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PRSC > SEC Filings for PRSC > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for PROVIDENCE SERVICE CORP

Form 10-Q for PROVIDENCE SERVICE CORP


9-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and accompanying notes for the three and nine months ended September 30, 2011 and 2012 as well as our consolidated financial statements and accompanying notes and management's discussion and analysis of financial condition and results of operations included in our Form 10-K for the year ended December 31, 2011. For purposes of "Management's Discussion and Analysis of Financial Condition and Results of Operations", references to Q3 2012 and Q3 2011 mean the three months ended September 30, 2012 and the three months ended September 30, 2011, respectively. In addition, references to YTD 2012 and YTD 2011 mean the nine months ended September 30, 2012 and the nine months ended September 30, 2011, respectively.

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 United States Supreme Court decision in 2012 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 through 2016 and no less than 90% of the cost permanently.

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.

During Q3 2012, WCG International Ltd. (our Canadian wholly-owned subsidiary), or WCG, experienced a decline in its business due to the impact of a reorganization of the service delivery system in British Columbia as described in further detail below. Under the reorganized service delivery system, WCG faces increased competition for services that we believe could adversely affect our ability to gain new business in this market. These factors resulted in a reduction of the carrying amount of customer relationships in Q3 2012 as discussed more fully below. While the reorganization of the service delivery system in British Columbia presents challenges to our operations there, we believe our business model allows us to make adjustments in all of our markets to help mitigate system reforms that could challenge our overall profit margins.

With respect to our non-emergency transportation management services segment, or NET Services, Q3 2012 consisted of ongoing implementations and start-up investments in multiple locations. These implementations included a region in Georgia that commenced on July 1, 2012, along with continued start-up efforts in the multi-phased implementation under our New York City contract. During Q3 2012, we also implemented an additional state contract in Wisconsin consisting of a managed care population for a six county region around Milwaukee.


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As of September 30, 2012, we provided social services directly to nearly 51,000 clients, and had approximately 14.8 million individuals eligible to receive services under our non-emergency transportation services contracts. We provided services to these clients from nearly 395 locations in 41 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 September 30, 2012, except as discussed below, there has been no change in our accounting policies or the underlying assumptions, estimates or methodology used to fairly present our financial position, results of operations and cash flows for the periods covered by this report.

Accounting for business combinations, goodwill and other intangible assets

When we consummate an acquisition we separately value all acquired identifiable intangible assets apart from goodwill in accordance with Accounting Standards Codification, or ASC, Topic 805-Business Combinations. We analyze the carrying value of goodwill at the end of each fiscal year. We analyze the carrying value of goodwill at the end of each fiscal year and between annual valuations if events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying value. Such circumstances could include, but are not limited to: (1) a significant adverse change in legal factors or in the climate of our business, (2) unanticipated competition, or
(3) an adverse action or assessment by a regulator. When determining whether goodwill is impaired, we compare the fair value of each reporting unit with its carrying value, including goodwill. If the carrying amount of a reporting unit exceeds its fair value, there is an indication of impairment. If an indication of impairment is identified, the impairment loss, if any, is measured by comparing the implied fair value of the reporting unit's goodwill with its carrying value. In calculating the implied fair value of the reporting unit goodwill, the fair value of the reporting unit is allocated to all of the other assets and liabilities of that unit based on their fair values. The excess of the fair value of a reporting unit over the amount assigned to its other identifiable assets and liabilities is the implied fair value of goodwill. An impairment loss would be recognized when the carrying value of goodwill exceeds its implied fair value. Our evaluation of goodwill completed as of December 31, 2011 resulted in no impairment losses.

