Description
Filed with the SEC from Sep 13 to Sep 19:
The Providence Service Corporation (PRSC)
Coliseum Capital increased its holdings to 2,100,556 shares (16.1%) after it bought 213,769 shares in the time span from Aug. 23 through Sept. 10 at prices ranging from $11.35 to $12.69 each.
BUSINESS OVERVIEW
Development of our business
We provide and manage government sponsored social services and non-emergency transportation services. With respect to our social services, our counselors, social workers and behavioral health professionals work with clients who are eligible for government assistance due to income level, emotional/educational disabilities or court order. The state and local government agencies that fund the social services we provide are required by law to provide counseling, case management, foster care and other support services to eligible individuals and families. We do not own or operate any hospitals or residential treatment centers. Instead, we provide social services primarily in the client’s home or community, reducing the cost to the government of such services while affording the client a better quality of life. With respect to our non-emergency transportation services, we manage and arrange for client transportation to health care related facilities and services for state or regional Medicaid agencies, health maintenance organizations, or HMOs, and commercial insurers.
Our social services revenue is derived from our provider contracts with state and local government agencies and government intermediaries, HMOs, commercial insurers, and our management contracts with not-for-profit social services organizations. The government entities that pay for our social services include welfare, child welfare and justice departments, public schools and state Medicaid programs. Under a majority of our social services provider contracts, we are paid an hourly fee. Under some of our social services provider contracts, however, we receive a set monthly amount or we are paid amounts equal to the costs we incur to provide agreed upon services. Where we contract to manage the operations of not-for-profit social services organizations, we receive management fees based on a percentage of revenues of the managed entity or a predetermined fee.
Where we provide management services for non-emergency transportation, we contract with either state or regional Medicaid agencies, local governments, or private managed care companies. Most of our contracts for non-emergency transportation management services are capitated (i.e. our compensation is based on a per member per month payment for each eligible member). For a majority of our contracts we do not direct bill our payers for non-emergency transportation services as our revenue is based on covered lives. Our special needs school transportation contracts are with local governments and are paid on a per trip basis or per bus per day basis.
When we formed our business as a Delaware corporation in 1996, most government social services were delivered directly by governments in institutional settings such as psychiatric hospitals, residential treatment centers or group homes. We recognized that social services could be delivered more economically and effectively in a home or community based setting. Additionally, we anticipated that payers would increasingly seek to privatize the provision of these social services in order to reduce costs and provide quality social services to an increasing number of recipients. Based on this outlook, we developed a system for delivering these services that is less costly and, we believe, more effective than the traditional social services delivery system.
Revenue and payers. Substantially all of our revenue related to our Social Services operating segment is derived from contracts with state or local government agencies, government intermediaries or the not-for-profit social services organizations we manage.
A majority of our contracts are negotiated fee-for-service arrangements with payers. Home and community based services are generally payable by the hour depending on the type and intensity of the service. Foster care services are generally payable pursuant to a fixed monthly fee. Approximately 70.6%, 68.1% and 71.1% of our Social Services operating segment revenue for the fiscal years ended December 31, 2009, 2010 and 2011 was related to fee-for-service arrangements. A significant number of our fee-for-service contracts allow the payer to terminate the contract immediately for cause (such as for our failure to meet our contract obligations). Additionally, these contracts permit the payer to terminate the contract at any time prior to its stated expiration date without cause, at will and without penalty to the payer, either upon the expiration of a short notice period, typically 30 days, and/or immediately, in the event federal or state appropriations supporting the programs serviced by the contract are reduced or eliminated.
We generate a significant portion of our revenue from a few payers. Under our contract with the State of Virginia’s Department of Medical Assistance Services, we derived approximately 12.6%, 11.7% and 11.5% of our social services revenue for the years ended December 31, 2009, 2010 and 2011, respectively.
Revenues from our cost based service contracts are generally recorded based on a combination of direct costs, indirect overhead allocations, and stated contractual margins on those incurred costs. These revenues are compared to annual contract budget limits and, depending on reporting requirements, allowances may be recorded for certain contingencies such as projected costs not incurred, excess cost per service over the allowable contract rate and/or insufficient encounters. This policy results in recognizing revenue from these contracts based on allowable costs incurred. The annual contract amount is based on projected costs to provide services under the contracts with adjustments for changes in the total contract amount. Annually, we submit projected costs for the coming year which assist the contracting payers in establishing the annual contract amount to be paid for services provided under the contracts. After the contracting payers’ year end, we submit cost reports which are used by the contracting payers to determine the amount, if any, by which funds paid to us for services provided under the contracts were greater than the allowable costs to provide these services. Completion of this review process may range from one month to several years from the date we submit the cost report. In cases where funds paid to us exceed the allowable costs to provide services under contract, we may be required to pay back the excess funds.
Our cost reports are routinely audited by our contracted payers on an annual basis. We periodically review our provisional billing rates and allocation of costs and provide for estimated adjustments from the contracting payers. We believe that adequate provisions have been made in our consolidated financial statements for any adjustments that might result from the outcome of any cost report audits. Differences between the amounts provided and the settlement amounts are recorded in our consolidated statement of operations in the year of settlement. Cost based service contracts represented approximately 18.5%, 21.3% and 19.3% of our Social Services operating segment revenue for the years ended December 31, 2009, 2010 and 2011.
We provide services under one annual block purchase contract in Arizona with The Community Partnership of Southern Arizona. We are required to provide or arrange for the behavioral health services to eligible populations of beneficiaries as defined in the contract. We must provide a complete range of behavioral health clinical, case management, therapeutic and administrative services. We are obliged to provide services only to those clients with a demonstrated medical necessity. There is no contractual limit to the number of eligible beneficiaries that may be assigned to us, or a limit to the level of services that must be provided to these beneficiaries if the services are deemed to be medically necessary. Therefore, we are at-risk if the costs of providing necessary services exceed the associated reimbursement. The terms of the contract typically are reviewed prospectively and amended as necessary to ensure adequate funding of our service offerings under the contract; however, no assurances can be made that such funding will adequately cover the costs of services previously provided. The annual block purchase contract represented 6.7%, 6.7% and 6.1% of our Social Services operating segment revenue for the years ended December 31, 2009, 2010 and 2011, respectively.
Due to the nature of our business and the requirement or desire by certain payers to contract with not-for-profit social services organizations, we sometimes enter into management contracts with not-for-profit organizations for the purpose of developing strategic relationships or providing administrative, program and management services. These organizations contract directly or indirectly with state government agencies to supply a variety of community based mental health and foster care services to children and adults. Typically these organizations are separately incorporated and organized with their own board of directors. Our management fees under these contracts are either based upon a percentage of the managed entities’ revenues or a predetermined fee. Management fees earned pursuant to our management contracts with these organizations represented approximately 4.2%, 4.0% and 3.5% of our Social Services operating segment revenue for the years ended December 31, 2009, 2010 and 2011.
Seasonality. Our quarterly operating results and operating cash flows normally fluctuate as a result of seasonal variations in our Social Services operating segment, principally due to lower client demand for our home and community based services during the holiday and summer seasons. As we have grown our home and community based services business, our exposure to seasonal variations has grown and will continue to grow, particularly with respect to our school based services, educational services and tutoring services. We experience lower home and community based services revenue when school is not in session. Our expenses, however, do not vary significantly with these changes and, as a result, such expenses may not fluctuate significantly on a quarterly basis. As a result, our Social Services operating segment experiences lower operating margins during the holiday and summer seasons. We expect quarterly fluctuations in operating results and operating cash flows to continue as a result of the uneven seasonal demand for our home and community based services. Moreover, as we enter new markets, we could be subject to additional seasonal variations along with any competitive response to our entry by other social services providers.
