ModivCare Inc (MODV) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third-quarter 2006 Providence Service Corporation earnings conference call. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to Ms. Alison Ziegler, with Cameron Associates. Please proceed.

Thank you. Good morning, everyone, and thank you for joining us this morning for Providence's conference call and webcast for it financial results for the third quarter ended September 30, 2006. You should have all received a copy of the press release last night. If you did not, please call Devin Rhoades at Cameron Associates at 212-554-5461; she will [fill] one out and confirm your name on our email list.

Before we begin, please note that we have arranged for a taped replay of this call which may be accessed by telephone. This replay will be available approximately one hour after the call's conclusion and will remain available until November 16. The replay number is 888-286-8010 with the pass code 12379026. The call is also being webcast live with a replay available; to access the webcast, go to www.provcorp.com. If you are having problems on the website, alternatively you can go www.earnings.com; and the call should be there as well.

Before we get started, I would like to remind everyone of the Safe Harbor statement included in the press release and that the cautionary statements apply to today's call 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 revenue and earnings for 2006 and 2007. 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. The Company's forecasts are dynamic and subject to change; therefore, these forecasts speak only as of the date of this webcast, November 9, 2006. The Company may choose from time to time to update them; and if they do, we will disseminate the updates to the investing public.

I would now like to turn the call over to Fletcher McCusker, Chairman and CEO. Fletcher?

Alison, thank you very much. I have the rare treat of being across the table from Alison. I am actually in New York attending the SunTrust Robinson Humphrey conference where we will present today at 1:30 New York time. I believe that is also a webcast presentation. In Tucson are Michael Deitch, our CFO, and Craig Norris, our COO. As always, all three of us will be available after the call to take your questions.

Clearly, this has been a very eventful quarter for us, with the announcement of the North Carolina new business; and one of our most urgent ramp-ups in that regard, the Texas bid, being placed on hold a few weeks ago; a large Florida contract being noticed and then subsequently reinstated.

Record revenue of over $47 million. Very strong organic growth, positive $6 million plus of cash flow. In addition to that, all of our contracts for renewal July 1 have been renewed. With the reinstatement of the Camelot contract where we help manage that in Fort Myers, Florida, our 100% contractual renewal rate remains intact.

You should note in the press release that our contracts have gone up now to 640 government contracts. That is up about 40 contracts sequentially. Obviously, there is a lot going on. Some of those are small awards, some of those are multi-million dollar awards in places like Arizona, and New Jersey, and North Carolina. We will talk some more about that here in a minute.

With the Texas election now over and the Republican incumbent squarely in charge, we would hope the state would focus on the outstanding bid there. We are on our way to Texas to do what we can to help in that regard. We have a number of scenarios that we will talk about today that could play out regarding that Texas situation.

Overall, the outlook is good. Clearly, this is a dramatic miss for us, the first miss that I would identify as material in 13 quarters.

Most of that is not operating issues for us. If you look at the things that drive our business in terms of census growth, organic growth, contracts, contract renewals, new states, new awards, you know, we feel very good about the outlook for our Company both in the short term and in the long term.

You will note that in this quarter, we deferred approximately $1 million of revenue, which I think speaks to how we view revenue recognition seriously in our Company. There are a number of things that give rise to how we can recognize or not recognize revenue.

This is our contract renewal period for us. With the volume of the contracts that we renew, it is not unlikely that some of those contracts don't get completed; signatures don't get obtained; amendments are missing; new rate increases don't come through; in some situations maybe we have even been paid and have the cash, but maybe don't have an amendment or a signature or a renewal in a contract. In those situations, we defer that revenue.

If we can resolve those issues in the next quarter, obviously that benefits us. If you cannot resolve the issue of the contract to our and our external auditors' satisfaction, then that deferred revenue would be treated ratably over the contract period. So that is a big piece of what is going on with us in this quarter.

Again, cash is very positive. Census is up 32%. Our management fee DSOs have come down dramatically. Our field expense you'll notice is about 3 points higher than historical trends, which is the result to a large extent of the revenue referral. And then some of the startups we will talk about, and then a couple of aggravating operational issues in some of our smaller locations in DC, which we have talked about.

So with that, Michael, I think it would be appropriate for you to go through the details. Then, I will come back on after you hear from Craig and talk about guidance; and then we will take your questions. So Michael, go ahead.

Thanks, Fletcher, and good morning, everyone. In our third quarter of 2006, revenue totaled $47 million, up from $37.3 million for the third quarter of 2005, a 26% increase. 14% of this increase was from organic growth. 12% of the increase was from companies we acquired in Kentucky, Tennessee, Missouri, Michigan, North Carolina, and Pennsylvania since the third quarter of 2005.

For the three months ended September 30, 2006, as compared to the three months ended September 30, 2005, home-based revenue grew 29%. We grew 17% organically and 12% from acquisitions.

Cost of care revenue grew 33%; 32% organically and 1% from acquisitions. Management fee revenue experienced a net decrease of approximately $212,000, primarily because we no longer pass-through health insurance costs to our not-for-profit managed entities nor record the related revenue.

