Dan McCartney - Chairman and Chief Executive Officer Ted Wahl - President and Chief Operating Officer Matt McKee - Vice President.

Michael Gallo - C.L. King A.J. Rice - UBS Chad Vanacore - Stifel Nick Heymann - William Blair Sean Dodge - Jefferies Toby Wann - Obsidian Research Group.

Good day, ladies and gentlemen and welcome to the Healthcare Services Group 2014 Fourth Quarter Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded.

The matters discussed on today’s conference call include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are often proceeded by words such as believes, expects, anticipates, plans, will, goal, may, intend, assumes or similar expressions.

Forward-looking statements reflect management’s current expectation as of the date of this conference call and involve certain risks and uncertainties. As with any projection or forecasts, they are inherently susceptible to uncertainties and changes in circumstances.

Healthcare Services Group actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors.

Some of the factors that could cause future results to materially differ from recent results or those projected in forward-looking statements are included in our earnings press release issued prior to the call and in our filings with the Securities and Exchange Commission.

We are under no obligation and expressly disclaim any obligation to update or alter its forward-looking statements, whether as a result of such changes, new information, subsequent events or otherwise. I will now turn the call over to Chairman and CEO, Dan McCartney..

Okay. Good morning, everybody and thank you for joining us today. I am with Ted Wahl and Matt McKee for the conference call for our fourth quarter. We released our fourth quarter results yesterday after the close and we will be filing our 10-K during the week of the 16th. So, with that, I will turn it over to Ted..

Hey, thank you Dan. Revenues for the fourth quarter increased over 12% to $341.6 million. Housekeeping and laundry grew at about 13%. Dining and nutrition was up almost 12% in the quarter. For the year, revenues were up about 13% to $1.293 billion.

Both quarterly and annual revenues were company records, as our divisional and regional management teams more than made up for the 2013 client modifications, which put our growth rate at less than 7% for that year.

Going into 2015, we have good momentum and expect double-digit top line growth with housekeeping and laundry at the lower end of our targeted range and dining and nutrition likely exceeding that range as the dining segment continues to have an underutilized district and regional management structure as well as a smaller base from which to grow.

Overall, the districts and regions really did do an outstanding job transitioning the new business during the fourth quarter, not only in minimizing inefficiencies, but more importantly for the long-term, fostering strong working relationships at the facility level with our new clients.

As the new business matures, we would expect ongoing margin improvement, while at the same time continuing to give proper attention and service levels to our existing customers.

As we announced last quarter, during the second half of this year, we do plan on transitioning our workers’ comp and certain employee health and welfare programs into the captive subsidiary that we introduced in 2013.

These programs will add to the general liability coverage, that’s already included as part of the captive as well as allow for greater efficiency in the management of claims, reduce our cost and provide needed flexibility for our facilities’ various health and welfare plans to meet the requirements of the Affordable Care Act, which took effect January 1.

Aside from the operational and administrative benefits, the planned insurance related enhancements will be accretive to earnings. With that abbreviated overview, I will turn the call over to Matt for a detailed discussion on the quarter..

Thanks Ted. Net income for the quarter was $15.4 million or $0.22 per share. Excluding the non-recurring charges that we took in the third quarter of ‘14, net income and earnings per share for the year would have approximated $58 million and $0.85 per share respectively.

Direct cost of services came in at 86.8% which is 80 basis points above our target of 86% and that was due to startup related costs for the new business that we started during the quarter. Going forward, our goal continues to be to manage the direct costs under 86% on a consistent basis and work our way closer to 85% direct cost of services.

SG&A expense was reported at 7.1% for the quarter, but after adjusting for the $500,000 related to the change in the deferred compensation investment accounts, which are held for and by our management people our actual SG&A was 6.9%.

We would expect normalized SG&A continue to be in the 7% range with the ongoing opportunities to garner some modest efficiencies. Our effective tax rate for the quarter was 29%, which is about 8% below our 37% run rate for the year and that was due to the reauthorization of the Work Opportunity Tax Credit which occurred during the quarter.

