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

A.J. Rice - UBS Ryan Daniels - William Blair Michael Gallo - CLK Chad Vanacore - Stifel Toby Wann - Obsidian Research.

Good day, ladies and gentlemen and welcome to the Healthcare Services Group Incorporated 2015 Third Quarter Conference Call. At this time, all participants are in a listen-only mode.

[Operator Instructions] 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 projections 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 and 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 turn today’s conference call to Mr. Dan McCartney, Chairman. You may begin..

Okay. Thank you, Kevin and good morning everybody. Thanks for joining us. I am here with Ted Wahl and Matt McKee. And we appreciate everybody participating in our conference call. We released our third quarter results yesterday after the close and we will be filing the 10-Q during the week of the 19th.

With that, I will turn the call over to Ted for a discussion about our third quarter results..

Thank you, Dan. Revenues for the third quarter increased nearly 13% to $360.2 million. Housekeeping and laundry grew at 8%. Dining and nutrition was up 22% for the quarter. Year-to-date revenues were also up about 13% to $1.1 billion. Earnings from operations for Q3 came in at $26.6 million bringing the year-to-date total to $77.6 million.

Both revenues and earnings from ops for the three and nine-month periods are company records.

As we enter the fourth quarter, we continue to expect double-digit top line growth for 2015 as the division successfully transitioned the new business added over the past year and have shifted their focus to managing the departments, servicing the clients, and most importantly, developing the next wave of management people to support our current and future expansion efforts.

In the year ahead, we will look to manage growth and retention rates within our historical targeted range, while at the same time adhering to our operational systems and budgetary commitments.

In September, we completed the transition of our workers’ comp and employee health and welfare programs into the captive insurance subsidiary, adding to the general liability coverage that’s already part of the program.

The captive structure will help contain cost, allow for greater efficiency in the management of claims, and provide needed flexibility for our facility level health and welfare plans to meet the requirements of the Affordable Care Act. So with that abbreviated overview, I will turn the call over to Matt for a more detailed discussion on the quarter..

Thanks Ted. Net income for the quarter increased to $17.1 million or $0.24 per share. Year-to-date net income came in at $48.9 million or $0.68 per share. Both net income and earnings per share for the quarter and year-to-date are company records. Direct cost of services came in at 85.7%, which is 30 basis points below our target of 86%.

And going forward, our goal is to continue to manage direct cost under 86% on a consistent basis and work our way closer to 85% direct cost of services.

SG&A expense was reported at 6.5% for the quarter, but after adjusting for the $1.4 million related to the change in the deferred comp investment accounts held for and by our management people our actual SG&A was 6.9%.

We 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 as a $1.3 million expense.

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. Depending on the timing of the WOTC reauthorization, we would expect our Q4 effective tax rate to be in the low 30s, assuming retroactive credit driven in the beginning of the year.

As far as the balance sheet, we continue to manage the balance sheet conservatively and at the end of the third quarter, we had over $103 million of cash and marketable securities at a current ratio of 4 to 1. Our accounts receivable remain in good shape, well below our DSO target of 60 days.

And as announced yesterday in conjunction with our earnings release, the Board of Directors approved an increase in the dividend to $0.18 per share, split adjusted and payable on December 18. The cash flow and the cash balances for the quarter more than support it.

And with the dividend tax rate in place for the foreseeable future, the dividend program continues to be the most tax efficient way to get the value and free cash flow back to our shareholders.

It will be the 50th consecutive cash dividend payment since the program was instituted in 2003 after the change in tax law and it’s the 49th consecutive quarter that we increased the dividend payment over the previous quarter. So, that’s a 13-year period now that includes 4, 3 for 2 stock splits.

So with those opening remarks, we would like to now open the call up for questions..

[Operator Instructions] Our first question comes from A.J. Rice with UBS..

Hi, everybody..

Good morning, A.J..

Maybe a follow-up question.

First of all, when you think about being able to recur both your hourly workers and your management trainees and so forth, have you seen any change in that with the pickup over the last year in the economy, any important picture?.

Not really, A.J. I mean, for us getting resumes and getting recruits in the door at least at the management level has never really been the issue. For us, it’s having them go through the 90-day apprenticeship, the MIT program that’s been the more challenging part.

And again just because of the hands-on nature of the management training program and what’s required from our perspective of learning the business and being able to work your way through the management levels that we have in the organization. At the staff level, it’s really a localized effort.

No, these jobs aren’t very desirable even for minimum wage type employees, which is why at the facility level most properties required to hire people of something higher than the minimum wage. And you may have some markets that are depending on the labor market, how tight it is have to increase their wages to be able to retain and recruit employees.

