UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2006
OR
[_] TRANSISTION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to _____
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" as defined in Rule 12b-2 of the Exchange
Act.
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]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date. Common Stock, $.01 Par Value:
27,291,000 shares outstanding as of July 21, 2006.
Total of 38 Pages
-0-
INDEX
PART I. FINANCIAL INFORMATION PAGE NO.
--------
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets as of
June 30, 2006 and December 31, 2005 2
Consolidated Statements of Income for the Three
Months Ended June 30, 2006 and June 30, 2005 3
Consolidated Statements of Income for the Six
Months Ended June 30, 2006 and June 30, 2005 4
Consolidated Statements of Cash Flows for the Six
Months ended June 30, 2006 and June 30, 2005 5
Consolidated Statement of Stockholders' Equity
for the Six Months Ended June 30, 2006 6
Notes To Consolidated Financial Statements 7 - 15
Item 2. Management's Discussion and Analysis of
Financial Condition and Results Of Operations 16 - 30
Item 3. Quantitative and Qualitative Disclosure About
Market Risk 31
Item 4. Controls and Procedures 31
Part II. Other Information
Item 1. Legal Proceedings 32
Item 1A. Risk Factors 32
Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds 32
Item 3. Defaults Upon Senior Securities 32
Item 4. Submission of Matters to a Vote of Security Holders 32
Item 5. Other Information 33
Item 6. Exhibits 33
Signatures 34
-1-
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2006 2005
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 92,318,000 $ 91,005,000
Accounts and notes receivable, less allowance for doubtful
accounts of $2,720,000 in 2006 and $2,275,000 in 2005 64,626,000 59,197,000
Inventories and supplies 12,048,000 11,729,000
Deferred income taxes 491,000 355,000
Prepaid expenses and other 3,864,000 3,330,000
------------ ------------
Total current assets 173,347,000 165,616,000
PROPERTY AND EQUIPMENT:
Laundry and linen equipment installations 1,926,000 2,416,000
Housekeeping and office equipment 15,437,000 15,141,000
Autos and trucks 80,000 79,000
------------ ------------
17,443,000 17,636,000
Less accumulated depreciation 12,734,000 12,892,000
------------ ------------
4,709,000 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 5,442,000 4,555,000
DEFERRED COMPENSATION FUNDING 6,239,000 5,626,000
DEFERRED INCOME TAXES- long term portion 6,731,000 6,181,000
OTHER NONCURRENT ASSETS 89,000 96,000
------------ ------------
TOTAL ASSETS $198,169,000 $188,430,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 9,170,000 $ 8,760,000
Accrued payroll, accrued and withheld payroll taxes 6,706,000 7,792,000
Other accrued expenses 1,685,000 657,000
Income taxes payable 377,000 1,467,000
Accrued insurance claims 4,661,000 4,405,000
------------ ------------
Total current liabilities 22,599,000 23,081,000
ACCRUED INSURANCE CLAIMS- long term portion 10,876,000 10,277,000
DEFERRED COMPENSATION LIABILITY 7,866,000 6,909,000
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value: 67,500,000 shares authorized,
28,866,000 shares issued in 2006 and 28,677,000 in 2005 289,000 287,000
Additional paid in capital 51,182,000 48,603,000
Retained earnings 118,548,000 112,299,000
Common stock in treasury, at cost, 1,579,000 shares in 2006
and 1,616,000 in 2005 (13,191,000) (13,026,000)
------------ ------------
Total stockholders' equity 156,828,000 148,163,000
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $198,169,000 $188,430,000
============ ============
See accompanying notes.
-2-
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
FOR THE THREE MONTHS ENDED
JUNE 30,
---------------------------
2006 2005
------------ ------------
Revenues $122,840,000 $116,048,000
Operating costs and expenses:
Costs of services provided 105,843,000 101,385,000
Selling, general and administrative 8,123,000 8,109,000
Other Income:
Investment and interest income 973,000 839,000
------------ ------------
Income before income taxes 9,847,000 7,393,000
Income taxes 3,644,000 2,809,000
------------ ------------
Net Income $ 6,203,000 $ 4,584,000
============ ============
Basic earnings per common share $ 0.23 $ 0.17
============ ============
Diluted earnings per common share $ 0.22 $ 0.16
============ ============
Cash dividends per common share $ 0.11 $ 0.07
============ ============
Basic weighted average number of
common shares outstanding 27,414,000 26,878,000
============ ============
Diluted weighted average number of
common shares outstanding 28,691,000 28,404,000
============ ============
See accompanying notes.
