ModivCare Inc (MODV) 2006 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth-quarter 2006 Providence Service Corporation earnings conference call. My name is Katina and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will conduct 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 your host for today's call, Ms. Alison Ziegler from Cameron Associates. Please proceed.

Good morning, everyone, and thank you for joining us this morning for Providence's conference call and webcast for its financial results for the fourth quarter and year ended December 31, 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 and she will send one out and confirm your name on our e-mail list.

Before we begin, please note that we have arranged for a taped replay of this call which can be accessed by telephone. This replay will be available approximately one hour after the call's conclusion and will remain available until March 22nd. The replay number is 888-286-8010 with pass code 858-64795. 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 or, alternatively, the call can be found at www.earnings.com.

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 including the Company's beliefs about its revenues and earnings for 2007. We wish to caution you that such statements are just projections 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, March 15, 2007. The Company may choose from time to time to update them, and if they do we'll 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.

Thank you, Alison. Good morning, everyone. Here in Tucson for today's call as well is Michael Dietch, our CFO, and Craig Norris, our COO. As always, we will take your calls after we finish our scripted remarks. February 1st this year we celebrated the 10th anniversary of the founding of Providence.

I think someone actually had to come in my office and remind me of that we were working so hard. I think it was actually Michael -- the first one to identify that we had passed our 10th anniversary. That year we enjoyed 1300 clients from four contracts in one state. Today we are announcing over 71,000 clients from 868 government contracts in 306 locations within 36 states. It's been a remarkable ride.

We can also now announce our 10th year in a row where we have not had a single contract terminated or failed to renew. We came close in 2006, as you know, in Florida and had some tense moments in Arizona, but ultimately we were successful in every single negotiation.

2006 was indeed a growth year for us as well as a learning year for us. Our revenue grew 32% to over $190 million; however, our earnings were flattened out by our first-ever material reserve for aged accounts arising from the Arizona contract that applied to both calendar 2005 and 2006. As you know, we have however renegotiated the economics of that contract and have not faced a similar issue since September of 2006.

Net income of $9.4 million after the $2.4 million reserve is identical to last year's earnings of $9.4 million. However, the share count in 2005 was about 9.9 million versus approximately 11.7 million shares for 2006. Our fourth-quarter results are in line with previous guidance given the startup expenses in Texas and the previous and previously announced reserve.

January and February are record months for us and we are guiding to over $20 million a month in revenue for 2007 before any consideration for the July contract cycle, the outcome of Texas or any of our acquisition activity. If you model our company operating margins going forward, in a normalized quarter we expect to be about 9.5% versus the 11.5% we had historically guided to. The difference is basically 100 basis points for stock compensation expense which amounts to about $0.10 per share in 2007, and a blended overall margin reduction of about the same 100 basis points due to increased revenue volume and lower margin business lines.

As we've guided to for the first quarter, we expect our 2007 guidance will contemplate approximately $200 million of our traditional business and about $40 million of revenue at more like a 7 or 8% pretax. This is also without any supplemental revenue from Arizona. We are not involved in that now; we've not had to provide any of those services, but indeed if we do we would defer that revenue now going forward. I'll let Michael walk you through the year-end and fourth-quarter results.

Thanks, Fletcher. Good morning, everyone. In our fourth quarter 2006 we set company records for revenue and cash flow from operations. Revenue for the fourth quarter totaled $55.9 million, up from $41.1 million for the fourth quarter of 2005, a 36% increase. 20% of this increase was from organic growth, 16% of the increase was from companies we acquired in Pennsylvania, Georgia, North Carolina and Tennessee since the fourth quarter of 2005.

For the three months ended December 31, 2006 as compared to the three months ended December 31, 2005 home-based revenue grew 43%; we grew 22% organically and 21% from acquisitions. Foster care revenue grew 28%, all from organic growth. Management fee revenue experienced a decrease of approximately $150,000 primarily because we no longer pass through health insurance cost to our not-for-profit managed entity which totaled $413,000 and the fourth quarter of 2005.

For the year ended December 31, 2006 as compared to the year ended December 31, 2005 our revenue grew from approximately $146 million to almost $192 million, a 32% increase. 21% of that increase was organic and 11% was acquired. For the year ended December 31, 2006 as compared to 2005 home-based revenue grew 32%; 21% organically and 11% was acquired. Foster care revenue grew 39%, all organically. Management fees grew 24%; 5% organically and 19% was acquired.

Our revenue guidance for the first six months of 2007 is $61 million in both Q1 and Q2 which is a 37% increase in the total for the first six months of 2006. During this time we expect that home-based revenue will grow 42%, foster care will grow 25%, and management fees will grow 6%. We are guiding to approximately 9.5% operating income in Q2 of 2007. The difference between this margin and our pro forma operating margin in Q4 of this year relates to Texas spending and Sarbanes-Oxley audit and related expenses in Q4 of this year.

