274,000
--------------- ----------------
Net increase in cash and cash equivalents 6,391,000 11,065,000
Cash and cash equivalents at beginning of the period 91,005,000 74,847,000
--------------- ----------------
Cash and cash equivalents at end of the period $ 97,396,000 $ 85,912,000
=============== ================
Supplementary Cash Flow Information:
Income taxes cash payments, net of refunds $ 2,771,000 $ 2,145,000
=============== ================
Issuance of 64,000 shares of Common Stock in 2006 and
90,000 shares of Common Stock in 2005 pursuant to
Employee Stock Plans $ 728,000 $ 643,000
=============== ================
See accompanying notes.
-4-
---
Consolidated Statements of Stockholders' Equity
(Unaudited)
For the Three Months Ended March 31, 2006
------------------------------------------
Additional
Common Stock Paid-in Retained
Shares Amount Capital Earnings
---------------- ------------ ----------------- ---------------
Balance, December 31, 2005 28,677,000 $287,000 $48,603,000 $112,299,000
Net income for the period 5,791,000
Exercise of stock options and other share-based compensation,
net of 1,000 shares tendered for payment 140,000 1,000 1,208,000
Tax benefit arising from stock option transactions 513,000
Acquisition of treasury stock (34,000 shares)
Shares purchased and shares sold in employee Deferred
Compensation Plan and other benefit plans (4,000 shares)
Shares issued pursuant to Employee Stock Plans (64,000 shares) 209,000
Cash dividends - $.10 per common share (2,730,000)
Shares issued pursuant to Dividend Reinvestment Plan (1,000 shares) 5,000
---------------- ------------ ----------------- ---------------
Balance, March 31, 2006 28,817,000 $288,000 $50,538,000 $115,360,000
================ ============ ================= ===============
For the Three Months Ended March 31, 2006
------------------------------------------
Treasury Stockholders'
Stock Equity
--------------- --------------------
Balance, December 31, 2005 ($13,026,000) $148,163,000
Net income for the period 5,791,000
Exercise of stock options and other share-based compensation,
net of 1,000 shares tendered for payment 1,209,000
Tax benefit arising from stock option transactions 513,000
Acquisition of treasury stock (34,000 shares) (613,000) (613,000)
Shares purchased and shares sold in employee Deferred
Compensation Plan and other benefit plans (4,000 shares) (37,000) (37,000)
Shares issued pursuant to Employee Stock Plans (64,000 shares) 519,000 728,000
Cash dividends - $.10 per common share (2,730,000)
Shares issued pursuant to Dividend Reinvestment Plan (1,000 shares) 4,000 9,000
--------------- --------------------
Balance, March 31, 2006 ($13,153,000) $153,033,000
=============== ====================
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 December 31, 2005 has been derived from, and does not include,
all the disclosures contained in the financial statements for the year ended
December 31, 2005. 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, 2005. The results of operations for the
quarter ended March 31, 2006 are not necessarily indicative of the results that
may be expected for the full fiscal year.
Inventories and supplies include housekeeping, linen and laundry
supplies, as well as food provisions. Inventories and supplies are stated at
cost to approximate a first-in, first-out (FIFO) basis. Linen supplies are
amortized over a 24 month period.
NOTE 2 - OTHER CONTINGENCIES
We have a $25,000,000 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,
2006 and December 31, 2005, there were no borrowings under the line of credit.
However, we had outstanding at such dates $23,925,000 and $17,925,000,
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 $23,925,000
and $17,925,000 at March 31, 2006 and December 31, 2005, respectively. The line
of credit requires us to satisfy two financial covenants. We were in compliance
with the financial covenants at both March 31, 2006 and December 31, 2005 and
expect to continue to remain in compliance with such financial covenants. This
line of credit expires on June 30, 2006. We believe the line of credit will be
renewed at that time.
We provide our services in 45 states and we are subject to 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 reporting
positions with respect to the application of its tax code to our services, which
may result in additional tax liabilities.
At both March 31, 2006 and December 31, 2005 we have unsettled tax
assessments from a state taxing authority of $550,000 ($358,000, net of federal
income taxes). With respect to these assessments, we have recorded a reserve at
March 31, 2006 of $275,000 ($175,000 net of federal income taxes) and at
December 31, 2005 of $155,000 ($100,000 net of federal income taxes).
