UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(215) 639-4274

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

This report and documents incorporated by reference into this report may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”), as amended, which are not historical facts but rather are based on current expectations, estimates and projections about our business and industry, and our beliefs and assumptions. Words such as “believes,” “anticipates,” “plans,” “expects,” “will,” “goal,” and similar expressions are intended to identify forward-looking statements. The inclusion of forward-looking statements should not be regarded as a representation by us that any of our plans will be achieved. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Such forward-looking information is also subject to various risks and uncertainties. Such risks and uncertainties include, but are not limited to, risks arising from our providing services exclusively to the health care industry, primarily providers of long-term care; having one client which accounted for approximately 13% and another client which accounted for approximately 9% of our total consolidated revenues for the six months ended June 30, 2017; credit and collection risks associated with this industry; having several clients who individually contributed over 4.0%, with one as high as 9.9%, of our total consolidated revenues for the three months ended March 31, 2017; our claims experience related to workers’ compensation and general liability insurance; the effects of changes in, or interpretations of laws and regulations governing the industry, our workforce and services provided, including state and local regulations pertaining to the taxability of our services and other labor related matters such as minimum wage increases; continued realization of tax benefits arising from our corporate reorganization and self-funded health insurance program; risks associated with the reorganization of our corporate structure; and the risk factors described in Part I of our Form 10-K for the fiscal year ended December 31, 2016 under “Government Regulation of Clients,” “Competition” and “Service Agreements and Collections,” and under Item IA. “Risk Factors.”Factors” in such Form 10-K and in this Form 10-Q.

These factors, in addition to delays in payments from clients and/or clients in bankruptcy or clients with which we are in litigation to collect payment, have resulted in, and could continue to result in, significant additional bad debts in the near future. Additionally, our operating results would be adversely affected if unexpected increases in the costs of labor and labor-related costs, materials, supplies and equipment used in performing services could not be passed on to our clients.

In addition, we believe that to improve our financial performance we must continue to obtain service agreements with new clients, retain and provide new services to existing clients, achieve modest price increases on current service agreements with existing clients and maintain internal cost reduction strategies at our various operational levels. Furthermore, we believe that our ability to sustain the internal development of managerial personnel is an important factor impacting future operating results and the successful execution of our projected growth strategies.

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

See accompanying notes.

See accompanying notes.

See accompanying notes.

See accompanying notes.

Healthcare Services Group, Inc. (the “Company”) provides 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. Although we dothe Company does not directly participate in any government reimbursement programs, ourthe Company’s clients receive government reimbursements related to Medicare and Medicaid. Therefore, they are directly affected by any legislation relating to Medicare and Medicaid reimbursement programs.

We provide ourThe Company provides services primarily pursuant to full service agreements with our clients. In such agreements, we arethe Company is responsible for the day-to-day management of employees located at ourthe clients’ facilities. WeThe Company also provideprovides services on the basis of management-only agreements for a limited number of clients. OurThe agreements with clients typically provide for renewable one year service terms, cancelable by either party upon 30 to 90 days’ notice after the initial 60 to 120 day period.

We areThe Company is organized into two reportable segments: housekeeping, laundry, linen and other services (“Housekeeping”), and dietary department services (“Dietary”).

Housekeeping consists of managing ourthe clients’ housekeeping departments, which are principally responsible for the cleaning, disinfecting and sanitizing of resident rooms and common areas of a client’s facility, as well as the laundering and processing of the bed linens, uniforms, resident personal clothing and other assorted linen items utilized at a client facility.

Dietary consists of managing ourthe clients’ dietary departments which are principally responsible for food purchasing, meal preparation and dietitian professional services, which includes the development of menus that meets residents’ dietary needs.

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”) for interim financial information and the requirements of Form 10-Q and Article 10 of Regulation S-X. Accordingly, these consolidated financial statements do not include all of the information and footnotes necessary for a complete presentation of financial position, results of operations and cash flows. However, in our opinion, all adjustments which are of a normal recurring nature and are necessary for a fair presentation have been reflected in these consolidated financial statements. The balance sheet shown in this report as of December 31, 2016 has been derived from, and does not include, all of the disclosures contained in the financial statements for the year ended December 31, 2016. These financial statements should be read in conjunction with the financial statements and notes thereto included in ourthe Company’s Annual Report on Form 10-K for the year ended December 31, 2016. The results of operations for the three and six months ended March 31,June 30, 2017 are not necessarily indicative of the results that may be expected for any future period.

Certain amounts in the prior year financial statements have been reclassified to conform to current presentation.

The accompanying consolidated financial statements include the accounts of Healthcare Services Group, Inc. and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.