Our 2006 fourth-quarter operating income totaled approximately $1 million which was 1.8% of our revenue. This compares with almost $4.3 million and 10.4% of revenue for the fourth quarter of last year. This year's quarterly result includes a $4 million bet debt reserve recorded in Q4 related to the supplemental services we performed under the at risk contract in Arizona for which we have not yet been paid.

Fourth-quarter net income totaled almost $670,000 which was 1.2% of our revenue. This compares with almost $2.4 million and 5.8% of revenue for the fourth quarter of last year. Fourth quarter diluted earnings per share totaled $0.05 on 12.3 million diluted shares outstanding compared with $0.24 for the fourth quarter of last year on approximately 10 million diluted shares outstanding at that time.

At the end of our fourth quarter our days sales outstanding from home and community-based services and foster care services was 80 days, down from 89 days at the end of our third quarter this year. As I mentioned on our call last quarter that I expected to see our home-based and foster care services DSO between 75 and 80 days as of December 31st, which is a normalize DSO amount for us.

You will note that our accounts receivable balance has grown from approximately $24 million at December 31, 2005 to about $38 million at December 31, 2006. About $5 million of this amount is attributable to the acquisitions of A to Z, Family Based Strategies, Innovative Employment Solutions and the corrections business we purchased from MAXIMUS. The balance of approximately $9 million is attributable to our core growth states of California, Nevada, North Carolina and Pennsylvania.

At December 31, 2006 our management fee DSO was 152 days, well under our 180 day target. During the fourth quarter our general and administrative expense totaled 11.5% of our revenue; this was consistent with the 11.6% of revenue experienced in Q3 of this year. Our G&A expense was approximately 12% for the 12 months ended December 31, 2006 versus almost 12.5% of revenue for the 12 months ended December 31, 2005. Our effective income tax was trued up in the fourth quarter to 41.5% for the year.

This increased effective tax rate resulted primarily from the $4 million reserve amount recorded in the fourth quarter and also from increased business in states with high tax rates, principally Pennsylvania and California. I expect that our effective income tax rate will approximate 41% for 2007 and we continue to work closely with our tax advisors at KPMG on federal and state income taxes strategies.

During the fourth quarter we generated $8 million in cash provided by operations up from $6 million in Q3 of this year. As I mentioned earlier, this $8 million of operating cash flow was a record for us. At the end of our fourth quarter we had almost -- about $40 million in cash and about $1 million of debt all related to acquisitions. And with that I'll turn the call over to Craig Norris, our Chief Operating Officer.

Thank you, Michael. For the quarter we ended with a total combined census between our owned and managed entities of 71,134 clients. These clients are being served from 306 local offices and 36 states and the District of Columbia. Compared to Q4 of 2005 this represents a total census increase of 35,488 clients. We have also added 101 new local offices in this same period. Combined between our owned and managed entities we have over 6800 employees serving 868 government contracts. This represents an increase of 341 contracts compared to Q4 of 2005.

During the fourth quarter we have completed our operational transition of the MAXIMUS correctional services unit which has operations in Georgia, Tennessee, South Carolina, Florida and the state of Washington. Also in the fourth quarter we prepared for the transition of services in our large privatization project in western North Carolina. As of Q1 of '07 operations are fully ramped up and we have hired approximately 200 employees in western North Carolina. This has been one of our quickest operational start ups in any privatization effort to date.

The A to Z business is fully operational and we are now serving approximately 3000 students. We have made some modifications to the A to Z operations by integrating it into our existing operational sites. The cross selling of this educational product, along with our other services, is being well-received in the marketplace. We are also seeing improved performance from our DC operations and we expect to see consistent budget performance in 2007. This past year of course we have won a large number RFPs through competitive procurements in California and we have been in the process of ramping up most of these awards.

Overall in 2006 we have expanded operations into 11 states and diversified our services into the educational arena, workforce development and job training, and privatized probation services. In 2007 we will continue to cross sell and integrate these new products into our existing Providence operations. Thank you and I'll turn it back to Fletcher.

Great job. You can see obviously that no moss is growing on our feet. You'll notice we've guided out another quarter which is pretty much as we've described. Run rate for us Q2 will not have a Sarbanes-Oxley and audit expenses that are loaded into Q1. So we view that as a pretty normalized quarter if you're modeling the business. The legislative debate in Texas over privatization initiatives there should be finalized soon and we'll know shortly whether or not that will have any impact on us in 2007 and out years.

House Bill 3916 which was introduced last week provides a pass that the San Antonio privatization can move forward as the demonstration project. While there appears to be some change in the rapid pace of privatization plans in Texas, we've seen no effort on behalf of their 80th Legislature to totally repeal or dismantle particularly child welfare privatization. Given the missteps in 2006 by other providers, this is very good news for the Company and for the overall privatization of social services.

