ModivCare Inc (MODV) 2008 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2008 Providence Service Corporation earnings conference call. My name is Sarah and I'll be your coordinator for today. At this time all participants are in a listen-only mode. We will be conducting 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 call over to Ms. Alison Ziegler with Cameron Associates. Please proceed, ma'am.

Good morning, everyone, and thank you for joining us this morning for Providence's conference call and webcast to discuss its financial results for the second quarter ended June 30, 2008. You should have all received a copy of the press release last night. If you'd like to be added to our e-mail list please call Devin Rhoades at Cameron Associates at 212-554-5461.

Before we begin please note that we've arranged for a replay of this call. The replay will be available approximately 1 hour after the call's conclusion and will remain available until August 14th. The replay number is 888-286-8010 with the pass code 839-42965. This call is also being webcast with a live replay. To access the webcast go to www.ProvCorp.com and look under the event calendar on the IR page.

Before we get started I'd like to remind every one of the Safe Harbor statement included in the press release and that the cautionary statements apply to today's conference call as well. During the course of this call the Company will make projections or other forward-looking statements regarding future events or the Company's beliefs about its revenues and earnings for 2008.

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 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, August 7, 2008. The Company may choose from time to time to update them and, if they do, will disseminate their updates to the investing public. I'd now like to turn the call over to Fletcher McCusker, Chairman and CEO. Go ahead, Fletcher.

Alison, thank you very much and good morning, everyone. Our management group is all here in Tucson. With me today is Michael Deitchm, our CFO; Craig Norris, our Chief Operating Officer; John Shermyen, the CEO of LogistiCare; and Tom Oram, the CFO of LogistiCare. We will all be available to answer your questions after our scripted remarks. Hopefully we can address many of the issues related to our recent guidance revisions and communication around those revisions before our Q&A session.

Let me begin. We fully expected to achieve our Q2 forecast until we were recently advised by a payer facing an unknown 2008/2009 budget that they have elected to withhold funds associated with the 2007/2008 year until they had a clearer picture of the forthcoming budget. GAAP prevents us from recognizing this anticipated revenue.

Since mid-June the budget picture has become clearer in most of our markets; however, there are a number of unresolved issues which we will report on here in more detail. Rather than withdraw our guidance entirely we elected to forecast a base case and also communicate what our payers are telling us regarding the potential upside to the base case. We elected not to hold an immediate conference call so we could continue to gather the facts affecting the forecast and hopefully have some additional visibility between the warning and our regularly scheduled call.

We also wanted to provide specific market details which we have never done, so we wanted to be assured our field staff was involved so that we did not alienate a payer or lose a competitive advantage by disclosing proprietary data.

The biggest challenge we faced this season over any year in our history is trying to predict the timing of state budget resolutions and create a clear forecast when many state budgets remain unclear or evolving. Normally our state budgets are completed in April and we have good visibility into the fiscal year.

We have always communicated precisely what our payers are telling us. But with the legislative delays, the rapidly declining economy and reduced tax revenues, many states have been left reeling and struggling to budget revenue and expenses. This uncertainty has caused us to be conservative in our guidance as of July 1, 2008, the new budget year.

We currently contract in 43 states, most of them have complete budgets, rates are set, renewals are done. We still have some markets that are struggling with complex issues where the budgets remain unclear or where the payer has implemented measures to reduce expenses in the short term beginning July 1st.

Part of our news update is that our social services segment did not have a single contract terminate during this very uncertain summer. The NET segment had six competitive renewal situations in existing markets. We are pleased to announce that the NET segment prevailed in five of those six markets, holding onto about $90 million of annual revenue for five years or $450 million worth of renewals.

We have only one NET contract worth about $10 million up for annual renew in 2009. Our NET loss in Kentucky was not assumed in our forecast and we could not foresee the general slowdown in the 2008/2009 fiscal year. John will offer more detail during his remarks.

Our original forecast assumed $3 million of rate and new business operating income in Q's three and four for LogistiCare. We have now eliminated most of this in our base case forecast. We have lowered our forecast by $0.36 for the second half, $0.13 of that is related to LogistiCare.

Likewise California is potentially becoming a problem for us, the Governor has asked for an across the board 10% cut, the Legislature is resisting, the session remains ongoing even today with the Governor taking steps recently to cut salaries and terminate positions.

Arizona had recently advised us it does not have a departmental budget and may not have the full picture until October. British Columbia has recently advised us that it will enforce revenue caps on a per client basis. North Carolina has elected to redesign its system of care and is reducing the number of authorizations in the meantime. Pennsylvania too has a system redesign proposal developing and is also reducing authorized levels of care.

We intend to work through these issues but have begun to see margin erosion that will likely continue. These reductions in revenue did not create a material problem in the first half, but would be dramatically off our second-half forecast and we cannot predict a resolution timeframe.

We believe we've captured the downward pressure we are facing as a result of the uncertainty around the 2008/2009 state budgets. Let me spend a minute outlining some of our upside. We expect some rate consideration with LogistiCare payers, but will report that now if and when it occurs. We expect procurement announcements in the near-term related to over $100 million annually of new business. Another $70 million of previously reported pipeline activity has been delayed until 2009, not withdrawn.

