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HCSG > SEC Filings for HCSG > Form 10-K on 21-Feb-2014All Recent SEC Filings

Show all filings for HEALTHCARE SERVICES GROUP INC

Form 10-K for HEALTHCARE SERVICES GROUP INC


21-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation.

You should read the following discussion and analysis of our financial condition and results of our operations in conjunction with our consolidated financial statements and the related notes to those statements included elsewhere in this report. This discussion contains forward-looking statements reflecting our current expectations that involve risks and uncertainties. Our actual results and the timing of events may differ materially from those contained in these forward-looking statements due to a number of factors, including those discussed in the section entitled "Risk Factors," and elsewhere in this report on Form 10-K. We are on a calendar year end, and except where otherwise indicated below, "2013" refers to the year ended December 31, 2013, "2012" refers to the year ended December 31, 2012 and "2011" refers to the year ended December 31, 2011.

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 December 31, 2013 and the year then ended and the notes accompanying those financial statements contained herein under Item 8.

Overview

We provide management, administrative and operating expertise and services to the housekeeping, laundry, linen, facility maintenance and dietary service departments of 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 management services to the long-term care industry in the United States, rendering such services to over 3,000 facilities in 48 states as of December 31, 2013. Although we do not directly participate in any government reimbursement programs, our clients' reimbursements are subject to government regulation. Therefore, our clients 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 day to day management of the department managers and hourly employees located at our clients' facilities. We also provide


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services on the basis of a management-only agreement for a very limited number of clients. Our agreements with clients typically provide for renewable one year service terms, 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 dietary department services ("Dietary"). At December 31, 2013, Housekeeping is provided at essentially all of our 3,000 client facilities, generating approximately 66% or $759,093,000 of 2013 total revenues. Dietary is provided to over 800 client facilities at December 31, 2013 and contributed approximately 34% or $390,797,000 of 2013 total revenues.

Housekeeping consists of managing the client's housekeeping department which is principally responsible for the cleaning, disinfecting and sanitizing of patient rooms and common areas of a client's facility, as well as laundering and processing of the personal clothing belonging to the facility's patients. Also within the scope of this segment's service is the responsibility for laundering and processing the bed linens, uniforms and other assorted linen items utilized by a client facility.

Dietary consists of managing the client's dietary department which is principally responsible for food purchasing, meal preparation and providing dietitian consulting professional services, which includes the development of a menu that meets the patient's dietary needs.

Our ability to acquire new clients and increase revenues is affected by many factors. Competitive factors consist primarily of competing with the potential client utilizing an in-house support staff, as well as local companies which provide services similar to ours. We are unaware of any other companies, on a national or local level, which have a significant presence or impact on our procurement of new clients in our market. We believe the primary revenue drivers of our business are our ability to obtain new clients and to pass through, by means of service billing increases, increases in our cost of providing the services. In addition to the recoupment of costs increases, we endeavor to obtain modest annual revenue increases from our existing clients to preserve current profit margins at the facility level. The primary economic factor in acquiring new clients is our ability to demonstrate the cost-effectiveness of our services. This is because many of our clients' revenues are generally highly reliant on Medicare and Medicaid reimbursement funding rates and mechanisms. Therefore, their economic decision-making process in engaging us is driven significantly by their reimbursement funding rate structure in relation to how their costs are currently being reimbursed and the financial impact on their reimbursement as a result of engaging us for the respective services. Another factor is our ability to demonstrate to potential clients the benefit of being relieved of the administrative and operational challenges related to the day-to-day management of their respective department services for which they contract with us. In addition, we must be able to assure new clients that we will be able to improve the quality of service which they are providing to their patients and residents. We believe the factors discussed above are equally applicable to each of our segments with respect to acquiring new clients and increasing revenues.

Our costs of services can experience volatility and impact our operating performance in two key cost indicators: costs of labor and costs of supplies. The volatility of these costs impacts each segment somewhat differently due to the respective costs as a percentage of that segment's revenues. Housekeeping is more significantly impacted than Dietary as a consequence of our management of our costs of labor. Such costs of labor can account for approximately 80% of Housekeeping revenues. Dietary costs of labor account for approximately 52% of Dietary revenues. Changes in wage rates as a result of legislative or collective bargaining actions, anticipated staffing levels, and other unforeseen variations in our use of labor at a client service location or in management labor costs will result in volatility of these costs. In contrast, supplies consumed in performing our services is more significant for Dietary, accounting for approximately 40% of Dietary revenues, of total operating costs incurred at a Dietary facility service location. Housekeeping supplies, including linen products, account for approximately 8% of Housekeeping revenues. Generally, the volatility of these expenses is influenced by factors outside of our control and is unpredictable. This is because Housekeeping and Dietary supplies are principally commodity products and affected by market conditions specific to the respective products. Although we endeavor to pass on such increases in labor and supplies costs to our clients, the inability or delay in procuring service billing increases to reflect these additional costs would negatively impact our profit margins.