Competition. The social services industry is a highly fragmented industry. We compete for clients with a variety of organizations that offer similar services. Most of our competition consists of local social services organizations that compete with us for local contracts, such as United Way supported agencies and faith-based agencies such as Catholic Social Services, Jewish Family and Children’s Services and the Salvation Army. Other competitors include local, not-for-profit organizations and community based organizations. Historically, these types of organizations have been favored in our industry as incumbent providers of services to government entities. On a national level, there are very few organizations that compete for local, county and state contracts to provide the types of services we offer. We also compete with larger companies, such as Res-Care, Inc., which provides support services, training and educational programs predominantly to Medicaid eligible beneficiaries. National Mentor, Inc. is the country’s largest provider of foster care services and competes with us in certain markets for foster care services. Many institutional providers offer some type of community based care including such organizations as Cornell Companies, Inc. and The Devereaux Foundation. While we believe that we compete on the basis of price and quality, many of our competitors have greater financial, technical, political and marketing resources, name recognition, and a larger number of clients and payers than we do. In addition, some of these organizations offer more services than we do. We have experienced, and expect to continue to experience, competition from new entrants into our markets. Increased competition may result in pricing pressures, loss of or failure to gain market share or loss of clients or payers, any of which could harm our business.
Sales and marketing. Substantially all of our marketing is performed at the local and regional level. Through our local and regional managers, we have successfully developed and maintained extensive relationships with various payers. These relationships allow us to develop leads on new business, cross-sell our other services to existing payers and negotiate payer contracts. A significant portion of our business is procured in this manner. We also seek to market our services to payers in geographical areas contiguous to existing markets and in which we believe our reputation as a low cost quality service provider will enhance our ability to compete for and win business. From time to time we respond to requests for proposals, or RFPs. Additionally, we subscribe to a service that keeps us informed of and tracks on a national basis RFPs for privatization of social services. We selectively choose the RFPs to which we respond based upon whether our reputation enhances our ability to compete or if the RFP presents a unique opportunity to develop a new service offering.
NET Services
Services offered. As a result of our acquisition of Charter LCI Corporation, including its subsidiaries, collectively referred to as LogistiCare, we are the preferred provider of non-emergency transportation management servicing clients under more than 70 contracts in 34 states and the District of Columbia. We provide responsive and innovative solutions for a healthcare recipient’s transportation needs through centralized call processing, development and management of transportation networks and through the use of proprietary technologies. Our current payers include state Medicaid programs, local government agencies, hospital systems and HMOs providing Medicare, Medicaid and commercial products. For 2009, 2010 and 2011 our NET services accounted for 57.5%, 61.1% and 61.7%, respectively, of our consolidated revenue.
We provide services to a wide variety of people with varying needs. Our clients are primarily state Medicaid agencies, and private managed care organizations and HMOs. Non-emergency transportation services are provided to individuals with limited mobility, people with limited means of transportation, and people with disabilities that prevent them from using conventional methods of transportation. The majority of our programs provide Medicaid non-emergency transportation services to Medicaid members who lack their own means of transportation. Utilization rates and vehicle requirements differ depending on the individual’s condition, the location of the individual relative to the final destination, and other available transportation systems. We also provide school transportation services to school children, including special needs students who are physically fragile, or mentally ill children who cannot commute to school via traditional mainstream transportation and/or need to be taken out of school for therapy.
As a transportation logistics manager, we match transportation services with the recipient’s needs. We employ a proprietary information technology platform and operational processes to manage the transportation services that we outsource to a network of local third party transportation providers. We typically do not provide direct transportation to end users. Rather, to fulfill requests under our contracts, we subcontract with local transportation providers, such as van, cab and ambulance companies. We receive transportation requests from members or their representatives (such as social workers) and arrange for the least costly and most effective transportation. We process transportation requests at one of our 14 regional call centers and assign appropriate local transportation providers. These decisions are aided by our proprietary logistics software. After we assign an appropriate transportation provider to the member we carefully monitor the transportation service provided to ensure that the transport was completed before we pay the transportation vendor. We do not normally pay for services if the member does not show up for transport or if the transport is not completed. A majority of the requests for transportation are standing orders, mostly for patients who require frequent, recurring services such as dialysis treatment. Other transportation requests are required to be scheduled with 48 to 72 hour advance notice, with a small number of requests scheduled on the same day, such as with hospital discharges.
We subcontract with larger transportation companies as well as a number of diverse, small, local companies in order to provide superior coverage in both urban and rural areas. In each region that we serve, we actively manage a network of local transportation providers, screening and credentialing providers, providing orientations, and monitoring performance on an ongoing basis through field audits and other reviews. Each of our state operations uses multiple transportation providers in our network, with an average provider fleet size of less than 10 vehicles. To ensure compliance and safety quality standards for all third party transportation providers, we perform a credentialing process on all of our network transportation providers who must meet minimum standards set by us and our payers. These standards include: (i) successful completion of criminal and driving record checks; (ii) required drug testing; (iii) required driver and program training on such things as the Health Insurance Portability and Accountability Act of 1996, or HIPAA, defensive driving, patient sensitivity, cultural diversity, ability to receive trip reservations and bill electronically; (iv) inspections, both scheduled and random of provider owned and or leased vehicles and communication systems; and (v) insurance coverage that complies with federal and/or state statutory requirements. We contract with third party transportation providers for trips on a per completed trip basis. Our subcontracts do not contain volume guarantees and can be cancelled with or without cause given 45 days notice.
Revenue and payers. We contract primarily with state and local government entities, HMOs and commercial insurers. Approximately 88% of our non-emergency transportation services revenue is generated under capitated contracts where we assume the responsibility of meeting the transportation needs of a specific geographic population. These contracts are generally structured with per member per month rates and have renegotiation or price increase triggers. Typical state payer contracts cover three to five years with renewal options and range in size from approximately $1 million to $110 million annually. Approximately 12% of our non-emergency transportation services revenue is derived from fee-for-service and fixed cost contracts. Our school transportation contracts are with local governments and are paid on a per trip basis or per bus per day basis.
We generate a significant portion of our revenue from a few payers. Under our contract with the State of Virginia’s Department of Medical Assistance Services we derived approximately 15%, 13% and 13% of our non-emergency transportation services revenue for the years ended December 31, 2009, 2010 and 2011, respectively. Additionally, under our contract with the State of New Jersey, we derived approximately 8%, 15% and 18% of our non-emergency transportation services revenue for the years ended December 31, 2009, 2010 and 2011, respectively. Our next three largest payers comprised approximately 23%, 21% and 19% of our non-emergency transportation services revenue for the years ended December 31, 2009, 2010 and 2011, respectively.
Our contracted per member per month fee is predicated on actual historical transportation data for the subject geographic region, future assumptions on key cost and program drivers, actuarial analysis performed in-house as well as by third party actuarial firms and actuarial analyses provided by our payers. Typically our government contracts are cancellable for cause with 180 days to 365 days notice. Our contract pricing is regularly revisited and may be reset based on actual experience under the contract with adjustments for membership fluctuations and such inflation factors as cost of labor, fuel, insurance and utilization increases and decreases stemming from program re-designs.
Seasonality. The quarterly operating results and operating cash flows of our NET Services operating segment normally fluctuate as a result of seasonal variations in the business, principally due to lower client demand for our non-emergency transportation services during the holiday and winter seasons. Due to the fixed revenue stream and variable expense base structure of our NET Services operating segment, expenses vary with these changes and, as a result, such expenses fluctuate on a quarterly basis. We expect quarterly fluctuations in operating results and operating cash flows to continue as a result of the seasonal demand for our non-emergency transportation services. As we enter new markets, we could be subject to additional seasonal variations along with any competitive response to our entry by other transportation providers.