Our third quarter operating income totaled almost $4.3 million which was 9.1% of our revenue. This compares with $4.6 million and 12.4% of revenue for the third quarter of last year. Third-quarter net income totaled $2.7 million, which was 5.8% of our revenue. This compares with almost $2.6 million and 6.9% of revenue for the third quarter of last year.

Third-quarter diluted earnings per share totaled $0.22, or nearly 12.3 million diluted shares outstanding, compared with $0.26 for the third quarter of last year, on approximately 10 million diluted shares outstanding at that time.

At the end of our third quarter, our Days Sales Outstanding from home- and community-based services and foster care services was 89 days, up from 80 days at the end of our second quarter of this year. We're still experiencing isolated payer remittance slowdowns, principally in Arizona, Maine, Nevada, and North Carolina.

Our management team in conjunction with our field operator is working diligently to reduce our Days Sales Outstanding by year-end. We have had some early success in these efforts in Q4, especially in Washington D.C., where we have just received a payment from the District for approximately $500,000 for receivables dating back to 2005. I expect to see our home-based and foster care services DSO between 75 and 80 days as of December 31.

During our third quarter, we have made great progress in reducing our management fee Days Sales Outstanding. Management fee DSO was 148 days at September 30, 2006, down from 174 days at June 30, 2006, and well under our 180-day target.

During our third quarter, we experienced a decrease in general and administrative expense of approximately $576,000 from the second quarter of this year. This decrease resulted from excluding the not-for-profit entities from our health insurance plan, as previously mentioned, and also from a decrease in expense resulting from favorable experience in our professional liability self-insurance program.

For the third quarter, general and administrative expense totaled 11.6% of our revenue. This compares with 12.5% year-to-date and 11.7% in the third quarter of last year.

During the third quarter, we generated almost $6.1 million in cash provided by operations, reversing our negative second-quarter experience. In the fourth quarter, I expect continued positive cash flow from operations. At the end of our third quarter, we had $40 million in cash and about $1 million of debt, all related to acquisitions.

With that, I will turn the call over to Craig Norris, our Chief Operating Officer.

Thanks, Michael. For the quarter, we ended with a total combined census between our own and managed entities of 45,089 clients. These clients are being served from 254 local offices in 34 states and the District of Columbia. Compared to Q3 of 2005, this represents a total census increase of 10,887 clients. We have added 50 new local offices in the same period.

Combined between our owned and managed entities, we have over 6,300 employees serving 641 government contracts. This represents an increase of 136 contracts as compared to Q3 of 2005.

During this quarter, we've completed our transition of the Ross acquisition, which has operations in Michigan, West Virginia, Pennsylvania, and New York. We have successfully transitioned over 200 employees and integrated this operation into our northeastern regional back office in Pennsylvania.

We have also recently announced the acquisition of the MAXIMUS correctional unit introducing private probation services into our service mix. We're presently transitioning this new operation into our southeastern region.

Our New Jersey foster care startups have seen delays due to licensing and regulatory processes. We are continuing to work through these issues. Most of this is standard provider credentialing procedures and foster care parent licensing delays that have taken longer than we have anticipated.

We also continued to hang in there with our DC operations. During this past summer, the Department of Mental Health has once again changed leadership, and we are hopeful that systemic improvements will be occurring in this environment. It is a positive first step, as Michael has said, that we received our final payment for 2005 services.

The Family Based Strategies acquisition we completed in February has seen a number of challenges operationally and has not met our expectations. We're making necessary programmatic changes to improve these operations.

Collectively, these three areas of operations account for approximately $263,000 of after-tax shortfall from budget expectations.

Lastly, in Q3 we began preparations and negotiations for the assignment and transition of over 4,000 consumers in a privatization project in Western North Carolina. We will be providing community-based mental health services to adults and children in a six-county region while employing approximately 180 staff. We will continue to ramp up and prepare for these operations in Q4.

Lastly, I would just like to say relative to this privatization project in Western North Carolina, it has been an extraordinary effort in a very short period of time. The state came to us with an urgent need, and we were able to ramp up our leadership team and our systems. This has met a tremendous need in that state, and it is going over very well. I look forward to the 2007 operation in this area.

Thank you, and I will turn it back to Fletcher.

Craig, Michael, thank you very much. You can kind of get a sense from them in terms of what is going on with us -- good, bad, and ugly, and the challenges we have in guiding you to Q4 and certainly to 2007.

In context, what you are not hearing is any rate pressure on any of our contracts; any renewal pressure on any of our agreements; any decline in census, organic growth; any decline in new opportunities. You are seeing some opportunities of scale, which we have not historically seen in our space, in places like California, North Carolina, Pennsylvania, and Texas.

You know, we clearly have a short-term issue in terms of how we have deferred revenue. We do not see the operational issues that Craig described as significant enough to deter any of those issues that we have discussed in 2007.

As it relates to Q4 guidance, what we have tried to provide to you is a range of possibilities that a number of things factor into. To the extent we can resolve any open issues with any of this deferred revenue, that is possible you could see that in Q4. If not, that will again be treated ratably over the contract year.