2006 was an unusually active year for us in terms of regulator oversight. We have been audited by the Internal Revenue Service, reviewed by the SEC, audited by numerous state Medicaid authorities. We're pleased to say that as a result of those audits it will not materially affect our historical presentations or the manner in which we do business going forward. We have initiated our repurchase program and to date have repurchased 442,000 shares of our stock at an approximate cost of $10,300,000 or a little over $23 a share in the average.

We feel very good today about where we are going into 2007. We have reduced the risk profile of the Company, both through regulatory review and contract term changes. Our services remain very much in demand by government payers; the demographics that drive our business have never been more compelling.

If you're following the Democratic Congress you'll see rhetoric there where they intend to increase the federal social services budget, that can only be good for us. Minor operational issues that we faced in 2006 have resolved themselves. As Craig suggested, we ramped up to and are integrating nearly 4000 clients in North Carolina. A to Z is making a strong contribution now with almost 3000 kids. Remember, we will lose that population in the summer, so we are beginning to see seasonality in our educational lines of business. And as Michael suggested, DSO is down or below our target levels.

This is a very challenging business. We've always paved the way with innovation and incredible payer loyalty. We're proud that we continue to measure up. We're now available to do take your questions. Operator, if you'll open the line?

(OPERATOR INSTRUCTIONS). Bob Labick, CJS Securities.

Good morning. Congratulations on the strong cash flow in the quarter. First question I wanted to ask, Craig touched on it in the ramp up of the western North Carolina award which sounds like it's underway. Could you give us a sense of the impact we're expecting? $250000 to $350,000 impact in Q4, how did that play out during the quarter?

What's the overall value of that contract, Craig? About $10 million. All of that we'll enjoy in calendar '07, Bob. So we're fully ramped up. As Craig said, we've hired a number of staff, we've opened up a number of locations. Unusual in a contract like that there is not a real transition period. So that is fully ramped. We're enjoying that revenue as of January. It's one of the reasons our revenue guidance is into the $60 million range because we're enjoying $800,000 a month or so of North Carolina revenue.

But I think we had been anticipating, because of the ramp up of the rapid start in Q4, that you would have some incremental expenses in Q4 related to that?

Not very much. We had some startup expenses in Texas. Most of the expenses in North Carolina ultimately were reimbursed to us by counties that initiated and requested startup funds. So we do not have to investment -- spend much in North Carolina to get there. The difference I think in our '04 margin -- the Q4 margin, as Michael alluded to, is a penny or so of Texas startup cost and probably a couple hundred thousand dollars of Sarbanes-Oxley expense. The good news there is that we were ready earlier. As a consequence the auditors started earlier. So we've actually expensed some of the audit costs in Q4 but that we didn't have much of North Carolina cost.

Okay, great. Then regarding the DC and North Carolina FSB contract in New Jersey which were all drag versus expectations in Q3, could you give us an update there?

DC is indeed profitable, has been for the last couple of quarters. We are actually getting paid there which we're very pleased to announce. The New Jersey contract continues to be delayed -- as yet to be implemented, right Craig? We're still waiting for licensing issues to initiate the foster care programs there. That's about $2 million of annual revenue, Bob, that is yet to start.

Great. Then you alluded to your Q2 run rate does not include -- obviously looking forward to any of the July procurement cycle. Can you give us just a sense of what's out there in July that you may be bidding on? Not obviously that you would per se win, but what are the opportunities for that procurement cycle?

It's an early in terms of RFP activity for the July 1 cycle. I don't know that we're currently involved in any request for proposals, but we do expect increased business in California as a result of just the increased funding through Proposition 63. We're hopeful that we see additional business in the core states that Michael described -- Arizona, Nevada, Pennsylvania and North Carolina. That is typically the cycle for the majority of our contracts, probably the substantial majority, more than 90% of our contract cycle July 1.

So we will be negotiating for cost of living increases, we'll be negotiating for census increases, and we'll be responding to requests for proposal. None of that, Bob, is contemplated in our guidance. We tend not to guide to it if we don't know it. So the downside to our guidance is that in the July cycle we get fired, that is we start having contracts that don't renew. The upside to that guidance of course is that we win some business; we get cost of living increases or rate increases that we don't currently know about.

Great. And then last question and I'll get back in queue. Obviously you took the reserve for CPSA in the quarter. What's your current thinking on the recovery of that money over the next year or so, where do we stand?

You'll notice that we reserved it rather than write it off. Our policy, I think we've communicated this extensively, requires any account that ages over 365 days we reserve 100% of that, that's the decision we made consistently with this Arizona contract. We intend to continue to pursue it. We've not guided to any collection of it. We're not comfortable that we would collect any of it otherwise we could probably argue to keep it on the books.

But this is a situation that involves more than just the negotiation between us and the payer; it would involve the state of Arizona, the federal Medicaid authority and others as they look at these supplemental services. And our experience in other states, it would not be unusual for that to take years to settle, Bob -- two years, three years or even longer. So we expect to continue to pursue it, but we can't be overly optimistic about our ability to collect any of it.

Great. I'll get back in queue. Thanks very much.