-6-
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 affect on our consolidated 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 consolidated 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 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 3 - SEGMENT INFORMATION
REPORTABLE OPERATING SEGMENTS
-----------------------------
We manage and evaluate our operations in two reportable segments. The
two reportable segments are Housekeeping (housekeeping, laundry, linen and other
services), and Food (food services). 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 segment's services. We consider the
various services provided within Housekeeping 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 attributable to 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.
Housekeeping 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 provides services solely in the United
States.
-7-
---
Housekeeping Food Corporate and
services services eliminations Total
------------ ------------ ------------- ------------
Quarter Ended March 31,
-----------------------
2006
----
Revenues $ 94,859,000 $ 23,039,000 $ 1,020,000 $118,918,000
Income before income
taxes $ 9,414,000 $ 703,000 $ (925,000)(1) $ 9,192,000
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
(1) represents primarily corporate office cost and related overhead, as well as
consolidated subsidiaries' operating expenses that are not allocated to the
reportable segments.
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 total revenues from clients in the following
service categories:
For the Quarter Ended March 31,
-------------------------------------------
2006 2005
---- ----
Housekeeping services $ 67,307,000 $ 64,459,000
Laundry and linen services 28,091,000 27,092,000
Food Services 22,909,000 22,437,000
Maintenance services
and Other 611,000 707,000
------------ ------------
$118,918,000 $114,695,000
============ ============
MAJOR CLIENT
------------
We have one client, a nursing home chain, which in each of the three
month periods ended March 31, 2006 and 2005 accounted for 19% of total revenues.
In the three month period ended March 31, 2006, we derived 17% and 27%,
respectively, of Housekeeping and Food's revenues from such client. According to
public filings, the client completed its previously announced merger on March
14, 2006. Although we expect to continue the relationship with this client's
successor, there can be no assurance thereof, and the loss of such client would
have a material adverse effect on the results of operations of our two operating
segments. In addition, if such client's successor changes its payment terms it
would increase our accounts receivable balance and have a material adverse
effect on our cash flows and cash and cash equivalents.
-8-
---
NOTE 4 - EARNINGS PER COMMON SHARE
A reconciliation of the numerator and denominator of basic and diluted
earnings per common share is as follows:
Quarter Ended March 31, 2006
----------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
----------- ------------- ---------
Net income $5,791,000
==========
Basic earnings per
common share $5,791,000 27,320,000 $ .21
Effect of dilutive securities:
Options 1,300,000 (.01)
---------- ---------- ------
Diluted earnings per
common share $5,791,000 28,620,000 $ .20
========== ========== ======
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 26,622,000 $ .16
Effect of dilutive securities:
Options 1,414,000 (.01)
---------- ---------- ------
Diluted earnings per
common share $4,263,000 28,036,000 $ .15
========== ========== ======
Options to purchase 426,000 shares of common stock at an average
exercise price of $20.71 were outstanding during the three month period ended
March 31, 2006 but not included in the computation of diluted earnings per
common share because the options' exercise prices were greater than the average
market price of the common shares, and therefore, would be antidilutive. No
outstanding options were excluded from the computation of diluted earnings per
common share for the three month period ended March 31, 2005 as none have an
exercise price in excess of the average market value of our common stock during
such period.
DIVIDENDS
---------
On February 13, 2006 we paid, to shareholders of record on February 3,
2006, a regular quarterly cash dividend of $.10 per common share. Such regular
quarterly cash dividend payment in the aggregate was $2,730,000. Additionally,
on April 18, 2006, our Board of Directors declared a regular cash dividend of
$.11 per common share to be paid on May 10, 2006 to shareholders of record as of
April 28, 2006.
