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 reportit 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, 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 carehealthcare industry, primarily providers of long-term care; having one client which accounted for approximately 16% and another client which accounted for approximately 9%a significant portion of our total consolidated revenues forcontributed by one customer during the nine months ended September 30, 2017;2018; credit and collection risks associated with thisthe healthcare industry; our claims experience related to workers’ compensation and general liability insurance; the effects of changes in, or interpretations of laws and regulations governing the healthcare 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; the Company's expectations with respect to selling, general, and administrative expense; 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; realization of our expectations regarding the impact of the Tax Cuts and Jobs Act on our financial results; and the risk factors described in Part I of our Form 10-K for the fiscal year ended December 31, 20162017 under “Government Regulation of Clients,” “Competition” and “Service Agreements and Collections,” and under Item IA. “Risk Factors” in such Form 10-K and in this Form 10-Q.10-K.

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 (including the impact of potential tariffs) could not be passed on to our clients.

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 carehealthcare industry, including nursing homes, retirement complexes, rehabilitation centers and hospitals located throughout the United States. Although the Company does not directly participate in any government reimbursement programs, the 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.

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

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

Housekeeping consists of managing the 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 the clients’ dietary departments, which are principally responsible for food purchasing, meal preparation and dietitian professional services, which includes the development of menus that meet 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 the Company’s 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, 20162017 has been derived from, and does not include, all of the disclosures contained in the financial statements for the year ended December 31, 2016.2017. These financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.2017. The results of operations for the three and nine months ended September 30, 20172018 are not necessarily indicative of the results that may be expected for any future period.

In preparing financial statements have been reclassifiedin conformity with U.S. GAAP, 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, conformthe Company’s allowance for doubtful accounts, accrued insurance claims, 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. Management regularly evaluates this information to current presentation.determine if it is necessary to update the basis for its estimates and to adjust for known changes.

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. InventoriesNon-linen 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.

RevenuesThe Company recognizes revenue from the Company’s service agreements with clients are recognizedcustomers when or as the promised goods and services are performed.provided to customers. Revenues are reported net of sales taxes that are collected from customers and remitted to taxing authorities.

The 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. The 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 basesbasis 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 the Company’s financial statements based on a recognition and measurement process.

Basic earnings per common share is 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 is 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.

In preparing financial statements in conformity with U.S. GAAP, estimates and assumptionsIdentifiable intangible assets are madeamortized on a straight-line basis over their respective lives. Goodwill represents the excess of cost over the fair value of net assets of acquired businesses. Management reviews the carrying value of goodwill at least annually during the fourth quarter of each year to assess for impairment, or more often if events or circumstances indicate 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,carrying value may exceed its estimated fair value. No impairment loss was recognized on the Company’s allowance for doubtful accounts, accrued insurance claims, 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. Management regularly evaluates this information to determine if it is necessary to updateintangible assets or goodwill during the basis for its estimates and to adjust for known changes.nine months ended September 30, 2018.

The 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. The Company’s marketable securities are fixed income investments which are highly liquid and can be readily purchased or sold through established markets. At September 30, 20172018 and December 31, 2016,2017, substantially all of the Company’s cash and cash equivalents and marketable securities were held in one large financial institution located in the United States.

The Company’s clients are concentrated in the health carehealthcare industry and are primarily providers of long-term care. The revenues of many of the Company’s clients 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

Accumulated other comprehensive income consists of unrealized gains and losses from the Company’s available-for-sale marketable securities. The following table provides a summary of the changes in accumulated other comprehensive income for the nine months ended September 30, 20172018 and 2016:2017:

Property and equipment are recorded at cost. Depreciation is recorded over the estimated useful life of each class of depreciable 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.

Depreciation expense for each of the three months ended September 30, 20172018 and 20162017 was $1.1 million. Depreciation expense for each of the nine months ended September 30, 20172018 and 20162017 was $3.7 million and $3.5 million, respectively.million.

The Company’s other intangible assets consist of customer relationships which were obtained 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 9.9approximately 10 years. As of September 30, 2017, certain customer relationship intangible assets were fully amortized and the respective balances were written off. The increase from year-end is related to the acquisition of certain Dietary-related assets during 2017.

The following table sets forth the estimated amortization expense for intangibles subject to amortization for the remainder of 2017,2018, the following five fiscal years and thereafter:

Amortization expense for the three months ended September 30, 2018 and 2017 and 2016 was $1.0$1.1 million and $0.6$1.0 million, respectively. Amortization expense for the nine months ended September 30, 2018 and 2017 and 2016 was $2.7$3.3 million and $2.1$2.7 million, respectively.

The Company’s current assets (other than marketable securities and inventories) and current liabilities are financial instruments and most of these items (other than marketable securities and inventories) 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. The carrying value of the Company’s line of credit represents the outstanding amount of the borrowings, which approximates fair value. The Company’s financial assets that are measured at fair value on a recurring basis are its marketable securities and deferred compensation funding. The recorded values of all of the financial instruments approximate their current fair values because of their nature, stated interest rates and respective maturity dates or durations.

