Dan McCartney – Chairman and Chief Executive Officer Ted Wahl – President and Chief Operating Officer Matt McKee – Vice President and Marketing Director.

AJ Rice – UBS Michael Gallo – CL King Nick Hiller – William Blair Chad Vanacore – Stifel Toby Wann – Obsidian Research Group Mitra Ramgopal – Sidoti and Company.

Good day, ladies and gentlemen, and welcome to the Healthcare Services Group Incorporated 2015 First 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 call may be 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 preceded by words such as believes, expects, anticipates, plans, will, goal, may, intends, 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 production or forecast, they are inherently susceptible to uncertainty 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 this call and 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 would now like to introduce your host for today’s conference Mr. Dan McCartney, Chairman and CEO. Sir, you may begin..

Okay, thank you, Kat, and good morning, everybody. Thank you for joining us. I'm with Ted Wahl and Matt McKee. And again, thank you for joining us for the conference call for the first quarter. We released our first quarter results last night after the close and we'll be filing 10-Q sometime next week.

But with that, I'd like to introduce Ted to do a quick review of the results..

Thank you, Dan. Revenues for the first quarter increased 14% to a company record $355.2 million. Housekeeping and laundry grew at 11%. Dining and nutrition was up almost 20%. We entered 2015 with good momentum and continue to expect double-digit topline growth throughout the year.

With housekeeping and laundry at the lower end of our targeted range and dining and nutrition likely exceeding that range, as even with the Q4 and Q1 expansion, 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 divisions have done a good job of transitioning and now managing the new business we added over the past six months. As that 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 at the end of last year, during the third quarter, we plan on transitioning our workers’ comp and certain employee health and welfare programs into the captive insurance subsidiary.

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 cost, and provide the needed flexibility for our facility-level health and welfare plans to meet the requirements of the Affordable Care Act, which took effect January 1.

With that abbreviated overview, I'll turn the call over to Matt for a more detailed discussion on the quarter..

Thanks Ted. Net income for the quarter was $15.5 million or $0.22 per share compared to $14.6 million or $0.21 per share in the first quarter of 2014. Both net income and earnings per share with were new company records.

Direct cost of services came in at 85.6%, 40 basis points below our target of 86%, Going forward, our goal is to continue to manage direct costs under 86% on a consistent basis and then ultimately work our way closer to 85% direct cost of services.

Selling, general and administrative expense was reported at 7.5% for the quarter, but after adjusting for the $370,000 related to the change in the deferred comp and about 20 to 30 basis points of divisional and corporate-related new business start-up costs, our normalized SG&A for the quarter was 7.1%.

So we would expect our normalized SG&A to continue to be in the 7% range going forward with the ongoing opportunity to garner some modest efficiencies.

Investment income for the quarter was reported at $0.5 million, but again, after removing the impact of the change in deferred comp investment accounts, our actual investment income was about $100,000 for the quarter.

Our effective tax rate was 38% and depending on the timing of the Worker Opportunity Tax Credit reauthorization in year ahead, our rate will likely be between 36% and 38% for the remainder of 2015.

We continue to manage the balance sheet conservatively, and at the end of the first quarter had $70 million of cash and marketable securities and a current ratio of 3 to 1. Accounts receivable remained in good shape below our DSO target of 60 days.

And as we announced yesterday, in the earnings release, the Board of Directors approved an increase in the dividend to $0.17725 per share, split-adjusted and payable on June 26.

The cash balances and net income for the quarter more than supported and with the dividend tax rate in place for this foreseeable future, the 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 the 48th consecutive cash dividend payment since the program was instituted in 2003 after the change in tax law, and it's the 47th consecutive quarter we increased the dividend payment over the previous quarter. That's a 12-year period that included 4-3-for-2 stock splits. With that, I would like to turn the call back over to Dan..

Okay. Before we open it up for questions, I wanted to review some areas that those who know the company very well are familiar with, but some others may not be. First of all, our service agreements.

Since the company's inception in 1977, they've always been and we've always used at-will contracts with a 30-day to 90-day cancellation clause by either party. The purpose has always been to assist the sales effort to make it easier for the customer or potential customer to make the decision to engage us.