-9-
---
NOTE 5 - SHARE-BASED COMPENSATION
During the three months ended March 31, 2006, the stock option activity
under our 2002 Stock Option Plan, 1995 Incentive and Non-Qualified Stock Option
Plan for key employees, and 1996 Non-Employee Director's Stock Option Plan
(collectively the "Stock Option Plans"), was as follows:
Weighted Average
Remaining
Contractual Aggregate
Weighted Average Number Term Intrinsic
Price of Shares (In Years) Value
---------------- ---------------- ---------- ----------
Outstanding, January 1, 2006 $ 8.91 2,843,000
Granted -- --
Cancelled 13.65 (2,000)
Exercised 8.68 (139,000)
-------- ---------
Outstanding, March 31, 2006 $ 8.92 2,702,000 6.04 $33,620,000
======== ========= ==== ===========
Options exercisable as of March 31, 2006 2,702,000 6.04 $33,620,000
========= ==== ===========
Other information pertaining to option activity during the three month
periods ended March 31, 2006 and March 31, 2005 was as follows:
March 31, 2006 March 31, 2005
-------------- --------------
Weighted average grant-date fair value of stock options granted: Not applicable Not applicable
Total fair value of stock options vested: Not applicable Not applicable
Total intrinsic value of stock options exercised: $1,512,000 $2,135,000
Under the Stock Option Plans, 3,863,000 shares of our Common Stock are
available for issuance. Options outstanding and exercisable were granted at a
stock option price which was not less than the fair market value of our Common
Stock on the date the option was granted and no option has a term in excess of
ten years. Additionally, options vested and became exercisable either on the
date of grant or commencing six months from the option grant date.
In December 2004, the Financial Accounting Standards Board issued SFAS
No. 123R, Share-Based Payment ("SFAS No. 123R" or the "Statement"). This
Statement is a revision of SFAS No. 123, Accounting for Stock-Based Compensation
("SFAS 123"), and supersedes Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees ("APB No. 25") and its related
implementation guidance. On January 1, 2006, we adopted the provisions of SFAS
No. 123R using the modified prospective method. SFAS No. 123R focuses primarily
on accounting for transactions in which an entity obtains employee services in
share-based payment transactions. The Statement requires entities to recognize
compensation expense for awards of equity instruments to employees based on the
grant-date fair value of those awards (with limited exceptions). SFAS No. 123R
also requires the benefits of tax deductions in excess of recognized
compensation expense to be reported as financing cash flows, rather than as an
operating cash flow as prescribed under the prior accounting rules. This
requirement reduces net operating cash flows and increases net financing cash
flows in periods after adoption. Total cash flow remains unchanged from what
would have been reported under prior accounting rules.
-10-
----
Prior to the adoption of SFAS No. 123R, we followed the intrinsic value
method in accordance with APB No. 25 to account for our employee stock options
and share purchase rights. Accordingly, no compensation expense was recognized
for share purchase rights granted in connection with the issuance of stock
options under any of our Stock Option Plans, or through our 2000 Employee Stock
Purchase Plan (the "ESPP") for periods ended prior to January 1, 2006. The
adoption of SFAS No. 123R primarily resulted in a change in our method of
recognizing the fair value of share-based compensation. Specifically, the
adoption of SFAS No. 123R will result in our recording compensation expense for
employee stock options and ESPP rights.
The pre-tax share-based employee compensation expense recorded in the
2006 first quarter was approximately $81,000. Such expense resulted solely from
the estimated value to be recognized from the share-based payments of our ESPP.
It is estimated, at this time, that the expense attributable to such share-based
payments in each of the subsequent quarters of 2006 will approximate the amount
recorded in the 2006 first quarter, dependent on the change in our stock price.
Additionally, we do not expect to grant any employee options and therefore
recognize any share-based payments' expense from the issuance of employee stock
options in 2006 until the fourth quarter. Although such impact is expected to be
material, the impact cannot be reasonably estimated because it will depend on
certain factors which are not fully known at this time. The options outstanding
at December 31, 2005 did not and will not impact 2006 consolidated results of
operations and financial position since all option-holders were fully vested in
such options at December 31, 2005.
The fair market value of the shared-based payments of our ESPP for the
2006 first quarter was estimated using the Black-Scholes option pricing model
with the following weighted average assumptions:
Risk-free interest rate 4.0%
Expected volatility 35.0%
Weighted average expected life (in years) 1.0
Dividend yield 1.9%
Results for the 2005 first quarter have not been restated. Had
compensation expense for employee stock options granted under our Stock Option
Plans and share purchase rights under our ESPP been determined based on fair
value at the grant date consistent with SFAS No. 123, our net income and
earnings per share for the 2005 first quarter would have been the pro forma
amounts indicated below:
-11-
----
Quarter Ended
March 31, 2005
--------------
Net Income
As reported $4,263,000
Deduct: Total share-based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects:
Stock Option Plans (1,020,000)
ESPP (151,000) (1)
----------
Pro forma net income $3,092,000
==========
Basic Earnings Per Common Share
As reported $ .16
Pro forma $ .12
Diluted Earnings Per Common Share
As reported $ .15
Pro forma $ .11
(1) Represents actual 2005 share-based compensation applicable to the ESPP
allocated to the 2005 first quarter.