Mark Hughes, SunTrust.

Thank you very much. Any bonus activity to speak of year-over-year? There was some in the fourth quarter of last year. Can you comment on the magnitude of any bonuses there might have been this year?

Good question, Mark. There are no bonuses. The question is specifically to an historical request that we've made of our managed entities at the calendar year end. Most of them are on a calendar basis. If we've had a good year we will ask for and have received in the past bonuses. There's been some criticism of that policy in the past. We have no bonus activity in Q4 from the tax-exempt organizations.

You will see in our K that we routinely (technical difficulty) mark from the Oregon operation which is not a tax exempt organization. We treat it like a consolidated entity, we don't have the same prohibitions there, but indeed there are no bonuses from the 501C3 organization.

All right, got you. In Texas, understanding it's still up in the air, if the state did decide to just outsource case management, what could that mean for Providence in terms of revenue?

Except for the position that we are currently in that would always be received as good news. That would mean that a state is expanding its array of services in the private sector. That would require, Mark, an entirely new procurement. It would require the design of a new RFP. So it's probably a year away before you would see any of that actually outsourced, but that's generally good news.

Any state that looks at the Florida model, the Missouri model, the Kansas model and other states and elects to privatize we're thrilled about. The difference here of course in Texas is that Texas has had a very aggressive privatization plan, more along the Florida model which privatized the entire administration of child welfare and of course that is Senate bill six, this appears to be a retreat from that position in that it still privatizes, still recognizes the private sector, but not nearly as comprehensively or as rapidly as the original legislation contemplated.

I think it's safe to say that our sense about the mood in Texas is that there is some backlash as a result of some of the earlier issues with some of their first privatization contracts. And indeed the overall comprehensive privatization has lost some momentum in the Texas Legislature. And I think that's resizing why the executive branch is asking the Legislature to weigh in here if they want to review this legislation, amend it and/or repeal it.

At this date we're comfortable that we've not seen any attempt to totally repeal or dismantle child welfare privatization in Texas. But you do see some bills that modify it. And you're speaking specifically to legislation that Senator Nelson has introduced that provides for some limits on privatization and the outsourcing of case management. Indeed that's a service that we provide in other states and we would see that as an opportunity to increase our business in Texas.

The bill in the House, House Bill 3916, however contemplates a more comprehensive privatization effort in that it's more along the traditional model of Senate Bill 6, but it's designed to be a demonstration project. And we've seen that occur in a number of states that were interested in privatization but maybe had some doubts about the effectiveness of it or their ability to attract providers to it. We were involved in the pilot in Florida, we were involved in the pilot in North Carolina and it would not have surprised us that the first attempts in Texas would have been through some sort of demonstration project.

So if both of those bills were to pass you would have some inconsistent language applied to Senate Bill 6 and, Mark, that would have to be resolved in a conference committee made up a both the Senate and the House members. So this is precisely why we encourage investors not to speculate on the outcome of Texas. It is indeed very political. There are a number of moving pieces to it. And if you're only buying our stock because you're betting on Texas, it's not a safe bet one way or the other. So we really encourage people to look at the Company ex Texas, but understand what's going on in Texas.

And I think our comments in summary are the news from Texas is good in that the privatization as alive. In appears to have lost some momentum, but at the same time they haven't thrown the baby out with the bathwater. So Texas is always a bellwether state. If you look at corrections the psychiatric industry, education -- any of the programs that have privatized -- Florida and Texas always set a number of benchmarks for other states. So it's encouraging to us that Texas intends to privatize and we'll see here by end of April, 1st of May what the ultimate program will look like.

Got you. How about in North Carolina. I think when you originally landed that business you might have discussed the fact that other parts of the state could follow suit, what's your sense there?

That's a good question, dovetailing our previous conversation. North Carolina started as a pilot, that was a very successful pilot. We were involved in that. The Legislature provided that other regions therefore could expand their privatization services. So we see this as an early effort to do that. It's hard to handicap that in terms of potential in North Carolina; it clearly doesn't have the scale of Texas. But in terms of North Carolina there's still several million dollars, tens of millions of dollars that will be privatized over the next couple years.

It is county led as opposed to state led, so each single county and district will make that decision in their own right. But we do expect, particularly given continued success there, that you'll see additional privatization in North Carolina.

Got you. And then final question, the revenue seasonality in Q3 -- you talked about population dipping because of A to Z, kids not being in school. What impact on the revenue should we think about?

We hope to remain flat by offsetting the seasonal dips with increases in rate and census and revenue. But generally speaking, that entire 3000 kid population will go dormant, Mark, entirely from the months of June through mid-September, beginning of October. We get basically $45 an hour per kid; we see a kid once a week, so you're talking about $180 of revenue per student.

So it's over $0.5 million of revenue that we will lose over the summer months. You also have some quieting in our other educational lines, so it will be significant and we'll know more about the ability to offset that by the time we get around to guiding for the rest of the year.