We have, as Craig mentioned, a significant investment spending commitment in North Carolina. We have talked about that in conjunction with the press release for that business. That could be $0.03 or $0.04 in Q4. But again, acquiring $10 million or plus business for 2007. Again, this was sole-sourced to us. This was not a competitive procurement. We believe there is significant upside given our ability to be successful and to respond in such a timely manner in North Carolina.

The investment spending in Arizona, you'll see in 2007 revenue. The investment spending in New Jersey, you'll see, as Craig suggested, those delays take care of themselves; and you will see that in 2007.

As it relates to Texas and part of the reason we have guided to a range in Q4, we have spent about $70,000 in Q3 in maintaining that Texas bid. We are prepared to spend significantly more than that in terms of time, energy, and money now that the election is over.

Conceivably, we could spend as much as we are spending in North Carolina in Texas, in preparation to help the state make that bid award decision -- in terms of staff time, my time, Craig's time, people from our Florida projects visiting with Texas policymakers to introduce them to the Company and our success in Florida. But also in addition to that, attorney assistance, lobby assistance, public relations assistance. We are pledging to you to commit that we are now going to go all-out for that Texas project, particularly given the successful incumbency in the recent Texas election. So if the governor were to announce that award tomorrow, then obviously we would avoid a lot of those expenses.

So at this point, there's a number of things that could factor into our Q4 performance ranging from significant expenses in North Carolina and Texas; and some ongoing startup in New Jersey, Arizona; and you could see some pickup of revenue, which would obviously be positive to the quarter.

So what we have tried to do is capture that for you in a range. We typically do not guide to a range. Our guidance has historically been very precise, and it usually is the result of our budgeted experience. This is the first time we have really created a wide spread of opportunities in Q4, which translate into our yearly guidance as well.

We have captured for you kind of our current thinking regarding 2007 revenue. We have got good visibility in that, which is a significant growth spurt for us over 2006. That is comprised kind of chiefly of our current base; plus the benefit of the MAXIMUS acquisition, which puts us at about a $200 million run rate. You add to that the $14 million or so of California wins; the $10 million of North Carolina win; $2 million of additional money in Arizona; $2 million of additional money in New Jersey. You can see that we have kind of already got in place Street expectations regarding our revenue for 2007.

That would not include any contracts that come to us in July of '07, or cost of living or rate increases we might enjoy, nor any contracts that we have not yet announced. Nor does it contemplate anything in Texas. So that is one of the reasons we are holding off on finalizing '07 guidance.

I think you all know that we generate our budget, as Craig said, by 250 locations. Those will begin to cycle through our Board in our November meeting. Then once those budgets are finalized, we can also guide you to earnings per share guidance for '07.

So those will remain probably [proposed] in a range. As we know more about what is going on with those activities, you will see an update from us. Again we can update everybody in Q4. So with that, I think we are prepared to answer questions.

(OPERATOR INSTRUCTIONS) Bob Labick with CJS Securities.

First question, you touched on this. I was hoping you could maybe just clarify a little bit. The impact in the quarter which you gave us of $263,000 shortfall from New Jersey, DC, and the FBS in North Carolina, you're anticipating that that has been resolved by year end; but there is still some impact in the fourth quarter for expenses for those? Is that accurate or how are you viewing that into Q4 and going into next year?

Craig, go ahead and take that.

Yes, I don't know. I think it is probably going to be early in '07, Bob, before we have a resolution to some of the New Jersey regulatory-type processes.

We have been told by the new leadership within the District of Columbia at the Department of Mental Health that they are making some changes to their delivery system. This is kind of a -- we have heard this before. But we are confident that he is making some positive changes, but we don't think that will happen till early in '07.

The FBS acquisition, again, the same type of thing. I think it is early '07. We are making some systemic changes with how we provide services, our productivity for staff, increased our efficiencies with staff, modeling that business more like our rest of our North Carolina operation. So I think, realistically, it is still going to be early in '07 to get these things stable.

Okay, that's very helpful. Switching gears to CPSA contract and other receivables, you mentioned you think you should get DSOs down materially in Q4, which would be terrific, obviously. Can you discuss the progress with CPSA? Was it looked at by your auditors during this quarter? And the likelihood of collecting those receivables?

Bob, it is reviewed every quarter, you know, by both our internal team, SOX team, and external auditors. That contract provides that that entity has 180 days post the end of the contract to true up to us. So that would be the end of the calendar year.

Arizona has yet to complete its reconciliation of enrollees with federal Medicaid, and that is what drives the whole process. I think we have talked a little bit about this before. But what is happening in Arizona is extraordinary in terms of population growth. But also in terms of the in-migration of indigent population. It is anticipated that that number in Arizona will double in the next 10 years.

So what happens between states like Arizona and Nevada and federal Medicaid, is that at the beginning of the year, you project your number of enrollees; and then to the extent that that was below that, the state may owe the federal government money back. To the extent that that was under what your actual enrollees are, the federal government will owe the state money. That is passed through to them on an enrolled member basis.

So Arizona has had dramatic increases in the year over what it projected a year ago. So that money trickled down from federal Medicaid, to the state of Arizona, to the regional behavioral health authority, and ultimately to us.

Now, that has to be resolved -- right, Michael? -- one way or the other by our year-end. Because Bob, those accounts would age to a point where we would automatically reserve them, whether collected or not, if they age beyond 365 days. So, that has to be collected, resolved, or reserved in Q4.