As a result of the current economic crisis, many states have significant budget deficits. State Medicaid programs are experiencing increased demand, and with lower revenues than projected, they have fewer resources to support their Medicaid programs. In addition, comprehensive health care legislation under the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 (together, the "Act") was signed into law in March 2010. The Act will significantly impact the governmental healthcare programs in which our clients participate, and reimbursements received thereunder from governmental or third-party payors. In July 2011, Centers for Medicare and Medicaid Services ("CMS") issued a final rule that reduced Medicare payments to nursing centers by 11.1% and changed the reimbursement for the provision of group rehabilitation therapy services to Medicare beneficiaries. This new rule was effective as of October 1, 2011. Furthermore, in the coming year and beyond, new proposals or additional changes in existing regulations could be made to the Act which could directly impact the governmental reimbursement programs in which our clients participate. As a result, some state Medicaid programs are reconsidering previously approved increases in nursing home reimbursement or are considering delaying or foregoing those increases. A few states have


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indicated it is possible they will run out of cash to pay Medicaid providers, including nursing homes. Any negative changes in our clients' reimbursements may negatively impact our results of operations. Although we are currently evaluating the Act's effect on our client base, we may not know the full effect until such time as these laws are fully implemented and CMS and other agencies issue applicable regulations or guidance. Additionally, even if federal or state legislation is enacted that provides additional funding to Medicaid providers, given the volatility of the economic environment, it is difficult to predict the impact of this legislation on our clients' liquidity and their ability to make payments to us as agreed.

In January 2013, the U.S. Congress enacted the American Taxpayer Relief Act of 2012, which delayed automatic spending cuts of $1.2 trillion, including reduced Medicare payments to plans and providers up to 2%. These discretionary spending caps were originally enacted under provisions in the Budget Control Act of 2011, an initiative to reduce the federal deficit through the year 2021, also known as "sequestration." The sequestration went into effect starting March 2013. In December 2013, the U.S. Congress enacted the Bipartisan Budget Act of 2013, which reduces the impact of the sequestration over the next two years, beginning in fiscal year 2014 and extended the reduction in Medicare payments to plans and providers for two years through the year 2023.

As of December 31, 2013, we operate two wholly-owned subsidiaries, Huntingdon Holdings, Inc. ("Huntingdon") and Healthcare Staff Leasing Solutions, LLC ("Staff Leasing"). Huntingdon invests our cash and cash equivalents, and manages our portfolio of available-for-sale marketable securities. Staff Leasing is an entity formed in 2011 to offer professional employer organization ("PEO") services to potential clients in the health care industry. As of December 31, 2013, we have PEO service contracts in several states. During the years 2011 through 2013, operating results from our PEO services contracts were not material and were included in our Housekeeping segment.

On July 12, 2013, the Company acquired substantially all of the operating assets of Platinum Health Services, LLC, a Delaware limited liability company and Platinum Health Services PEO, LLC, a Delaware limited liability company (collectively "Platinum") pursuant to an Asset Purchase Agreement dated July 11, 2013. Platinum was a privately-held provider of professional housekeeping, laundry and maintenance services to long-term and post-acute care facilities and operated solely within the United States. The acquisition has been included within the consolidated results of operations and financial condition from the date of the acquisition.

Consolidated Operations

The following table sets forth, for the years indicated, the percentage which
certain items bear to consolidated revenues:

                                         Relation to Consolidated Revenues
                                             Years Ended December 31,
                                        2013            2012           2011
Revenues                                100.0 %         100.0 %         100.0 %
Operating costs and expenses:
Costs of services provided               86.5 %          86.4 %          86.3 %
Selling, general and administrative       8.0 %           7.4 %           7.3 %
Investment and interest income            0.3 %           0.3 %           0.1 %
Income before income taxes                5.8 %           6.5 %           6.5 %
Income taxes                              1.7 %           2.4 %           2.2 %
Net income                                4.1 %           4.1 %           4.3 %

Subject to the factors noted in the Cautionary Statement Regarding Forward Looking Statements included in this report, we anticipate, although there can be no assurance thereof, our financial performance in 2014 may be comparable to the 2013 percentages presented in the above table as they relate to consolidated revenues.

Housekeeping is our largest and core reportable segment, representing approximately 66% of 2013 consolidated revenues. Dietary revenues represented approximately 34% of 2013 consolidated revenues.

Although there can be no assurance thereof, we believe that in 2014 Dietary's revenues, as a percentage of consolidated revenues, may increase from its respective 2013 percentages noted above. Furthermore, we expect the sources of growth in 2014 for the respective operating segments will be primarily the same as historically experienced. Accordingly, although there can be no assurance thereof, the growth in Dietary is expected to come from our current Housekeeping client base, while growth in Housekeeping will primarily come from obtaining new clients.