Cash and cash equivalents are held in U.S. financial institutions or in custodial accounts with U.S. financial institutions. Cash equivalents are defined as short-term, highly liquid investments with a maturity of three months or less at the time of purchase, that are readily convertible into cash and have insignificant interest rate risk.

Inventories and supplies include housekeeping, linen and laundry supplies, as well as food provisions and supplies. Inventories and supplies are stated at cost to approximate a first-in, first-out (FIFO) basis. Linen supplies are amortized on a straight-line basis over their estimated useful life of 24 months.

Revenues from our service agreements with clients are recognized as services are performed. Revenues are reported net of sales taxes that are collected from customers and remitted to taxing authorities.

We useThe Company uses the asset and liability method of accounting for income taxes. Under this method, income tax expense is recognized for the amount of taxes payable or refundable for the current period. We accrueThe Company accrues for probable tax obligations as required by facts and circumstances in various regulatory environments. In addition, deferred tax assets and liabilities are recognized for expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities. When appropriate, valuation allowances are recorded to reduce deferred tax assets to amounts for which realization is more likely than not.

Uncertain income tax positions taken or expected to be taken in tax returns are reflected within ourthe Company’s financial statements based on a recognition and measurement process.

Basic earnings per common share areis computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per common share areis calculated using the weighted-average number of common shares outstanding and dilutive common shares, such as those issuable upon exercise of stock options and upon the vesting of restricted stock and restricted stock units.

We estimateThe Company estimates the fair value of share-based awards on the date of grant using the Black-Scholes valuation model for stock options and using the share price on the date of grant for restricted stock and restricted stock units. The value of the award is recognized ratably as an expense in the Company’s Consolidated Statements of Comprehensive Income over the requisite service periods, with adjustments made for forfeitures as they occur.

In preparing financial statements in conformity with U.S. GAAP, we make estimates and assumptions are made that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities, and the reported amounts of revenues and expenses. Actual results could differ from those estimates. Significant estimates are used in determining, but are not limited to, ourthe Company’s allowance for doubtful accounts, accrued insurance claims, asset valuations, deferred taxes and reviews for potential impairment. The estimates are based upon various factors including current and historical trends, as well as other pertinent industry and regulatory authority information. WeManagement regularly evaluateevaluates this information to determine if it is necessary to update the basis for ourits estimates and to adjust for known changes.

OurThe financial instruments that are subject to concentrations of credit risk are cash and cash equivalents, marketable securities, deferred compensation funding and accounts and notes receivable. We define ourThe Company’s marketable securities asare fixed income investments which are highly liquid and can be readily purchased or sold through established markets. At March 31,June 30, 2017 and December 31, 2016, substantially all of ourthe Company’s cash and cash equivalents and marketable securities were held in one large financial institution located in the United States.

OurThe Company’s clients are concentrated in the health care industry and are primarily providers of long-term care. ManyThe revenues of many of our clients’ revenuesclients are highly reliant on Medicare, Medicaid and third party payors’ reimbursement funding rates. New legislation or changes in existing regulations could be made which could directly impact the governmental reimbursement programs in which our clients participate. As a result, we may not know the full effects of such programs until these laws are fully implemented and governmental agencies issue applicable regulations or guidance.

Accumulated other comprehensive income consists of unrealized gains and losses from our available for salethe Company’s available-for-sale marketable securities.

Property and equipment are recorded at cost. Depreciation is recorded over the estimated useful life of each class of depreciable assets,asset, and is computed using the straight-line method. Leasehold improvements are amortized over the shorter of the estimated asset life or term of the lease. Repairs and maintenance costs are charged to expense as incurred.

The following table sets forth the amounts of property and equipment by each class of depreciable assetsasset as of March 31,June 30, 2017 and December 31, 2016:

Depreciation expense for the three months ended March 31,June 30, 2017 and 2016 was $1.3 million respectively. Depreciation expense for the six months ended June 30, 2017 and $1.22016 was $2.6 million and $2.4 million, respectively.

Goodwill represents the excess of the purchase price over the fair value of the net assets of an acquired business. Goodwill is not amortized, but is evaluated for impairment on an annual basis, or more frequently if impairment indicators arise.

Goodwill by reportable operating segment, as described in Note 10 herein,- Segment Information, was approximately $42.4 million and $8.1 million for Housekeeping and Dietary, respectively, as of June 30, 2017. At December 31, 2016, goodwill by reportable operating segment was $42.3 million and $2.1 million for Housekeeping and Dietary, respectively, asrespectively. The increase in goodwill is related to the acquisition of both March 31, 2017 and December 31, 2016.certain Dietary-related assets during the second quarter 2017.