-3-
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
FOR THE SIX MONTHS ENDED
JUNE 30,
---------------------------
2006 2005
------------ ------------
Revenues $241,758,000 $230,743,000
Operating costs and expenses:
Costs of services provided 208,025,000 201,155,000
Selling, general and administrative 17,014,000 16,538,000
Other Income:
Investment and interest income 2,320,000 1,219,000
------------ ------------
Income before income taxes 19,039,000 14,269,000
Income taxes 7,045,000 5,422,000
------------ ------------
Net Income $ 11,994,000 $ 8,847,000
============ ============
Basic earnings per common share $ 0.44 $ 0.33
============ ============
Diluted earnings per common share $ 0.42 $ 0.31
============ ============
Cash dividends per common share $ 0.21 $ 0.13
============ ============
Basic weighted average number of
common shares outstanding 27,367,000 26,750,000
============ ============
Diluted weighted average number of
common shares outstanding 28,656,000 28,221,000
============ ============
See accompanying notes.
-4-
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE SIX MONTHS ENDED
JUNE 30,
-------------------------
2006 2005
----------- -----------
Cash flows from operating activities:
Net Income $11,994,000 $ 8,847,000
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation 952,000 977,000
Bad debt provision 625,000 625,000
Deferred income taxes benefits (686,000) (739,000)
Unrealized gain on deferred compensation
fund investments (364,000) (208,000)
Changes in operating assets and liabilities:
Accounts and notes receivable (6,054,000) (4,358,000)
Prepaid income taxes (286,000)
Inventories and supplies (319,000) (359,000)
Notes receivable- long term portion (887,000) 1,704,000
Deferred compensation funding (248,000) (567,000)
Accounts payable and other accrued expenses 1,438,000 631,000
Accrued payroll, accrued and withheld payroll taxes (357,000) (40,000)
Accrued insurance claims 855,000 1,169,000
Deferred compensation liability 957,000 1,005,000
Income taxes payable (1,091,000) (1,016,000)
Prepaid expenses and other assets (528,000) (762,000)
----------- -----------
Net cash provided by operating activities 6,287,000 6,623,000
----------- -----------
Cash flows from investing activities:
Disposals of fixed assets 95,000 33,000
Additions to property and equipment (1,012,000) (992,000)
----------- -----------
Net cash used in investing activities (917,000) (959,000)
----------- -----------
Cash flows from financing activities:
Treasury stock transactions in benefit plans (79,000) (147,000)
Dividends paid (5,745,000) (3,466,000)
Acquisition of treasury stock (613,000) --
Reissuance of treasury stock pursuant to Dividend
Reinvestment Plan 20,000 15,000
Proceeds from the exercise of stock options 1,597,000 3,065,000
Tax benefit of stock option transactions 763,000 2,555,000
----------- -----------
Net cash provided by (used in) financing activities (4,057,000) 2,022,000
----------- -----------
Net increase in cash and cash equivalents 1,313,000 7,686,000
Cash and cash equivalents at beginning of the period 91,005,000 74,847,000
----------- -----------
Cash and cash equivalents at end of the period $92,318,000 $82,533,000
=========== ===========
Supplementary Cash Flow Information:
Income taxes cash payments, net of refunds $ 8,057,000 $ 4,908,000
=========== ===========
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.
-5-
Consolidated Statements of Stockholders' Equity
(Unaudited)
For the Six Months Ended June 30, 2006
-------------------------------------------------------------------------------------
Common Stock Additional
----------------------- Paid-in Retained Treasury Stockholders'
Shares Amount Capital Earnings Stock Equity
---------- ---------- ------------ ------------- ------------ -------------
Balance, December 31, 2005 28,677,000 $287,000 $48,603,000 $112,299,000 ($13,026,000) $148,163,000
Net income for the period 11,994,000 11,994,000
Exercise of stock options and other
share-based compensation, net
of 2,000 shares tendered
for payment 189,000 2,000 1,595,000 1,597,000
Tax benefit arising from stock
option transactions 763,000 763,000
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
(5,000 shares) (79,000) (79,000)
Shares issued pursuant
to Employee Stock Plans
(64,000 shares) 209,000 519,000 728,000
Cash dividends - $.21
per common share (5,745,000) (5,745,000)
Shares issued pursuant
to Dividend Reinvestment Plan
(1,000 shares) 12,000 8,000 20,000
---------- -------- ----------- ------------ ------------ ------------
Balance, June 30, 2006 28,866,000 $289,000 $51,182,000 $118,548,000 ($13,191,000) $156,828,000
========== ======== =========== ============ ============ ============
See accompanying notes.