We have begun our acquisition strategy and are active again in the acquisition market. Consultant reports, chiefly from Mercer in Pennsylvania and North Carolina, favor our delivery model. By creating loyalty and a willing partner reputation in British Columbia we would hope other Canadian business opportunities develop. With that I'll let Michael give you the details for the quarter.

Thanks, Fletcher. In our second quarter 2008 revenue totaled $173 million, up from $62.3 million for the second quarter of 2007, a 178% increase. 9% of this increase was from organic growth, 17% of the growth was from acquisitions in Canada and Pennsylvania and 152% of the growth resulted from the LogistiCare acquisition transaction.

For the three months ended June 30, 2008 as compared to the three months ended June 30, 2007, home-based revenue grew 27%; we grew 7% organically and 20% from acquisition. Foster care revenue grew 28.6%. This organic growth came primarily from five of our foster care markets -- Arizona, Indiana, Kentucky, Oregon and Tennessee.

Management fee revenue grew 8.7%, all organically. Second-quarter operating income totaled approximately $10.1 million which was 5.9% of our revenue. This compares with approximately $6 million and 9.7% of revenue for the second quarter of last year.

Second-quarter net income totaled $3.4 million which was 2% of our revenue. This compares with almost $3.6 million and 5.7% of revenue for the second quarter of last year.

Second-quarter diluted earnings per share totaled $0.27, or nearly 12.7 million diluted shares outstanding, compared with $0.30 for the second quarter of last year when we had almost 11.8 million diluted shares outstanding.

At the end of our second quarter our days sales outstanding was 39 days and our management fee days sales outstanding was 191 days. The reason for the DSO increase in our not-for-profit management business is primarily due to both organic and acquired growth experienced by a large Missouri not-for-profit entity we manage. This entity has experienced total revenue growth of approximately 77% from fiscal year 2007 to 2008. The increase in management fee receivable is supporting its growth. Local management in Missouri anticipates bringing the management fee receivable current on or before September 30, 2009.

During our second quarter we experienced a net decrease in general and administrative expense of approximately $1.6 million from the first quarter. This decrease was due to decreases in accounting and auditing expense totaling approximately $400,000 and compensation expense of $1.6 million offset by expense increases in legal, insurance and annual printing costs totaling approximately $400,000. Cash used by operating activities totaled $675,000 in Q2.

Each Q2 we renew our professional liability and workers' compensation coverages and we have income tax payments for both 2007 tax year extensions and Q2 quarterly estimated tax payments. Also during Q2 we made an acquisition earnout payment totaling approximately $8.8 million, approximately $6.7 million of which was paid in cash. Included in total cash used by operating activities was $1.5 million for an amount due back from an insurance carrier which we collected in early Q3 and thus we'll have a corresponding positive cash flow impact in Q3.

For the six months ended June 30, 2008 stock compensation expense totaled almost $1.2 million, almost $609,000 of which occurred in the second quarter. At the end of our second quarter we had $39 million in cash, we had short-term and long-term notes payable totaling $241 million, all related to acquisitions. We also have a $40 million working capital facility of which almost $30 million was available to us as of June 30, 2008.

After our press release last week I received several calls regarding our bank covenants. In response to these inquiries I wish to note that our covenant requirements can be found as an attachment to the Form 8-K that we filed with the SEC on December 12, 2007. Exhibit 10.1 contains the credit and guarantee agreement. In Article 8 on pages 87 and 88 you will find the applicable financial covenants. Financial covenants relate to total leverage, senior leverage and fixed charges coverage. We have forecast in our ratios based upon or financial projections through the end of 2008 which indicate compliance for that period.

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 77,821 clients. Compared to Q2 of 2007 this represents a total census increase of close to 7,000 clients.

In addition, over 6 million individuals are eligible to receive services under our non-emergency transportation program through LogistiCare. All clients are being server from 426 local offices in 43 states, the District of Columbia and Canada. We have added 108 new local offices since Q2 of 2007. Combined between our owned and managed entities there are over 10,000 employees serving 948 government contracts. This represents an increase of 110 contracts as compared to Q2 of 2007.

On the social services side our North Carolina operations are continuing to manage through a very difficult environment related to system reforms. These reforms continue to evolve and the final system design has still yet to be determined. The state has more recently significantly cut back service authorizations and this has negatively impacted our utilization trends across the state. We are seeing a consolidation of smaller providers in the state and, while unfortunate, we believe this will benefit our future business opportunities.

Our regional and state leadership teams have been engaged at all levels of state government, including cabinet level meetings and contacts with state legislators, in an effort to advocate for system changes as one of the few statewide providers in North Carolina.

During this difficult period we moved forward and obtained our national accreditation for the North Carolina operations. This is a requirement of all providers who wish to remain in the system and we are significantly ahead of this accreditation deadline.

There are discussions in the state about moving toward a preferred provider network and we believe we are well positioned. During the present time we are becoming as efficient and productive as we can while maintaining a stable workforce that complies with the evolving qualification standards in North Carolina. We have made the strategic decision to continue to support our state leadership team and position ourselves in this evolving market.