OurThe Company’s intangible assets consist of customer relationships which were acquired through acquisitions and are recorded at their fair values at the date of acquisition. Intangible assets with determinable lives are amortized on a straight-line basis over their estimated useful lives. The customer relationships have a weighted-average amortization period of 9.79.9 years.

The following table sets forth the estimated amortization expense for intangibles subject to amortization for the remainder of 2017, the following five fiscal years and thereafter:

Amortization expense for the three months ended March 31,June 30, 2017 and 2016 was $0.6$1.1 million and $0.8$0.7 million, respectively. Amortization expense for the six months ended June 30, 2017 and 2016 was $1.7 million and $1.5 million, respectively.

The Company’s current assets (other than marketable securities and inventories) and current liabilities are financial instruments and most of these items are recorded at cost in the Consolidated Balance Sheets. The estimated fair value of these financial instruments approximates their carrying value due to their short-term nature. OurThe Company’s financial assets that are measured at fair value on a recurring basis are ourits marketable securities and our deferred compensation funding. We believe theThe recorded values of all of ourthe financial instruments approximate their current fair values because of their nature, stated interest rates and respective maturity dates or durations.

For the three months ended March 31,June 30, 2017 and 2016, wethe Company received total proceeds, less the amount of interest received, of $7.5$7.0 million and $2.0$3.1 million, respectively, from sales of available-for-sale municipal bonds. For the three months ended March 31,June 30, 2017, these sales resulted in realized losses of $48$125 thousand which were recorded in “Other income, net – Investment and interest”

The investments under the funded deferred compensation plan are accounted for as trading securities and unrealized gains or losses are included in earnings. The fair value of these investments are determined based on quoted market prices (Level 1).

The following tables provide fair value measurement information for our marketable securities and deferred compensation fund investments as of March 31,June 30, 2017 and December 31, 2016:

The following table summarizes the contractual maturities of debt securities held at March 31,June 30, 2017 and December 31, 2016, which are classified as marketable securities in the Consolidated Balance Sheets:

A summary of stock-based compensation expense for the threesix months ended March 31,June 30, 2017 and 2016 is as follows:

At March 31,June 30, 2017, the unrecognized compensation cost related to unvested stock options and awards was $15.2$13.7 million. The weighted average period over which these awards will vest is approximately 3.53.2 years.

The Company’s 2012 Equity Incentive Plan (the “Plan”) provides that current or prospective officers, employees, non-employee directors and advisors can receive share-based awards such as stock options, restricted stock, restricted stock units and other stock awards. The Plan seeks to promote the highest level of performance by providing an economic interest in the long-term success of the Company.

The Nominating, Compensation and Stock Option Committee of the Board of Directors is responsible for determining the terms of the grants in accordance with the Plan.

A summary of our stock options outstanding under the Plan as of December 31, 2016 and changes during the threesix months ended March 31,June 30, 2017 is as follows:

The weighted average grant-date fair value of stock options granted during the threesix months ended March 31,June 30, 2017 and 2016 was $8.52 and $7.46 per common share, respectively. The total intrinsic value of options exercised during the threesix months ended March 31,June 30, 2017 and 2016 was $3.5$7.0 million and $1.7$3.9 million, respectively.

The fair value of stock option awards granted in 2017 and 2016 was estimated on the date of grant using the Black-Scholes option valuation model using the following assumptions:

During the threesix months ended March 31,June 30, 2017, the Company did not grant shares ofany restricted stock. During the threesix months ended March 31,June 30, 2016, the Company granted 44 thousand shares of restricted stock with a weighted average grant date fair value of $34.14 per share. Fair value is determined based on the market price of the shares on the date of grant.

A summary of ourthe outstanding restricted stock awards as of December 31, 2016 and changes during the threesix months ended March 31,June 30, 2017 is as follows:

During the threesix months ended March 31,June 30, 2017, the Company granted 81 thousand restricted stock units with a weighted average grant date fair value of $39.38 per share.unit. Fair value is determined based on the market price of the underlying shares on the date of grant. During the threesix months ended March 31,June 30, 2016, there were no grants of restricted stock units.

A summary of ourthe outstanding restricted stock units as of December 31, 2016 and changes during the threesix months ended March 31,June 30, 2017 is as follows:

The Company offers anCompany's Employee Stock Purchase Plan (“ESPP”("ESPP") is currently available through 2021 to all eligible employees. The ESPP was scheduled to expire after 2016, however the Board of Directors extended the program for an additional five offerings through 2021. All full-time and certain part-time employees who have completed two years of continuous service with us are eligible to participate. Annual offerings commence and terminate on the respective year’s first and last calendar day.