-6-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - BASIS OF REPORTING
The accompanying financial statements are unaudited and do not include
certain information and note disclosures required by accounting principles
generally accepted in the United States 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 either the quarter or the six month period ended June
30, 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 June 30, 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 June 30, 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 June 30, 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, 2007. We believe the line of credit will be
renewed at that time.
We provide our services in 44 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 June 30, 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
June 30, 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).
-7-
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 effect 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.
-8-
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.
Housekeeping Food Corporate and
services services eliminations Total
------------ ----------- ------------- ------------
Quarter Ended June 30,
2006
Revenues $ 98,291,000 $24,673,000 $ (124,000) $122,840,000
Income before income
taxes $ 9,436,000 $ 915,000 $ (504,000)(1) $ 9,847,000
Quarter Ended June 30,
2005
Revenues $ 93,275,000 $22,924,000 $ (151,000) $116,048,000
Income before income
taxes $ 8,152,000 $ 785,000 $(1,544,000)(1) $ 7,393,000
Six Months Ended June 30,
2006
Revenues $193,150,000 $47,712,000 $ 896,000 $241,758,000
Income before income
taxes $ 18,851,000 $ 1,617,000 $(1,429,000)(1) $ 19,039,000
Six Months Ended June 30,
2005
Revenues $184,365,000 $45,539,000 $ 839,000 $230,743,000
Income before income
taxes $ 16,433,000 $ 1,430,000 $(3,594,000)(1) $ 14,269,000
(1) represents primarily corporate office cost and related overhead, as well as
consolidated subsidiaries' operating expenses that are not allocated to the
reportable segments.
-9-
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
June 30,
---------------------------
2006 2005
------------ ------------
Housekeeping services $ 69,039,000 $ 65,485,000
Laundry and linen services 28,880,000 27,367,000
Food Services 24,301,000 22,631,000
Maintenance services and Other 620,000 565,000
------------ ------------
$122,840,000 $116,048,000
============ ============
For the Six Months Ended
June 30,
---------------------------
2006 2005
------------ ------------
Housekeeping services $136,347,000 $129,944,000
Laundry and linen services 56,971,000 54,459,000
Food Services 47,210,000 45,068,000
Maintenance services and Other 1,230,000 1,272,000
------------ ------------
$241,758,000 $230,743,000
============ ============
MAJOR CLIENT
We have one client, a nursing home chain (the "Major Client"), which
accounted for 19% of total revenues in each of the three month periods ended
June 30, 2006 and June 30, 2005. Additionally, in the three month period ended
June 30, 2006, we derived 17% and 27%, respectively, of Housekeeping and Food's
revenues from such client. This client completed its previously announced merger
on March 14, 2006. Our relationship with the successor entity remains under the
same terms and conditions as established prior to the merger. 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.
-10-
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 June 30, 2006
---------------------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
----------- ------------- ---------
Net income $6,203,000
==========
Basic earnings per
common share $6,203,000 27,414,000 $ .23
Effect of dilutive securities:
Options 1,277,000 (.01)
---------- ---------- -----
Diluted earnings per
common share $6,203,000 28,691,000 $ .22
========== ========== =====
Quarter Ended June 30, 2005
---------------------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
----------- ------------- ---------
Net income $4,584,000
==========
Basic earnings per
common share $4,584,000 26,878,000 $ .17
Effect of dilutive securities:
Options 1,526,000 (.01)
---------- ---------- -----
Diluted earnings per
common share $4,584,000 28,404,000 $ .16
========== ========== =====
Six Months Ended June 30, 2006
---------------------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
----------- ------------- ---------
Net income $11,994,000
===========
Basic earnings per
common share $11,994,000 27,367,000 $ .44
Effect of dilutive securities:
Options 1,289,000 (.02)
----------- ---------- -----
Diluted earnings per
common share $11,994,000 28,656,000 $ .42
=========== ========== =====
Six Months Ended June 30, 2005
---------------------------------------
Income Shares Per-share
(Numerator) (Denominator) Amount
----------- ------------- ---------
Net income $8,847,000
==========
Basic earnings per
common share $8,847,000 26,750,000 $ .33
Effect of dilutive securities:
Options 1,471,000 (.02)
---------- ---------- -----
Diluted earnings per
common share $8,847,000 28,221,000 $ .31
========== ========== =====
-11-
Options to purchase 426,000 and 424,000 shares of common stock at an
average exercise price of $20.71 were outstanding during the three and six month
periods ended June 30, 2006, respectively, 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 either of the three or six month periods
ended June 30, 2005 as none have an exercise price in excess of the average
market value of our common stock during such periods.