In Pennsylvania we've also seen a reduction of services as the state struggles with budget issues. Similar to North Carolina the utilization decline has negatively impacted us and we are adapting to this new reality. The Commonwealth has now also begun to address the over utilization of psychiatric residential facilities.

As Fletcher alluded, there's been a recent Mercer study that has identified Pennsylvania as having more of these residential facilities than any other state. Their findings recommend that the Commonwealth begin to expand community-based services as alternatives to costly inpatient care. We see this as a positive sign and we are working to become the preferred statewide provider in order to meet this anticipated demand.

As to North Carolina, we are seeing a consolidation of smaller providers in many Pennsylvania markets. The Commonwealth's intentions appear to be to identify their primary statewide providers who have the necessary sophistication and systems in place to be successful in this evolving system. We have a strong leadership team in Pennsylvania and we will continue to position ourselves in this evolving system.

In Canada we are adjusting our operational model due to the restrictions imposed on our per client service levels. We are taking action by reducing cost and addressing productivity issues given the new set of circumstances.

Clearly we have some markets that have become very challenging. In many states however we continue to perform quite well and as expected. We see growing client demand and clearly the need for services has not diminished and our model of care continues to be in high demand. Thank you and I'll now turn it over to John Shermyen, the Chief Executive Officer of LogistiCare.

Thank you, Craig. I will keep my remarks brief as I'm sure there are specific questions that you would all like us to address in the Q&A segment on the call. Our non-emergent medical transportation business, like any other business, is impacted by internal and external factors that we must react to and manage in order to execute on our plans.

I am very pleased that in spite of record costs in the fuel area that negatively impact our single largest cost driver, we have managed to stay within our historic cost levels. And this was a credit to our front-line operations professionals and the way in which our provider network in all levels of service, from our volunteer drivers to our (inaudible) providers have worked to enhance efficiency in routing, to lessen no shows and generally work smarter in these tough times.

We all hope that energy costs will trend down significantly from current levels, but we are not counting on that, and these pressures will continue to be a primary area of focus and concern throughout 2008. Unlike the social services division, our business is not based on annual renewals. We have multi-year contracts procured through competitive bids with rates determined for these multi-year contracts. Those rates often have an opportunity for an escalator and the annual state budget cycle may impact the opportunity for a rate increase, but not the underlying contracted rate.

The end quote's tight budgets that have impacted our 2008 forecast is new procurements have been delayed and the potential for rate adjustments has been limited or delayed. In some instances contracts that have been awarded have delayed implementation and that has reduced revenue, in others a potential pickup for a rate adjustment has been reduced.

The good news is that there's not been an NEMT RFP process that has been completed and that we have not received a contract award with the exception of Kentucky. As you know, it has always been our policy to not discuss any pending procurements as there are very strict rules about confidentiality in all phases of the process. I do feel confident in saying however, that as in past budget crises years there is an increased interest in our NEMT model as budget predictability is of paramount importance in a tight budget year. Thank you. I will now turn it back to Fletcher.

John, I thank you very much. Operator, we're ready for questions.

(OPERATOR INSTRUCTIONS). Kevin Campbell, Avondale Partners.

Hi, Fletcher. This is Nathan sitting in for Kevin. First of all, I just want to start off with a question about the $1.5 million incentive payment. Could you talk a little bit more about that, maybe how many more contracts you've had that are set up this way? And just from my rough math, I show that that $1.5 million represents roughly $0.07 or $0.08, yet you reduced guidance by about $0.10. So maybe you could address that as well.

Sure, Nathan. Thank you. That's a highly unusual event for us. I can't remember it occurring in the Company's history, 12 years. It certainly has not occurred in the time we've been a public company, it's extremely unusual, unprecedented for a payer to try and deal with a future budget by curtailing expenses in the current year. And I think it's representative of some of the chaos that we're seeing, some of the lack of clarity we're seeing in many of our states.

We expect that to be resolved in the near term. They've indicated to us that once their budget is clear that should be a resolvable issue. I don't believe, Michael, we have any other contract that has similar features where you have a bonus or a supplemental payment at the year-end based upon particular benchmarks.

We have some small ones, but nothing of that magnitude.

Nothing of this materiality, Nathan, in that regard.

Okay. And could you just -- I guess the difference in guidance from $0.07 to $0.08 to $0.10? Was there something else in 2Q that we should be aware of or something else that was going on there?

I think Craig touched on that without identifying specifically a dollar amount to that. You're on target in terms of our EPS estimates of the payer withhold. We probably would have been off the forecast by a penny or two as a result from some of the issues we're seeing in some of these evolving markets, particularly North Carolina and Pennsylvania.

Okay. And then maybe a question for John. We saw costs on the LogistiCare side increase in 2Q. Is this a result of seasonality and maybe could you talk a little bit about that?

Certainly. Yes, you're right on target. The primary driver is seasonality and it's specifically in our school segment. We have a segment of our business which is fee for service and in the school business and that obviously goes away and we begin to see the impact of that in the end of the second quarter of the year. And conversely, some programs for students that are handled within the school setting then turn into a potential utilization driver for us and so they have a bit of a double whammy which rolls on into Q3. But seasonality primarily in the school business is what you saw the impact of.

Okay, so we can expect some of the seasonality in the third quarter?