Under the ESPP, the Company is authorized to issue up to 4.1 million shares of ourits common stock to our employees. Pursuant to such authorization, there are 2.3 million shares available for future grant at March 31,June 30, 2017.

The stock-based compensation expense associated with the options granted inunder the ESPP during the six months ended June 30, 2017 and 2016 under our ESPP was estimated on the date of grant using the Black-Scholes option valuation model using the following assumptions:

The Company offers a Supplemental Executive Retirement Plan (“SERP”) for certain key executives and employees. The SERP allows participants to defer a portion of their earned income on a pre-tax basis and as of the last day of each plan year, each participant will be credited with a match up toof a portion of their deferral in the form of ourthe Company’s Common Stock based on the then-current market value. Under the SERP, we arethe Company is authorized to issue 1.0 million shares of ourits common stock to ourits employees. Pursuant to such authorization, we havethe Company has 0.4 million shares available for future grant at March 31,June 30, 2017. At the time of issuance, such shares are accounted for at cost as treasury stock.

The following table summarizes information about ourthe SERP during the threesix months ended March 31,June 30, 2017 and 2016:

During the threesix months ended March 31,June 30, 2017, wethe Company paid regular quarterly cash dividends totaling approximately $13.6$27.4 million as follows:

Additionally, on AprilJuly 11, 2017, ourthe Company’s Board of Directors declared a regular quarterly cash dividend of $0.1875$0.18875 per common share, which will be paid on June 23,September 22, 2017, to shareholders of record as of the close of business on May 19,August 18, 2017.

Cash dividends declared on ourthe outstanding weighted average number of basic common shares for the periods presented were as follows:

The 2017 estimated annual effective tax rate is expected to be approximately 35%33.7%. Due to the adoption of ASU 2016-09, the tax effects of option exercises or vested awards should be treated as discrete items in the reporting period in which they occur, and therefore cannot be considered in the calculation of the estimated annual effective tax rate. Excluding the impact of ASU 2016-09, the estimated annual effective tax rate would be 35.7%.

Differences between the effective tax rate and the applicable U.S. federal statutory rate arise primarily from the effect of state and local income taxes, share-based compensation and tax credits available to the Company. The actual 2017 effective tax rate will likely vary from the estimate depending on the availability of tax credits.credits and the exercises of stock options and vesting of share-based awards. Due to the adoption of ASU 2016-09, the tax effects of option exercises or vested awards should be treated as discrete items in the reporting period in which they occur, and therefore cannot be considered in the calculation of the estimated annual effective tax rate.

We accountThe Company accounts for income taxes using the asset and liability method, which results in recognizing income tax expense based on the amount of income taxes payable or refundable for the current year. Additionally, we evaluatethe Company regularly evaluates the tax positions taken or expected to be taken resulting from financial statement recognition of certain items. Based on ourthe evaluation, we have concluded that there are no significant uncertain tax positions requiring recognition in ourthe Company’s financial statements. OurThe evaluation was performed for the tax years ended December 31, 2013 through 2016 (with regard to U.S. federal income tax returns) and December 31, 2012

WeThe Company may from time to time be assessed interest or penalties by taxing jurisdictions, although any such assessments historically have been minimal and immaterial to ourits financial results. When we havethe Company has received an assessment for interest and/or penalties, it has beenwill be classified in the financial statements as selling, general and administrative expense. In addition, any interest or penalties relating to recognized uncertain tax positions would also be recorded in selling, general and administrative expense.

A director is a member of a law firm retained by us.the Company. In each of the threesix months ended March 31,June 30, 2017 and 2016, fees received from uspaid to such firm by such firmthe Company did not exceed $120,000. Additionally, such fees did not exceed, in either period, 5% of such firm’s or the Company’s revenues.

We manageThe Company manages and evaluate ourevaluates its operations in two reportable segments: Housekeeping (housekeeping, laundry, linen and other services) and Dietary (dietary department services). Although both segments serve the same client base and share many operational similarities, they are managed separately due to distinct differences in the type of services provided, as well as the specialized expertise required of the professional management personnel responsible for delivering each segment’s services. Such services are rendered pursuant to distinctdiscrete service agreements, specific to each reportable segment.