DIVIDENDS
We have paid regular quarterly cash dividends since the second quarter of
2003. During the six month period ended June 30, 2006, we paid regular cash
dividends totaling $5,745,000 as follows.
1st Quarter 2nd Quarter
----------- -----------
Cash dividend per common share $.10 $.11
Total cash dividends paid $2,700,000 $3,045,000
Record date February 3 April 28
Payment date February 13 May 10
Additionally, on July 18, 2006, our Board of Directors declared a regular
quarterly cash dividend payment of $.12 per common share to be paid on August
11, 2006 to shareholders of record as of July 28, 2006.
NOTE 5 - SHARE-BASED COMPENSATION
During the six month period ended June 30, 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 Life Intrinsic
Price of Shares (In Years) Value
---------------- --------- ---------------- -----------
Outstanding, January 1, 2006 $ 8.91 2,843,000
Granted -- --
Cancelled 18.09 (5,000)
Exercised 8.53 (189,000)
------ ---------
Outstanding, June 30, 2006 $ 8.92 2,649,000 5.78 $31,877,000
====== ========= ==== ===========
The following table summarizes information about stock options outstanding at
June 30, 2006.
Options Outstanding Options Exercisable
------------------- -------------------
Average Weighted Weighted
Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Price Range Outstanding Life Price Exercisable Price
-------------- ----------- ------------------- -------- ----------- -------------------
$ 2.25 - 3.75 522,000 3.36 $ 3.08 522,000 $ 3.08
$ 4.11 - 5.62 852,000 5.70 4.66 852,000 4.66
$ 8.29 - 8.29 435,000 7.49 8.29 435,000 8.29
$13.65 - 20.71 840,000 6.50 17.18 840,000 17.18
--------- ---- ------ --------- ------
2,649,000 5.78 $ 8.92 2,649,000 $ 8.92
========= ==== ====== ========= ======
-12-
Other information pertaining to option activity during the six month
periods ended June 30, 2006 and June 30, 2005 was as follows:
June June
30, 2006 30, 2005
-------------- --------------
Weighted average grant-date fair value of
stock options granted: Not applicable Not applicable
Total pre-tax fair value of stock options
vested: Not applicable $2,294,000
Total pre-tax intrinsic value of stock options
exercised: $2,151,000 $7,339,000
Under our Plans at June 30, 2006, in addition to the 2,649,000 issuable
pursuant to outstanding option grants, an additional 1,728,000 shares of our
Common Stock are available for future grants. 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.
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 has resulted in our recording compensation expense for
employee stock options and ESPP rights.