Okay, thank you.

Craig, did you want to say something about summer programs?

I was just going to mention, Mark, that we are trying to expand the A to Z business to deal with seasonality in a number of our cities. We've had some encouraging discussed summer programs in essence to keep tutoring through the summer rather than stopping it. That's something heretofore that the prior A to Z owners never really pursued and we're looking at that very aggressively. We don't have anything to report at this point, but we are looking at strategies to deal with the seasonality.

Right, I understand. Thank you.

Greg Williams, Sidoti.

Good morning, guys. I just had a question about your core business versus your cost reporting contracts that you talked about earlier. It looks like it's about an 84/16 split. What are the propensity of your new contracts being cost reporting? Where do you see that 84/16 split gravitating in the future? I'm thinking like in the '08, the outer quarters?

You sound like an analyst. Our core business is about $200 million, Greg. We've not seen any margin pressure there, any length of stay pressure, any rate pressure, any renewal pressure there. We would expect those lines to grow traditionally in the 10 to 15% kind of basis. That money is appropriated to us. It comes through County, regional, municipalities, state governments, so they have to go through their legislatures to appropriate.

So even with the demand that's on that business, it's not the kind of business that will grow at 30 or 40% a year because legislatures just won't allow that. So to some extent that business is rationed, but we're not seeing any pressure on our margins.

In other states where you either have volume contracting, like we've talked about in Texas, or cost reporting contracting you are seeing less tolerance of profitability than we enjoy in our fee for service environments. We don't want to begin too much of a dialogue specific to payers because we don't want to publicly start comparing one payer to another. But it's safe to say that I think we would see both of those lines grow proportionately. That is we might see -- in '08 you'd see $220 million of traditional business and $50 million of cost reported business.

So we don't see any movement on behalf of our traditional states to move into managed care or cost reporting environments or other things that would limit our margins so I think what we're trying to communicate is we do not enjoy margin pressure per se, but we do have incremental margin impact to the extent we continue to win in these business lines that have less tolerance of profitability. But in terms of modeling the business, I would think it would be proportionate.

Okay. And the cost reporting contracts are generally much larger in revenue?

They're much larger in scale and every line item, Greg, is identified and profitability is one of the line items that you budget for and is monitored and you cannot exceed it. The good news is that its profit is identified and allowed, but it's going to be a smaller operating income than in a fee for service state where we don't have to report our profitability on a line item basis.

Okay. And just speaking of margins, earlier you guys talked about the -- it looks like the operating margin in the first quarter 8.7% and the second quarter a little higher, 9.3%. Is that difference all Sarbanes-Oxley related costs?

Sarbanes-Oxley and audit expenses primarily.

Auditing.

That's about $300,000 I think, isn't it Michael?

In Q4 and about -- I don't know. We'll spend $1 million on Sox, both internal and external costs, and about another -- well all in about $900,000.

Stock comp, Greg, is -- run rate is about $600,000 a quarter. The blended margin impact we talked about, so the only other thing that's in Q1 it's not into is going to be S-Ox and audit expenses.

Okay. Thanks, guys.

Pat Swindle, Avondale Partners.

Good morning. First question, on free cash flow there was a pretty strong working capital benefit during the fourth quarter. At this point what are your expectations in terms of working capital during 2007 and then do you have a free cash flow expectation at this point that you could also relay?

Patrick, we don't really forecast the cash flow statement in and of itself. It really is a function of hustle, a function of billing and collecting, that is a top priority for Craig and me on a daily basis. So that's really the key metric. To the extent we are successful in doing that, our cash flow from operations will be good.

Note that in the second quarter however we do have a couple things going on. Number one, our insurance program is the April time frame and we then have a big prepaid amount going into our captive. Secondly, there are two income tax payments due in the second quarter. The first-quarter estimated payment -- the estimated payment from the first quarter and also somewhere around in the middle of June I think is the second-quarter estimated payment is do. So very similar to last year. Those two items will have an impact on our cash flow from operations in Q2, but other than that there's nothing that I'm aware of that will materially affect us.

I think we said too that we see Q4 as a pretty normalized DSO for us, so if you were to look at the percentage of cash flow versus earnings in Q4 that should be a pretty normalized quarter for us. If DSO goes up cash flow obviously is going to be affected by that. But we believe we can maintain these targets unless something happens to a payer or a fiduciary or somebody gets audited or somebody's computer gets stolen. Right now we don't have any expectations of anything externally that would impact normalized DSO for us.

Asked another way, given that you're assuming pretty static working capital, would there be anything that you would expect that would materially cause your cash flow to deviate from your net income?

Only if we were to declare a dividend or something like that and that's highly unlikely.

Okay.

They should correlate, Patrick.

Next, on the margin comment regarding a 9% margin, is that the annualized expectation? Obviously you have the audit expenses and Sarbanes-Oxley impacting the first quarter of every year because you don't accrue for them. Is that 9% on an annualized basis? So you should see a weaker first quarter followed by a relatively higher than 9% second, third and fourth quarter? Or are you saying that in the back half of the year 9% would be a reasonable expectation?