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Fiscal 2013 Compared to Fiscal 2012

The following table sets forth 2013 income statement key components that we use
to evaluate our financial performance on a consolidated and reportable segment
basis compared to 2012 amounts. The differences between the reportable segments'
operating results and other disclosed data and our consolidated financial
statements relate primarily to corporate level transactions and recording of
transactions at the reportable segment level.

                                                                                        Reportable Segments
                                                                            Housekeeping                     Dietary
                                                    Corporate and
                     Consolidated      % Change     Eliminations         Amount        % Change        Amount        % Change
Revenues           $ 1,149,890,000        6.7  %   $           -     $ 759,093,000        2.9  %   $ 390,797,000        15.0 %
Cost of services
provided               995,104,000        6.9        (64,670,000 )     690,221,000        3.3        369,553,000        15.0
Selling, general
and administrative      91,998,000       16.0         91,998,000                 -          -                  -           -
Investment and
interest income          3,701,000       26.7          3,701,000                 -          -                  -           -
Income before

income taxes $ 66,489,000 (5.4 )% $ (23,627,000 ) $ 68,872,000 (0.8 )% $ 21,244,000 15.0 %

Revenues

Consolidated

Consolidated revenues increased 6.7% to $1,149,890,000 in 2013 compared to $1,077,435,000 in 2012 as a result of the factors discussed below under Reportable Segments.

Reportable Segments

Housekeeping's 2.9% net growth in reportable segment revenues resulted primarily from an increase in revenues attributable to service agreements entered into with new clients and the acquisition of Platinum on July 12, 2013.

Dietary's 15.0% net growth in reportable segment revenues is primarily a result of providing this service to a greater number of facilities for existing Housekeeping clients.

Costs of services provided

Consolidated

Consolidated costs of services increased 6.9% to $995,104,000 in 2013 compared to $930,814,000 in 2012. The increase in costs of services is a direct result of growth in our consolidated revenues. Certain significant components within our costs of services are subject to fluctuation with the changes in our business and client base. The increase in such components during 2013 compared to 2012 include labor and other labor related costs, housekeeping and dietary supplies, and workers' compensation and general liability insurance, partially offset by a decrease in our bad debt provision. Historically, these significant components have accounted for approximately 97% of consolidated costs of services.

As a percentage of consolidated revenues, cost of services increased to 86.5% in 2013 from 86.4% in 2012. 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 as %
of Consolidated Revenue                           2013 %       2012 %      % Change
Bad debt provision                                 0.2          0.2           -
Workers' compensation and general liability
insurance                                          3.2          3.4         (0.2)

As a percentage of consolidated revenues, the bad debt provision remained constant due to our assessment of the collectability of our receivables. When we evaluate that there is an uncertainty associated with the collectability of amounts due from a client, we record a bad debt provision based upon our initial estimate of ultimate collectability. We revise such provision as additional information is available which we believe enables us to make a more accurate estimate of the collectability of an account. Some of our clients may experience liquidity problems because of governmental funding or operational issues. Such liquidity problems


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may cause them to not pay us as agreed upon or necessitate them filing for bankruptcy protection. In the event of additional clients filing for bankruptcy protection, we would increase our bad debt provision during the reporting period when such filing occurs. Therefore, if more clients file for bankruptcy protection or if we have to increase our current provision related to existing bankruptcies, our bad debt provision may increase from our last two years' average as a percentage of consolidated revenues.

As a percentage of consolidated revenues, the workers' compensation and general liability insurance expense decreased primarily due to more favorable claims' experience during the year ended December 31, 2013 compared to 2012.

Reportable Segments

Cost of services provided for Housekeeping, as a percentage of Housekeeping revenues for 2013, increased slightly to 90.9% compared to 90.6% in 2012. Cost of services provided for Dietary, as a percentage of Dietary revenues for 2013, remained constant at 94.6% compared to 2012.

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 as %
of Segment Revenue                                2013 %       2012 %      % Change
Housekeeping labor and other labor costs           80.4         80.3         0.1
Housekeeping supplies                              8.0          7.8          0.2
Dietary labor and other labor costs                51.8         52.3        (0.5)
Dietary supplies                                   39.9         39.3         0.6

Housekeeping labor and other labor costs, as a percentage of Housekeeping revenues, slightly increased due to inefficiencies recognized in managing labor at the facility level. The increase in Housekeeping supplies, as a percentage of Housekeeping revenues, resulted primarily from an increase in supplies due to the growth in housekeeping, laundry and linen revenue compared to overall Housekeeping revenues. Additionally, we have added more clients where we provide a greater amount of supplies under the terms of our service agreements compared to what we have historically provided to our client base.