So depending on the timing of the WOTC reauthorization for the year ahead, our rate will likely be between 36% and 38% for 2015. We continue to manage the balance sheet conservatively and at the end of fourth quarter had $87 million of cash and marketable securities and the current ratio of 3-to-1.

Accounts receivable remain in good shape below our DSO target of 60 days. As we also announced yesterday in conjunction with earnings release, the Board of Directors approved an increase in the dividend of $0.17625 per share split-adjusted and that will be payable on March 27.

The cash flow, cash balances and net income for the quarter more than supported and with the dividend tax rate in place for this foreseeable future, cash dividend program continues to be the most tax efficient way to get the value and free cash flow back to the shareholders.

It will be our 47th consecutive dividend payment since the program was instituted in 2003 and the 46th consecutive quarter in which we increased the dividend payment over the previous quarter, that’s a 12-year period included for 4-3-for-2 stock splits. So with those opening remarks Dan, Ted and I would like to open up the call for questions..

Thank you. [Operator Instructions] The first question is from Michael Gallo of C.L. King. Your line is open..

Hi, good morning..

Good morning..

Good morning, Mike..

Question I have is on the receivables, it was nice to see them come down, DSOs came down nicely, was that just some of the legacy platinum business that have been acquired finally getting down your contract terms or just better collections overall and do you think you can maintain the receivables at that somewhat lower-level in terms of DSOs?.

I think it was a combination of both. First, our guys have done a very good job in managing the existing clients and the new clients and getting them more in line to the credit terms that corporately we set out for our objectives.

But chipping away some of the older part of the acquisition of platinum clients a couple of days or a little bit improvement quarter-to-quarter they have done a very good job in that area as well. So our internal target is still to try to improve a day a quarter in the receivables.

But frankly where they are the guys have done a real good job both in the field, the district and regional participation and financial department and credit and collection guys in their corporate office, so I am very happy with that..

And Mike just to add a little more color specifically on the PHS receivables that Dan referenced of that $5 million to $6 million that we identified 18 months or so ago after the acquisition, the majority of that opportunity really is now included as part of our normal payment schedules and conforms more to our standard receivables.

So that certainly has been part as Dan said of the progress that we have made..

Okay, great.

And the second part of that question, cash is obviously starting to build back up as a result, you had $87 million I think you still have most or all of the $20 million from the captive coming in which would take the balances at or north of $100 million, you are getting to the point now where I guess use of cash certainly will be a good problem to have, so either you have increased the dividend modestly over the last several quarters you certainly out-earning if the cash is starting to build up on the balance sheet, should we start to think about maybe faster increases later in the year or are there other things of uses of cash that you see coming down the pipe?.

The other uses we are looking at big management bonuses, that’s the best use of cash. No, I mean it’s something that the Board in all seriousness evaluates every quarter.

And I think certainly the increase in the dividend being steady was important to us as we established it and it’s getting to the point where we think down the road was certainly considered being a little bit more ambitious with the increases..

Okay, great. And then Dan, could you give us an update on the captive, now you are set up and going, you have been doing the general liability. How is it going, how has the experience been? And would you still expect it to be incremental the way you thought when you kind of put it in? Thanks..

We do. I think that it’s going to be incrementally put into effect during the course of the year, but all projections in the startup costs have come in as good or better than we expected. We just got some additions for additional coverage in approval, which is only going to enhance it.

The captive was attractive to us not only because of the coordination with the change in the medical environment, with the Affordable Care Act, but we had enough – we had enough administrative support to really pursue it, not only financially short-term for this year, but it’s going to give us the platform administratively to give us the flexibility with all of our clients to really put the program in place that mirrors that client rather than taking standard Blue Cross and Blue Shield or medical policies, for example and have them earmarked for particular facilities with modest adjustments.

Now, we can have them conform to exactly what the customer had been doing to a greater degree. And the real payoff is putting the third largest cost component, our workmen’s compensation into the program to where the real benefits are going to be.

We have managed the claims more aggressively the last 6 or 7 years, now being able to do it for ourselves with a profit motive even makes it more attractive for us. So, it’s given us a good platform, not just for the short-term, but for the years to come..