Given a recent reorganization of the service delivery system in British Columbia, Canada, we evaluated whether events, referred to as triggering events, had occurred during Q3 2012 and YTD 2012 that would require us to perform an interim period goodwill impairment test in accordance with ASC Topic 350-Intangibles-Goodwill and Other, or ASC 350. During YTD 2012, the impact of changes in the above mentioned service delivery system resulted in, among other things, the expiration of all contracts for services under this system. The service delivery system reorganization commenced in the latter part of the


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first quarter of 2012 (in accordance with the time line the payer set forth) when the payer put up for bid new contracts that combined federal and provincial funding streams and services which were previously contracted separately. Due primarily to an increased level of competition (including over 400 bidders for 60 awards) and a decrease in the number of services funded in this market, WCG was unable to regain the level of business it enjoyed prior to the reorganization of the service delivery system. The impact of this system reorganization was not fully realized until the conclusion of the transition to the new system in Q3 2012 and contributed to a decrease in the financial results of operations of WCG for Q3 2012 and YTD 2012. We determined that these factors were indicators that an interim goodwill impairment test was required under ASC
350. As a result, we estimated the fair value of the goodwill we acquired in connection with our acquisition of WCG based on the weighted-average of a market-based valuation approach and income-based valuation approach at September 30, 2012. We determined that goodwill related to WCG was not impaired.

As of September 30, 2012, the amount of goodwill allocated to WCG was approximately $2.4 million. Based on the results of our interim asset impairment test completed as of September 30, 2012, we determined that, although our goodwill related to WCG was not impaired, the percentage by which the fair value of WCG exceeded the carrying value of its total assets was approximately 2.2%. The assumptions used to estimate fair value were based on estimates of future revenue and expenses incorporated in our current operating plans, growth rates and discounts rates, our interpretation of current economic indicators and market valuations. Significant assumptions and estimates included in our current operating plans were associated with revenue growth, profitability, and related cash flows. The discount rate used to estimate fair value was risk adjusted in consideration of the economic condition of WCG. We also considered assumptions that market participants may use. In light of the nominal excess of fair value over current carrying values, management cannot guarantee that impairments of goodwill will not occur in future periods.

With respect to our intangible assets other than goodwill, we recorded a non-cash charge of approximately $2.5 million for Q3 2012 to reduce the carrying value of customer relationships acquired in connection with our acquisition of WCG based on their revised estimated fair values. Our analysis to determine the amount of this impairment charge was based upon a projected discounted cash flow basis. We anticipate finalizing our intangible asset impairment analysis in the fourth quarter of 2012.

The non-cash charge for the intangible asset impairment did not impact our cash balance, debt covenant compliance or ongoing financial performance.

Changes in assumptions or circumstances could result in an additional impairment in the period in which the change occurs and in future years. Factors which could cause impairment of WCG's goodwill and further impairment of other intangible assets include, but are not limited to, further declines in our operating activities in British Columbia due to increased competition and additional changes to the service delivery system that affect funding levels and services to be provided. As of December 31, 2011, the fair values of our other reporting units were in excess of their carrying values. No triggering events or circumstances have occurred since December 31, 2011 through the date of the filing of this report that would have caused the fair values of our other reporting units to be below their carrying values.

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.


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Consolidated Results. The following table sets forth the percentage of consolidated total revenues represented by items in our unaudited condensed consolidated statements of income for the periods presented:

                                                     Three months ended             Nine months ended
                                                       September 30,                  September 30,
                                                    2011            2012           2011           2012
Revenues:
Home and community based services                      33.0 %         25.8 %          33.8 %        28.7 %
Foster care services                                    3.6            3.0             3.7           3.1
Management fees                                         1.4            1.2             1.4           1.1
Non-emergency transportation services                  62.0           70.0            61.1          67.1

Total revenues                                        100.0          100.0           100.0         100.0

Operating expenses:
Client service expense                                 32.3           26.2            32.4          28.1
Cost of non-emergency transportation services          58.4           65.4            56.7          63.6
General and administrative expense                      5.4            4.3             5.3           4.7
Asset impairment charge                                  -             0.9              -            0.3
Depreciation and amortization                           1.4            1.4             1.4           1.4

Total operating expenses                               97.5           98.2            95.8          98.1


Operating income                                        2.5            1.8             4.2           1.9

Non-operating expense:
Interest expense (income), net                          0.9            0.7             1.1           0.7
Loss on extinguishment of debt                           -              -              0.4            -
Gain on bargain purchase                                 -              -             (0.4 )          -