Others that have looser labor markets don’t have the same type of labor pressure. So, it’s really for us at least the district by district exercise both at the management level and then at the facility level, a localized effort..

Okay. In the housekeeping business, you were a little below your target. I know you have said that it will grow at the lower end of the 10% to 15% target for the overall company, but it was a little below that.

Is there anything in that the timing on when the business came on or anything else worth highlighting this?.

Yes. I guess, during the quarter, the majority of the business we started in Q3 was in the back half of the quarter, but when we look out over the next 12 to 18 months growth and expansion opportunities are really the least of our concerns.

The demand for the services continues to be as strong as it’s ever been which is why our focus and attention needs to be on the quality and the quantity of our management pipeline and each district and region is in a different stage of development in that process.

But ultimately, it’s that pipeline of management candidates that’s going to act as the accelerator or in some quarters and years, the decelerator of that growth rate. I would just add that beyond the management capacity consideration, there is a lot of other variables that add that impact to top line as well, the timing of when we add the business.

If we add 20 or 30 more facilities, A.J., than what we expect in a given quarter, we may grow the top line at the higher end of our historical range. If we’re 20% or 30% facilities lighter than what we anticipate in the quarter, then maybe we grow at the lower end of that range. Even the geography of where we add the business matters.

A 100-bed facility in Manhattan with high wage rates and a rich benefit plan maybe a seven-figure contract, that same size facility in rural Louisiana that’s pin to the minimum wage and has a limited medical plan maybe a $200,000 contract. There are similar operational requirements in both properties, but varying price points.

Our retention rate and client satisfaction standards impact how quickly we will expand.

I know 90% client retention has been the foundation of the company since its inception and it’s certainly something we are proud of, but we can never take it for granted, the amount of work, really the amount of time and treasure, human capital that goes into maintaining that type of retention rate is substantial.

But over the long-term, our expansion efforts are ultimately going to be driven by the management development purpose..

Okay, that’s great. Maybe one last question and on the captive subsidiary, I figured it out there for a minute in Matt’s comments said this, it’s fine, but did it have any impact, the insurance captive on the P&L for the quarter.

And your long-term thoughts about what the impact of that will be, has there been any update on that?.

Well, the re-org was completed during the third quarter and simultaneous to that re-org being completed, we did fund the captive with $70 million in transition to workers’ comp and some of the voluntary health and welfare programs into the captive.

But we continue to target $6 million to $8 million of annualized save, which we should begin realizing during the first half of next year.

Although ultimately that number could prove to be conservative depending on how things evolve, we also targeted the $20 million cash benefit as a result of the accelerated tax deduction from capitalizing the entity. $15 million of which has already been realized through lower estimated tax payments during the first nine months of the year.

And there is going to be another $5 million to $7 million at Q4 of the cash benefit as a result of the lower payments..

Okay, great. Thanks a lot..

Great. Take care, A.J..

Alright..

Our next question comes from Ryan Daniels with William Blair..

Yes. Good morning guys. Thanks for taking the questions..

Good morning Ryan..

Let me follow-up with A.J.’s question on the captive, you mentioned that you should start to see the benefit on the run rate in the first half of ‘16, should we be modeling any improvement in Q4, is it safer at this point just to assume that doesn’t really start to hit the P&L till ‘16?.

During Q4, there is going to be some transitory expenses due to the switch from our third-party insured to the captive and PPA model. So that would offset whatever modest savings we would have for the fourth quarter anyway. So we are really looking towards next year as when the captive savings would take hold..

Okay, that’s helpful. And then I appreciate the cost savings, I am curious if it gives you anymore opportunities in regards to new business as well.

So thinking new ways to structure contracts or move more labor on to your income statement offer clients or drive even better savings at an equal margin, anything like that that could take place too?.

I think Ryan, when you think about how we structure the contracts and specially the pricing of the prospective contracts with our clients, the pricing limitation is really due to the high visibility that there is in our pricing structure because we match the wage rates near the benefits and recognize the seniority of the employees that we are bringing on.

Even without a calculator, the prospective client can have a pretty good idea of how we are staffing, pricing and the margins that we are making. So, for us, the margin limitation on pricing has really always been due to the recognition of the wage and benefit structure. So don’t anticipate that they are de-leveraged there.

Where there will be an opportunity though is in the flexibility that the captive offers us to ultimately move the health and welfare in the major medical, specifically into the captive vehicle. So as we are looking to put together new proposals for prospective clients, because mirroring the benefits has always been a key of our structure.

Due to the captive we will now have better – greater flexibility to put together a program that better mirrors the structure that they have in place now, while serving as a benefit to the company because we won’t have to farm that out to an Aetna or to a Blue Cross and Blue Shield type program..