Thank you..

Thank you. And the next question is from A.J. Rice of UBS. Your line is open..

Hello..

Good morning, A.J..

A couple of questions if I could ask.

First, on the startup costs you have incurred with the new business, the $120 million or so of new business that came on in the fourth quarter I believe was obviously the order of magnitude of that is large just because of the nature of the business, but in terms of the startup cost associated with that versus startup cost associated with normal business you bring online in the normal course of business.

Would you say that there has been more startup cost, less startup cost associated with this new business and is it training in terms of the time to get into your target margin about as expected or is there a much variance there?.

A.J., I would say that of the $120 million of new business we phased in during the quarter, so beginning in October through December, the business that we started the first half of Q4 is online. The business in the normal startup and efficiencies for the facilities we started mid-November through December will certainly have some carryover into Q1.

So, you could see some modest margin pressure in Q1, but we would expect that given the volume of the business that we added. I would say that there is nothing unusual or out of the ordinary that would impact our ability to get these facilities on budget and certainly at the lower end of our 30-day to 90-day window.

And I think the fact that the new business touches all 10 of our operating divisions and is split pretty evenly between the housekeeping and dining segment allows us to digest it in a more business as usual fashion. So, it should be normal course of business given the fact that it’s spread across the various divisions and regions in the company.

So, there is nothing specific to this group of new business relative to any other groups that we have started..

I think the districts that are impacted with the new business will get them on budget as we have historically done in this 60-day, 90-day at the outset timeframe, but it has a bigger impact as there was more volume, more business.

So, it impacted the margins a little bit more, but we would expect within a 90-day framework, each of the districts will be able to get their new business on budget just as they historically have over the last 30 some years..

Okay. And then thinking about obviously your focus has been on these big blocks of businesses, in the last year, you have had a couple of ways of that.

If you move into a mode of more your traditional blocking and tackling approach to new business development, it’s sort of the pipelines moderated and therefore you guys, it will take a while in 2015 for that pipeline to rebuild or you turn on the switch, – off the switch of the big boluses of business and have the one-off as just kick-in right away, I guess how would that – how you transitioned back to more of your traditional growth?.

I think in my respects other than the timing of some of the business that we otherwise would have started during the second quarter into the third quarter that for a variety of reasons was pushed back into the fourth quarter. This really was growth in a more typical fashion. Some of it was centered around large chains.

There were state based operators and there was local growth that was included in that $120 million as well. And as you know, we are not managing the growth on a month-to-month or quarter-to-quarter basis.

Our growth targets, certainly when you look at next quarter for the balance of the year and beyond continue to be in that 10% to 15% targeted range with housekeeping and laundry at the lower end and dining nutrition on a longer-term basis at the higher end of that 10% to 15% range.

And even to go a little more granular as far as the two different segments, the demand for dining and nutrition services is really no different than that of housekeeping and laundry, and that there is more demand really pent-up demand in both segments and we are capable of managing.

And over the past 24 months, that demand has really only increased along side the reimbursement pressures and the regulatory uncertainty that the providers feel. So, the tighter, they are getting squeezed, real or perceived the more opportunity that opens up for us.

Having said that, the rate limiting factor on our growth as it always has been continues to be our ability to hire and successfully develop management people at not just the facility level, but also the district and regional levels of the organization. As a company, we are more committed than ever to the idea of promotion from within.

So, regardless of the reimbursement environment or the pent-up demand, we can only grow as fast as our ability to manage it. But I think that’s an important challenge for us going forward too.

I mean, one of the balancing acts that we have to continuously address is you get seduced by the corporate chains and it’s nice to get that business and the planning from an operational standpoint is very similar as if they were individual clients with individual properties operationally as far as the management resources and drain that go along with it.

The temptation is you start chasing the great whale or you want the big fish and you forget the nuts and bolts, and the local operators as well because to pay-off the so much greater when you close and we have been fortunate the past few years to grow in that arena more quickly than any of the other client breakdowns.