That's correct.

Okay. And then lastly, can you talk a little bit about the impact on Medicaid enrollment that you're seeing at the state level from the current budget environment and the economy?

I think both sides are seeing enrollment increase, the federal government has projected a 2 million client enrollment increase in '09. John, I think you're seeing enrollment increases in your states?

Absolutely and that is helping us on the revenue side. We assume that that trend is going to continue as we don't see -- there's not an ability for the states, even in a tight budget year, to deny services. And as we are a [capitative] program, as enrollment kicks up so does our revenue in lockstep with that.

Great. Thank you very much.

Bob Labick, CJS Securities.

Good morning. First question, I was hoping maybe you could take a step back and just walk us through and remind us how the funding dollars from the federal Medicaid dollars flow through to the states because our understanding is the federal Medicaid budget was increased and the matching that states will then put up for these programs and what does it risk to the states if they don't match these funds? Just walk us through that on both the social services and maybe just the funding cycle through for LogistiCare is well so we can get a little context on that, please?

That's the rock and the hard place part of our story, Bob. The Federal Medicaid program is a match. The Feds did increase the Medicaid budget by 6.5%. However, obviously a state has to increase their state match year-over-year to maximize that. So part of the challenges these states face is if they don't increase their state allocation they leave Federal money on the table and they'll never see it again, it will reduce their base in upcoming years.

That's part of the argument the Legislature has used in California to the Governor's proposal which provide for across the board cuts is that they actually will lose Federal money by not achieving the maximum match. So the Federal trends continue to be good for us. Medicaid enrollment is indeed up and Medicaid match is indeed up.

So that's been part of the challenges our state payers have tried to deal with in this current year is how to deal with budget deficits in their own backyard at the same time that enrollment is increasing and in fact the Federal match dollars have increased. And I don't how that plays out, John, in the transportation business, but it's an enrollment driver.

It's basically exactly the same and that means not only in our state Medicaid direct to government contracts but also in our Medicaid managed care contracts. We're anticipating the enrollment to continue to increase and, as a Fletcher pointed out, the rock and the hard place is the state having the funds to take down the enhanced match. With us though being viewed both books of business as a way to provide budget predictability it gives the state payers a lot more confidence about what they're obligating themselves to do and what the cost is going to be per Medicaid recipient.

Okay, terrific. That's helpful. And then just looking at -- you obviously gave us a lot of details today and we appreciate that. It sounds more like a timing issue given that you maintain all your contracts and everything else. Could you at least try to give us a sense of, particularly in California, how long can this drag out? Is this months, quarters, years? What's the opportunity there? When must this be resolved?

And then it sounds like in Pennsylvania, North Carolina and Canada each of those outcomes could lead to more business for you than you currently -- or than you previously had been doing. Is that the right interpretation?

Bob, I've been in the business 40 years and I've never seen a summer like this. So part of our disappointment is in our ability to predict those kinds of issues. We have never seen states go into the fiscal year without a budget and that's happening in a number of states. You have states that have budgets that don't have departmental budgets. You have universities who have yet to receive their allocation, school starts on Monday.

So these are unprecedented times and you have to believe intuitively that it can't go on for much longer. But I would have said that to you in April and May and assumed that these states would have to have clarity by the beginning of their fiscal year July 1st. So they're establishing new rules for us, new landscape that we're having to react to and to some extent making short-term decisions that don't necessarily benefit us.

We do agree with you, this is primarily a timing issue. But we've lost any capability of trying to identify the light at the end of the tunnel for you because these states are acting uncharacteristically different in terms of how they wrestle with these issues. If you look at the Pennsylvania Mercer report, it's very clear that Pennsylvania has got to change the way it delivers its system of care. At the same time may have formed committees and work groups and pilot projects which are not fast track reactions to their problem up there.

So this appears to be something that's certainly going to go on for us through the end of '08, and that was kind of what was behind the premise that we would develop this base case forecast. Because I can't tell you with any assurance today that any of these issues we've identified on a state-by-state basis will resolve between now and the end of the year.

I might mention on the LogistiCare side, at the time of the transaction with Providence we had procurements that were in process, some of those have been delayed. From our side of the house we are actually kind of used to some of those delays; we've had contracts that have sometimes gone 18 months before an award actually happened.

So on the LogistiCare side we have a positive and a negative. The positive is because our program gives states budget predictability in a tight budget year they can't delay moving forward with a procurement or a new rate with LogistiCare because it essentially already baked in the savings. What they can do though is delay an implementation or potentially a rate increase.

So without giving you too many details I would say you're spot on that certainly in both of our cases and probably even more so in LogistiCare we are suffering from some delays. I want to underscore, there's no business that's been awarded, there's no business really that's been lost, there's just business that's been delayed and rate increases and so forth that may have been delayed as well.

Great, thank you very much. I'll get back in queue. And Fletcher, we look forward to seeing you next week at the conference.

Thank you, Bob.

Kevin Ellich, RBC.

Good morning, guys. Thanks for taking my questions. Fletcher, I was just wondering if you could talk a little bit about what's different in this current environment now versus the last time the states were facing challenging budgeting cycles.