The easier we can make it for them, the better shot we have, since all the risk going into a new contract is ours. We also know that once we get the opportunity with a customer, we more than hold up our end. So as demonstrated by our client retention, we are not there at the client's facility because they're contractually locked in.

We're there because the facility has judged us to be in their best interest. As far as the credit and collection, we've always managed the credit customer by customer and have historically written off less than one half of 1% of our billing. Over the last 38 years, that's been the case.

In the past 15 years the industry has had a relatively – I use the word relatively – stable reimbursement environment, yet some operators still have trouble.

We've managed the credit as a policy much more firmly these past few years, keeping the receivables below 60 days, unusual for any healthcare services company, and using notes as an effective collection tool when and where appropriate.

We’ve also converted when there's a credit issue, services to management, with the customer taking and assuming the payroll and purchasing responsibilities, and then finally, but reluctantly, leaving the facility all together as we also have the right to 30-day cancellation provision if credit and a relationship become an issue.

But that's why our cash balances have been what they have been the past 10 years and we’ve increased our dividend every quarter for 47 quarters consecutively.

And finally, those who know the company are aware that in 2008, after the development of the initial district and regional management structure and food service for a number of years prior we committed and told everybody we’re going to expand the food service more aggressively.

The demand for food service is especially within our existing client base was always there but we needed to develop a more seasoned and experienced management structure before we felt confident in our expansion plans.

The management people were and still are in some regions, underutilized, which puts a little bit of pressure on our margins, but based on our regional and district model of 10 to 12 facilities per district and 4 to 6 districts per region over the past few years we’ve gotten closer and closer to meeting that structure.

As the food services continued its growth over these past years, the margins have improved every year, and will ultimately continue that pattern and reach the margins in the housekeeping and laundry division, as food service continues to mature. So with that further explanation, I'll open it up to questions..

Thank you. [Operator Instructions] And our first question comes from the line of AJ Rice from UBS. AJ, your line is open. Please go ahead..

Thanks, hello, everybody. First maybe following up on Dan's comments just made, can you comment – I appreciate there hasn't been any change in the structure of the contracts to speak of.

Can you just update us on the latest in the cancellation rates, the trends there versus what you were seeing a few years ago? Has there been any movement?.

I think over the last five years, our client retention has been better than it has been and a long time, in fact we've always used 90% as the measuring stick, but it's been closer to 95% the past few years. And we go back and forth on the reasons why.

If I’m honest, I don’t think we’re doing a better job as far as client satisfaction, and we're still more at risk when there's a change in ownership or control or administration within a facility that new decision maker wasn't part of engaging us in the first place.

However, I think it's because also, in this environment, as the industry is under financial pressure, all the time really since we’ve been doing this longevity of the relationship with the customers is because we save them money initially.

They know whatever departments they've outsourced are going to hit their budget with no unfavorable variance because the risk is transferred to us and allows them the comfort, especially in the larger change, to concentrate on their major expense, the nursing department and their life blood which is the patient mix.

So I think the longevity and the client retention improvement over the past few years has been as much – we always try to do a better job but we don't bat a thousand, but it's been as much the value that the corporate chains see on having us as a comfort zone with these support services being outsourced..

Okay, All right, and then might on operations in the quarter, you have any further color on the margin trends by segment and how do you see that evolving over the rest of the year?.

Yes, AJ, that information will be in the 10-Q as far as the detail, but from a housekeeping and laundry perspective, we would expect it to be at the higher end of our historical ranges and dining and nutrition to show significant progress as the districts and regions especially after the expansion continue to come closer to managing the right complement of facilities.

Although, I would say even after the fourth quarter, we continue to have that underutilized middle management structure in dining relative to housekeeping where if a typical housekeeping and laundry district oversees 10 to 12 facilities in dining we're now averaging 8 facilities per district.

If a typical housekeeping and laundry region oversees 4 to 6 districts in dining we're now averaging 4 districts per region.

So over the next 12 to 24 months as we add additional business on to our existing infrastructure, the dining margins should continue to expand and as Dan highlighted at the outset of the call ultimately mirror those of housekeeping and laundry..

And that’s where we think we can get the direct costs closer to 85% on a consistent basis..

Right, okay.

And then last question on, Matt you mentioned worker opportunity tax that will swing around your tax rate, what is the – what do you guys see is the latest on that? Is there any movement or is that going to be toward the end of the year event like it was last year?.