We're guiding to 9.5%, Patrick, as the normalized (multiple speakers).

I'm sorry, I misstated, I apologize.

For us. So we would expect that that would normalize out in the back half of the year. So if you were to look at Q2 as a [runway] quarter, that's a pretty safe assumption for three and four before any of the conversation we've had about the contract renewal cycle whether or not we lose contracts or win contracts but that would probably not impact the margin.

To the extent we win a lot of business at the higher margin level, the conversation we just had with Sidoti, if in the July cycle we don't have any new business in the lower margin side of our business, then you might see that creep up a little bit. But I think given what we know today, 9.5% is a good way to model the business. And that's after -- I don't know if you do -- how do you treat stock comp, Pat, but that's about 100 basis points again going to stock compensation expense.

Very helpful. Next question, you made comments regarding having been reviewed this year by the SEC, IRS and various state Medicaids. Was that a normal course of business or can you elaborate on that a bit?

It's not normal that you would see all those regulators in the same year. We don't know if there's any cause and effect to that by anything that's gone on with the Company. In my experience short sellers do what they can to foment the market. I can't tell you, Patrick, if there's any relation to that. The good news from our perspective is whatever attracted the regulators to us they've come and gone without any material affect on the Company. That was our third year as a public company so if companies are reviewed every three years by the SEC, but no, that's not a routine year for us. It was indeed more active then you would normally expect.

And all of those reviews have been completed or are now closed?

Yes. The SEC file is public you can go to the website and look at that. Everything else is done. I think our K will indicate we have no unresolved issues with any regulators including the Securities and Exchange Commission.

All right. And then last question -- on the acquisition side of the business, what's your current view on acquisitions? Is the pipeline equally robust as it has been in the past? And then should we expect a normal acquisition environment this year? Or because of Texas and the uncertainty there do you expect to maintain a slower pace?

Well, we did five acquisitions in '06, so we actually were a little better than one a quarter pace. We've already closed on one in '07. So I think it's safe to expect we're not retreating from our one a quarter expectation. But again, we really ask that you don't try and model this into your forecast because we cannot predict when we are going to close on any of these things. We remain very active, the pipeline characteristics are about the same in terms of number and size.

We still have not seen anything of serious scale become available to us. We are seeing less competitive interest in our targets. MAXIMUS who we viewed at one point as a competitor, we no longer see as an acquisition competitor. We do bump into Res-Care, as you would expect, in the market. We would expect to see Mentor and some others engaging with our targets. But for the most part we don't see or contemplate any changes in our strategy; however, we can't really predict the closing schedule.

All right. And then, actually I do have one more question. In the comments that you made around the margin expectation on new business, would you say that the margin differential that you're seeing is purely by business line and that as you look out on a going forward basis as you look at the various business lines it will shift based on opportunities within each of those, but that there is no change in overall trend and that all-new business is coming in at lower margins?

It's both geographic and business line, Patrick. There are some states that require cost reports across business lines and there are the workforce initiative programs that we've become involved in are costs reported by business line irregardless of the state because they go directly to the Department of Labor. So you're seeing some cost reporting impact both geographically which right now I think, Michael, is isolated to California? Do we cost report anyplace else?

(inaudible question - microphone inaccessible)

A couple of states but primarily California. And then workforce development clearly is cost reported.

As you go through the contract renewal cycle are you seeing any pressure from your existing customers that may be at higher margins?

We've had a couple of conversations with people and our response is typically scale. A [union] dollar contract with us, we're not going to do that for 6% profit margin. If you want to give me $100 million then we're happy to talk to you about reduced margin expectation. So we've not seen any serious threat, Patrick, as a result of us doing some business at a lower margin with our overall customer base.

So consistent with other areas of outsourcing, smaller contracts require higher margins, larger contracts lower margins and that should be the expectations. So although the overall margin may shift even within the same market in some cases a small contract could generate or warrant higher margins?

Yes, I think that's a question of how much the bigger contracts are monitored, how topical they are, how much more you operate in a fishbowl, you have media attention attached to those larger volume contracts. Our little $100,000 contract, its profitability is not typically a concern for the press, the Legislature, the bureaucracy. You get north of $10 million and it is an issue.

So the good news/bad news of the evolution of privatization is the larger volume contract is consistent with privatization maturation and acceptance. You saw this in corrections, you saw it in education. As they started out contracts got bigger, but they also have margin pressure attached to them. So we would expect, again, to grow with both sides of our business and one is not necessarily translated into the other.

Thank you very much.

(OPERATOR INSTRUCTIONS). Richard Close, Jefferies.

This is Paul Joiner for Richard. Richard is on an airplane right now. But I want to go back to the beginning, one of the early on questions and look into the unsigned contracts in 3Q. And I was wondering if you can recap what was the progress made in 4Q and if there was revenue recognized from signed contracts what was the related expense or did most of that fall to the bottom line?