The primary difference, Kevin, is the calendar. This is not an environment dissimilar to when we started our company in 1997. It's not an environment that was dissimilar to when we went public in 2003. We've seen similar recessions in 2001. But typically the resolution to those politics occurred in the late spring.

So by the time we got around to forecasting a budget to providing guidance, whether we were a private company or a public company, we had pretty good visibility into the fiscal year. We have never seen a situation where we're here into August and have the kind of lack of clarity that we have regarding some of our payers' intentions.

But the turmoil that's produced out of this historically drives business opportunities to us. And you're seeing that develop in terms of consultant reports who are recommending reductions in out of home care, the reallocation of dollars to community-based treatment. You're seeing that in states who have acknowledged that they will move more rapidly toward the brokered transportation model.

So the history of this turmoil is that it benefits us. The primary difference is that we have incredible lack of visibility here coming into the end of our first quarter when the budgets were in fact affective July 1st.

Okay, I guess that's helpful. Do you think there is any possibility that the 10% cut in California could be mitigated? If my memory serves me correctly, last time around I think in '03 they had a 5% cut that was mitigated a little bit also.

A few months ago we didn't think that those proposals stood a snowball's chance, but here you are in the middle of August without a budget resolution in California. The legislature is still in session. The Governor is terminating part-time employees and has put all full-time employees on minimum wage. And you have an incredible standoff, Kevin, in terms of ideology between the legislature and the Governor.

So again, it's really hard for us to try and handicap ultimately what will happen. Normally even if there are cuts at departmental levels or at the gubernatorial level they would not do something to distress a federal match, that's penny wise and pound foolish. So this environment and these across the board cuts is incredibly atypical for any state that we've ever seen and is certainly unusual it would be occurring at this late a date. So I don't think anyone can tell you now what's going to happen in California.

Okay. Any idea of -- what's the outlook for the state spending environment heading into 2009? I know we haven't even finished '08 yet, but given the preliminary report from the NCSL, it seems like things are deteriorating and are there any other states that you guys are looking at where they're talking about across the board cuts?

No one has said anything publicly. I think you're right, very few people are talking about '09 because most of them are still wrestling with '08. I do think the recession came upon these states very rapidly from what we were being told, and revenue forecasts were dynamically changing to the bad constantly by legislative and gubernatorial budget office. And they ended up facing these huge deficits.

The Wall Street Journal had an article I think July 21st, they kind of identified the rapid onset of these problems and how much of it was a surprise to state government. So at least the surprise element should be factored out of this by the budget year next year. And good or bad, Kevin, we should have much more visibility hopefully in the spring of '09.

And again you have these enrollment issues which challenge the state. States cannot ration this care, they can't deny this care, they can't try and budget away from this care. They've tried that in the past and they've been sued time and time again for denying what is a congressionally mandated program.

So the states cannot balance their budget on the back of Medicaid beneficiaries and that's been proven time and time again. So I think states are going to have to deal with this. We see it as a driver to our business ultimately and things should settle out.

Now having said that, you obviously hear a note of caution in our voice because of the craziness in this current year. We're not sure how states will deal with this in '09. And most of them that we deal with have not even said anything to us about what they anticipate the '09 year to look like.

Okay. And then just one last one for Michael. How much was fuel expense for the quarter for the -- on the social services side? And can you remind us how much do you guys pay on a per mile basis?

I can tell you that we budget about $5 million a year on our segment of the business for mileage costs.

And we do reimburse on a per mile basis rather than direct fuel, Kevin, and did not change that even with the IRS change, right, Craig?

We don't change.

It varies by market what we reimburse.

Okay, thank you.

Greg Williams, Sidoti & Co.

Good morning. Thanks for taking my call, guys. Last time when you acquired LogistiCare you guided to a free cash flow guidance around $30 million to $35 million, I'd imagine that would come down. Can you maybe help us in terms of updating that guidance?

With the addition of LogistiCare cash flow really did improve our DSO especially because they're paid in the month for the month. I'm watching very closely the cash flow provided or used by operating activities, making sure that that amount is at or above our net income. And we made our earnout payment, we didn't have to borrow for that this quarter. So what I'll say to you is that, except for Q2 when it's generally down, we should have very strong free cash flow from operations.

And as he said in his script, Greg, we've got enough coverage there to deal with the bank and the debt service issue. So our debt service, Michael, is around $22 million, $23 million. The original forecasted EBITDA was around $60 million. So with the reduction in guidance obviously the biggest disappointment is that we will not delever this debt as fast as we could, but we'll still spin off free cash, but not to the degree that we identified in November.

Okay. And again, on the Arizona incentive payments, or incentive payments that don't come through, and if they did come through obviously that would help your cash, but you won't be recognizing that on the income statement?

Again, we're not identifying any particular state for obvious and confidential reasons. But any retroactive payment, any adjustment, any issue that we've identified would indeed create an earnings pick up. The challenge is the timing of anything like that. For example, if a payer that's dealing with us finishes their budget in January and gives us a retroactive payment or a payment back to July 1st it's not going to do anything for our '08 calendar year.

So that's one of the reasons that we've not made any assumptions about recovery, Greg, of anything that's affected our current guidance whether it was a Q2 payment withheld or rate adjustments that many payers have in fact told us when they get to them on both sides of the business that they would like to make them retroactive or they've requested that they be retroactive again.