The Company’s marketable securities consist of tax-exempt municipal bonds, which are classified as available-for-sale and are reported at fair value. Unrealized gains and losses associated with these investments are included in other comprehensive income (net of tax) within the Consolidated Statements of Comprehensive Income. The fair value of these marketable securities is classified within Level 2 of the fair value hierarchy, as these securities are measured using quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable. Such valuations are determined by a third-party pricing service. For the three months ended September 30, 20172018 and 2016,2017, the Company recorded unrealized losses of $0.5 million and unrealized gains of $82 thousand and unrealized losses of $0.4$0.1 million on marketable securities, respectively. For the nine months ended September 30, 20172018 and 2016,2017, the Company recorded unrealized losses of $1.5 million and unrealized gains of $1.2 million and $0.8 million on marketable securities, respectively.

For the three months ended September 30, 20172018 and 2016,2017, the Company received total proceeds, less the amount of interest received, of $5.7$2.9 million and $3.0$5.7 million, respectively, from sales of available-for-sale municipal bonds. For the three months ended September 30, 2018 and 2017, these sales resulted in realized losses of less than $0.1 million and realized gains of $171 thousand$0.2 million, respectively. For the nine months ended September 30, 2018 and 2017, the Company received total proceeds, less the amount of interest received, of $8.7 million and $20.4 million, respectively, from sales of available-for-sale municipal bonds. For the nine months ended September 30, 2018 and 2017, these sales resulted in realized losses of $0.2 million and less than $0.1 million, respectively, which were recorded in “Other income, net – Investment and interest” in the Consolidated Statements of Comprehensive Income. The basis for the sale of these securities was the specific identification of each bond sold during the period. For the three months ended September 30, 2016, there were $17 thousand in realized losses.

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 table summarizes the contractual maturities of debt securities held at September 30, 20172018 and December 31, 2016,2017, which are classified as marketable securities in the Consolidated Balance Sheets:

A summaryThe components of the Company’s stock-based compensation expense for the nine months ended September 30, 2018 and 2017 and 2016 isare as follows:

At September 30, 2017,2018, the unrecognized compensation cost related to unvested stock options and awards was $12.7$15.3 million. The weighted average period over which these awards will vest is approximately 3.02.7 years.

The Company’s Second Amended and Restated 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.

As of September 30, 2017, 3.42018, 2.9 million shares of common stock were reserved for issuance under the Plan, including 0.80.5 million shares available for future grant. No stock award will have a term in excess of ten years. All awards granted under the Plan become vested and exercisable ratably over a five year period on each yearly anniversary of the grant date.

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 stock options outstanding under the Plan as of December 31, 20162017 and changes during the nine months ended September 30, 20172018 is as follows:

The weighted average grant-date fair value of stock options granted during the nine months ended September 30, 2018 and 2017 was $10.48 and 2016 was $8.52 and $7.46 per common share, respectively. The total intrinsic value of options exercised during the nine months ended September 30, 2018 and 2017 and 2016 was $13.3$5.9 million and $4.6$13.3 million, respectively.

The fair value of stock option awards granted in 20172018 and 20162017 was estimated on the date of grant using the Black-Scholes option valuation model usingwith the following assumptions:

The following table summarizes other information about the stock options at September 30, 2017:2018:

During the nine months ended September 30, 2017, the Company did not grant any restricted stock. During the nine months ended September 30, 2016, the Company granted 44 thousand shares of restricted stock with a weighted average grant dateThe fair value of $34.14 per share. Fair value isoutstanding restricted stock units and restricted stock was determined based on the market price of the shares on the date of grant.

During the nine months ended September 30, 2016, there were no grants2018 and 2017, the Company did not grant any restricted stock.

A summary of the outstanding restricted stock units and restricted stock as of December 31, 20162017 and changes during the nine months ended September 30, 20172018 is as follows:

The Company's Employee Stock Purchase Plan ("ESPP") is currently available through 2021 to all eligible employees. All full-time and part-time employees who work an average of 20 hours per week and have completed two years of continuous service with the Company 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 its common stock to its employees. Pursuant to such authorization, there are 2.3 million shares available for future grant at September 30, 2017.2018.

The stock-based compensation expense associated with the options granted under the ESPP during the nine months ended September 30, 20172018 and 20162017 was estimated on the date of grant using the Black-Scholes option valuation model usingwith the following assumptions:

The Company offers a Supplemental Executive Retirement Plan (“SERP”) for executives and 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 of a portion of their deferral in the form of the Company’s common stock based on the then-current market value. Under the SERP, the Company is authorized to issue 1.0 million shares of its common stock to its employees. Pursuant to such authorization, the Company has 0.4 million shares available for future grant at September 30, 2017.2018. At the time of issuance, such shares are accounted for at cost as treasury stock.

The following table summarizes information about the SERP during the nine months ended September 30, 20172018 and 2016:2017:

During the nine months ended September 30, 2017,2018, the Company paid regular quarterly cash dividends totaling approximately $41.3$42.7 million as follows:

Additionally, on October 17, 2017,16, 2018, the Company’s Board of Directors declared a regular quarterly cash dividend of $0.19$0.19500 per common share, which will be paid on December 22, 2017,28, 2018, to shareholders of record as of the close of business on November 17, 2017.23, 2018.