Let me add to that. We would reserve it normally unless we had some documentation from the payer, specific documentation that payment was forthcoming. Under those circumstances we may not reserve it.

So the timing of that, as we understand that, is we should hear something from federal Medicaid in November; and then that will give the state a better indication of how that trickles down to the regional entities; and ultimately reconciled with us.

So the auditors do look at that. Of course, one of the things in terms of looking at those receivables and anything that we look at in terms of deferral, is the probability of its collection. Unless you can determine that that is improbable, then the revenue will stay on our books until we either collect it, or it becomes probable that we're not going to collect.

Great, very helpful. My last question and I will get back in queue. Can you discuss -- ? I know this quarter was back-to-school versus the summer. So for A to Z and your other tutoring-related operations, how has the enrollment been for them? What is the progress? What is the outlook there?

We can talk a little bit about that. It is a subsequent event, but so topical I think we can kind of talk about generally what we see there.

We have about 1,000 kids, Bob, enrolled in that program today, with a number as great as that as current referrals. That is a fourth-quarter, first-quarter seasonal business. So you know, we enjoy none of that A to Z activity in Q3. So part of our revenue going from 47 or $48 million to $50 million in Q4 is in recognition of the A to Z seasonality.

We are still very early in that program. There's still a lot of execution challenges and meeting the demands that are placed on us for tutors and schools that need tutors.

The one statistic that you may not know is at the end of the summer, there were 6,000 American schools failing the No Child Left Behind Act. At the beginning of the fall term, there are now 9,000 schools in America that fail to meet those standards. So that is the genesis of this business, and for the most part, it is an unmet need by every other provider in the space.

Our biggest challenge has been to identify tutors, connect them to tutoring referrals, so that we can maximize the demand that is placed on that business. We have chosen to do that in states where we had a geographic presence in our social services product, as opposed to just isolate a tutorial business with A to Z. So you will see some seasonal uptick in 4 and 1 as a result of A to Z's ramp-up.

Great, thank you very much. Good luck in Texas, and I will get back in queue.

Patrick Swindle with Avondale Partners.

In looking at the contracts that require you to defer revenue during the third quarter, do you expect to be able to resolve the issues, get the appropriate signatures, etc., so that that will not impact the fourth quarter? Or do you assume some revenues will also have to be deferred during the fourth quarter as well within your guidance?

We should not have any additional deferrals. We may not have resolution to the deferrals that we have identified in 3, but that is consistent with the timing in which we renew contracts. And now, as Craig said, with 640 contracts, most of them were renewed July 1. 40 new contracts.

You're talking about a handful of agreements, Patrick, where there may be not enough documentation to allow that revenue to be recognized. Now, it is a delicate issue between us and payers when you identify things like this. Because for the most part, our 640 contracts don't have a lot of language negotiability in them.

We typically don't push back on a payer contract, so if their standard contract is absent some language that a public company needs to recognize revenue; and we go back and say, gee, we need you to do this, or change this, or amend this, or provide us with this -- sometimes that doesn't go over very well.

So that is part of the give and take process that we have being a public company, operating in what has historically been a very nonchalant kind of private environment, where sometimes providers will operate for a year without a contract. But as long as they are getting paid, they don't worry about the revenue recognition issue in the same manner that we would.

So, we will deal with those payers. We will try and educate them about what our specific challenges are. If we cannot resolve it in the short term, then we don't lose the revenue; it will be deferred ratably over the contract period.

Okay. So to clarify, in the fourth quarter specifically, you have not assumed that any additional revenue will have to be deferred; but you would not expect that because it is not consistent with the beginning of a contract period?

Yes, it would have to be an agreement, a new agreement, or something that comes to us -- or something in North Carolina that doesn't rise to revenue recognition standards. But of those 640 contracts, we have cycled all of them now and either have them renewed; you have identified the rate increase; you have the specific period, the determinable price, all the kinds of things that give rise to recognition. And some of those, obviously, we don't, but it should not be an ongoing quarter in, quarter out phenomenon.

Right, so the key drivers behind the variability in the guidance, the reason for the range is some uncertainty regarding the absolute level of startup cost in North Carolina; and then uncertainty regarding how much it's going to cost down in Texas during the fourth quarter.

Yes, I think that is on the expense side. Then we cannot predict for you accurately whether or not you do get the benefit of any of this deferred revenue back the other way. So we have kind of given a low-end range, and a range typical to what our prior guidance was assuming that you resolve those things. We would expect to obviously come in someplace between those two numbers.

A big piece of that on the expense side of course is, as we discussed, is going to be Texas investment spending.

Do you have any sense yet on what potential timing could be for an award? Or is it still very much up in the air, I assume, given the political environment?

We don't know anything officially, Patrick. There are a couple of scenarios that could play out now, post-election. Clearly, the Republican governor has retained his office. It is one of the few states, in fact, that has had a Republican governor, a Republican Legislature. To the extent these issues were partisan, they could resolve them very quickly now by dismissing any partisan politics and getting on with the award.

There obviously is some peace that has to be made there between the anti-privatization forces and the pro-privatization forces that are diplomatic, if not legislative, which, you know, the Governor and his staff may be inclined to resolve.