The pre-tax share-based employee compensation expense recorded in the three
and six month periods ended June 30, 2006 was approximately $35,000 and
$116,000, respectively. Such expense resulted solely from the estimated value to
be recognized from the share-based payments
-13-
of our ESPP. It is estimated, at this time, that the expense attributable to
such share-based payments in each of the remaining quarters of 2006 will
approximate the average of the amounts recorded in the 2006 first and second
quarter. Such future expense will be impacted by and dependent on the change in
our stock price over the remaining period up to the December 31, 2006
measurement date. 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
three and six month periods ended June 30, 2006 were estimated using the
Black-Scholes option pricing model with the following weighted average
assumptions:
Risk-free interest rate 4.5%
Expected volatility 34.5%
Weighted average expected life (in years) .5
Dividend yield 2.1%
Results for the three and six month periods ended June 30, 2005 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 such 2005 periods would have been the pro
forma amounts indicated below:
Quarter Ended Six Months Ended
June 30, 2005 June 30, 2005
------------- ----------------
Net Income
As reported $4,584,000 $ 8,847,000
Deduct: Total share-based employee compensation expense
determined under fair value based method for all
awards, net of related tax effects:
Stock Option Plans (680,000) (1,699,000)
ESPP (151,000)(1) (302,000)(1)
---------- -----------
Pro forma net income $3,753,000 $ 6,846,000
========== ===========
Basic Earnings Per Common Share
As reported $ .17 $ .33
Pro forma $ .14 $ .26
Diluted Earnings Per Common Share
As reported $ .16 $ .31
Pro forma $ .13 $ .24
(1) Represents actual 2005 share-based compensation applicable to the ESPP
allocated to the three and six month periods ended June 30, 2005,
respectively.
-14-
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 six month periods' ended June 30, 2006 and June 30, 2005, the service
agreements with the client facilities in which the Related Parties have
ownership interests resulted in revenues of $3,963,000 and $3,805,000,
respectively. At June 30, 2006 and December 31, 2005, accounts and notes
receivable from such facilities of $2,764,000 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 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 six month periods' ended June 30, 2006 and June 30, 2005, fees
received from us by such firm did not exceed $75,000 in either period.
Additionally, such fees did not exceed, in either period, 5% of such firm's
revenues.
NOTE 7 - RECENT ACCOUNTING PRONOUNCEMENTS
In June 2006, the Financial Accounting Standards Board (the "FASB") issued
FASB Interpretation No. 48 "Accounting for Uncertainty in Income Taxes (an
interpretation of FASB Statement No. 109") which is effective for fiscal years
beginning after December 15, 2006 with earlier adoption encouraged. This
interpretation was issued to clarify the accounting for uncertainty in income
taxes recognized in the financial statements by prescribing a recognition
threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return. We
are currently evaluating the potential impact of this interpretation.
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 six month period ended June 30, 2006 (such
client has completed its previously announced merger on March 14, 2006); our
claims experience related to workers' compensation and general liability
insurance; the
-15-
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 June 30, 2006 and December 31, 2005 and the periods then ended, 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 1,725 facilities in 44 states as of June 30, 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.
-16-
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.
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 For the Six Months
Ended June 30, Ended June 30,
--------------- ------------------
2006 2005 2006 2005
----- ------- ------ ---------
Revenues 100.0% 100.0% 100.0% 100.0%
Operating costs and expenses:
Costs of services provided 86.2 87.3 86.1 87.2
Selling, general and
administration 6.6 7.0 7.0 7.1
Investment and interest income .8 .7 1.0 .5
----- ----- ----- -----
Income before income taxes 8.0 6.4 7.9 6.2
Income taxes 3.0 2.4 2.9 2.4
----- ----- ----- -----
Net income 5.0% 4.0% 5.0% 3.8%
===== ===== ===== =====
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 six month period
ended June 30, 2006 percentages presented in the above table as they relate to
consolidated revenues.
Housekeeping is our largest and core reportable segment, representing
approximately 80%
-17-
of consolidated revenues for both the quarter and six month
period ended June 30, 2006. Food revenues represented approximately 20% of
consolidated revenues for such periods.
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.
-18-
2006 SECOND QUARTER COMPARED WITH 2005 SECOND QUARTER
The following table sets forth 2006 second 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 second quarter amounts.
Reportable Segments
----------------------------------------
Housekeeping Food
Percent Corporate and ------------------- -------------------
Consolidated increase eliminations Amount %incr Amount %incr
------------ -------- ------------- ----------- ----- ----------- -----
Revenues $122,840,000 5.9% $ (124,000) $98,291,000 5.4% $24,673,000 7.6%
Cost of services provided 105,843,000 4.4 6,770,000 88,855,000 4.4 23,758,000 7.3
Selling, general and
administrative expense 8,123,000 .2 (8,123,000) -- --
Income before income taxes $ 9,847,000 33.2% (504,000) $ 9,436,000 15.8 $ 915,000 16.6
REVENUES
Consolidated
Consolidated revenues increased 5.9% to $122,840,000 in the 2006 second
quarter compared to $116,048,000 in the 2005 second quarter as a result of the
factors discussed below under Reportable Segments.