Competition. We compete with a variety of organizations that provide similar non-emergency transportation services to Medicaid eligible beneficiaries in local markets such as American Medical Response, Coordinated Transportation Solutions, Inc., First Transit, Inc., Medical Transportation Management Inc., MV Transportation, Inc., and Southeast Trans. as well as a host of local/regional transportation providers. Most local competitors may seek to win contracts for specific counties or small geographic territories whereas we and the larger competitors listed above, seek to win contracts for the entire state or large regional areas. Historically, we have been successful in competitively bidding our non-emergency transportation management services for state-wide or other large Medicaid population programs, as well as specialized non-emergency transportation benefits often offered to populations covered by managed care organizations. We compete based on our technical expertise and experience, which is delivered in a high service, competitive price environment although we are not necessarily the lowest priced management service provider. We have experienced, and expect to continue to experience, competition from new entrants into our markets that may be able to provide services at a lower cost. Regardless of how well we perform under our contracts (based on service or cost), we face competitive rebid situations from time to time. Increased competitive pressure could result in pricing pressures, loss of or failure to gain market share or loss of payers, any of which could harm our business.
CEO BACKGROUND
Fletcher Jay McCusker has served as our chairman of the board of directors and Chief Executive Officer since our company was founded in December 1996. Prior to founding our company, Mr. McCusker served as Executive Vice President of Youth Services International, Inc., a Nasdaq listed company that provided private institutional care for at-risk youth, from July 1995 until December 1996. From September 1992 until July 1995, he served as Chief Executive Officer of Introspect Healthcare Corporation, a large multi-state behavioral health provider. In 1983, Mr. McCusker co-founded a mental health care company, Century Healthcare, which was sold to New York Stock Exchange listed Columbia Healthcare in 1992. Mr. McCusker received a bachelor’s degree in rehabilitation from the University of Arizona in 1974 and completed the public programs graduate program without a terminal degree at Arizona State University in 1982.
Mr. McCusker brings to Providence over forty years of experience in the social services industry. Mr. McCusker’s day to day leadership of Providence, as Chief Executive Officer, provides him with intimate knowledge of our business, results of operations and financial condition. As one of the founders of Providence, he has provided and continues to provide strategic guidance. Under his leadership we have grown our business to become a leading provider of home and community based social services and non-emergency transportation management services to over 10.0 million beneficiaries including children, adolescents and families who are eligible to receive our services due to income level and emotional and educational disabilities. The Board believes that Mr. McCusker provides unique insights into the Company’s challenges, opportunities, risks and operations.
Kristi L. Meints has served as our director and chairperson of the audit committee of our board of directors since August 2003. From January 2005 to December 2009 when she retired, and from August 1999 until September 2003, Ms. Meints served as Vice President and Chief Financial Officer of Chicago Systems Group, Inc. (now known as CSG Government Solutions, Inc.), a technology consulting firm based in Chicago, Illinois. From October 2003 through December 2004, she served as Chief Financial Officer of Peter Rabbit Farms, a carrot and vegetable farming business in Southern California. From January 1998 until August 1999, she was interim Chief Financial Officer for Cordon Corporation, a start-up services company. Ms. Meints was group finance director for Avery Dennison Corporation, a New York Stock Exchange listed company that is a multi-national manufacturer of consumer and industrial products, from March 1996 until December 1997. From February 1977 until June 1995, she held a variety of financial positions at SmithKline Beecham Corporation, including as director of finance, worldwide manufacturing animal health products; and as manager of accounting and budgets for Norden Laboratories, Inc., one of its wholly owned subsidiaries. She received a bachelor’s degree in accounting from Wayne State College in 1975 and a master’s degree in business administration from the University of Nebraska in 1984.
Ms. Meint’s strong financial and operational background, including her experience as Chief Financial Officer of Chicago Systems Group, Inc. and Peter Rabbit Farms and senior finance positions at Avery Dennison Corporation and SmithKline Beecham Corporation, provides financial expertise to the Board, including an understanding of financial statements, budgeting, operational and corporate finance and accounting.
Richard A. Kerley has served as our director since May 2010 and chairperson of the Compensation Committee since March 2011. Mr. Kerley is currently the Senior Vice President and Chief Financial Officer and member of the board of directors of Peter Piper, Inc., a privately-held pizza and entertainment restaurant chain. Mr. Kerley has served in these positions since November 2008. From July 2005 to October 2008, Mr. Kerley served as the Chief Financial Officer of Fender Musical Instruments Corporation. From June 1981 to July 2005, Mr. Kerley was an audit partner with Deloitte & Touche LLP. Prior to becoming a partner in Deloitte & Touche, Mr. Kerley served as an audit manager and staff accountant from August 1971 to June 1981. He received a bachelor of business administration degree in accounting from Marshall University in 1971 and is a certified public accountant in the State of Arizona.
Mr. Kerley is a senior financial executive with experience in a variety of operational issues, financial budgeting, planning and analysis, capital investment decisions, mergers and acquisitions, operational and financial controls, internal and external reporting, financings and public offerings and filings with the SEC. Mr. Kerley’s strong financial background provides our board of directors with financial expertise, including an understanding of financial statements, finance, capital investing strategies and accounting.
Warren S. Rustand has served as our director since May 2005, our lead director since January 2007. Since January 2004, Mr. Rustand has served as managing director of SC Capital Partners LLC, an investment banking group which includes: corporate advisory services, a private equity fund, capital sourcing, with a focus on the microcap market. Since January 2001, he has served as the Chief Executive Officer of Summit Capital Consulting, a firm which specializes in the development of small to midsize companies by sourcing, and structuring financial, and human capital resources for the organization. Mr. Rustand has served as a member of the board of directors for over 40 public, private, and not-for-profit organizations. The range of these organizations is from multibillion dollar public companies, to midsize, early stage, and startup companies. Mr. Rustand was chairman and Chief Executive Officer of Rural Metro Corp., an emergency health care company. In addition, Mr. Rustand has had a long term interest in public policy, and in 1973, was selected as a White House Fellow. During his fellowship, he served in various positions such as special assistant to the Secretary of Commerce and special assistant to the Vice President. In addition, from 1974 to 1976, he served as the Appointments Secretary to the President. Mr. Rustand serves as a director of MedPro Safety Products, Inc., a medical device safety products company, where he chairs the audit committee and serves on other board committees. He received his bachelor’s degree and master’s degree from the University of Arizona in 1965 and 1972, respectively.
Mr. Rustand’s positions as a member of the board of directors for many public, private and not-for-profit organizations, managing director of SC Capital Partners LLC, Chief Executive Officer of Summit Capital and tenure as a senior executive at other organizations has enabled him to provide our board of directors with valuable business, leadership and management perspectives and business acumen. Mr. Rustand also brings financial expertise to our Board, including his prior service as chairman of the audit committee of other public companies.
MANAGEMENT DISCUSSION FROM LATEST 10K
Overview of our business
We provide government sponsored social services directly and through not-for-profit social services organizations whose operations we manage, and we arrange for and manage non-emergency transportation services. As a result of and in response to the large and growing population of eligible beneficiaries of government sponsored social services and non-emergency transportation services, increasing pressure on governments to control costs and increasing acceptance of privatized social services, we have grown both organically and by consummating strategic acquisitions.
We believe our business model enables us to be nimble in the face of uncertain market conditions. We are focused on legislative trends both at the federal and state levels as the federal government has enacted healthcare reform legislation. We believe that the passage of healthcare reform legislation in the first quarter of 2010 could accelerate the demand for our services.
While we believe we are well positioned to benefit from healthcare reform legislation and to offer our services to a growing population of individuals eligible to receive our services, there can be no assurances that programs under which we provide our services will receive continued or increased funding. Additionally, there can be no assurance of when the legislation will be implemented or when, and if, we will see any positive impact.
We completed our 2011-2012 social services contract renewal cycle with substantially all contracts renewed and with relatively stable rates. With respect to our non-emergency transportation management services segment, or NET Services, we were awarded six of the nine incumbent contracts in Arkansas, Connecticut, Delaware, Pennsylvania, South Carolina and Virginia (one of our largest contracts). Two of the nine incumbent contracts in Georgia and Nevada have yet to be finalized as they are subject to or under protest by competitors in these states. Moreover, we lost one incumbent contract in Colorado. In addition, we added new contracts in Michigan, Missouri, New York, Wisconsin and Texas. Additionally, our new contract awards, and some of our renewed contracts, have come at lower margins relative to historical amounts.