If none of that seems palatable to anybody, then they always have the option of deferring all this back to the legislative session. Texas is a two-year, every two-year Legislature, and that would convene in January. January 4. So, that is one possible scenario is that if the executive branch believes there is any significant misgivings about the overall privatization program, then they could defer the whole thing back to the Legislature.

So those are the kind of scenarios that could happen. We just want to be available in that state to make sure that our Company is fairly and properly presented in terms of the resources we bring to Texas, and the experience and success we have had in Florida and other states that have already gone through this. So that is our intent in terms of time and energy in Texas with not an entirely predictable outcome.

Okay, that's helpful. Last question, on North Carolina, should we expect startup costs will extend into the first quarter of next year?

Craig, will you be up and running by January 1, or will you still have some stuff you got to do in Q1?

It is hard to say. I suspect we will have a little bit, Patrick. This is a huge client population we are taking on. We are actively recruiting staff, trying to fill positions, setting up systems. So we are going to press to get all this in place, but it could dribble into '07 for a little bit.

Okay. Then could you define what the aggregate revenue opportunity that you all see in North Carolina ultimately may be, for Providence specifically?

30 to $50 million. Is that a safe range, Craig?

I think that is safe.

Over what period of time do you get there?

You would expect to see that over multiple years, given just the nature of the obligation the privatized provider has to prove up their model, demonstrate to the Legislature that these are successful programs, that they are economically good for the state. Normally that requires some interaction with the Legislature.

So we view this as the prototypical project, that if it is successful, then in the next couple legislative sessions you would expect to enjoy growth in that business. So, we wouldn't think we would see that in '07. But if we are successful in '07, you would see that in '08 and '09 and etc.

It is possible, given the demand in North Carolina, that if we are successful in the short term, we could see additional business in '07.

Thank you very much.

Mark Hughes with SunTrust.

How much revenue have you deferred in the past in this way? I guess I would ask -- why were you willing to accept the incomplete contract, etc., in this case, perhaps anticipating that you might have to defer some of that revenue?

It is not a matter of accepting the contract. It is just a matter of getting all the work done and not offending the payer by pushing too hard when you are playing in their sandbox. Michael, I think it has probably in the past never been $100,000 maybe or so?

It has been around 4, 450, dwindled down. The usual run rate is a couple hundred thousand. This is clearly the most we have deferred that I can remember.

Some of this is consistent with the Sarbanes-Oxley requirements, Mark, of quarter-end review. We now have a Sarbanes-Oxley process. We have a disclosure committee. We have an audit committee. You have the external auditors. So (multiple speakers) more focus than ever before on the contractual files that produce revenue.

You know, our payers historically have been pretty nonchalant. They will cut checks based on verbal commitments and e-mails back and forth. But you know, it has not been unusual for us to go four or five months without getting an amendment, or a rate increase documented, or a contract signature, etc.

You know, it is not something that we would necessarily accept, but kind of gingerly cope with and try and deal with the payer, so that we get the proper paperwork but don't bite the hand that feeds us in the process.

Right. How much of that is extra scrutiny versus you just happened to have more of these types of agreements this year?

I think it is a combination of both. You have an unprecedented amount of new contracts, 40; you have the largest number of renewals we have ever dealt with, 600; at a time when you have a clearly defined focus in terms of what Sarbanes-Oxley's intent is and how that interfaces with the external auditors.

Remember, Sarbanes-Oxley is about looking at thing in a company at its lowest level. So, it would be the chart audits, the contract audits, those kinds of things that would identify these issues. Of course, that work is unprecedented now in the three years that we have been a public company. So I think it is safe to say it is probably the combination of both of those.

Right. As you look at the $235 million for next year, any comments you can make in terms of the mix of that business? Home-based, foster, management; and what that might mean in terms of profitability?

Yes, Michael, jump in here too. Our instincts are, Mark, that the mix you see in this quarter will likely be the mix in '07, which is predominantly home-based. 78, 79% of our core business remains home- and community-based care.

You have seen an increase in our organic foster care growth to where I think that now represents 12% of our revenue; and a proportional decrease in the managed fee side of our business, which now represents about 8% of our overall revenue. So you're beginning to see some of the flatness that we saw in last year in foster care resolve itself, as states are looking for more capable foster care providers. That is the product that we have introduced in Arizona and New Jersey and other places. So that has come up a few points, and I think you'd see that probably consistently apply in '07.

Right, now if your historical margin had been say, 11 and 12%, but management fee had been a little more profitable, what should we think just notionally about margins for next year?

Your instincts are good. We don't know that we can tell you until we see our field budgets. But you are onto one of the issues that we are addressing -- is that if you decrease the incremental margin on the managed fee side, you would expect to see some margin erosion overall.

We have normally been able to accommodate that with the variability we have in our field-based expenses. You have seen this a couple of times with us when Sarbanes-Oxley cost increased, field expenses went down. When we have had other kind of G&A increases, we have been able to manage to this kind of 11% margin.

We really won't be able to tell you that until we have collected all 250 of our field budgets, and see how they are dealing over all with the changes in our payer (inaudible).