Now this is going to be up to Cabinet level and gubernatorial level people, some legislative input in that. Normally when we do get a late rate or a late contract it is retro to July 1st. We've not made those assumptions in the base case forecast that we presented the market.

Okay. I just thought of another question from a cash flow perspective. Any more earnouts that we could expect or, maybe said another way, how much in earnouts are remaining?

We have two potential earnouts, one for LogistiCare and one in Canada. They will be resolved in '09 after we report -- after our audit for '08.

Okay. And of the $8 million this time around, was that split between LogistiCare and Canada?

No, that's a two-year-old acquisition, Greg. This is their second earnout payment and it's the final earnout -- right, Michael? So the only two that remain are the Canadian acquisition and their targets and LogistiCare and their targets.

Okay, that's very helpful. And talking about LogistiCare and the $0.13 negative impact, I guess what we're saying here is it's less to do with rate adjustments and it's more to do with just a delay in the ramp, is that right?

Yes. Let me just remind everybody, the first one of these statewide NEMT contracts was led in 1997; we've never had an underlying decrease in those negotiated rates so that that's not what we're really talking about, it's to the extent there's an opportunity to increase or --. In a couple of instances we've actually been awarded contracts this year that would have increased our revenue and they've just been delayed in terms of implementation so that's had a negative on this year. We're still there as an incumbent, but we're working at the lower rate on a smaller population. So those kinds of examples are what you're seeing in the numbers.

Okay, thanks. Just a final quick question on the pipeline and the $100 million that's up for procurement that you guys are going after. I imagine that's split between some core business and LogistiCare and is the Arizona Magellan procurement in there as well?

Again we're bound by confidentiality. I think we have talked historically about opportunities on both sides. They have consistently been delayed. The news we're trying to communicate today is that we believe those delays are over and both segments of the business are in active procurement mode which even makes it -- the communication around that, Greg, even tighter.

Some portion of that we've talked about historically is available to the social services side, something in the $30 million to $40 million range. The remaining piece of that rounding to $100 million or above $100 million are states that are procuring the NAT brokered model business. These are states and payers that have indicated to us in the spring that they were delaying these procurements because of particular budget issues and the lack of visibility into '09. They have now indicated to us that those procurements are back on track.

So again, we have an identifiable pipeline, but a real challenge in identifying the timeframe associated with that pipeline activity. So we are hopeful that these are imminent announcement awards that we would know something about in the short term and, again, have backed anything like that or not included anything like that in our base case guidance.

Okay, thanks, guys. No further questions.

Jack Sherck, SunTrust.

Thank you very much. Just a question on the Mercer study in North Carolina where the outcome there resulted in numerous payers having to return money to the state. Were those nominal amounts or were they enough that may have put some of those providers out of business or possibly look to be acquisition targets in the future?

This is Craig. I think the amounts are all over the place, but some of them certainly were significant and I think that's probably leading to some of this consolidation of some of these smaller providers certainly.

We've not seen North Carolina as acquisition ripe, more as market share opportunity. We are completing the accreditation requirements there, as Craig has suggested. We have left all of our regional offices and infrastructure in tact even though utilization is down. We believe that kind of consolidation actually supports a larger, stronger model that has some sophistication, particularly in its billing practices. So we think the shakeout will benefit us; it may or may not increase acquisition opportunities. We've not seen it as a rollup market, more as a market share opportunity.

And then also it's (inaudible) other states, your other markets undertaking studies similar to the Mercer study, and then when other states do bring in outside consultants like that, does that tend to accelerate the resolution of the issue or any color there?

It does accelerate it typically, states do rely on outside consultants often when there is particularly ideological debates amongst the parties or the legislature or the governor. Mercer is the leader by far of those kind of consultant activity. Both of their reports favor our model and we like to think that we are therefore aligned with the trends that states are going through.

Accelerate is a relative term because nothing happens immediately in our experience following one of these reports. It does go to the legislature. It goes to the administrative branch. There usually are studies of the studies, committees formed, legislation may have to be passed and budgets have to be reallocated. So there's a lot of Cabinet level activity, there's a lot of legislative activity to create these kinds of system changes.

So it's not going to happen immediately, but we expect that clearly as it evolves it will favor those providers that are in tune with those recommendations. And that's the business decision we've made to experience some short-term pain in those markets.

And then also, if I heard you correctly, you've added 108 offices since this period last year. What's your total office count now and at what point in time would you think about any office closures or anything along those lines?

We have 426 offices. We had about 108 of those this past year. We're always looking at are there more efficient ways to manage our offices. Most of these offices are very small coat rack offices; they're not large buildings or anything like that. And for the social service side what it allows us to do is give our local staff a place to have supervision and training that's really about all they are because most of our work is done in the home. So where there are opportunities certainly to be more efficient we're going to look for those, but the offices themselves are quite small and expensive.

If you look at the benchmarks that a company would monitor in terms of in a deteriorating environment, we are not seeing demand for our business change, we are not seeing opportunities in our business change. We are not seeing procurements in our business change. So we're not going through any sort of restructuring or consolidation or laying off people, consolidating offices because, again, in many of our markets we are flourishing. So in those markets that we specifically identify we're taking steps to manage in the short term.