NOTE 6 - RELATED PARTY TRANSACTIONS
One of our directors, as well as the brother of an officer and director
(collectively "Related Parties"), have separate ownership interests in several
different client facilities which have entered into service agreements with us.
During the three month periods' ended March 31, 2006 and March 31, 2005, the
service agreements with the client facilities in which the Related Parties have
ownership interests resulted in revenues of $1,932,000 and $1,920,000,
respectively. At March 31, 2006 and December 31, 2005, accounts and notes
receivable from such facilities of $2,266,000 and $2,343,000, respectively, are
included in the accompanying consolidated balance sheets. During 2005, we were
issued interest bearing promissory notes in the aggregate amount of $1,200,000
for the obligations due amounts due from facilities operated by the brother of
an officer and director. The subject accounts and notes receivable balances due
from the Related Parties are within agreed upon payment terms.
Another of our directors is a member of a law firm which was retained
by us. During the three month periods' ended March 31, 2006 and March 31, 2005,
fees received from us by such firm did not exceed $75,000 in either period.
Additionally, such fees did not exceed, in either three months period, 5% of
such firm's revenues.
-12-
----
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, 2006
(the client has completed its previously announced merger on March 14, 2006- see
Note 3, "Major Client" above); 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, 2005 and in Part I thereof under
"Government Regulation of Clients", "Competition", "Service
Agreements/Collections" and "Risk Factors". 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
effect 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 be helpful 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 consolidated results of operations.
This discussion should be read in conjunction with our financial statements as
of March 31, 2006 and December 31, 2005 and the periods then ended, and the
notes accompanying those financial statements.
-13-
----
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 45 states as of March 31, 2006.
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 the management and
hourly employees located at our clients' facilities. We also provide services on
the basis of a management-only 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.
We are organized into two reportable segments; housekeeping, laundry,
linen and other services ("Housekeeping"), and food services ("Food").
The services provided by Housekeeping 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.
Food, 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.
Additionally, we operate two wholly-owned subsidiaries, HCSG Supply,
Inc. ("Supply") and Huntingdon Holdings, Inc. ("Huntingdon"). Supply purchases,
warehouses and distributes the supplies and equipment used in providing our
Housekeeping segment services. Huntingdon invests our cash and cash equivalents.
-14-
----
CONSOLIDATED OPERATIONS
-----------------------
The following table sets forth, for the periods indicated, the
percentage which certain items bear to consolidated revenues:
Relation to Consolidated Revenues
For the Quarter Ended March 31,
----------------------------------
2006 2005
---- ----
Revenues 100.0% 100.0%
Operating costs and expenses:
Costs of services provided 85.9 87.0
Selling, general and
administration 7.5 7.3
Investment and interest income 1.1 .3
----- -----
Income before income taxes 7.7 6.0
Income taxes 2.8 2.3
----- -----
Net income 4.9% 3.7%
===== =====
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 2006 to be comparable to the three month period
ended March 31, 2006 percentages presented in the above table as they relate to
consolidated revenues.
Housekeeping is our largest and core reportable segment, representing
approximately 81% of consolidated revenues for the quarter ended March 31, 2006.
Food revenues represented approximately 19% of consolidated revenues for such
quarter.
Although there can be no assurance thereof, we believe that for the
remainder of 2006 each of Housekeeping's and Food's revenues, as a percentage of
consolidated revenues, will remain approximately the same as their respective
percentages noted above. Furthermore, we expect the sources of growth for the
remainder of 2006 for the respective operating segments will be primarily the
same as historically experienced. Accordingly, although there can be no
assurance thereof, the growth in Food is expected to come from our current
Housekeeping client base, while growth in Housekeeping will primarily come from
obtaining new clients.
-15-
----
2006 FIRST QUARTER COMPARED WITH 2005 FIRST QUARTER
The following table sets forth 2006 first quarter income statement key
components that we use to evaluate our financial performance on a consolidated
and reportable segment basis, as well as the percentage increases of each
compared to 2005 first quarter amounts.