There hasn't been a lot of guidance from certainly the advisors and the service companies we work with but we're projecting 36% to 38%, It will be at the lower end once the WOTC is reauthorized and the one thing that seems to be consensus among everyone that we've spoken with and the discussions we've had is that it will ultimately be either reauthorized or made permanent.

Again, this program has been in place 18 years and all five times it was delayed, including last year. It was reauthorized retroactively back to the previous expiration date so there's been no break in either the continuity of the credits or the availability of the credits. So we would anticipate going forward that that's the case again.

Whether it’s in the fourth quarter or perhaps even into 2016 where they retroactively apply to 2015 and then 2016 is another alternative.

But in our SG&A cost we are operating as if it’s just the matter of the time until its approved and keeping the records in the personal requirements to be eligible for that credit when and if it's approved hopefully permanently..

AJ, we thought since it was tax day you were going to propose signing a petition for the abolishment of the IRS.

Wouldn't that be your answer then working around the fringes of WOTC?.

There you go. All right, well, thanks a lot..

Thanks, AJ..

And I'll pass the baton on to the next question..

Thank you. Our next question comes from the line of Michael Gallo from CL King. Your line is open..

Hi, good morning..

Good morning, Mike..

Question I don’t know its better question for Ted or Dan.

As we kind of drill into the margin improvement on the gross margin line, I think sequentially up a 110 basis points, I was wondering if we could break down sort of that the three buckets of how much of that was from bringing in the fourth-quarter business on budget versus the expansion of the food service margins versus – and have you even started to get some of the benefits from moving to the captive?.

Yes. I think no benefits to-date from the captive because that's not going really live till second half of this year. And I think to answer your question regarding whether it was new business or dining, it was a combination of both.

And I know Matt highlighted it at the outset of the call as well, but if you think about the SG&A line, the $370,000 related to the change in deferred comp and the 20 or 30 basis points of the corporate and divisional cost related to new business, our normalized SG&A was 7.1%.

Now as far as the new business is concerned, we did provide a disproportionate amount of corporate and divisional support for the recent expansion, at least compared to other larger scale transitions that we've done, specifically around our operational systems and procedures which is why again the corporate and divisional support that we provided to the new business would have shown up at the SG&A line.

For clinical dietitians for menu and purchasing programs, quality assurance and then all the travel, relocation and administrative cost associated with that.

But I think, Mike, when you think about direct costs and how that ties in, the improvement in direct cost of services was as I said the result of the new business coming online in a timely manner.

And one of the reasons the new business, we think the primary reason the new business came online in such a timely manner was because of the additional corporate and divisional support.

So we believe we're going to continue to manage the direct costs under 86% and continue to work back to 85% over the next year or two and then SG&A should continue to be in that 7% range going forward, which as we talked about on the last call that’s where it’s been five of the last six quarters notwithstanding some new business….

Yes. Just to follow up on that. I mean, I guess, I mean if I look at the whole number in terms of SG&A. It was up about, call it, $4 million year on year. Even stripping out the deferred tax item, it still would have been up the whole number significant. How much of that was due to this additional corporate support, relocation, et cetera.

And then also, would you expect that, then, will – in terms of the whole number of SG&A, forgetting about a percentage of sales, that should actually come down a little bit in future quarters?.

Yes. It should come down in absolute dollars sequentially over the next couple of quarters..

Right.

How much was that stuff in the quarter? Do you have a breakdown?.

How much was what?.

How much was the cost in SG&A from related to corporate support, relocation?.

It was about 20 or 30 basis points..

All right. Okay. Perfect. Thanks very much..

I think before we leave that topic, too, the guys in the field, the divisional and regional managers, the direct cost came down faster than I expected with the new business we added in the fourth quarter and the discussions we had.

They really did a good job getting the new business on budget frankly not taking their eye off the ball on the existing client base. There were a lot of moving parts, district and regional management people being relocated in different areas to support where the new business was procured which was unusual for us.

We really have, typically, very little relocation impact with the districts and regions more firmly established, but with so much new business, there was a little more of the personnel type of moving parts and the guys did a real good job getting the new business on budget and not seeing any erosion in the existing client base with all those moving parts.