Our Major Client accounted for 19% of consolidated revenues in each of the
three month periods ended June 30, 2006 and June 30, 2005. This client completed
its previously announced merger on March 14, 2006. Our relationship with the
successor entity remains under the same terms and conditions as established
prior to the merger. 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.
-19-
Reportable Segments
Housekeeping's 5.4% net growth in reportable segment revenues is primarily
a result of an increase in service agreements entered into with new clients.
Food's 7.6% 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
second quarter revenues from the Major Client.
COSTS OF SERVICES PROVIDED
Consolidated
Cost of services provided, on a consolidated basis, as a percentage of
consolidated revenues for the 2006 second quarter decreased to 86.2 % from 87.3
% 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 .2 .2 --
Workers' compensation and general
liability insurance 4.0 4.3 (.3)
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 second quarter decreased to 90.4% from 91.3% in the
corresponding 2005 quarter. Cost of services provided for Food, as a percentage
of Food revenues, for the 2006 second quarter decreased to 96.3% from 96.6% 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 81.4 82.4 (1.0)
Housekeeping supplies 5.4 5.7 (.3)
Food labor and other labor costs 54.3 54.4 (.1)
Food supplies 37.0 37.3 (.3)
The decrease in Housekeeping labor and other labor costs, as a percentage
of Housekeeping revenues, resulted primarily from efficiencies achieved. The
decrease in Housekeeping supplies resulted primarily from price decreases in the
cost of supplies for our laundry services.
-20-
The decrease in Food supplies, as a percentage of Food revenues, is a
result of price decreases in vendor purchasing agreements.
CONSOLIDATED SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Even though we had a 5.9% growth in consolidated revenues, selling, general and
administrative expenses increased by only .2% or $14,000. As a percentage of
total consolidated revenues, these expenses decreased to 6.6% in the 2006 second
quarter as compared to 7.0% in the 2005 second quarter. The decrease is
primarily attributable to our ability to control these expenses and comparing
them to a greater revenue base in the current quarter.
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 second quarter increased to
8.0 %, as a percentage of consolidated revenues, compared to 6.4% in the 2005
second quarter.
Reportable Segments
Housekeeping's 15.8% 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 5.4% increase in reportable segment revenues.
Food's income before income taxes increased 16.6% 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 7.6%
increase in reportable segment revenues.
CONSOLIDATED INVESTMENT AND INTEREST INCOME
Investment and interest income, as a percentage of consolidated revenues,
was .8% in the 2006 second quarter compared to .7% in the 2005 second quarter.
The slight net increase is attributable to improved rates of return on the
higher cash and cash equivalents' average balances, which was offset by the
decrease in market value of the investments held in our Deferred Compensation
Fund.
CONSOLIDATED INCOME TAXES
Our effective tax rate for the quarter ended June 30, 2006 was 37% compared
to our June 30, 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 second 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.
-21-
CONSOLIDATED NET INCOME
As a result of the matters discussed above, consolidated net income for the
2006 second quarter increased to 5.0%, as a percentage of consolidated revenues,
compared to 4.0% in the 2005 second quarter.
2006 SIX MONTH PERIOD COMPARED WITH 2005 SIX MONTH PERIOD
The following table sets forth, for the six month period ended June 30, 2006
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 the six month period ended June 30,
2005 amounts.
Reportable Segments
------------------------------------------
Housekeeping Food
Percent Corporate and -------------------- -------------------
Consolidated increase eliminations Amount %incr Amount %incr
------------ -------- ------------- ------------ ----- ----------- -----
Revenues $241,758,000 4.8% $ 896,000 $193,150,000 4.8% $47,712,000 4.8%
Cost of services provided 208,025,000 3.4 12,369,000 174,299,000 3.8 46,095,000 4.5
Selling, general and
administrative expense 17,014,000 2.9 (17,014,000) -- --
Income before income taxes $ 19,039,000 33.4% (1,429,000) $ 18,851,000 14.7 $ 1,617,000 13.1%
REVENUES
Consolidated
Consolidated revenues increased 4.8% to $241,758,000 in the six month
period ended June 30, 2006 compared to $230,743,000 in the same 2005 period as a
result of the factors discussed below under Reportable Segments.