But because we are bracing for anticipated business gains we're not going to demolish the business. North Carolina is a good example. We've left all of our offices open, we've maintained the infrastructure to support them even though the business is off, except for the opportunities we see there. Normally if you see business fall off like that you would begin to take steps to diminish the damage.

We on the other hand believe that this is creating opportunity for us and it's worth some short-term margin issues in order to create a much larger opportunity down the road. The question for us then becomes how long are we willing to suffer in those markets? I will tell you that we're not losing any money -- right, Craig? -- in any of these markets. This is an issue to forecast, not an issue where you have any of our operations or locations creating a loss, but it is creating a challenge to the budget and that's what we've tried to represent in our revised guidance.

And just one final question. On the direct contract count of 531 down from 705 in the first quarter, I noticed in the last few years the sequential drop has been about 11% or so, but this year it was 25%. Is that just more seasonality with growth in the school business or just some color there would be great.

I think what you're seeing there is the A to Z business, that's our tutoring business that typically goes dormant at the end of the second quarter. And because that business has been growing the contracts that go off at the end of the second quarter is also up.

Those contracts actually terminate. They are written with us through the school year, particularly September through May. So the contract itself actually terminates and then the contract count goes down in the summer. And then if you go back and look in this quarter you'll see it again, the contract count will increase come September when we renew the school contract.

Great, thank you very much.

Chris Robertson, Cardinal Capital.

This is Gene Fox, I'm here with Chris. We had several questions actually. As it relates to the $1.5 million payment, Fletcher, that I guess the state chose not to pay, is there any question as to whether or not you actually met the terms under which you're entitled to that payment and has there ever been an instance with that particular payer where you ultimately haven't been paid an obligation which you have ultimately met the terms of the contract for?

Gene, we have virtually no bad debt over our 12-year history with payers of this nature. You will have occasional issues regarding delays or reconciliations or supplemental payments, but our history in this regard is very good. We did indeed meet the benchmarks that would trigger that payment and in fact expected it, budgeted for it, advised our Board we expected to receive it. And until literally just a couple of weeks ago were advised by the payer that they were electing to withhold it until they -- and it's not just us, there are a number of providers in the same situation.

So they're basically having the opportunity to hold onto some cash until they have clarity with their '08-'09 budget. Again, the challenge for us is trying to predict a -- clearly this is under the payer control now. We may have been able to book it, but then if we didn't receive it, Gene, we would look at writing it off. So we think the more prudent action was not to book it in the first place. It created a miss to budget, but it's now not an Accounts Receivable issue. If indeed we do get paid it will be a pickup at the time because -- Michael, right? -- we would now book it on a cash basis?

That's right, Fletcher.

But they're not really (inaudible) they owe you the money, they're just not choosing to pay you right now?

We can't get into exactly what the issues are but, yes, there is not a dispute about the type of payment, the benchmarks we've achieved. They've indicated to us they are electing to withhold their decision and payment in that regard until they have clarity in their '08-'09 budget. So what you seem to be alluding to that I can't tell you is, yes, we're going to get this and when we get this it's going to be an $0.08 pickup because it's just not clear to us what this payer's ultimate decision will be, Gene. And that's the way we've guided our forward case -- our base case assumes no pickup of these funds.

Well, you would have the option, if you chose to, to sue to get it. But I presume it's a business decision on your part not to get the money today.

That in our experience is biting the hand that feeds you. I don't think we've ever had a situation where we've sued a payer. And it's highly unlikely that we would unless the relationship was over. Historically we would work these kinds of timing issues out with the payer so that we both stay in business together. Because in the long term, again, the Feds drive most of this and we've had a historical willingness to kind of work through these kinds of issues with state payers. It's highly unlikely in my opinion and experience that we would sue a payer unless, Gene, we were exiting the market and it didn't matter anymore what our relationship with the payer was.

Thank you on that score, Fletcher. As it relates to North Carolina and Pennsylvania, it seems that in those states specifically your census has gone down. The question that that brings up is what is happening to the people who you would have been seeing? Are they going to another provider or how is the state meeting its legal obligation to provide services to these individuals?

It is not so much census as it is authorizations. Part of why the state can deal with in that regard is instead of authorizing 10 sessions they might be authorizing five or three. So they can't ignore the census, Gene, they have to respond to it. And our experience is if they ration care too aggressively some external advocate is going to intervene in that regard. And I think most states are aware of that. The ACLU's activity in here is highly public and it's a balancing act the state has to endure while they're trying to, A, save money and, B, redesign the system.

We believe, and if you meet read the Mercer report, that the evolution in Pennsylvania is right in our sweet spot that it will ultimately pay off for us and it's prudent for us to hang in there with them while they go through this. We have done this, and you've been around long enough I think to know this, we have done this in a couple of markets in the past.

DC is a good example where the system was in incredible disarray, providers were not getting paid, providers were bailing, many times we were the only for-profit provider in a system like this and people would expect we'd be the first one out the door. And we usually command incredible payer loyalty by working through these issues. And that's our intent in Pennsylvania, that's our intent in North Carolina and that's our intent in British Columbia.