While we believe we are positioned to potentially benefit from recent trends that favor our in-home provision of social services, budgetary pressures still exist that could reduce funding for the services we provide. For example, President Obama’s proposed budget for fiscal year 2013 seeks to reduce spending for federal health care programs by approximately $360 billion over the next decade. As funding under our contracts is dependent in part upon federal funding, such funding changes, if adopted, could have a significant effect upon our business. We believe our business model allows us to make adjustments to help mitigate state budget pressures that are impacted by federal spending and system reforms that could challenge our overall profit margins.
As of December 31, 2011, we provided social services directly to approximately 61,000 clients, and had approximately 11.3 million individuals eligible to receive services under our non-emergency transportation services contracts. We provided services to these clients from almost 400 locations in 42 states, the District of Columbia and British Columbia.
Our working capital requirements are primarily funded by cash from operations and borrowings from our credit facility, which provides funding for general corporate purposes and acquisitions. We remain focused on reducing our debt and in March 2011 we replaced our then existing credit facility with a new credit agreement and repurchased approximately $20.0 million in principal amount of the 6.5% Convertible Senior Subordinated Notes due 2014, or the Notes, during YTD 2011 as discussed in further detail below under the heading entitled Liquidity and capital resources— Obligations and commitments .
How we grow our business and evaluate our performance
Our business has grown internally through organic expansion into new markets, increases in the number of clients served under contracts we or the entities we manage are awarded, and externally through acquisitions.
We typically pursue organic expansion into markets that are contiguous to our existing markets or where we believe we can quickly establish a significant presence. When we expand organically into a market, we typically have no clients or perform no management services in the market and are required to incur start-up costs including the costs of space, required permits and initial personnel. These costs are expensed as incurred and our new offices can be expected to incur losses for a period of time until we adequately grow our revenue from clients or management fees.
We continue to selectively identify and pursue strategic acquisitions in markets where we see opportunities but where we lack the contacts and/or personnel to make a successful organic entry. Unlike organic expansion which involves start-up costs that may dilute earnings, expansion through acquisitions have generally been accretive to our earnings. However, we bear financing risk and where debt is used, the risk of leverage by expanding through acquisitions. We also must integrate the acquired business into our operations which could disrupt our business and we may not be able to realize operating and economic synergies upon integration. Finally, our acquisitions may involve purchase prices in excess of the fair value of tangible assets and cash or receivables. This excess purchase price is allocated to intangible assets, including goodwill, and is subject to periodic evaluation and impairment or other write downs that are charges against our earnings. There are no assurances, however, that we will complete acquisitions in the future or that any completed acquisitions will prove profitable for us.
In all our markets we focus on several key performance indicators in managing our business. Specifically, we focus on growth in the number of clients served, as that particular metric is the key driver of our revenue growth. We also focus on the number of employees and the amount of outsourced transportation cost as these items are our most important variable costs and the key to the management of our operating margins.
Acquisition
On June 1, 2011, we acquired all the equity interest of The ReDCo Group, Inc., or ReDCo. ReDCo is a Pennsylvania corporation that provides home and community based services. The purchase price of $605,000 was funded by our cash flow from operations. Additionally, we repaid ReDCo’s debt of approximately $8.0 million in connection with the acquisition. Historically, we have provided various management services to ReDCo for a fee under a management services agreement. This acquisition further expands our home and community based services in Pennsylvania.
How we earn our revenue
We operate in two segments: Social Services and Non-Emergency Transportation Services, or NET Services.
Social Services
Our revenue is derived from our provider contracts with state and local government agencies and government intermediaries, HMOs, commercial insurers, and from our management contracts with not-for-profit social services organizations. The government entities that pay for our services include welfare, child welfare and justice departments, public schools and state Medicaid programs. Under a majority of the contracts where we provide social services directly, we are paid an hourly fee. In other such situations, we receive a set monthly amount or we are paid amounts equal to the costs we incur to provide agreed upon services. These revenues are presented in our consolidated statements of operations as either revenue from home and community based services or foster care services.
Where we contract to manage the operations of not-for-profit social services organizations, we receive a management fee that is either based upon a percentage of the revenue of the managed entity or a predetermined fee. These revenues are presented in our consolidated statements of operations as management fees. Because we provide substantially all administrative functions for these entities and our management fees are largely dependent upon their revenues, we also monitor for management and disclosure purposes the revenues of the entities we manage. We refer to the revenues of these entities as managed entity revenue.
NET Services
Where we provide non-emergency transportation management services, we contract with state Medicaid and local agencies, regional and medical hospital systems or private managed care companies. Most of our contracts for non-emergency transportation management services are capitated (where we are paid on a per member per month basis for each eligible member). We do not direct bill for services under our capitated contracts as our revenue is based on covered lives. Our school transportation contracts are with local governments and are paid on a per trip basis or per bus per day basis. These revenues are presented in our consolidated statements of operations as non-emergency transportation services revenue.
Critical accounting policies and estimates
General
In preparing our financial statements in accordance with accounting principles generally accepted in the United States, or GAAP, we are required to make estimates and judgments that affect the amounts reflected in our financial statements. We base our estimates on historical experience and on various other assumptions we believe to be reasonable under the circumstances. However, actual results may differ from these estimates under different assumptions or conditions.
Critical accounting policies are those policies most important to the portrayal of our financial condition and results of operations. These policies require our most difficult, subjective or complex judgments, often employing the use of estimates about the effect of matters inherently uncertain. Our most critical accounting policies pertain to revenue recognition, accounts receivable and allowance for doubtful accounts, accounting for business combinations, goodwill and other intangible assets, accrued transportation costs, accounting for management agreement relationships, loss reserves for certain reinsurance and self-funded insurance programs, stock-based compensation and income taxes. We have reviewed our critical accounting estimates with our board of directors, audit committee and disclosure committee.
Revenue recognition
We recognize revenue at the time services are rendered at predetermined amounts stated in our contracts and when the collection of these amounts is considered to be reasonably assured.
At times we may receive funding for certain services in advance of services actually being rendered. These amounts are reflected in the accompanying consolidated balance sheets as deferred revenue until the actual services are rendered.
As services are rendered, documentation is prepared describing each service, time spent, and billing code under each contract to determine and support the value of each service provided. This documentation is used as a basis for billing under our contracts. The billing process and documentation submitted under our contracts vary among our payers. The timing, amount and collection of our revenues under these contracts are dependent upon our ability to comply with the various billing requirements specified by each payer. Failure to comply with these requirements could delay the collection of amounts due to us under a contract or result in adjustments to amounts billed.
The performance of our contracts is subject to the condition that sufficient funds are appropriated, authorized and allocated by each state, city or other local government. If sufficient appropriations, authorizations and allocations are not provided by the respective state, city or other local government, we are at risk of immediate termination or renegotiation of the financial terms of our contracts.
Social Services segment
Fee-for-service contracts. Revenue related to services provided under fee-for-service contracts is recognized at the time services are rendered and collection is determined to be probable. Such services are provided at established billing rates. Fee-for-service contracts represented approximately 68.1% and 71.1% of our Social Services operating segment revenue for 2010 and 2011, respectively.
Cost based service contracts. Revenue from our cost based service contracts is recorded based on a combination of direct costs, indirect overhead allocations, and stated contractual margins on those costs. These revenues are compared to annual contract budget limits and, depending on reporting requirements, allowances may be recorded for certain contingencies such as projected costs not incurred or excess cost per service over the allowable contract rate. This policy results in recognizing revenue from these contracts based on allowable costs incurred. The annual contract amount is based on projected costs to provide services under the contracts with adjustments for changes in the total contract amount. We annually submit projected costs for the coming year which assist the contracting payers in establishing the annual contract amount to be paid for services provided under the contracts. After the contracting payers’ year end, we submit cost reports which are used by the contracting payers to determine the amount, if any, by which funds paid to us for services provided under the contracts were greater than the allowable costs to provide these services. Completion of this review process may take several years from the date we submit the cost report. In cases where funds paid to us exceed the allowable costs to provide services under contract, we may be required to pay back the excess funds.