So we were pleasantly surprised that direct costs came in where they had. Both in food service and in housekeeping and laundry..

Thank you very much..

Thank you. And our next question comes from the line of Ryan Daniels from William Blair. Your line is open..

Hi, this is Nick Hiller in for Ryan Daniels. Good morning and thanks for taking my questions..

Good morning, Nick..

I just had a quick modeling question, actually. Most of my questions have been asked already.

Roughly, how many housekeeping and food service customers did you end the quarter with?.

It’s really – it’s really similar to where we were last quarter. We’re going to end up with just about over 3,800 housekeeping and laundry accounts and 1,000 or so in dining and nutrition accounts..

Okay. And then on the captive insurance subsidiary, I was wondering your view on the financial benefits.

Has that changed at all for after it goes live in the third quarter?.

No, I really – I think it’s consistent with what we’ve talked about before, Nick, the captive initiatives on track.

We expect to finalize the corporate reorganization during the third quarter and once the REORG is completed, then we’ll fund the captive and transition the workers comp and then on the selected basis some of our health and welfare plans into the captive, but financially we continue to target the $6 million to $8 million of annualized savings although that could prove to be conservative depending on how things evolve as well as the $20 million cash benefit as a result of the accelerated tax deduction from capitalizing the entity.

Now, as positive I know we spent a lot of time talking about the financial benefit as positive as those near-term financial opportunities are, we believe the more compelling and longer-term benefit of having the captive in place is that it really establishes a platform for what is our third largest spend after payroll in food purchases that provides us with significant operational and administrative flexibility with respect to program, design and implementation going forward both for the property and casualty programs as well as for health and welfare.

So that flexibility is going to benefit the company for years to come..

Okay, great. Thank you..

Thanks, Nick..

Thank you. And our next question comes from the line of Chad Vanacore from Stifel. Your line is open. Please go ahead..

All right. Thanks a lot. Most of my questions have been answered. But is there anything that you'd point to as far as the direct costs that kept them low? Is this a mix of business, or is this some initiatives that you put into place? Any color would be helpful..

Yes, really, Chad for us I mean if you think about our cost structure it's really driven by payroll and payroll related expenses and that’s where as Dan alluded to earlier, the divisions, regions and district managers have all done really a tremendous job on managing not only the new business, but also not taking their eye off the existing business, which is obviously a temptation when you are adding 200 facilities across all 10 operating divisions, certainly a lot of effort and focus goes into getting the new business up and on budget, getting particularly the inefficient payrolls that we've inherited into our systems and on budget according to our programs and systems.

So the temptation is certainly to take the eye off the ball with the existing facilities and really the divisions each and every division has done a tremendous job in managing the labor and both the new and existing facilities and that's been the main driver..

Where we're most inefficient is that first 30, 60 days where we begin a facility and have the surplus or excess staff that we're supporting until we get the jobs operating on budget.

When there's so much new business infused in one quarter or short period a time, it’s a lot to juggle to get the new business on budget, keep the client happy, get off to a good start, and keep your eye on the existing client base and that’s why we’ve been pleasantly surprised but very complimentary about the job the guys in food service the new contracts as well as housekeeping and laundry have done the past few months..

All right. Then, just last question. So SG&A was high this quarter, and you think it's only temporary and this relates to those new business that you brought on.

Do you think this bleeds into second quarter as well?.

No..

All right. That was a nice direct answer. Thanks for your time, guys..

Thanks, Chad..

Thank you. And our next question comes from the line of Toby Wann from Obsidian Research Group. Your line is open. Please go ahead..

Hi, thanks for the question, guys.

Most of mine have been answered, but one just kind of quick thought about new business opportunities kind of pace of activity, increased, about the same? Any kind of color there on anything?.

Yes.

For us Toby, I'm actually glad you asked that question because obviously, with the volumes of new business that we did add in the fourth quarter and the attention focus from an operational perspective that’s required to get the new business on budget and to Dan’s previous comments managing client relationships throughout that process as well, you know, there is sometimes an external expectation that everything on the management development side sort of comes to a grinding halt, which is not the case.

For us, as often as we do have visibility and transparency into significant starts like we did leading up to the fourth quarter starts. The management development which is our most crucial function at the company continues regardless at where we are with new business adds or any other factors.