But our regional directors and regional mangers know they have to do the grassroots to sustain our growth rate on a continuous basis as well and making sure that we pay attention to both that’s really been critical for us..

Okay, great. Thanks a lot. .

Great. Take care, A.J..

Thank you. The next question is from Chad Vanacore of Stifel. Your line is open..

Hey, good morning..

Hey, Chad..

Hey, continuing the discussion on the new contract adds, can you remind us what the mix of new clients versus existing clients are?.

Yes, Chad.

So for us, that was part of the attractiveness of the fourth quarter adds not only the dollar amount and total revenue anticipated, but for us, it was really a nice lens kind of looking across the board at the various factors that make up our client base you had a 50-50 split roughly between the dining segment and housekeeping and laundry segment and geographically touched all 10 of our operating divisions.

So, that coupled with the fact that about half of the new opportunities were really an additional cross-sell with existing clients, another probably quarter or so where Greenfield opportunities in housekeeping with new clients.

And then an additional quarter, we are actually rather unique for us and that it was Greenfield opportunity that combined both housekeeping and dining services, which as you all know is atypical for us and that we have thus far been really for the most part only cross-selling dining new opportunities within our existing housekeeping base.

But for us, it was the new client that we had had extensive discussions with. And their preference was far and away to add both dining and housekeeping services in lock-step fashion.

So, again, that was a unique offering for us, but really if you look again across the full offering of the new facilities it was a great blend of business in geography and segments..

And Chad, just as far as the breakdown, you will see in the fourth quarter results, it looks more – like it’s more disproportionately tilted towards dining and nutrition, two-thirds of the new business as opposed to housekeeping and laundry one-third. And that’s really just due to the timing of the starts.

The majority of the dining business was started during the first half of the quarter with the housekeeping and laundry business being weighed more towards the back half of the quarter. So, that should even out more in Q1 once the full run-rate is reflected and then that will get you closer to Matt’s suggestive 50:50 breakdown..

Alright.

And so with all the new dining ads, should we expect some kind of margin improvement in foodservices as you ramp that up or is there going to be something that’s still more gradual, evolutionary?.

I think it’s going to be more gradual though we have – we continued to have the underutilized middle management structure in dining relative to housekeeping even with the Q4 expansion. If a typical housekeeping and laundry district oversees 10 to 12 facilities, in dining, we are averaging right around 8 facilities per district.

If a typical housekeeping and laundry region oversees 4 to 6 districts, in dining we are averaging 4 districts per regions, which is why we are able to grow dining at an accelerated rate relative to housekeeping, because we have that capacity that’s available within the middle management network.

But as you thought over the next 2 years or so, the margin should continue to tick up just as they have the past 3 or 4 years, up almost 2% in the segment. So, that’s what we expect going forward, but that will happen incrementally, not in one failed swoop in the first half of this year..

Alright, thanks for your time..

Excellent. Thanks, Chad..

Thank you. The next question is from Ryan Daniels of William Blair. Your line is open..

Hi, this is Nick in for Ryan Daniels. Thanks for taking my questions..

Good morning, Nick..

Good morning.

I was just wondering how has client retention been trending relative to historical averages?.

Yes, Nick, they have actually been – we have been able to maintain above the 90% targets that we have had since the existence of the company. And over the past few quarters, we have actually kept it closer to 95%.

So, we are very pleased with the efforts that were in the field organization has made to maintain that client base, which is so crucial for us. As we look for future growth opportunities, more than 9 out of 10 of our new business opportunities can be traced in one way or another back to that existing client base.

So, maintaining that retention level is key for our model..

And that doesn’t happen by accident, I mean, certainly the work and the effort, significant effort put forth by the district and the regional team, but we do a better job today than probably we have ever done at the transitory stages of facilities where we are most at risk.

When an administrator or Director of Nursing changes jobs, we are better be selling that individual when they come in and they don’t have the benefit of the before-and-after picture.

So, typically if an administrator leaves one facility and moves into another, they may have a preference to bring in their own Director of Nursing, their own Activities Director, perhaps their own culinary [ph] director or Director of Environmental Services.