Our cost reports are routinely audited by our payers on an annual basis. We periodically review our provisional billing rates and allocation of costs and provide for estimated adjustments from the contracting payers. We believe that adequate provisions have been made in our consolidated financial statements for any adjustments that might result from the outcome of any cost report audits. Differences between the amounts provided and the settlement amounts, which historically have not been material, are recorded in our consolidated statement of operations in the year of settlement. Cost based service contracts represented approximately 21.3% and 19.3% of our Social Services operating segment revenue for 2010 and 2011, respectively.
Annual block purchase contract. Our annual block purchase contract with The Community Partnership of Southern Arizona, referred to as CPSA, requires us to provide or arrange for behavioral health services to eligible populations of beneficiaries as defined in the contract. We must provide a complete range of behavioral health clinical, case management, therapeutic and administrative services. We are obliged to provide services only to those clients with a demonstrated medical necessity. Our annual funding allocation amount is subject to increase when our encounters exceed the contract amount; however, such increases in the annual funding allocation amount are subject to government appropriation and may not be approved. There is no contractual limit to the number of eligible beneficiaries that may be assigned to us, or a specified limit to the level of services that may be provided to these beneficiaries if the services are deemed to be medically necessary. Therefore, we are at-risk if the costs of providing necessary services exceed the associated reimbursement.
We are required to regularly submit service encounters to CPSA electronically. On an on-going basis and at the end of CPSA’s June 30 fiscal year, CPSA is obligated to monitor the level of service encounters. If the encounter data is not sufficient to support the year-to-date payments made to us, unless waived, CPSA has the right to prospectively reduce or suspend payments to us.
For revenue recognition purposes, our service encounter value (which represents the value of actual services rendered) must equal or exceed 90% of the revenue recognized under our annual block purchase contract for the contract year. The remaining 10% of revenue recognized in each reporting period represents payment for network overhead administrative costs incurred in order to fulfill our obligations under the contract. Administrative costs include, but are not limited to, intake services, clinical liaison oversight for each behavioral health recipient, cultural liaisons, financial assessments and screening, data processing and information systems, staff training, quality and utilization management functions, coordination of care and subcontract administration.
We recognize revenue from our annual block purchase contract which correlates to the service encounter value. If our service encounter value is less than 90% of the amounts received from CPSA for the contract year, unless waived, we recognize revenue equal to the service encounter value and record a liability for any excess amounts received. CPSA has not reduced, withheld, or suspended any material payments that have not been subsequently reimbursed. We believe our encounter data is sufficient to have earned all amounts recorded as revenue under this contract.
If our service encounter value equals 90% of the amounts received from CPSA for the contract year, we recognize revenue at the contract amount, which is one-twelfth of the established annual contract amount each month.
If our service encounter value exceeds 90% of the contract amount, we recognize revenue in excess of the annual funding allocation amount if collection is reasonably assured. We evaluate factors regarding payment probability related to the determination of whether any such additional revenue over the contractual amount is considered to be reasonably assured.
The terms of the contract may be reviewed prospectively and amended as necessary to ensure adequate funding of our contractual obligations; however, we cannot guarantee amendments will be completed or that funding will be adequate. Our revenues under the annual block purchase contract for 2010 and 2011 represented approximately 6.7% and 6.1%, respectively, of our Social Services operating segment revenues for each year.
Management agreements. We maintain management agreements with a number of not-for-profit social services organizations whereby we provide certain management services for these organizations. In exchange for our services, we receive a management fee that is either based on a percentage of the revenues of these organizations or a predetermined fee. Management fees earned under our management agreements represented approximately 4.0% and 3.5% of our Social Services operating segment revenue for 2010 and 2011, respectively.
The costs associated with generating our management fee revenue are accounted for in client service expense and in general and administrative expense in our consolidated statements of operations.
NET Services segment
Capitation contracts. Approximately 88% of our non-emergency transportation services revenue is generated under capitated contracts where we assume the responsibility of meeting the transportation needs of a specific geographic population. Revenues under capitation contracts with our payers result from per-member monthly fees based on the number of participants in our payer’s program. Aggregate revenue from our top five payers for 2010 and 2011 represented approximately 49% of our NET Services operating segment revenue for such period.
Fee-for-service contracts. Revenues earned under fee-for-service contracts are recognized when the service is provided. Revenue under these types of contracts is based upon contractually established billing rates less allowance for contractual adjustments. Estimates of contractual adjustments are based upon payment terms specified in the related agreements.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Overview of our business
We provide government sponsored social services directly and through not-for-profit social services organizations whose operations we manage, and we arrange for and manage non-emergency transportation services. As a result of and in response to the large and growing population of eligible beneficiaries of government sponsored social services and non-emergency transportation services, increasing pressure on governments to control costs and increasing acceptance of privatized social services, we have grown both organically and by consummating strategic acquisitions.
We believe our business model enables us to be nimble in the face of uncertain market conditions. We are focused on legislative trends both at the federal and state levels as the federal government has enacted healthcare reform legislation. We believe that the passage of healthcare reform legislation in the first quarter of 2010 could accelerate the demand for our services when it takes effect. Moreover, we believe we will have enhanced opportunities going forward due to the recent U.S. Supreme Court decision providing for state led voluntary increases in Medicaid enrollment under the 2010 healthcare reform legislation where states may choose to opt into increased enrollment by accepting federal incentives designed to fund all of the enrollment expansion.
While we believe we are well positioned to benefit from healthcare reform legislation and to offer our services to a growing population of individuals eligible to receive our services, there can be no assurances that programs under which we provide our services will receive continued or increased funding. Additionally, there can be no assurance of when the legislation will be implemented or when, and if, we will see any positive impact.
While we believe we are positioned to potentially benefit from recent trends that favor our in-home provision of social services, budgetary pressures still exist that could reduce funding for the services we provide. Medicaid budgets are fluid and dramatic changes in the financing or structure of Medicaid could have a negative impact on our business. We believe our business model allows us to make adjustments to help mitigate state budget pressures that are impacted by federal spending and system reforms that could challenge our overall profit margins.
With respect to our non-emergency transportation management services segment, or NET Services, Q2 2012 consisted of multiple implementations throughout the country. We increased staff hiring and expansion efforts during Q2 2012 associated with bringing on one additional region in Georgia, which began April 1, 2012, and a second additional region in that state that began July 1, 2012, the Texas (Dallas) contract, which started in April 2012, and the first phase of the New York City contract, which began on May 1, 2012 (with the second phase commencing in August 2012). In addition, our Connecticut Medicaid contract was expanded to incorporate the entire covered population in the state and we added a couple of managed care contracts in New York.
As of June 30, 2012, we provided social services directly to approximately 53,000 clients, and had approximately 13.6 million individuals eligible to receive services under our non-emergency transportation services contracts. We provided services to these clients from nearly 400 locations in 43 states, the District of Columbia, United States, and British Columbia and Alberta, Canada.
Our working capital requirements are primarily funded by cash from operations and borrowings from our credit facility, which provides funding for general corporate purposes and acquisitions. We remain focused on deleveraging our balance sheet and continue to identify opportunities to further diversify our service offerings.
Critical accounting estimates
In preparing our financial statements in accordance with accounting principles generally accepted in the United States, or GAAP, we are required to make estimates and judgments that affect the amounts reflected in our financial statements. We base our estimates on historical experience and on various other assumptions we believe to be reasonable under the circumstances. However, actual results may differ from these estimates under different assumptions or conditions.
Critical accounting policies are those policies most important to the portrayal of our financial condition and results of operations. These policies require our most difficult, subjective or complex judgments, often employing the use of estimates about the effect of matters inherently uncertain. Our most critical accounting policies pertain to revenue recognition, accounts receivable and allowance for doubtful accounts, accounting for business combinations, goodwill and other intangible assets, accrued transportation costs, accounting for management agreement relationships, loss reserves for certain reinsurance and self-funded insurance programs, stock-based compensation and income taxes.