Dietary labor and other labor costs, as a percentage of Dietary revenues, decreased due to increased efficiencies in managing these costs at the facility level. The increase in Dietary supplies, as a percentage of Dietary revenues, is a result of the inefficient management of these costs, partially offset by more favorable vendor pricing programs obtained through further consolidation of dietary supply vendors.

Consolidated Selling, General and Administrative Expense

                                                           Year Ended December 31,
                                                     2013             2012         % Change
Selling, general and administrative expense w/o
deferred compensation change (a)                $ 88,993,000     $ 77,559,000          14.7 %
Deferred compensation fund gain                    3,005,000        1,718,000          74.9 %
Consolidated selling, general and
administrative expense (b)                      $ 91,998,000     $ 79,277,000          16.0 %

(a) Selling, general and administrative expense excluding the change in the market value of the deferred compensation fund.

(b) Consolidated selling, general and administrative expense reported for the period presented.

Although our growth in consolidated revenues was 6.7% for the year ended December 31, 2013, selling, general and administrative expenses excluding the change in market value of the deferred compensation fund increased 14.7% or $11,434,000 compared to the 2012 period. Consequently, for the year ended December 31, 2013, selling, general and administrative expenses (excluding the impact of deferred compensation fund), as a percentage of consolidated revenues, increased to 7.7% of consolidated revenues as compared to 7.2% in the 2012 comparable period. This percentage increase resulted primarily from the increase in our payroll and payroll related expenses, professional fees, and legal expenses and matters as a percentage of revenues. The increase in payroll and payroll related costs resulted from the development of additional regions, districts and overall management personnel in advance of the new business. The primary increase in our legal expenses were the related costs and expenses associated with mediated settlements regarding certain employment related matters. In 2014, we expect to incur selling, general and administrative expenses as a percentage of consolidated revenues consistent with historical levels.


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For the year ended December 31, 2013, the portion of our consolidated selling, general and administrative expense attributable to deferred compensation increased $1,287,000 compared to the 2012 period. The increase in the deferred compensation liability is a result of an increase in the market value of the investments held in our deferred compensation fund as noted below in Consolidated Investment and Interest Income. Consolidated selling, general and administrative expenses increased $12,721,000 or 16.0%.

Consolidated Investment and Interest Income

Investment and interest income, as a percentage of consolidated revenues, remained constant at 0.3% for the year ended December 31, 2013 compared to the corresponding 2012 period.

Income before Income Taxes

Consolidated

As a result of the discussion above related to revenues and expenses, consolidated income before income taxes for 2013 decreased to 5.8%, as a percentage of consolidated revenues, compared to 6.5% in 2012.

Reportable Segments

Housekeeping's decrease in income before income taxes is primarily attributable to the key indicators discussed above, specifically the increase in labor and labor related costs and housekeeping supplies as a percentage of segment revenue, partially offset by an increase in reportable segment revenues.

Dietary's increase in income before income taxes is primarily attributable to the key indicators discussed above, specifically the increase in reportable segment revenues, as well as the decrease in labor and labor related costs as a percentage of segment revenue, partially offset by the increased cost of dietary supplies.

Consolidated Income Taxes

Our effective tax rate was 29.1% for the year ended December 31, 2013 and 37.1% for 2012. The decrease in the effective tax rate was primarily the result of increased tax credits realized in 2013. The Company receives credits related to the Work Opportunity Tax Credit ("WOTC") program but this program expired at December 31, 2011. The WOTC was subsequently renewed, but not until January 2, 2013, as part of The American Taxpayer Relief Act of 2012 (the "Relief Act"). The tax effect of a change in tax law is recognized in the period in which the date of the enactment occurs. Since the WOTC was renewed during the three month period ended March 31, 2013, the total tax effect of additional expected credits for 2012 was included in this period. The Relief Act, among other tax changes, extended the WOTC and other similar wage-related credits for another two years, retroactive to January 1, 2012.

Absent any other significant change in federal or state and local tax laws, we expect our effective tax rate for 2014 to be higher than the 2013 rate and more comparable to the 2012 rate. Since the WOTC program expired again as of December 31, 2013 and has not yet been renewed, the 2014 income tax provision will only include any tax credits realized in 2014 relating to prior year certifications, unless the WOTC program is extended in 2014. If the program is extended during 2014, the tax effect of expected 2014 credits will be included in the tax provision in the period of enactment, which should reduce our effective tax rate. Other than the effect of the WOTC, our 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 as a percentage of revenue for 2013 remained constant at 4.1% compared to the corresponding 2012 period.


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Fiscal 2012 Compared to Fiscal 2011

The following table sets forth 2012 income statement key components that we use
to evaluate our financial performance on a consolidated and reportable segment
. . .
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