Reportable Segments
-----------------------------------------
Housekeeping Food
Percent Corporate and ------------------ -----------------
Consolidated increase eliminations Amount %incr Amount %incr
------------ -------- ------------ ------ ----- ------ -----
Revenues $118,918,000 3.7% $ 1,020,000 $94,859,000 4.1% $23,039,000 1.9%
Cost of services provided 102,182,000 2.4 (5,599,000) 85,445,000 3.2 22,336,000 1.7
Selling, general and
administrative expense 8,891,000 5.5 8,891,000 -- --
Income before income taxes 9,192,000 33.7 ( 925,000) 9,414,000 13.7 703,000 9.1
REVENUES
--------
Consolidated
------------
Consolidated revenues increased 3.7% to $118,918,000 in the 2006 first
quarter compared to $114,695,000 in the 2005 first quarter as a result of the
factors discussed below under Reportable Segments.
We have one client, a nursing home chain ("Major Client"), which in
both the three month periods ended March 31, 2006 and March 31, 2005 accounted
for 19% of consolidated revenues. According to public filings, the client
completed its previously announced merger on March 14, 2006. Although we expect
to continue our relationship with the Major Client's successor, there can be no
assurance thereof, and the loss of such client would have a material adverse
effect on our consolidated results of operations. Additionally, if such client's
successor changes its payment terms it would increase our accounts receivable
balance and have a material adverse effect on our cash flows and cash and cash
equivalents.
Reportable Segments
-------------------
Housekeeping's 4.1% net growth in reportable segment revenues is
primarily a result of an increase in service agreements entered into with new
clients.
Food's 1.9% net growth in reportable segment revenues is a result of
providing this service to existing Housekeeping clients.
We derived 17% and 27%, respectively, of Housekeeping and Food's 2006
first quarter revenues from the Major Client.
-16-
----
COSTS OF SERVICES PROVIDED
--------------------------
Consolidated
------------
Cost of services provided, on a consolidated basis, as a percentage of
consolidated revenues for the 2006 first quarter decreased to 85.9% from 87.0%
in the corresponding 2005 quarter. The following table provides a comparison of
the primary cost of services provided-key indicators that we manage on a
consolidated basis in evaluating our financial performance
Cost of Services Provided-Key Indicators 2006 % 2005 % (Decr) %
---------------------------------------- ------ ------ --------
Bad debt provision .3 .3 --
Workers' compensation and general
liability insurance 3.6 4.3 (.7)
The decrease in workers' compensation and general liability insurance
is primarily a result of reduced payments to claimants due to improved claims'
experience.
Reportable Segments
-------------------
Cost of services provided for Housekeeping, as a percentage of
Housekeeping revenues, for the 2006 first quarter decreased to 90.1% from 90.9%
in the corresponding 2005 quarter. Cost of services provided for Food, as a
percentage of Food revenues, for the 2006 first quarter decreased to 96.9% from
97.2% in the corresponding 2005 quarter.
The following table provides a comparison of the primary cost of
services provided-key indicators, as a percentage of the respective segment's
revenues, that we manage on a reportable segment basis in evaluating our
financial performance:
Cost of Services Provided-Key Indicators 2006 % 2005 % Incr (Decr) %
---------------------------------------- ------ ------ -------------
Housekeeping labor and other labor costs 81.3 81.8 ( .5)
Housekeeping segment supplies 5.4 4.7 .7
Food labor and other labor costs 54.6 54.6 --
Food segment supplies 37.7 42.1 ( 4.4)
The decrease in Housekeeping labor and other labor costs, as a
percentage of Housekeeping revenues, resulted primarily from efficiencies
achieved. The increase in Housekeeping supplies resulted primarily from vendor
price increases.
The decrease in Food segment supplies, as a percentage of Food segment
revenues, is a result of price decreases in vendor purchasing agreements.
CONSOLIDATED SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
--------------------------------------------------------
Consistent with our 3.7% growth in consolidated revenues, selling,
general and administrative expenses increased by 5.5% or $462,000. However, as a
percentage of total consolidated revenues, these expenses increased only .2% to
7.5% in the 2006 first quarter as compared to 7.3% in the 2005 first quarter.