Right. Then a couple of specific numbers, I think you had mentioned $14 million in California. Is that a little bit higher than the numbers you have used before, what you have (multiple speakers)?

Now remember, we don't announce anything that is under $2 million. So material contract announcements, it's easy for you to track. Things that are below that, for example in Arizona and New Jersey, pickups we have had there, you know, are not material enough to announce. But in terms of their collective run rate, yes, that is a little better, maybe $1.5 million better than the announced wins.

North Carolina, right now, all we know is what has been awarded to us. The $2 million both in New Jersey and in Arizona would be unannounced wins that are atypically a little larger than our garden variety $0.5 million contract renewal. So those are kind of the big-picture items.

Then again, you have got an additional 40 contracts that bring anything in from $100,000 to a few hundred thousand dollars.

Any more outstanding in Florida?

No, Florida, the last contracts (multiple speakers).

I'm sorry, not Florida; I meant California.

California, yes, there is. Clearly L.A. County has yet to announce any of their procurement activity. Not unlike Texas, that is a highly politicized environment. Their delay, I think, is to try and deal with the number of providers that have requested dollars, and how to fairly spread that.

We have about six bids in L.A. County that we have yet to hear anything on. So that is (multiple speakers) effective likewise January 1. They may go ahead and announce or they may go ahead and spread that money differently. But to the extent they don't start it up in January, they run the risk of losing that money in their base.

So we would expect that that activity would pick up, but this is the first-time L.A. County has done this, so we don't know how they are going to deal with probably providers requesting more money than they have funding to accommodate.

Just finally, how much -- those six bids, how much in dollar volume?

They have averaged for us in California, about $2 million apiece. So that being another $12 million of revenue. Our win rate is a little better than 50%. We have won basically five out of eight in California. So conceptually, you have got another $6 million or so of California business, to the extent that L.A. awards that.

Now, given the politics of that, one of the scenarios that is likely in L.A. County is that they spread the money around in smaller increments and give everybody $1 million so they can deal with the provider politics, knowing that there will be a shakeout in the out-years regarding some people that could not deliver the service.

So you know, our historical win rate in the other counties, Mark, may not mean as much in L.A. County, given the political struggle they are dealing with, with the number of providers that are requesting dollars. Where you didn't have as much competition in Orange and Kern and San Diego County.

Okay, thank you.

Richard Close with Jefferies.

Yes, a quick question on the investment being required in these new businesses. Is this greater than it has been historically? When we look back at the Company, one of the positive attributes, I guess, versus a facility-based operation has been that it has not required this type of investment. It seems as though with North Carolina and then I guess some of the other stuff that you're having to invest more. Maybe you'd talk about that?

That is a great question, Richard. That has a lot to do with scale. Historically it is very easy for us to incrementally ramp up to a small contract, $0.5 million or $1 million contract. We can absorb that typically without any investment spending, even in a new state.

For example, West Virginia, we were able to temporarily locate staff from Virginia and other places to open up that office. So our incremental expenses has been very small and the return on that investment has been very large.

The difference in North Carolina is that you have a huge volume of clients that is not rampable that we have to immediately be able to provide services to, 4,000 clients. So in that we are pre-spending the revenue there, uniquely.

You're right, normally we would not have to do that. But in order to bring those staff on, to have the offices and infrastructure in place to accommodate that, we are going to spend in advance of that contract.

Then of course, Texas is the other anomaly in that regard. Is that we did not anticipate having to invest this kind of time and money in Texas. But given the political environment now and the fact that that contract is so large -- but also in that we are probably in the best position to win that award -- it would be foolish of us not to spend some money to assure that we have the best chance we can of getting that.

So those are unique situations to us and very atypical. Most of our contracts we can ramp up without a lot of investment spend.

Okay. Then a follow-up question. It seems as though some of the new business that you have been adding, either acquired new business or contracts such as California, I think have been coming in less profitable or smaller margins than historical. I noticed in the North Carolina, you didn't given an incremental earnings per share accretion from that contract.

I was just wondering, if you can comment, is there something going on in the macro marketplace that you're not able to get a similar profitability? Does that pose risk come July 1 of next year when you do renewals, in terms of whether renewed contracts -- your profitability drops off?

You are too smart for your own good, Richard. The scale issue also does affect margin. You have more visibility with a larger contract; less tolerant of profitability in larger contracts. So ultimately, the North Carolina contract will be at a smaller incremental margin than probably the rest of our business.

We have not guided to that because we really don't know how we are going to staff that or what that is going to look like. It is a fee-for-service environment, but part of our challenge is to be 100% successful in that initial fee-for-service environment.

Part of our ability to win business is that we don't cut corners or shave costs or weight-lift clients in the early going of a contract, which is why our renewal rate is so high. So we do think that the North Carolina business will not be as profitable as some of our more mature programs.

That is clearly the case in Texas. Because of the scale of that contract and the fishbowl nature of that contract, it will be substantially less profitable than probably anything else that we do. We would think that would be more in the 7% probably op income range as opposed to the 11% or 12% op income range. Part of our ability to be successful in that is, of course, scale; but also introducing a for-profit motive into what has historically been a not-for-profit sector only.