As of June 30, 2012, there has been no change in our accounting policies or the underlying assumptions or methodology used to fairly present our financial position, results of operations and cash flows for the periods covered by this report. In addition, no triggering events have come to our attention pursuant to our review of goodwill and long-lived assets that would indicate impairment of these assets as of June 30, 2012. However, it is possible that a triggering event could occur by December 31, 2012 that would indicate a possible impairment of the intangible assets of one of our operating subsidiaries.
For further discussion of our critical accounting policies see management’s discussion and analysis of financial condition and results of operations contained in our Form 10-K for the year ended December 31, 2011.
Results of operations
Segment reporting. Our financial operating results are organized and reviewed by our chief operating decision maker along our service lines in two reportable segments – Social Services and NET Services. We operate these reportable segments as separate divisions and differentiate the segments based on the nature of the services they offer as more fully described in our Form 10-K for the year ended December 31, 2011.
Overview of trends of our results of operations for YTD 2012
Our Social Services revenues for YTD 2012 as compared to YTD 2011 were favorably impacted by the additional revenue contributed by The ReDCo Group, Inc., or ReDCo, which we acquired in June 2011, continued increases in Medicaid enrollment, our preferred provider status we enjoy in many of our markets, and relatively stable rates overall. Partially offsetting increases in these revenues for YTD 2012 as compared to YTD 2011, was the impact of contract reductions and terminations and reforms such as managed care in certain of our markets where tighter controls over authorizations and referrals are being implemented in response to continuing state budget challenges.
We believe the trend away from the more expensive out of home providers in favor of home and community based delivery systems like ours will continue. In addition, we believe that our effective low cost home and community based service delivery system is becoming more attractive to certain payers that have historically only contracted with not-for-profit social services organizations.
Our NET Services revenue for YTD 2012 as compared to YTD 2011 was favorably impacted by a new contract in Wisconsin effective July 1, 2011, the re-contracting of the Missouri program in November 2011, an expansion of our contracts in New Jersey, Connecticut, South Carolina and Georgia, a new contract in Texas that started in April 2012, phase one of a state administered New York City contract, that started in May 2012, as well as the continued expansion of our California ambulance commercial and managed care lines of business. We incurred additional operating and implementation costs related to these market expansions including staffing, training, travel and communication costs and will continue to incur these implementation costs as we continue to operationalize additional New York City phases through the rest of the year. In addition, we experienced higher utilization in YTD 2012 as compared to YTD 2011 due to the impact of an unusually mild winter in certain of our markets, which resulted in higher transportation costs for YTD 2012. While we expect margins to improve as start-up costs will be lower for the remainder of 2012, utilization may continue to increase throughout 2012, which could unfavorably impact the results of our operations for the year.
Provision for income taxes
Our effective tax rate from continuing operations for YTD 2011 and YTD 2012 was 32.9% and 38.3%, respectively. Our effective tax rate was higher than the United States federal statutory rate of 35.0% for YTD 2012 due primarily to state taxes as well as non-deductible stock option expense. Additionally, our effective tax rate for YTD 2012 was favorably impacted by the final determination of the tax benefits related to certain liabilities assumed as a result of a 2011 acquisition. The tax rate for YTD 2011 was favorably impacted by the gain on bargain purchase, recorded net of deferred taxes of approximately $1.4 million, which was not subject to income taxation.
Seasonality
Our quarterly operating results and operating cash flows normally fluctuate as a result of seasonal variations in our business. In our Social Services operating segment, lower client demand for our home and community based services during the holiday and summer seasons generally results in lower revenue during those periods; however, our expenses related to the Social Services operating segment do not vary significantly with these changes. As a result, our Social Services operating segment experiences lower operating margins during the holiday and summer seasons. Our NET Services operating segment also experiences fluctuations in demand for our non-emergency transportation services during the summer, winter and holiday seasons. Due to higher demand in the summer months and lower demand in the winter and holiday seasons, coupled with a fixed revenue stream based on a per member per month based structure, our NET Services operating segment normally experiences lower operating margins in the summer season and higher operating margins in the winter and holiday seasons.
We expect quarterly fluctuations in operating results and operating cash flows to continue as a result of the seasonal demand for our home and community based services and non-emergency transportation services. As we enter new markets, we could be subject to additional seasonal variations along with any competitive response by other social services and transportation providers.
Liquidity and capital resources
Short-term liquidity requirements consist primarily of recurring operating expenses and debt service requirements. We expect to meet these requirements through available cash, generation of cash from our operating segments, and from our revolving credit facility.
Sources of cash for YTD 2012 were primarily from operations. Our balance of cash and cash equivalents was approximately $43.2 million at December 30, 2011 and $50.2 million at June 30, 2012. Approximately $3.3 million of cash was held by WCG International Ltd. (our foreign wholly-owned subsidiary), or WCG, at June 30, 2012. We had restricted cash of approximately $15.5 million and $14.6 million at December 31, 2011 and June 30, 2012, respectively, related to contractual obligations and activities of our captive insurance subsidiaries and other subsidiaries. At December 31, 2011 and June 30, 2012, our total debt was approximately $150.5 million and $145.5 million, respectively.
Cash flows
Operating activities. Net income of approximately $4.5 million plus net non-cash depreciation, amortization, amortization of deferred financing costs, provision for doubtful accounts, stock-based compensation, deferred income taxes and other items of approximately $11.6 million was partially offset by the growth of our accounts receivable of approximately $9.9 million for YTD 2012. The growth of our accounts receivable during YTD 2012 was primarily attributable to our revenue growth.
The decrease in management fee receivable resulted in additional cash provided by operations of approximately $936,000. A net increase in accounts payable and accrued expenses resulted in cash provided by operating activities of approximately $977,000, while increases in deferred revenue resulted in cash provided by operating activities of approximately $1.7 million. An increase in accrued transportation costs, due to growth of our non-emergency transportation services costs, resulted in cash provided by operating activities of approximately $11.3 million. Reinsurance liability reserves related to our reinsurance programs increased resulting in cash provided by operating activities of approximately $2.9 million. Other long-term liabilities increased since December 31, 2011 due primarily to the cash receipt of approximately $3.3 million from British Columbia related to an arbitral award, however, in the event British Columbia prevails in its arguments during the appeal process, British Columbia will seek immediate repayment of the amount of the arbitral award. Additionally, an increase in other receivables, partially due to a stop loss receivable related to our self-funded health insurance program, resulted in cash used in operating activities of approximately $989,000, while an increase in our prepaid expenses and other assets resulted in cash used in operating activities of approximately $9.2 million. The increase in prepaid expenses and other assets was primarily attributable to an increase in prepaid insurance, as we renewed our insurance contracts during Q2 2012, and estimated tax payments we made during 2012. As a result of the foregoing, net cash flows from operating activities totaled approximately $17.1 million for YTD 2012.
Investing activities. Net cash used in investing activities totaled approximately $5.1 million for YTD 2012. We spent approximately $6.3 million, net, for property and equipment to support the growth of our operations. Changes in restricted cash, primarily related to cash restricted in relation to our auto liability program, resulted in cash provided by investing activities of approximately $980,000.
Financing activities. Net cash used in financing activities totaled approximately $4.9 million for YTD 2012, which resulted primarily from repayments on our term loan.
Exchange rate change. The effect of exchange rate changes on our cash flow related to the activities of WCG for YTD 2012 was a decrease to cash of approximately $84,000.
Obligations and commitments
Convertible senior subordinated notes. On November 13, 2007, we issued the Notes under the amended note purchase agreement dated November 9, 2007 to the purchasers named therein in connection with the acquisition of Charter LCI Corporation, including its subsidiaries, in December 2007, or LogistiCare. The proceeds of $70.0 million were used to partially fund the cash portion of the purchase price paid by us to acquire LogistiCare. The Notes are general unsecured obligations subordinated in right of payment to any existing or future senior debt including our credit facility described below.