So for us, again, the rate limiting factor on our growth and our ability to add new facilities has always been and continues to be our ability to develop the next wave of management candidates.

So, out in the divisions we're comfortable that throughout the initiation of all the new contracts that continue to focus on the management development function and develop the next wave of management folks who will be able to then move into a new business opportunity.

So the long answer to your question or the short answer rather to your question is really kind of same as always that we’ve got the management pipeline primed and ready to go, and we should be able to continue to add business throughout the course of 2015 along the same historical lines..

Okay. Perfect thanks..

If you ask that question five years ago, one quarter from now or five years from now, you know, it's likely to be a similar answer.

As Matt said, the rate limiting factor on the growth to our ability to really higher develop and retain talented management people and that's why management development continues to be our highest priority going forward..

And each division is at a different stage in the quality of their management pipeline. And we’ve really gear those divisions and constrain how quickly that can expand depending on the quality and stability and the progress they’re making in the management development area.

That's why when we try to describe to people in the investment community and anybody who wants to know about the company the decentralized network of management people on how we deliver the services that allows us to access each component to a degree that we feel they can expand as opposed to doing it in the aggregate..

Okay. Thanks for all that color. Appreciate it..

Great thanks, Toby..

Thank you. And our next question comes from the line of Mitra Ramgopal from Sidoti. Your line is open. Please go ahead..

Yes, good morning. Just had a quick question. I'm just wondering, I mean increasingly, we're hearing talk in some states about raising the minimum wage.

Is that a concern for you, or is it more non issue in that you can pretty much pass that to any contracts you have?.

I know it's counterintuitive, but because we match the wage rates and benefits, frankly, the more the employees get paid at a particular facility, the better it is for us.

So because we mirror whatever the client's personnel policies are, if it impacts them because of what their wage rate is for that particular operation, we'll pass it through via our contract and it will have really no impact..

Okay thanks..

Okay, great..

Okay well..

Thank you. And I’m showing no further questions. I would now like to turn the call back over to Dan McCartney for any further remarks..

Okay. Good Kat, because I'm exhausted. I guess before we wrap up, Matt just wanted to review our conference schedule for the next few months..

Yes, we’ll be presenting at several conferences upcoming including the Bank of America Merrill Lynch, Healthcare Conference, which is on the 12 of May, at the Encore at Wynn in Las Vegas.

We’ll be at the UBS Global Healthcare Conference on the 19 of May at the Sheraton New York Times Square Hotel in New York, and then the Jefferies Global Healthcare Conference on June 2 at the Grand Hyatt New York also in New York City. So looking forward to seeing some of you there.

Thanks, Dan?.

Okay. Thank you.

I guess to wrap it up just looking forward in 2015 we expect to continue to expand our client base both in food service and housekeeping and laundry within our historical targets as far as the expansion that we absorbed in the fourth and first quarter of this year gives us a good platform going into the year, and with proper execution, we should maintain not only the growth rate but the margin improvement that we demonstrated in the first quarter.

And this environment, the demand for our services is as great as it’s ever been and our balancing act is and always has been – the balance of client growth with the satisfaction measurements of the client base existing and new and get the jobs on budget in dealing with all start-up variables.

All divisions continue to perform better but we need to assure consistency in our performance. We’ll keep – we’ll look to keep our direct costs below 86%, work our way down to 85%.

The primary improvement is going to be with the new business digestion aside in food service but there is always efficiencies we can get in housekeeping and laundry and do better as well. We expect our normalized SG&A to be about 7%, excluding any deferred comp impact.

I think our expansion in the legal and personnel and human resource functions have been a valuable resource to our management people in the field. And in this environment was probably required in dealing with very difficult, highly regulated work force.

But our tax provision is going to be in the 38% range until the WOTC is resolved one way or the other I know it looks a little bizarre because our tax rate was 31% in the fourth quarter. We expect the captive subsidiary to give us improved platform financially, administratively and really benefit us for years to come.

Our business still benefits from having the best management team that we've had in the history of the company, greater demand or as good a demand as we’ve had for the services and our management people continue to get better. So these are still pretty good times for us. So with that, thank you for joining us in onward and upward..

Ladies and gentlemen, thank you for participating in today’s conference. This concludes today’s program. You may all disconnect. Everyone, have a great day..