Again, we have done a better job over the last 3 years of being able to get a trial with that individual and that’s why you have seen the retention rates tick up, because that’s where we are most at risk..

And I think that’s been the critical part to our consistent growth rate that you have a founding block.

And the reason even though we may beat it to death sometimes, the client retention has been critical for us away from the marketing opportunities and the expansion opportunities when clients grow, acquire new facilities, administrators, Directors of Nursing change jobs that the client retention opens the door for us for those new opportunities, but it doesn’t happen by accident.

In many cases, it’s taken for granted that we are going to have a 90% client retention rate, so the growth rate of 10% to 15% just becomes a new business model, which is far from the case [indiscernible] in the field. The existing clients with their at-will contracts we are only there everyday, because we are in the clients’ best interest.

When they think we are not, they can cancel at anytime. So, our management people have really done a very good job and sometimes it’s not as acknowledged externally as it should be to keep the existing clients happy.

I mean, most of you guys on the call are in the service business, so keeping 95% of your clients relatively happy and we don’t bat a thousand everyday is no small task. So, the customer is always right, but they also always want more..

Okay, great. Thanks. That’s really helpful.

And then just on the corporate reorganization, does that help you saving taxes at all after 2015?.

It does. We would expect and it’s really part and parcel with the captive in terms of the corporate reorganization. I mean, it’s done for a variety of different reasons, but the IRS has certain Safe Harbor guidelines that require appropriate distribution between captive insurance – captive and short subsidiaries.

So by reorganizing the organization into a variety of different subsidiaries, not only are we able to enjoy the benefits of potential tax planning and efficiencies as related to the captive, but we were able to accelerate what would be $60 million or so of future claims payment made for insurance programs into 2015.

So if you think about that $60 million at a 35% effective tax rate, that’s where I think it was Mike Gallo that referenced earlier the potential to pickup another $20 million or so of balance sheet benefit as a result of the corporate re-org..

Okay, great. Thank you..

Thank you. The next question is from Sean Dodge of Jefferies. Your line is open..

Yes, good morning. Thanks for taking the questions..

Hi, Sean..

So, taken a little bit different approach to A.J.’s earlier question and clarifying a comment that Matt had made, did I hear correctly the implementation had an 80 basis point drag on fourth quarter gross margin.

And then can you put some book ends around how much of that you expect to carry into the first quarter?.

Yes.

I think that what Matt was referring to that our direct cost of services was about 80 basis points or so, our historical target of 86%, and the majority of that [indiscernible] was related to the new business inefficiencies by carrying the payrolls for the first 30 days, 60 days, and 90 days that we are inheriting as of the transition date, as well as the supply budgets in consumables that’s when we are most inefficient.

So once that’s 60-day process winds down and the facilities are on budget, then we don’t have that over budget spending that results in the higher direct costs of services. So you think about the majority of the business that was opened up during the first half of the quarter, is on budget going into Q1.

There will be some December starts that are still in 30-day to 60-day window that has some – that could put some pressure on the margins in Q1, but it will be modest relative to what we saw in the fourth quarter..

Understood, okay.

And then Dan on the last call you had mentioned a greater amount of corporate involvement in the decision making process and you typically experienced, what has changed the causes, is this the bigger change attempting to aggregate their buying power and efforts to more closely control their costs or is it just you guys doing more whale hunting like you talked about before?.

I think I feel like [indiscernible] they have. But frankly I think over the last 10 years, if you broke up our client base 10 years, 15 years ago, I would have said 50% or 60% were individual mom-and-pop operators or even if they were part of a chain, the negotiation and the marketing effort, and sales effort were done with the individual property.

Our strategy with the corporate chains had been to neutralize the corporate people, get them to feel comfortable with outsourcing our services in general both us as company specifically, but sell the services locally property by property.

And if they needed some kind of corporate approval or blessing, we go back to the administrator or decision maker, we go back to the corporate people and say, I know those guys if you want use them, go ahead.

Over the last 10 years, as we have maybe had built inroads to a lot of these corporate chains, we become more visible and probably more attractive to the corporate decision makers than we were 10 years ago, that we have been making contributions to the organization that they have recognized is beneficial in a lot of cases.