We pay interest on the Notes in cash semiannually in arrears on May 15 and November 15 of each year. The Notes will mature on May 15, 2014.
During 2011, we repurchased approximately $20.0 million principal amount of the Notes with cash.
Credit facility. On March 11, 2011, we replaced the then existing credit facility, or Old Credit Facility, with a new credit agreement and paid all amounts due under the Old Credit Facility with cash in the amount of $12.3 million and proceeds from the new credit agreement as discussed in further detail below.
On March 11, 2011, we entered into a new credit agreement, or Credit Agreement, with Bank of America, N.A., as administrative agent, swing line lender and letter of credit issuer, SunTrust Bank, as syndication agent, Bank of Arizona, Alliance Bank of Arizona and Royal Bank of Canada, as co-documentation agents, Merrill Lynch, Pierce, Fenner & Smith Incorporated and SunTrust Robinson Humphrey, Inc., as joint lead arrangers and joint book managers and other lenders party thereto. The Credit Agreement provides us with a senior secured credit facility, or the Senior Credit Facility, in aggregate principal amount of $140.0 million, comprised of a $100.0 million term loan facility and a $40.0 million revolving credit facility. There is an option to increase the amount of the term loan facility and/or the revolving credit facility by an aggregate amount of up to $85.0 million as described below. The Senior Credit Facility includes sublimits for swingline loans and letters of credit in amounts of up to $10.0 million and $25.0 million, respectively. On March 11, 2011, we borrowed the entire amount available under the term loan facility and used the proceeds thereof to refinance the Old Credit Facility. Prospectively, the proceeds of the Senior Credit Facility may be used to (i) fund ongoing working capital requirements; (ii) make capital expenditures; (iii) repay the Notes; and (iv) other general corporate purposes.
Interest on the outstanding principal amount of the loans accrues, at our election, at a per annum rate equal to the London Interbank Offering Rate, or LIBOR, plus an applicable margin or the base rate plus an applicable margin. The applicable margin ranges from 2.25% to 3.00% in the case of LIBOR loans and 1.25% to 2.00% in the case of the base rate loans, in each case, based on our consolidated leverage ratio as defined in the Credit Agreement. The interest rate applied to our term loan at June 30, 2012 was 3.25%. Interest on the loans is payable at least once every three months in arrears. In addition, we are obligated to pay a quarterly commitment fee based on a percentage of the unused portion of each lender’s commitment under the revolving credit facility and quarterly letter of credit fees based on a percentage of the maximum amount available to be drawn under each outstanding letter of credit. The commitment fee and letter of credit fee ranges from 0.35% to 0.50% and 2.25% to 3.00%, respectively, in each case, based on our consolidated leverage ratio.
We are subject to financial covenants, including consolidated net leverage and consolidated net senior leverage covenants as well as a consolidated fixed charge covenant. We were in compliance with all financial covenants as of June 30, 2012.
Borrowings under the revolving credit facility totaled $8.0 million as of June 30, 2012. Additionally, $25 million of the revolving credit facility may be allocated to collateralize certain letters of credit. As of June 30, 2012, there were six letters of credit in the amount of approximately $6.7 million collateralized under the revolving credit facility. At June 30, 2012, our available credit under the revolving credit facility was $25.3 million.
The terms of the Notes and the Credit Agreement are more fully described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the heading entitled “Liquidity and capital resources” included in our Annual Report on Form 10-K for the year ended December 31, 2011.
Contingent obligations. Under The Providence Service Corporation Deferred Compensation Plan, as amended, or Deferred Compensation Plan, eligible employees and independent contractors or a participating employer (as defined in the Deferred Compensation Plan) may defer all or a portion of their base salary, service bonus, performance-based compensation earned in a period of 12 months or more, commissions and, in the case of independent contractors, compensation reportable on Form 1099. The Deferred Compensation Plan is unfunded and benefits are paid from our general assets. As of June 30, 2012, there were seven participants in the Deferred Compensation Plan. We also maintain a 409(A) Deferred Compensation Rabbi Trust Plan for highly compensated employees of our NET Services operating segment. Benefits are paid from our general assets under this plan. As of June 30, 2012, 18 highly compensated employees participated in this plan.
CONF CALL
Alison Ziegler
Thanks (inaudible). Good morning everyone and thank you for joining us this morning for Providence’s conference call and webcast to discuss its financial results for the first quarter ended March 31, 2010. You should have all received a copy of the press release last night. If you would like to be added to our email list please call Devin Rhoades at 212-554-5461 .
Before we begin please note that we have arranged for a replay of this call, the replay will be available approximately one hour after the call’s conclusion and will remain available until May 13. The replay number is 888-286-8010 with the pass code 24914056. This call is also being webcast live with a replay available. To access the webcast go to www.provcorp.com and look under the event calendar on the IR page.
Before we get started I’d like to remind everyone of the Safe Harbor statement included in the press release and that the cautionary statements apply to today’s conference call as well. During the course of this call the company will make projections or other forward-looking statements regarding future events or the company’s beliefs about its financials results for 2010 and beyond.
We wish to caution you that such statements are just predictions and involve risks and uncertainties. Actual results may differ materially. Factors which may affect actual results are detailed in the company’s filings with the SEC including the company’s 10-K. The company’s forecast are dynamic and subject to change. Therefore these forecasts speak only as of the date of this webcast, May 6, 2010. The company may choose from time-to-time to update them and if they do will disseminate the updates to the investing public.
I’d now like to turn the call over to Fletcher McCusker, Chairman and CEO. Go ahead Fletcher.
Fletcher McCusker - Chairman & CEO
Thank you very much Allison and good morning everyone. In Tucson today with me is Craig Norris, our Chief Operating Officer; Michael Deitch, our CFO; and introducing Leamon Crooms, our new Chief Strategy Officer on the line from Atlanta is Herman Schwarz, CEO of LogistiCare and is always we’ll all be available for your questions following our scripted remarks. We are coming of the most amazing quarter we have ever experienced and clearly in a remarkable position as a company when you consider we’ve remained embedded in a recession with many if not all of our state payers still struggling with budget deficits.
Now since the creation of Medicaid has there been the kind of congressional support for America’s indigent that we are collectively witnessing today. The Health Care Reform Legislation will increase Medicaid by 33% bringing the number of enrollees to around 70 million people literally one in every six Americans. Equally as important in the bill are the mandates for states to develop home-based delivery systems something this company pioneered in 1997.
The bill also includes what is called the maintenance of efforts section that requires states to maintain the Medicaid plan at stimulus levels established by the February 2009, Medicaid stimulus legislation. This is called states like Arizona to reverse anticipated reductions to Medicaid eligibility. States remain stymied as well in their attempts to reduce Medicaid rates due to the advocacy group led actions in federal court resulting in a number of co-beneficiary rulings. We are seeing in a new round of litigation is a number of Republican led states have actually sued the federal government over the mandates in the Healthcare Reform bill. This pro-Medicaid spending environment is certainly partisan, but so was the initial legislation adopted in the 60s.
The combined effect of this environment has flattened down our rates, but continues to pump volume as state shift away from the more expensive out-of-home providers even before the class act in the pro-home-based language of the reform bill. There is an earlier doctor provision in the bill and we do expect some states will move to attract federal dollars long before the 2014 start date.
Our news on a couple of other fronts, we did win the arbitration in Canada and British Columbia. The 3 million and change dollars that are recoup there will be returned to us that will not affect our earnings but as good news in terms of our situation in Canada and on LogistiCare front we had a very interesting situation developed in Idaho, where basically our proposal was disqualified when the state of Idaho gave LogistiCare a zero score due to their historical financial section being presented under the name Charter LCI which was the holding company when Charterhouse own LogistiCare before we acquired in, otherwise they would have won that bid, but we are essentially viewed as non-responsive. All this basically to provide a backdrop for you and reviewing are now fifth record quarter in a row benefiting from these trends benefiting from our ability to manage costs and blessed with virtually no turnover of our key personnel. Then Michael will walk you through the particulars in the quarter. Mike?