Our Major Client accounted for 19% of consolidated revenues in each of the
six month periods ended June 30, 2006 and June 30, 2005.
Reportable Segments
Housekeeping's 4.8% net growth in reportable segment revenues is primarily
a result of an increase in service agreements entered into with new clients.
Food's 4.8% 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 six
month period's revenues from the Major Client.
-22-
COSTS OF SERVICES PROVIDED
Consolidated
Cost of services provided, on a consolidated basis, as a percentage of
consolidated revenues for the six month period ended June 30, 2006 decreased to
86.1% from 87.2% in the corresponding 2005 period. 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 3.8 4.3 (.5)
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 six month period ended June 30, 2006 decreased to 90.2% from
91.1% in the corresponding 2005 period. Cost of services provided for Food, as a
percentage of Food revenues, for the 2006 six month period decreased to 96.6%
from 96.9% in the corresponding 2005 six month period.
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 82.1 ( .8)
Housekeeping supplies 5.4 5.2 .2
Food labor and other labor costs 54.4 54.3 .1
Food supplies 37.3 39.7 (2.4)
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 4.8% growth in consolidated revenues, selling, general
and administrative expenses increased by 2.9% or $476,000 in comparing the six
month periods ended June 30, 2006 and June 30, 2005. However, as a percentage of
total consolidated revenues, these expenses decreased by .1% to 7.0% in the 2006
period as compared to 7.1% in the 2005 period. The decrease is primarily
attributable to our ability to control these expenses and comparing them to a
greater revenue base in the current six month period.
-23-
INCOME BEFORE INCOME TAXES
Consolidated
As a result of the discussion above related to revenues and expenses,
consolidated income before income taxes for the six month period ended June 30,
2006 increased to 7.9 %, as a percentage of consolidated revenues, compared to
6.2% in the same 2005 period.
Reportable Segments
Housekeeping's 14.7% 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 4.8% increase in reportable segment revenues.
Food's income before income taxes increased 13.1% 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 4.8%
increase in reportable segment revenues.
CONSOLIDATED INVESTMENT AND INTEREST INCOME
Investment and interest income, as a percentage of consolidated revenues,
was 1.0% in the six month period ended June 30, 2006 compared to .5% in the same
2005 period. The slight net increase is attributable to improved rates of return
on the higher cash and cash equivalents' average balances, which was offset by
the decrease in the market value of the investments held in our Deferred
Compensation Fund.
CONSOLIDATED INCOME TAXES
Our effective tax rate for the six month period ended June 30, 2006 was 37%
compared to our June 30, 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 six month period. 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
six months ended June 30, 2006 increased to 5.0%, as a percentage of
consolidated revenues, compared to 3.8% in six month period ended June 30, 2005.
-24-
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in accordance with accounting
standards generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. 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 managements'
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.
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 accounting standards
generally accepted in the United States, 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
critical accounting policies and estimates and other disclosures required by
accounting principles generally accepted in the United States.
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
-25-
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 June 30, 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 $2,720,000 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 $14,000.
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, 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 38%
of our liabilities at June 30, 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 $41,000. Additionally, reducing the estimated payout period by six
months would result in an approximate $104,000 reduction in net income.
-26-
For general liability, we record a reserve for the estimated ultimate
amounts to be paid for known claims. The estimated ultimate reserve amount
recorded is derived from the estimated claim reserves provided by our insurance
carrier reduced by an historical experience factor.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2006, we had cash and cash equivalents of $92,318,000 and
working capital of $150,748,000 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
June 30, 2006 increased to 7.7 to 1 compared to 7.2 to 1 at December 31, 2005.
This increase 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.
OPERATING ACTIVITIES
The net cash provided by our operating activities was $6,287,000 for the
six month period ended June 30, 2006. The principal sources of net cash flows
from operating activities for the six month period ended June 30, 2006 were net
income, including non-cash charges to operations for bad debt provisions and
depreciation. Additionally, operating activities' cash flows increased by
$1,438,000 as a result of the timing of payments for accounts payable and other
accrued expenses. The operating activity that used the largest amount of cash
during the six month period ended June 30, 2006 was a net increase of $6,941,000
in accounts and notes receivable and long-term notes receivable resulting
primarily from the 4.8% growth in the Company's 2006 six month period revenues.