So you have got to be careful, given our legacy ancestors that we don't overcharge or look overly profitable in these large-scale contracts. So scale does indeed produce opportunities for us we have never seen before. The flipside of that, of course, it does produce concentration of risk and also introduces a lower-margin business (inaudible).

Okay, so with respect to renewals next year, we wouldn't see any necessarily pressure on profitability on those renewals? You are not seeing that currently?

No, we just went through that cycle in the summer. We had no rate pressure in any of our contracts. We did not enjoy the cost of living situations we have seen in historical years. But we're not getting pushed back to do more work for the same rate or to do it for less.

You are seeing that on the institutional side. There was a lot of rate pressure over the summer regarding rates and length of stays. We have not seen any of that in our sector yet.

So generally, the notion that you can take away from that is in our smaller contract business we don't see any pressure on margin. To the extent we are now winning and bidding on contract of scale, it is likely that they will be at a lower margin.

Okay, then on the $0.05 in unanticipated deferred or delayed revenue, I was wondering if you can walk me through how you guys get to $0.05 on that. Just because I mean, I guess on the balance sheet deferred revenue just went from around $200,000 up to $500,000. So I don't know, maybe I am doing math wrong or something. But how do you get to the $0.05 related to that?

Okay, to the extent where you have received cash but have not recognized the revenue, you will see that on the balance sheet in deferred revenue. To the extent you have deferred revenue but no cash, you won't see that anywhere. So deferred revenue on the balance sheet is not going to equate dollar to dollar to deferred revenue.

Without lecturing you on revenue recognition, there are three or four components, Richard, in looking at a contract in terms of our ability to recognize the revenue associated with that contract. It has to be, A, in writing. There has to be evidence of an agreement. It has to cover a specific time period. The services have to be identifiable. There has to be a fixed and determinable price. To the extent any one of those agreements is missing that, you would defer the revenue associated with that whether or not you have received the cash.

So that $1 million, some portion of that that you would see in deferred cash would represent the cash that we have received but deferred the revenue. You would not see -- except for us communicating it to you -- what the amount of otherwise deferred revenue is. So that $1 million in total tax effected is about $600,000 divided by 12,200,000 shares.

Okay, then, can you guys talk a little bit about the year-over-year decline in DC? What was the revenue decline? I guess it was $700,000 in the second quarter if I am not mistaken, or $800,000. Was it a similar year-over-year decline in 3Q and the loss generated on that business?

Michael, Craig, you have that?

I have got it. DC, Q3 of last year was $845,000, Richard. Q3 of this year was $263,000.

Okay.

So a pretty significant decrease in revenue Q last year to Q this year.

Okay, then maybe I missed it. Why exactly is North Carolina underperforming. Was this a dramatic change from when you acquired this business?

Let's make sure we don't confuse North Carolina with North Carolina. The North Carolina that we have talked about in terms of new business has nothing to do with the acquisition that we made in February of a small North Carolina-based business called Family Based Strategies. We call it FBS.

If you remember that announcement, this was a very small proprietary business that had made a couple of inroads in some markets where we were seeing upside opportunities in North Carolina. We negotiated almost an entirely earned-out purchase price based upon the future probability of success of that program.

It has not measured up to our standards. It has been treated kind of independently as an organization that is run by the sellers. It may have produced some opportunities for us in North Carolina in these other ventures. But it has not grown its own revenue to the extent that we would have wanted it to.

Craig, you might want to speak to what you're going to do about that. It is not a significant amount, is it, Craig, Michael?

No.

Their revenue in Q3 is $364,000.

You know, we would have expected it to do substantially better than that, given that they had an earnout, Richard, that if they triggered it, I think we viewed that more like a 3 or 4 or $5 million a year operation.

So it is a component of our miss to guidance. You should not over-dwell on it in terms of operational interference. But we don't like having any operation that is not carrying its weight.

So the point of that is, I think even if we had realized all of our deferred revenue, we still had a couple of pennies of operational challenges going on out there, chiefly in New Jersey, Washington D.C., and in FBS of North Carolina.

Craig, go ahead and talk about what you're doing about it.

Yes, as I'd mentioned before, one of the biggest things we're doing is taking a look at, with our existing North Carolina operation -- which is the one primarily that was requested to step up to the 4,000 consumers in Western North Carolina -- remember we were part of the original pilot in North Carolina for privatized case management. So we have achieved a strong reputation in North Carolina. I think that is part of the reason we were brought into this new area.

But we're going to be integrating these operations a lot closer; replicating some of the productivity and staffing efficiencies that exist on the other side of our North Carolina operation; and bringing the model more in line with the success we have had with the Family Preservation Services side of North Carolina.

So that is -- the biggest thing is increasing productivity, staffing efficiency, and some diversification in services that they had not yet pursued.

Okay, if I could ask one more question. Michael, maybe when looking at the organic revenue -- gosh, I forgot what you said for the home-based and organic in the quarter. I was wondering if you could talk a little bit about what the contribution in third-quarter '05 and third-quarter '06 of your Georgia acquisition, made in September; and maybe the Maple Star acquisition, made in I believe September of '05?

Sure, Richard. I would be glad to give you those numbers. In Georgia last year, about $111,000. This year, $745,000. We have grown them substantially.