Michael Deitch - CFO
Thanks, Fletcher. In our first quarter of 2010, revenue totaled almost $221 million which was a record quarter for us, up from $186.7 million for the first quarter of 2009, 19.3% increase. All the increase was from internal organic growth.
For the three months ended March 31, 2010 as compared to the three months ended March 31, 2009, home based revenue grew 5.2%. Foster care revenue declined by 2.4% or about $213,000. The decline is mostly attributable to our Tennessee foster care operations, which is increasing its home-based services as part of its efforts to offsets its reduction in foster care services.
Management fee revenue declined by 8.3% due to renegotiated management services contract since the year ago and an operational restructuring at one of the manage entity. Transportation services revenue grew by 13.5%, primarily due to the New Jersey contract which began in July 2009 and various other new contract wins.
First quarter operating income, which was also a record for us totaled $19.9 million, which was 9% of our revenue. This compares to $15 million and about 8.1% of revenue for the first quarter of last year. First quarter net income also a record totaled $9.1 million, which was 4.1% of our revenue. This compares to almost $5.9 million and 3.1% of revenue for the first quarter of last year.
First quarter diluted earnings per share totaled $0.66 with approximately $14.9 million diluted shares outstanding. This compares to $0.44 and approximately $14.9 million diluted shares outstanding for the first quarter of last year. The diluted earnings per share amounts for Q1 of this year and last year are not readily computed from the income statements.
The computation results from the effect of accounting for our convertible debt under statement of accounting standards codification topic 260 earnings per share. I would like to direct you to footnote number 10 in our Form 10-Q which discloses the details of our earnings per share computations.
The financial results in Q1 include approximately $1.9 million in operational and administrative incentive compensation expense of which $471,000 is recorded in client service expense, $353,000 is recorded in cost for transportation services and $1.1 million is recorded in general and administrative expense. At the end of our first quarter our days sales outstanding was 39 days and management fees day sales outstanding was a 184 days. At the end of our first quarter we had $55.5 million in unrestricted cash. Cash provided by operating activities totaled almost $15.4 million in the quarter, which was a first quarter record for us. As of today we have not needed to draw any funds from our revolving line of credit to find ongoing operations.
With that I’ll turn the call over to Craig Norris, our COO.
Craig Norris - COO
Thank you, Michael. For the quarter our direct client census on the social service side was approximately 62,000 clients which is an increase of over 2,500 clients compared to the same quarter of 2009. In addition we are closed to 7.9 individuals eligible to receive services under our LogistiCare division. This is an increase of approximately 300,000 eligible clients compared to Q1 of 2009.
All clients were being served from 430 local offices in 43 states, the District of Colombia and Canada combined between our owned and managed entities there are over 10,000 employees serving 1,030 government contracts. Overall this was certainly a good quarter for LogistiCare, the social service sides well manage to stay on budget even with the extreme weather disruptions in the east during the month of February primarily affecting the fee-for-service side of our business. We are still hearing the background noise of state budget deficits and states are still dribbling program priorities and funding initiatives, however as Fletcher mentioned the stimulus funding and healthcare reform seems to be contributing to the stability of our systems overall. We are continuing to monitor these challenges that may arise in our states as well as prepared for our continued client demand and enrollment within both segments of the operations.
I’m pleased with how we start 2010, the operations continually stay efficient and we are seeing mostly consistent budget performance and productivity across our regions. Thank you and I’ll turn it over to Herman Schwarz the CEO for LogistiCare.
Herman Schwarz - CEO, LogistiCare
Thanks, Craig and good morning everyone. During the membership growth in many of our programs and the new contracts we’ve added since June 2009 we did anticipate strong first quarter results relative to last year. That being said the actual performance was better than expected due to a favorable variance and transportation expense. Our gross margins percent, which was budgeted to remain basically flat in fact improved by nearly two points in the first quarter.
This improvement can be primarily attributed to the positive impact, the bad weather that Craig alluded to has on our utilization level. Our continued focus on lower cost transportation alternatives as well as a pickup and payroll expenditures. You will recall that the East Coast in particular had several major snowstorms during the quarter, which resulted in significant trip cancellations in many of our markets. Our portion of these trips do ultimately get run in subsequently weeks, those trips associated with the adult day care or mental health services are paramilitary canceled and therefore do not generate in associated expense in the period.
Additionally we have been able to reduce our trip unit cost in several markets by expanding our provider networks, and shifting volume to lower cost options like mass transit. The payroll variances at function of a delayed investment in Human Resources, while we won’t fill all of the rolls budgeted, much of the savings is related to open positions that still need to be filled, in order to ensure our ability to serve our clients effectively.
In spite of the Idaho loss our sales pipeline remains active. We are waiting decisions on statewide RFPs from Nebraska and Iowa, which are both Greenfield opportunities. As well as an eight county region of Minnesota, which is presently managed by our competitor. We continue to grow our presence from managed care programs and are implementing a few smaller contracts were $3 to $5 million during the summer months. In general, I am pleased with our first quarter performance and commend our management teams for their diligent focus on maintaining efficient operations in the face of the increased volume demands.
We remain concerned about budget pressure in certain states and are in discussions with specific clients regarding future program rates. I’d like to now introduced Leamon Crooms to give you a brief update.
Leamon Crooms III - CSO
Thank you, Herman. Let me first start by saying that I am happy to be a part of the team especially on this side of healthcare reform. And during what promises to be an exciting time for problems. My role is to further develop and drive our strategy as we look to capitalize on developing growth opportunities. Areas of opportunity for province exist with the continued focus on our vision; hoping those were most in need by delivering human services with our loss. We view several opportunities are significant for us to delivery the same or very similar services to new payer client segments. And we are working on strategic initiatives in the following areas.
Services to seniors, which is a market that has estimated to grow to just over 100 billion by 2017. DoD/VA, a market that will because of budgetary issues need to continue to shift to more cost effective human service for active military invest. And redirected tension to behavioral health services to address record high suicide rates currently greater than the general population. The fiscal year 2010 budget requested 47.4 billion total for the unified medical budget of the military health system and that budget has grown by approximately 15% per year since fiscal 2000. And of course health care reform which is expected to increase medicate roles by adding 16 million new recipients, deliver mental health parity that will put attention in financial focus on mental and behavioral health services as a part of a total plan of care and boost community health by adding $11 billion over the next 10 years to community health centers and provide another community partner in delivering behavioral health care to 20 million new low income patients.
As we work through our strategic initiative process we will be identifying acting upon opportunities that align with our strategy. To that end, we are currently engaged in number of activities that we expect to yield the results. For example, we are working with each state on a business marketing plan to booster our organic growth and our pull through across service lines. We are identifying and aligning ourselves as industry specialist to increase the effectiveness of our strategic decisions.
We are meeting with and targeting M&A types to help, find the acquisition targets that best reflect our strategy and developing business model. We are working with each state to understand how reform will impact their payers and clients and developing options designed to move us to the best possible position as reform unfolds.
Of course we are continuing to maintain focus on our existing business by supporting organic and acquisitive growth in our core social services and non-emergency transportation businesses as we have always done. And with that I will turn the call back over to Fletcher.
Fletcher McCusker - Chairman & CEO
Thank you very much, as you can see this is a remarkable time for us, if not only survive the 2008 recession for a striving today and in a position to play offence in a market that favors our business model. We expect to grow, we expect to diversify and we in fact may be the company best position to take advantage of health care reform.
We have guided out for the remainder of the year, basically picking up our Q1 earnings anticipating the accrual of our 60%, deep bonus plan and staying on budget for the rest of the year. This guidance assumes no new contract wins, no new acquisitions. And with that Grace Ann we’ll open the line for questions.
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Fund Letters