INVESTING ACTIVITIES
Our principal use of cash in investing activities for the six month period
ended June 30, 2006 was $1,012,000 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 $1,000,000 to $1,500,000 during the remainder
of 2006 for such capital expenditures.
FINANCING ACTIVITIES
We have paid regular quarterly cash dividends since the second quarter of
2003. During the six month period ended June 30, 2006, we paid regular cash
dividends totaling $5,745,000 as follows.
1st Quarter 2nd Quarter
----------- -----------
Cash dividend per common share $.10 $.11
Total cash dividends paid $2,700,000 $3,045,000
Record date February 3 April 28
Payment date February 13 May 10
Additionally, on July 18, 2006, our Board of Directors declared a regular
quarterly cash dividend payment of $.12 per common share to be paid on August
11, 2006 to shareholders of record as of July 28, 2006.
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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 six month period ended June 30, 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 the six month period ended June 30, 2006, we received proceeds of
$1,597,000 from the exercise of stock options by employees and directors, as
well as recognizing an income tax benefit of $763,000 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 June 30, 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
June 30, 2006 and December 31, 2005, respectively.
The line of credit requires us to satisfy two financial covenants. Such
covenants, and their respective status at June 30, 2006, were as follows:
Covenant Description and Requirement Status at June 30, 2006
----------------------------------------- ----------------------------------
Commitment coverage ratio: cash and cash Commitment coverage is 3.9
equivalents must equal or exceed
outstanding obligations under the line
by a multiple of 2.
Tangible net worth: must exceed Tangible net worth is $154,964,000
$118,000,000.
As noted above, we complied with the financial covenants at June 30, 2006
and expect to continue to remain in compliance with such financial covenants.
This line of credit expires on June 30, 2007. 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
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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 June 30, 2006 and December 31, 2005, we had $10,189,000 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 $625,000 in each of the six month periods
ended June 30, 2006 and June 30, 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.
At June 30, 2006, amounts due from our Major Client represented less than
1% of our accounts receivable balance.
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.
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For general liability, we record a reserve for the estimated ultimate
amounts to be paid for known claims. The estimated ultimate reserve amount
recorded is derived from the estimated claim reserves provided by our insurance
carrier reduced by an historical experience factor.
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 2006, we
estimate that for the remainder of 2006 we will have capital expenditures of
approximately $1,000,000 to $1,500,000 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 such cost increases through to our clients.
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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 June 30, 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.
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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.
Repurchases
(c) (d)
Total number of Maximum
shares purchased as number of shares
(a) (b) 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
----------- ---------------- -------------- ------------------- -------------------
April 1 to
June 30 None
ITEM 3. DEFAULTS UNDER SENIOR SECURITIES.
Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our Annual Meeting of Shareholders was held on May 23, 2006. The
results were as follows.
(1) All of management's nominees for directors were elected as follows:
Shares voted
Director "FOR" Withheld
------------------- ------------ ----------
Daniel P. McCartney 20,538,623 5,042,777
Barton D. Weisman 24,293,580 1,287,820
Joseph F. McCartney 18,687,853 6,893,547
Robert L. Frome 18,990,195 6,591,205
Thomas A. Cook 20,068,899 5,512,501
Robert J. Moss 22,178,646 3,402,754
John M. Briggs 24,209,997 1,371,403
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(2) Proposal to approve and ratify selection of Grant Thornton LLP as the
independent certified public accountants of the Company for its fiscal year
ending December 31, 2006 was approved as follows:
Shares Voted Shares Voted Shares Broker
"FOR" "AGAINST" "ABSTAINING" Non-votes
------------ ------------ ------------ ---------
25,258,105 154,376 168,918 -0-
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
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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.
July 21, 2006 /s/ Daniel P. McCartney
Date ----------------------------------------
DANIEL P. McCARTNEY, Chief
Executive Officer
July 21, 2006 /s/ Thomas A. Cook
Date ----------------------------------------
THOMAS A. COOK, President and
Chief Operating Officer
July 21, 2006 /s/ James L. DiStefano
Date ----------------------------------------
JAMES L. DiSTEFANO, Chief Financial
Officer and Treasurer
July 21, 2006 /s/ Richard W. Hudson
Date ----------------------------------------
RICHARD W. HUDSON, Vice
President-Finance, Secretary and Chief
Accounting Officer
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