Maple Star last year, $144,000. This year, $1 million -- almost $3 million, 278. So we have had terrific success in our organic growth there, which bodes well for why we consider if we had the acquisition in the quarter last year and this year, that we call it organic growth.

Maple Star's foster care, that is one of the reasons you're seeing the payer mix shift, too, Richard. Because of their success in bringing on foster care service.

Okay, when will the Q be filed?

Today.

Okay, thank you.

[Gil Alexander] with [Darfil Associates].

Is there a way you can let us know on your contract spend and setting up of new offices for nine months for '05 and '06? And what it might have been for the total year '05?

Is the question to what our investment spending was last year versus what we are seeing in '06?

Yes, sir.

Michael, I don't know that we have that handy. It may be something that we have to get back to you on. I don't know that I have seen anything like that, Michael. Do we?

Let me tell you what our model has been historically, which would be to investments spend for maybe a couple months to hire staff when we go into a new location. But then, we have been able to offset that investment spending historically in about six months. Six to nine months, we make that back.

So it really hasn't been an issue. Of course, these new markets have been relatively small. As Fletcher said, we are now seeing larger markets that do require a bit more investment spending to get into them, sir.

Typically that would be $100,000 or something, right, Michael? It would not be a big number to open up a new office.

No, $50,000 would be my average, I suspect.

So the investment spending in North Carolina, the investment spending situation in Texas are unique to us only in that contracts of huge scale have presented themselves to us that would require us to develop the infrastructure and staff. Certainly in North Carolina to be able to support that contract.

But that is an atypical rather than a typical situation for us, and one that we don't see coming along again. There are a handful of states that are privatizing of that scale. They are Florida, which is entirely mature. North Carolina, which is just beginning. Texas, which is just beginning. And California, which is about a year old in terms of its new initiatives.

Other states that are watching these models include states like Michigan and others. But you have not seen any movement there toward actual procurement.

But the most topical of those states on our watch today would be North Carolina, Texas, and California. Those are the states that if somebody were to ask me -- where do you see the most privatization activity? Texas, clearly, of course, is the largest with almost $1.5 billion coming into play over the next three years.

Thank you very much.

Rick D'Auteuil with Columbia Management.

My question involves the deferred revenue issue. Is there a way, going forward, now that you realize that this is becoming a bigger quarterly issue for you guys, to write into your contracts some sort of clause that would address this? Something like, if we don't have all the documentation and we continue to do service, or we continue with the old monthly rates or monthly contract as it related to our prior contract.

That is a great question. Unfortunately, the short answer is probably no. We don't have a lot of negotiability with these payer contracts. The 650 that we currently enjoy, no two of them are alike. They are typically generated at a very low-level of government. They are usually boilerplate kind of contracts. They don't necessarily provide that the provider is going to be a public company that might have different issues than the run of the mill not-for-profit company.

As Sarbanes-Oxley moves into the not-for-profit sector, I think you will see some standardization of language in these contracts. But right now, we appear to be different. If we go in and challenge their contract or ask for language, sometimes we literally could lose the opportunity to enjoy that renewal. So it is a very diplomatic and delicate process that we go through with these guys.

The one thing that we probably wouldn't do is to refuse to provide service to their clients just because they hadn't tidied up a contract. In our experience, we have always gotten whatever we need to get from the payers, even though it might take some time to do that.

So, you know, it is a very interesting give and take process. This is not traditional healthcare, where you have standardized forms like the HCFA 1500 or the UB92s, where every provider uses the same contract. We are at the mercy of our county and state and regional providers to deliver us a contract. Some of them may not measure up to revenue recognition standards, particularly if they are not executed timely or they don't meet some of the other things that we have talked about.

So in context, some $400 million of contracts were renewed in this quarter; 100% of our contracts were renewed; and we had about $1 million that we had to defer. So it is not obviously the majority of our issues.

But the important thing about this, of course, is that is pure EBIT for us, because the expenses are already in the system -- that any deferred revenue for us literally drops right to earnings before interest and taxes.

So as long as we are doing the work, seeing the clients, we would ultimately expect to get paid. Then we would deal gingerly with these government payers to make sure that we have the proper documentation.

Thank you.

Mark Hughes with SunTrust.

Could you talk about the census increases under existing contracts? What -- any numbers you can share with us about how it shook out this year?

Michael, do you have sequential census for 2? I don't have that, and we might have to get back to you, Mark. Because we have census data Q-over-Q. But do you have it, Michael, Q-to-Q?

I do not have it at my fingertips, but Mark, we can certainly get it for you and get it to you.

Do you have just a general sense of it? If we looked at the same contract year-over-year, what the normal growth might be, perhaps?

I think we would be guessing, Mark, so we will get it and get it to you.

Okay.

There are no further questions at this time.

Thank you, everyone. With the unusual nature of the quarter and upcoming events, we will certainly continue to be available and reachable to you. If we did not get to your question today, and it sounds like we have a couple to get back to, please give Michael or I a call. I am in New York today, but will be back in the office tomorrow. We always welcome your questions and visits.

We will see many of you later today, and we are available if anybody needs any additional information. Thank you very much.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.