The increase is primarily attributable to the increase in the deferred
compensation expense resulting from an increase in value of the assets held in
the Company's trust account for the participants. Such expense increase is
offset by a corresponding increase recorded in our Consolidated Investment and
Interest income, see such discussion below.
-17-
----
INCOME BEFORE INCOME TAXES
--------------------------
Consolidated
------------
As a result of the discussion above related to revenues and expenses,
consolidated income before income taxes for the 2006 first quarter increased to
7.7 %, as a percentage of consolidated revenues, compared to 6.0% in the 2005
first quarter.
Reportable Segments
-------------------
Housekeeping's 13.7% increase in income before income taxes is
attributable to the improvement in the gross profit earned at the client
facility level and the gross profit earned on the 4.1% increase in reportable
segment revenues.
Food's income before income taxes increased 9.1% on a reportable
segment basis which is primarily attributable to an improvement in the gross
profit earned at the client facility level and the gross profit earned on the
1.9% increase in reportable segment revenues.
CONSOLIDATED INVESTMENT AND INTEREST INCOME
-------------------------------------------
Investment and interest income, as a percentage of consolidated
revenues, was 1.1% in the 2006 first quarter compared to .3% in the 2005 first
quarter. The increase is attributable to improved rates of return on the higher
cash and cash equivalents' average balance and the increase in market value of
the investments held in our Deferred Compensation Fund.
CONSOLIDATED INCOME TAXES
-------------------------
Our effective tax rate at March 31, 2006 was 37% compared to our March
31, 2005 effective tax rate of 38%. The decrease in the effective tax rate is
primarily a result of a reduction in the state and local effective tax rate.
Absent any significant change in federal, or state and local tax laws, we expect
our effective tax rate for the remainder of 2006 to be approximately the same as
realized in the 2006 first quarter. Our 37% effective tax rate differs from the
federal income tax statutory rate principally because of the effect of state and
local income taxes.
CONSOLIDATED NET INCOME
-----------------------
As a result of the matters discussed above, consolidated net income for
the 2006 first quarter increased to 4.9%, as a percentage of consolidated
revenues, compared to 3.7% in the 2005 first quarter.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
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 and
estimates are described in the following paragraphs. For these estimates, 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.
-18-
----
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, 2005, 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 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, 2006, we identified accounts totaling $3,157,000 that
require an Allowance for Doubtful Accounts based on potential impairment or loss
of value. An Allowance for Doubtful Accounts totaling $2,485,000 was provided
for these accounts at such date. 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 $21,000.
-19-
----
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, 2005 in Part I thereof under "Government Regulation of
Clients", "Service Agreements/Collections" and "Risk Factors", 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 effect 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 32%
of our liabilities at March 31, 2006. 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
consolidated 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 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 $47,000. Additionally, reducing the estimated payout
period by six months would result in an approximate $102,000 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, 2006, we had cash and cash equivalents of $97,396,000 and
working capital of $147,821,000 compared to December 31, 2005 cash and cash
equivalents of $91,005,000 and working capital of $142,535,000. We view our cash
and cash equivalents as our principal measure of liquidity. Our current ratio at
March 31, 2006 decreased to 6.1 to 1 compared to 7.2 to 1 at December 31, 2005.
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 anticipated growth.
-20-
----
OPERATING ACTIVITIES
--------------------
The net cash provided by our operating activities was $8,495,000 for
the three month period ended March 31, 2006. The principal sources of net cash
flows from operating activities for the three month period ended March 31, 2006
were net income, including non-cash charges to operations for bad debt
provisions and depreciation. Additionally, operating activities' cash flows
increased by $5,493,000 as a result of the timing of payments for accrued
payroll, accrued and withheld payroll taxes. The operating activity that used
the largest amount of cash during the three month period ended March 31, 2006
was a net increase of $3,729,000 in accounts and notes receivable and long-term
notes receivable resulting primarily from the 3.7% growth in the Company's 2006
first quarter revenues.
INVESTING ACTIVITIES
--------------------
Our principal use of cash in investing activities for the three month
period ended March 31, 2006 was $487,000 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 $2,500,000 during the
remainder of 2006 for such capital expenditures.