The Company’s accounting policies for the segments are generally the same as described in the Company’s significant accounting policies. Differences between the reportable segments’ operating results and other disclosed data and ourthe information in the consolidated financial statements relate primarily to corporate level transactions and recording of transactions at the reportable segment level which use methods other than generally accepted accounting principles. There are certain inventories and supplies that are primarily expensed when incurred within the operating segments, while they are capitalized in the consolidated financial statements. As discussed,In addition, most corporate expenses are not allocated to the operating segments. Such expenses includesuch as corporate salary and benefit costs, certain legal costs, information technology costs, depreciation, amortization of finite livedfinite-lived intangible assets, share based compensation costs and other corporate-specific costs.costs, are not allocated to the operating segments. Additionally, there are allocations for workers’ compensation and general liability expense within the operating segments that differ from our actual expense recorded for U.S. GAAP. Segment amounts disclosed are prior to any elimination entries made in consolidation.

We haveThe Company has tax matters with various taxing authorities. Because of the uncertainties related to both the probable outcomes and amount of probable assessments due, we arethe Company is unable to make a reasonable estimate of a liability. We doThe company does not expect the resolution of any of these matters, taken individually or in the aggregate, to have a material adverse effect on ourthe consolidated financial position or results of operations based on ourthe Company’s best estimate of the outcomes of such matters.

We areThe Company is subject to various claims and legal actions in the ordinary course of business. Some of these matters include payroll and employee-related matters and examinations by governmental agencies. As we becomethe Company becomes aware of such claims and legal actions, we recordthe Company records accruals for any exposures that are probable and estimable. If adverse outcomes of such claims and legal actions are reasonably possible, we assessManagement assesses materiality and provide suchprovides financial disclosure, as appropriate. The Company believes it is not a party to, nor are any of its properties the subject of, any pending legal proceeding or governmental examination that would have a material adverse effect on the Company’s consolidated financial condition or liquidity.

OurThe Company’s clients are concentrated in the health care industry and are primarily providers of long-term care. ManyThe revenues of many of our clients’ revenuesclients are highly reliant on Medicare, Medicaid and third party payors’ reimbursement funding rates. New legislation or additional changes in existing regulations could be made which could directly impact the governmental reimbursement programs in which ourthe clients participate. As a result, wethe Company may not knowrealize the full effects of such programs until these laws are fully implemented and government agencies issue applicable regulations or guidance.

TheOn July 11, 2017, the Company has entered into new service agreements with expected annualized revenuesan Amended and Restated Committed Line of over $160 million,Credit Note to begin duringincrease the second quarterexisting bank line and letter of 2017. The recent expansion consists of multiple customer groups including one national, multi-state provider, with whomcredit availability to $300 million. There were no other changes to the Company has an existing contractual relationship, that makes up a substantial portionterms of the aforementioned growth. In conjunction with said customer expansion,line of credit and amounts drawn under the Company acquired certain dietary-related assets, including inventory, and intellectual property.line of credit remain payable upon demand. The proceeds available under the facility will be used for general corporate purposes.

WeThe Company evaluated all other subsequent events through the filing date of this Form 10-Q. We believe thereThere were no other events or transactions occurring during this subsequent reporting period which require recognition or additional disclosure in these financial statements.

Item 2.  Management’s Discussion and Analysis of Financial Condition and 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 inwhen 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

We provide management, administrative and operating expertise and services to the housekeeping, laundry, linen, facility maintenance and dietary service departments of the healthheath care industry,providers, including nursing homes, retirement complexes, rehabilitation centers and hospitals located throughout the United States. We believe 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 3,500 facilities throughout the continental United States as of March 31,June 30, 2017. 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 management of the department serviced, employing Housekeeping or Dietary personnel located at our clients’ facilities and providing certain supplies. We also provide services on the basis of management-only agreements for a 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 period of 60 to 120 days.

We are organized into two reportable segments;segments: housekeeping, laundry, linen and other services (“Housekeeping”), and dietary department services (“Dietary”).

Housekeeping consists of managing the client’s housekeeping department which is principally responsible for the cleaning, disinfecting and sanitizing of resident rooms and common areas of a client’s facility, as well as laundering and processing of the bed linens, uniforms, resident personal clothing and other assorted linen items utilized at a client facility.

Dietary consists of managing the client’s dietary department which is principally responsible for food purchasing, meal preparation and providing dietitian professional services, which includes the development of menus that meet residents’ dietary needs.

At March 31,June 30, 2017, Housekeeping services were provided at essentially all of our more than 3,500 client facilities, generating approximately 60.2%55.6% or $243.4$486.3 million of our total revenues for the threesix months ended March 31,June 30, 2017. Dietary department services were provided to over 1,0001,500 client facilities at March 31,June 30, 2017 and contributed approximately 39.8%44.4% or $161.1$389.0 million of our total revenues for the threesix months ended March 31,June 30, 2017.