Let me take a shot at that and make sure I understand your question. There are a couple of things in Q3 that affected our revenue that contributed to us guiding to a range in Q4. On the deferred revenue piece, that was primarily the result of some documentation issues with our payers. To the extent that we resolve those, we were able to recognize that revenue in Q4. To the extent we couldn't resolve those we would recognize the revenue of those contracts ratably over the contract life which would end June 30th.

For the most part we did not have significant gains and just correcting documentation issues to allow us to pick up revenue in Q4. And we did guide to the range also because we anticipated startup costs in North Carolina which were primarily offset by startup funds in North Carolina. We also guided to significant startup or investment is pending expenses in Texas which have to date not been offset by any revenue.

So the primary -- the guidance in Q3 and the actual in Q4, we did not see a lot of pick up in terms of the deferred revenue. We would have been at the higher end of the range. We did enjoy a significant amount and over $100,000 of Texas expense. The tax impact of that of course kept us at the lower end of the guidance range as well.

So I mean in 4Q it was immaterial, the amount from the unsigned contracts in 3Q, the deferred revenue?

I would say that's right. Michael, would you disagree with that?

I would not disagree with that.

Okay. And then with regard to the Arizona CPSA contract and the restructuring, can you give us some more detail around the restructured contract? And then also what is your expectation in terms of size of the contract in '07?

The current size of the contract, Craig, is about $17 million. That's up about $1.5 million over as a result of recent renegotiations. This is a 10-year-old contract for us, we're quite knowledgeable about it, in fact was the Genesis contract for the Company. Historically it has been what we would describe as a block purchase. We sit down with them, we negotiate a rate, we negotiate budget and they pay us 1/12 of that each month.

Historically the contract has provided that if we exceed the budget forecast that the payer can, but is not obligated to, reconcile with us any of those over encountered situations. Historically over the 10 years, probably five years that we've gone over the contract amount, the payer has always reconciled with us. So consequently when we got into the '05/'06 cycle we were dramatically over the budget forecast, about $2 million in '05 and about $2 million in '06. We continued to book that revenue because we had a consistent practice of being screwed up with that payer.

As those accounts approach 365 days old they bumped up against our own policy regarding bad debt, which we did not believe we could waiver from. So we went ahead and reserved those funds as they became a-year-old or older. It consequently we've been able to deal with the payer and the state in terms of the overall requirement of those contracts that we respond to every referral that's made to us. We are now applying -- this may be a foreign term to you -- but we are now applying medical necessity to any referral we receive from and on behalf of this payer.

In other words, now since September of '06 we are able to ration our care or to deny care when we deem it's not appropriate. That's the major change in the contract. Prior to that we took all comers we went above the budget if that was required, the payer trued up to us. We are now and since Q3 of last year applying medical necessity to any referral we get from that payer and if we believe that services aren't medically necessary then we're not engaging the client. And that has allowed us to stay under the budget allocation since September of '06.

And so now in terms of -- now you have this eligibility check. Is your timetable -- I'm just recapping. It's 112 so you bill a total amount in a month or over a period of time and it will be ratably spread out throughout the 12 months?

That's the way we're recognizing the revenue currently; we're responsible under the contract to deliver 90% of that amount in terms of client services value. We have historically been running at about 110% of that contract amount which has led to these what we call supplemental receipts. Going forward we expect two things. One is we do have the ability now, as you suggested, to look at eligibility.

To the extent, however, we do exceed that forecast, we will now defer that revenue. So we will no longer book the revenue associated with any supplemental services in that we now have experienced at least one payment issue with this payer so it changes the fact pattern in terms of the history of the relationship. So even to the extent we were to exceed this contract we would not book the revenue.

One last question. On the reserves -- on the AR reserve what's the likelihood of a reconciliation between the reserve and getting paid on any of those dollars?

The history of Medicaid is that in situations like this you'll see some sort of negotiation occur and in our experience it takes months, years sometimes to resolve. So ultimately the federal government is responsible for these clients. We have appeal rights all the way of course to federal Medicaid. This is a very diplomatic issue as you might expect. So we want the contract to renew, we want it to continue to be a provider under that agreement. So it's not the kind of thing you rush off and get a lawyer and start suing everybody.

So we kind of will work through these things diplomatically. In our experience there is always some sort of compromise. We've reserved 100% of it because we have no means today of predicting any payment given that these funds, first of all, have to be supplementally provided to the payer and then the state of Arizona would have to receive supplemental funds from the federal Medicaid authority.

So there are a lot of bureaucracies involved here. Arizona is subject right now to a huge in migration of these eligible clients, so their budget is probably increasing more dramatically than any other state in the country right now and Medicaid is scrutinizing every request for funds. So what all that means is time, time and delays and audits and reconciliations.