Income before income taxes                              1.6            1.1             3.1           1.2
Provision for income taxes                              0.8            0.7             1.1           0.5

Net income                                              0.8 %          0.4 %           2.0 %         0.7 %

Overview of trends of our results of operations for YTD 2012

Our Social Services revenues for YTD 2012 as compared to YTD 2011 were unfavorably impacted by contract amount 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. In addition, revenue from our Canadian operations declined from YTD 2011 to YTD 2012 due to the impact of a reorganization of the service delivery system in British Columbia and increased competition in this market as described above. Increased competition in this market could unfavorably impact our ability to generate the level of revenue enjoyed by WCG prior to this reorganization. Partially offsetting decreases in these revenues for YTD 2012 as compared to YTD 2011, was 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.

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 the expansion of current business in our New Jersey, Connecticut, Georgia and South Carolina markets, the reinstatement of our contract with the State of Missouri as well as the continued expansion of our California ambulance commercial and managed care lines of business. Revenue for YTD 2012 also reflects new contracts in New York and Texas, as well as the initial Wisconsin contract implemented in


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July 2011 and an additional expansion contract in that state which commenced on September 1, 2012. We incurred additional operating and implementation costs related to these market expansions and new contracts including staffing, training, travel and outreach communication material costs. 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 and the sustained high level of gas prices across the country. These factors resulted in higher transportation costs both in absolute dollars and as a percentage of revenue for YTD 2012. While we believe that increased utilization will continue to be a factor which could impact the results of our operations for 2012, we expect continued positive revenue impact from new contracts implemented in 2012. In addition, we continue to focus on optimizing our operating income.

Q3 2012 compared to Q3 2011

Revenues

                                                Three Months Ended
                                                   September 30,               Percent
                                              2011              2012           change
  Home and community based services       $  77,679,065     $  72,258,697          -7.0 %
  Foster care services                        8,598,022         8,394,474          -2.4 %
  Management fees                             3,228,629         3,296,939           2.1 %
  Non-emergency transportation services     146,046,427       196,335,247          34.4 %


  Total revenues                          $ 235,552,143     $ 280,285,357          19.0 %

Home and community based services. Contract terminations in Michigan, Virginia and Canada led to a decrease in home and community based services revenue for Q3 2012 as compared to Q3 2011. The decrease in revenue was partially offset by increased census in certain other locations and the impact of new programs being implemented in various markets.

Foster care services. Our foster care services revenue decreased from Q3 2011 to Q3 2012 primarily as a result of a new per diem rate structure implemented in Indiana in January 2012, which reduced payments for foster care services in that state. This decrease, however, was partially offset by increased foster care services provided in Tennessee as we continue to build our foster care program in that state.

Management fees. Fees for management services provided to certain not-for-profit organizations under management services agreements remained relatively constant for Q3 2012 as compared to Q3 2011.

Non-emergency transportation services. The increase in NET Services revenue was favorably impacted by the following:

re-contracting of the Missouri program in November 2011;

expansion of our regional Connecticut contract to a statewide contract;

re-award of the two additional South Carolina regions;

the award of two additional regions in Georgia;

a new contract in Texas starting in April 2012;

multiple phases of a state administered New York City contract which began in May 2012;

implementation of a Wisconsin contract effective September 1, 2012; and

continued expansion of our California ambulance commercial and managed care lines of business.

A significant portion of this revenue was generated under capitated contracts where we assumed the responsibility of meeting the transportation needs of beneficiaries residing in a specific geographic region. Due to the fixed revenue stream and variable expense structure of our NET Services operating segment, expenses related to this segment vary with seasonal fluctuations. We expect our operating results will continuously fluctuate on a quarterly basis.