Okay. Now, that makes good sense, that’s good color. And then last one, I will hop off. Just on the Ted, you managed or you mentioned management capacity considerations.

How are you looking on the food services side, I know that’s been underutilized historically, but you have been seeing some really good growth there last few years, can you maybe give us update on the regional infrastructure and where you stand there? Thanks..

Yes. No problem, Ryan. We are right around, if you look at it from an average perspective, we are around eight facilities per district and about four facilities per region, which when you compare that to 4 years or 5 years ago, a substantial improvement.

I would say we are another 2 years to 3 years away from being the dining and nutrition segment managing a similar complement of facilities to what housekeeping and laundry typically manages, which is 10 to 12 facility districts and four to six district regions.

And even with the growth, I mean it’s not an Excel spreadsheet exercise where we layer certain amount of growth on and the districts and regions are fully utilized because it’s really driven by where we are adding the business.

If we are adding new dining business in the Northeast or Mid-Atlantic where we have more matured districts and regions, similar to housekeeping, we are promoting district managers from within as we add that business versus areas that are less penetrated like the Southwest, Southeast and Far West.

We still have five facility districts and three district regions that are – if we add business in those areas, we get that disproportionate jump in earnings in that particular division..

Okay, great. Thanks for all the color guys..

Absolutely Ryan, take care..

Our next question comes from Michael Gallo with CLK..

Hi, good morning..

Mike, how are you?.

Good and I have two questions. I was wondering Ted, as you look at each of the regions in terms of food service additions, where do you feel like there is the most room, are they really to add facilities and where is it still going a little bit slower? And then I have a follow-up question..

In dining, it’s really the capacities throughout the country.

I mean, it’s just the growth in the Northeast and the Mid-Atlantic would just be more traditional within our historical targeted range that we have had, whereas in some of the areas where we have disproportionately underutilized middle management structures, we are able to grow at an accelerated rate, but the same opportunity exist from a cross-sell perspective throughout the country..

Okay, great.

And then I have a question, Ted, the cash balances obviously, you are going to be building up here, you are certainly out-earning the dividend now by a decent amount, so how should we think about the dividend as we go into 2016 I know you have been bumping it up in a relatively modest rate more recently, but it seems like the cash flows and the cash balances support that maybe moving a little bit faster, is it something we should think about for 2016?.

Well, we thought since this was such a significant milestone quarter for us being the 50th anniversary of our dividend inception, 50 consecutive quarters we wouldn’t have to address this, but really it’s something the Board evaluates on an ongoing basis.

And to your point Mike, if earnings and cash flow continue to accelerate at a rate faster than the dividend which we would anticipate, then bumping up the dividend would warrant some serious consideration.

And our plan, as we talked about last quarter was to complete the captive re-organization, because it does – it is a different capital structure than what we have operated under historically. So we have completed that during the third quarter.

And then over the next six months to nine months of operating the captive, determine what makes the most sense in terms of capital allocation going forward.

But it is something that we are seriously considering going forward and depending on the balance sheet and how it continues to evolve over the next six months to nine months that’s when we will make the decision..

Thank you..

Thank you, Mike..

Our next question comes from Chad Vanacore with Stifel..

Good morning..

Chad, good morning..

Alright. Since all the other guys asked such great questions, I have just got a few cleanup ones.

So, on the captive, how much impact should we expect in the fourth quarter, I know you said $6 million to $8 million in 2016, but it should be fully funded now and should we get a pro rata share of that in the fourth quarter?.

Yes. I have mentioned that earlier Chad, but nothing in the fourth quarter just because it’s really a transition quarter for us from switching from our third-party insurer to the captive PPA model that’s going to be managing the P&C programs and really the voluntary health and welfare programs out of the subsidiary..

Alright, thanks.

And then what can you tell us about the pace of new contracts adds, are you seeing any pressure on SNF operators that may lead to them outsourcing more business at a faster rate?.

Chad, like we have talked about previously the demand for the services remains far greater than what we are able to service at present. So for us, it really gets down to growth being tied to our ability to develop the management personnel to be able to put new managers into the new facilities that we will be bringing onboard.

So for us, the demand has never been greater. Specifically though as Ted alluded to, we did see nice growth in the latter portion of Q3 and we will continue to build that momentum on a go-forward basis. And that’s driven largely by the management capacity that we have been working to develop and build up since the first half of this year.

So external factors related to demand aside, reimbursement, uncertainty aside, for us, we continue to develop the management personnel to be able to grow within our historical target ranges..

Alright, that’s it for me. Thank you..