And then had been more proactive in the decision making and giving us a license to hunt and then coordinating the decision from a corporate level, which wasn’t the case 10 years or so ago. So I think when we get these big chunks of new business, the decision had been less prior to 10 years ago had been made individually property by property.

That’s changed over the last 10 years much more so corporately driven. Now, we operate them in the same. We survey every one of the buildings the same. It’s not a top side down proposal.

We have proposed and developed the work plan for each of the properties as if they were an individual operator, but the decision making in the past few years has been more corporately driven than it ever has in the 38 years we have been doing this..

Okay. And so from the facility standpoint of point of view, nothing has really changed, it’s just who is….

Who has given us the go ahead….

Got it. Okay, great. Thanks..

Thank you. The next question is from Toby Wann of Obsidian Research Group. Your line is open..

Hey, good morning guys. Congratulations on the quarter.

Quickly, a little bit of a slight housekeeping part on the pun item, could you kind of give us the split between housekeeping in food services in revenues and margins?.

Toby you mean for the quarter as far as dollar amount?.

Yes, just for the fourth quarter.

Yes, dollar amount?.

For the quarter for the dollar amounts for housekeeping we are at $218.9 million and for dining we are at $122.7 million..

So it’s still about social two-thirds, one-third..

Okay.

And then any margin commentary on any of that?.

That will be in the K, but it should be in line with our historical margin..

But food service….

Is still not at the margins that housekeeping and laundry are and that’s still our objective to utilize the district and regional structure spread out over the right complement of properties, the margin should continue to improve in food service as they have in the past 3 to 4 years.

And ultimately when we execute properly and ramp-up the – at the level of housekeeping and laundry and that’s going to be reflected in the direct cost improvement that Matt described..

Okay, perfect. Thank you..

Excellent. Thanks Toby..

Thank you. There are no further questions in queue at this time. I will turn the call back over to Dan for closing remarks..

Okay. Thanks. Matt just wanted to update you guys on the conferences that we are going to be attending over the next few weeks..

Yes, thanks Dan. Just wanted to note that we will be attending and presenting at three upcoming conferences, all of which are in New York City. The first is on February 24, that’s RBC Capital Markets Global Healthcare Conference that will be at the New York Palace Hotel.

On March 16, we will be at Sidoti & Company’s Annual Small-Cap Equity Conference that’s at the Grand Hyatt Hotel. And on 19 of May UBS Global Healthcare Conference is at the Sheraton New York Times Square Hotel. So hopefully we will see some of you at those events. Thanks Dan..

Okay. Well, thanks everybody again for joining us. Ending 2014 and going into 2015, we expect to continue to expand our client base in housekeeping and laundry within our historical targets and food service.

With the new business we started in the fourth quarter getting on budget with proper execution we will not only maintain our double-digit growth rate, but have the margin improvement and get the direct costs closer to 86%. The demand for the services in this environment is as great it’s ever been since we have been doing this.

All our divisions continue to perform better, but with any expansion we have to make sure we keep our eye on the ball with the existing clients and not just focus on the new business. We want to get our direct costs closer to 85% over the next year, year and a half with incremental improvement quarter-to-quarter.

With the changes in some of the state tax policies and the investment we made in our legal and personnel departments not only for the captive but in this litigious environment that we find ourselves in we have expanded the legal and personnel departments to be a more value and more detailed resource for our management people in the field.

We expect our SG&A to be in the 7% range with no deferred comp impact. We expect the captive insurance subsidiary to give us an improved platform financially, administratively and more flexibility operationally for 2015, but more importantly benefit us for years to come.

Our business still benefits from strong demand, our management people in all divisions especially in food service continue to get better. We have never had better management people in the history of the company. So we believe that we will continue to operate on budget going forward.

As we expand in 2015, we anticipate it to be our 39th consecutive record year. So these are still pretty good times for us. Thanks again for joining us onward and upward..

Thank you. Ladies and gentlemen, this concludes today’s program. You may now disconnect. Good day..