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Operating expenses

Client service expense. Client service expense included the following for Q3 2011 and Q3 2012:

                                            Three months ended
                                               September 30,             Percent
                                           2011             2012          change
        Payroll and related costs      $ 55,332,738     $ 55,030,288         -0.5 %
        Purchased services                8,275,800        5,951,092        -28.1 %
        Other operating expenses         12,145,044       12,260,256          0.9 %
        Stock compensation                  216,639          219,953          1.5 %

        Total client service expense   $ 75,970,221     $ 73,461,589         -3.3 %

Payroll and related costs. Our payroll and related costs decreased from Q3 2011 to Q3 2012 due to a net decrease in payroll in Michigan, Virginia and Canada in the amount of approximately $1.5 million primarily as a result of contract terminations in these markets. Partially offsetting this decrease in payroll and related costs was an increase in healthcare claims activity under our self-funded employee health plan, which resulted in increased expense of approximately $1.0 million for Q3 2012 as compared to Q3 2011. As a percentage of revenue, excluding NET Services revenue, payroll and related costs increased from 61.8% for Q3 2011 to 65.6% for Q3 2012 primarily due to the impact of increased healthcare claims activity under our self-funded employee health plan.

Purchased services. We subcontract with a network of providers for a portion of the workforce development services we provide throughout British Columbia. In addition, we incur a variety of other support service expenses in the normal course of business including foster parent payments, pharmacy payments and out-of-home placements. Included in Q3 2012 were decreased costs resulting from contract terminations in Canada of approximately $1.7 million, other support services of approximately $437,000 and foster parent payments of approximately $225,000, as compared to Q3 2011. Purchased services, as a percentage of revenue, excluding NET Services revenue, decreased from 9.2% for Q3 2011 to 7.1% for Q3 2012 due to the impact of decreased workforce development costs in Canada relative to the level of revenue from this market.

Other operating expenses. Other operating expenses increased by approximately $1.1 million for Q3 2012 as compared to Q3 2011 due to a change in estimated expense from period to period related to our wholly-owned captive insurance subsidiary for workers compensation and general and professional liability claims incurred but not reported as determined by actuarial analysis. The increase in other operating expenses for Q3 2012 relative to Q3 2011 was partially offset by decreased costs associated with our operations in Michigan, Virginia and Canada due to contract terminations in these markets. Other operating expenses, as a percentage of revenue excluding NET Services revenue, increased from 13.6% for Q3 2011 to 14.6% for Q3 2012 primarily due to the change in estimated expense for workers compensation and general and professional liability claims incurred but not reported.

Stock compensation. Stock compensation expense primarily consisted of approximately $195,000 and $200,000 for Q3 2011 and Q3 2012, respectively, which represents the amortization of the fair value of stock options and restricted stock awarded to key employees since January 1, 2009 under our 2006 Long-Term Incentive Plan, or 2006 Plan.


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Cost of non-emergency transportation services.

                                               Three months ended September 30,           Percent
                                                  2011                   2012             Change
Payroll and related costs                   $      14,707,091        $  20,241,337            37.6 %
Purchased services                                116,866,737          155,674,906            33.2 %
Other operating expenses                            5,696,523            6,967,123            22.3 %
Stock compensation                                    280,592              365,076            30.1 %

Total cost of non-emergency
transportation services                     $     137,550,943        $ 183,248,442            33.2 %

Payroll and related costs. The increase in payroll and related costs of our NET Services operating segment for Q3 2012 as compared to Q3 2011 was due to additional staff hired for new contracts and contract expansions in New Jersey, Georgia, Connecticut, Texas and New York, along with additional staffing needed for expansion of the California ambulance commercial and managed care lines of business. In addition, we re-entered the State of Missouri on October 31, 2011 and expanded in South Carolina in February 2012. We continue to provide implementation efforts for the additional phases set to commence in New York for the remainder of the year, as well as additional managed care organization implementations. Payroll and related costs, as a percentage of NET Services revenue, increased from 10.1% for Q3 2011 to 10.3% for Q3 2012 as we have added additional call center staff to ensure our compliance with the more demanding service authorization process and intake response time requirements of some of our new contracts.

Purchased services. Through our NET Services operating segment we subcontract with third party transportation providers to provide non-emergency transportation services to our clients. Since Q3 2011, we have added numerous . . .

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