Thanks Chad..

Take care, Chad..

Our next question comes from Toby Wann with Obsidian Research..

Hi, good morning guys. Quickly on the SG&A line, Matt, if I heard you correctly and I want to make sure that I did, I know if we back out the deferred comp component this time, 6.9%, and if I recall correctly, I thought you said you are going to continue to kind of manage to that 7% number.

But – so I guess my question really is, is that a little bit of a revision from previous guidance, which was you are going to manage to 7% to 7.25%?.

Yes, it is, Toby. If you look back over the past 7 quarters with some one-time exceptions aside, we have pretty consistently managed it in now that 7% range.

So over the past couple of quarters, we have become more confident to say that 7% should be the new target as opposed to – you are correct, historically, it had been kind of the 7% to 7.25% range.

So for us, 7% is the target range going forward and we will continue to manage that aggressively and look for ongoing opportunities to garner additional efficiencies..

Okay, that’s great color. Thanks. And then just more from a macro perspective and I think maybe Chad kind of hit on this a little bit. Are you guys seeing – I know it’s dependent upon management infrastructure to be able to service new clients.

But are you seeing – are you guys seeing any increased demand as we are kind of seeing as operators are seeing more pressure on in the post-acute world from whether it’s reimbursement, implementation of stars ratings or bundled payments? Just kind of – if you could kind of characterize any – the demand side of that?.

Yes, I think that’s a fair statement, Toby. We have continued to see increase in demand for outsourced services of all kinds. Now certainly the focus for the operators’ perspective is to manage in the most financially efficient manner and really to kind of refocus on their core competencies and direct patient care.

So, outsourcing of secondary functions of all kinds has certainly continued to increase specific to our types of services.

We have seen increase in the demand for the services, which maybe allows us to be a bit more selective in both the clients with whom we continue to expand the timing of those expansions and the geographies in which we would like to expand, but it doesn’t change the overall opportunity from a top line perspective in that.

Again, we are really dependent upon our ability to develop the managers and we have demonstrated historically we have not been able to develop managers at a clip greater than 10% to 15% per year. So, that’s what we expect regardless rather of the external demand for the services. That’s the rate that we are comfortable to grow within..

Okay, thanks for the color..

And I am not showing any further questions at this time. I would like to turn the call back over to Ted Wahl for closing remarks..

Thanks, Kevin.

Before we wrap up, Matt wanted to review our conference schedule for the next few months, so Matt?.

Yes, I just want to let everyone know we will be participating in several conferences in the fourth quarter.

We will be at the Stifel Healthcare Conference on November 17 at The New York Palace Hotel in New York City and then the Oppenheimer 26th Annual Healthcare Conference, which will be December 8 and 9 at The Westin New York Grand Central also in New York City. So, we will look forward to seeing some of you there.

I am going to turn it back over to Ted now to wrap up..

Thank you, Matt. And overall, the demand for our services continues to be greater than what we are capable of managing and with the uncertain regulatory and reimbursement environment facing the provider community, we would expect that demand to only increase in the years ahead.

Over the next 12 months, we will look to selectively expand our customer base controlling our growth to ensure that facility execution and financial performance are in line with what we committed to both our clients and one another.

The rate limiting factor on our growth continues to be the pace at which we are able to develop and promote from within management candidates, which is why people development really at all levels of the organization remains our highest priority.

We will look to keep direct costs below 86% and work our way closer to 85% direct cost of services with the primary drivers of that margin improvement being the dining and nutrition districts and regions managing the right complement of facilities as well as our property and casualty and employee health and welfare programs being managed out of the captive.

We expect our normalized SG&A to be about 7%, excluding any deferred comp impact, but remain committed to ongoing investment in our clinical HR and legal functions. These subject matter experts are valuable resources for the field and allow us to more proactively navigate the highly regulated litigious industry in which we operate.

We would expect our Q4 effective tax rate to be in the low 30s, assuming WOTC reauthorization is retroactive at the beginning of the year. As we look to 2016 and what will be our 40th year of business, we continue to operate in the recession proof market niche.

The demographic trends has been and continue to be in our favor with an unprecedented cost containment environment that’s really increased the demand for outsourcing services of all kinds, including ours.

We have the most talented management team that we have had in the history of the organization and we have the financial wherewithal to grow the business as best as our ability to manage it. Ours is an execution business and our ability to execute is what will drive our success in the months and years to come.

So, on behalf of Dan, Matt and all of us at Healthcare Services Group, I wanted to thank Kevin for hosting the call today and thank you to everyone for participating..

Ladies and gentlemen, this does conclude today’s presentation. You may now disconnect and have a wonderful day..