So it was clear to us as that account aged beyond a year that the likelihood of us collecting on it in the near-term was not very good. However, as I said before, we have not written it off, we've reserved it which means we will continue to tenaciously pursue its collection.

Thank you very much.

Geoffrey Harris, Sirios Capital Management.

If I may, I actually had four questions just quick. A big part of the cash flow improvement looked like it came from an increase in payables. I was wondering is that something that you expect to stay the same or are those payables going to come down and thus be a use of cash in the coming quarters. That was the first question.

Second, I was wondering if you could comment on margins on renewals. You mentioned you never lost an account. You have a lot of renewables coming up in July, just curious what you expect on the margins with the renewables? Third question was the size of the bonus from Oregon this quarter and just wondering what it was for. And then the fourth question which I don't think you had addressed is what exactly was the SEC looking at at the Company? Thank you.

Michael, you want to take the payable question?

The payables, note December last year it was over $2 million -- that is '05. It was up a little bit in 2006, that's partly due to some acquired activity. I expect it to come down a little bit, not significantly. We do manage our cash closely. So our AP days -- I don't know, 45 to 60 days. So I expect it to come down a little bit, not significantly going forward.

So it shouldn't materially affect cash flow one way or the other?

That is correct. The Oregon bonus I believe was $60,000 or so, that's the normal quarterly bonus that the Board grants to its manager, the manager being Providence. So again, it's not a 501C3 organization, it's simply a state-controlled not-for-profit.

And basically, Jeff, that's representative of the profit that that entity makes. That's a member organization where Providence is the member. So as a consequence we treat it, for all practical purposes, like a consolidated entity. So if we have a percentage of revenue agreement there and they've done very well, then we may bonus that over. But it's not a significant amount. I think $60,000.

It's been consistent from quarter to quarter.

Probably $50,000 to $60,000 a quarter. The renewal question is a very good question. We have never in 10 years had to renew a contract for the same volume of clients at the same rate or a lesser rate. We don't however enjoy huge rate increases when we renew. Typically they've been a percentage point or maybe a percentage and a half. If you look at kind of what the state workers are getting when they request or their union represents them for an increase, typically they would provide a similar rate increase for the private sector. So we would expect they would be small, maybe a point, maybe a point and a half. We do not expect to renew any contract at a reduced rate nor would we expect to renew any contract where we would see more clients for the same dollar amount.

Is the 1 to 1.5% enough to maintain margins?

Yes, because we typically pass that on as salary increases to our employees. But in the past it has not eroded -- renewal has not eroded margins in and of itself. The SEC review is pretty traditional. It is public if you want to go in and look at the file. They look at everything. They look at -- they're primarily reviewing your 10-K. So they pick apart the K and ask questions about the K, they look specifically at rev rec, they look at anything that might be unusual about your business and ask a million questions.

And you respond to those and to the extent that they have issues you have to address them. The ultimate end of the day they stop asking questions, and that's kind of the last volley of correspondence you get from them is thank you, we have no further comments that this time. It is a traditional process, I think all public companies are subject to it and it is pretty encompassing in terms of what they look at, what they review and it's primarily in and around the 10-K.

Great, thank you very much for answering all those questions.

Greg Williams, Sidoti.

Just one quick question on the repurchasing program. It sounds like the remainder of the Board authorized shares is a little over 500,000 and at $23 the stock is trading below that, is it safe to say that you're continuing forward with the buyback plan?

Good question, Greg. We are currently quiet on the repurchase. We went quiet at the beginning of the week in the advance of a call. We have also elected to suspend the repurchase during our window. You may know that the Company's trading window for staff, executive directors, officers, board directors opens three days after this call and stays open for 30 days.

So anyone that might be exercising options or any of the accounting staff that might otherwise have non-public information are allowed to trade. So we've elected to not be repurchasing stock at a time when our employees might be selling stock. We'll be quiet through that window period. And then we'll again look at the price of the stock at that point. But you're right, the Board did authorize up to 1 million shares in the repurchase and we've done about half of that.

Great, thanks.

There are no further questions at this time. I would now like to turn the presentation back over to Mr. Fletcher McCusker, CEO, for closing remarks.

Thank you, everyone. Good questions. If we did not get to you today, please call any of us directly. I will be out next week to the Midwest we are visiting Detroit, Chicago, Milwaukee, Minneapolis, so we're going to try and get out and visit accounts because there have been a lot of questions about the Company and our prospects and operations in Texas. We also encourage you to come visit us if you're out traveling or at a conference, there probably will be a program of ours nearby and we would welcome any shareholder or perspective shareholder visiting us.

So we feel really good about where we are, about the risk that the Company has been able to diminish in the last few months. We feel very confident in our '07 numbers and that's before any conversation about Texas. So we're pleased to have your involvement and questions and look forward to seeing you on the road. Again, if you have anything we didn't get to, please give us a call. And again, thank you very much.

We thank you for your participation in today's conference. This concludes your presentation, you may now disconnect. Good day.