FINANCING ACTIVITIES
--------------------
On February 13, 2006 we paid, to shareholders of record on February 3,
2006, a regular quarterly cash dividend of $.10 per common share. Such regular
quarterly cash dividend payment in the aggregate was $2,730,000. Additionally,
on April 18, 2006, our Board of Directors declared a regular cash dividend of
$.11 per common share to be paid on May 10, 2006 to shareholders of record as of
April 28, 2006.
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.
During the three month period ended March 31, 2006, we expended
$613,000 for the repurchase of 34,000 shares of our common stock. We remain
authorized to purchase 1,248,000 shares pursuant to previous Board of Directors'
actions.
During 2006, we received proceeds of $1,209,000 from the exercise of
stock options by employees and directors, as well as recognizing an income tax
benefit of $513,000 from such stock option transactions.
LINE OF CREDIT
--------------
We have a $25,000,000 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,
2006 and December 31, 2005, there were no borrowings under the line. However, at
such dates, we had outstanding $23,925,000 and $17,925,000, 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 $23,925,000 and $17,925,000 at
March 31, 2006 and December 31, 2005, respectively.
-21-
----
The line of credit requires us to satisfy two financial covenants. Such
covenants, and their respective status at March 31, 2006, were as follows:
Covenant Description and Requirement Status at March 31, 2006
------------------------------------ ------------------------
Commitment coverage ratio: cash and cash Commitment coverage is 4.1
equivalents must equal or exceed outstanding
obligations under the line by a multiple of 2.
Tangible net worth: must exceed $115,000,000. Tangible net worth is $151,400,000
As noted above, we complied with the financial covenants at March 31,
2006 and expect to continue to remain in compliance with such financial
covenants. This line of credit expires on June 30, 2006. We believe the line of
credit will be renewed at that time.
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, 2006 and
December 31, 2005, we had $8,415,000 and $8,514,000, net of reserves,
respectively, of such promissory notes outstanding. Additionally, we consider
restructuring service agreements from full service to management-only service in
the case of certain clients experiencing financial difficulties. We believe that
such restructurings 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 in each of the three month periods
ended March 31, 2006 and 2005. These provisions represent approximately .3%, as
a percentage of total revenues for each respective period. 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.
-22-
----
At March 31, 2006, amounts due from our Major Client represented less
than 1% of our accounts receivable balance. If such client's successor changes
its payments terms, it would increase our accounts receivable balance and have a
material adverse affect on our cash flows and cash and cash equivalents.
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.
-23-
----
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 2006, we
estimate that for the remainder of 2006 we will have capital expenditures of
approximately $1,500,000 to $2,500,000 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
anticipated 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.
-24-
----
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 Securities and Exchange Commission ("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 March 31, 2006 (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.
-25-
----
PART II. OTHER INFORMATION
-----------------
ITEM 1. LEGAL PROCEEDINGS. Not Applicable
------------------
ITEM 1A. RISK FACTORS
------------
The materialization of any risks and uncertainties identified in our
Cautionary Statement Regarding Forward Looking Statements contained herein
together with those risks previously disclosed in our Form 10-K (referred to
elsewhere herein) filed with the Securities and Exchange Commission for the year
ended December 31, 2005 or those that are presently unforeseen, could result in
significant adverse effects on our financial position, results of operations and
cash flows.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
(a) (b) (c) (d)
Total number of Maximum
shares purchased as number of shares
part of publicly that may yet be
Total number of Average price announced plans purchased under the
2006 Period Shares purchased paid per share or programs plans or programs
----------- ---------------- -------------- ----------------- ------------------
January 1 to
March 31 34,000 $17.67 34,000 1,248,000
ITEM 3. DEFAULTS UNDER SENIOR SECURITIES. Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not Applicable
ITEM 5. OTHER INFORMATION.
a) None
ITEM 6. EXHIBITS
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
-26-
----
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.
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April 21, 2006 /s/ Daniel P. McCartney
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Date DANIEL P. McCARTNEY, Chief
Executive Officer
April 21, 2006 /s/ Thomas A. Cook
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Date THOMAS A. COOK, President and
Chief Operating Officer
April 21, 2006 /s/ James L. DiStefano
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Date JAMES L. DiSTEFANO, Chief Financial
Officer and Treasurer
April 21, 2006 /s/ Richard W. Hudson
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Date RICHARD W. HUDSON, Vice
President-Finance, Secretary and Chief
Accounting Officer
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