Regardless of any of the delays that we've identified or the lack of clarity into the budgets, these three payers are dealing with both budgetary issues and a system design that will help them save money and that is our business model. So we're going to stay involved with those three payers as they work through this.

Having said that, Fletcher, you're not in business not to make money. So I presume -- and neither is anybody else. So you wouldn't be doing this if you didn't expect that the business model to ultimately evolve into a more normal business relationship, albeit perhaps next year as opposed to this one?

And not just normal, but substantial upside. These are market share opportunities for us, Gene, that we believe will be a significant benefit to us, not just a return to our historical levels, but both of these we see as incredible opportunities to grow our market share and expand our business in these markets that are going through system change.

It's not unlike investment spending where we've elected to -- rather than to have to de novo startup we are incumbents in these states, we are well thought of incumbents and we do expect to do more than our fair share ultimately in each of these markets. So that's a business decision that we've made and we would hope our shareholders see the wisdom of.

Fletcher, can you talk about California for a second, specifically as it relates to the 10% across the board cut? It would seem that given your margins there even aren't 10% that if an across the board cut were to happen that effectively you would be unprofitable in that state. How would they hope to retain providers under that kind of business model? Also, how would they hope to keep any of the Federal matching fund?

I don't know what they're thinking in terms of the damage it will do to provider morale and provider stick-to-itiveness. That will be a challenge clearly for us. Remember, California is a cost-plus state, so whatever we end up doing there we still have the opportunity to make margin on, but it will reduce our capabilities clearly as long as those cuts are in place.

I can tell you that the legislative committees that are responsible for our budgets have sumarily denied the Governor's request for across the board cuts. So that's the standoff that has resulted in the Governor laying off people, terminating people. In Arizona that kind of standoff, our Governor responded that she was going to close the Grand Canyon if the state did not deliver her budget.

So these are unprecedented times again and we don't know how this or when this is going to resolve in California, but we cannot envision a situation where they would attack programs that have Federal dollars attached to them, that by cutting some state dollar they leave literally hundreds of millions of dollars of Federal match on the table. But I've given up trying to handicap California and are now, like you, an observer to the process.

In any of these states that you've identified, Fletcher, are they foregoing federal dollars or we're not sure what position they're taking relative to the Medicaid matching funds at this point?

Arizona is up in the air in that regard, they've foregone federal dollars before. California is up in the air in that regard. Most of the other states have accommodated and tried to maximize the match. So you've got at least a couple of states where we have some issues that we can't be entirely precise with you about, but I would not be surprised that you have some states forgo federal dollars.

In terms of California, Arizona and Canada, British Columbia you haven't seen a change in census there, you're still seeing the same number people that you've seen in the past?

Yes, that's correct.

That was Craig. No change in census. Again, reductions in service authorizations. You can tell by our census that we continue to accommodate state referrals, but they're not allowing us in those particular markets to provide the same level of care.

Had they changed the rates that you're being paid in any of those states?

We've not had any rates diminish, if that's your question. We have had delays in what we would have hoped to have been rate increases, but we've not had anyone come back and offer us a rate decrease. California is the only place where that's still up in the air in terms of how they would handle that given what happens with their budget.

Last question, Fletcher. As it relates to the significant potential earnout with LogistiCare could you explain to us, review again how that works and how you would see that based on your new forecast?

Yes. The earnout is a target that's 110% above their last year actual results. So we have a confirmation and audited EBITDA for the prior year, so it is audit to audit, Gene. So in April of '09, based upon audited results, if they achieve 110% or more of the prior year's EBITDA we will provide 9 times additional consideration for every dollar up to a cap I believe of $40 million. They are tracking to achieve that earnout even with their delays in the current market. Their delays, again, are creating issues to forecast, not to -- necessarily to perform.

So I wasn't clear what you just said, Fletcher. Does that mean they're targeting to the $40 million earnout or they're targeting to some level of earnout?

At the current pace they would achieve their maximum earnout.

Okay. Thank you very much.

Richard Close, Jefferies.

Thank you. Just to be clear on one of the last questions, I think it was with respect to California, Arizona and Canada, on census changes. And you said there's been no changes there but reduction of authorized services. So just to be clear, you've seen reductions in authorized services in those particular markets?

Yes, typically what happens is the states can't get rid of the entitlement, so client demand doesn't go anywhere. But what they can do, which we've seen, is they can ratchet down what they will approve, how much service you can provide, and in some cases like North Carolina they can change some of the definitions about what types of services you can provide. So the demand doesn't change, the census doesn't go anywhere, in fact it's probably growing given Medicaid enrollment and economic issues. But the states then have to manage the utilization side of that which is the much bigger issue for us.

I would think in California you haven't seen much of that yet because we really don't know what they're doing, but in Pennsylvania in terms of authorizations --.

More Pennsylvania, British Columbia, North Carolina is really the utilization issue.

Okay. And when did this utilization issue first come across I guess your desks?

We've seen utilization changes occurring in those three markets starting in Q2. It was not material enough for us to assume that we would have material issues into. It does create a much more serious issue to Q3 and 4 given that we budgeted for increases in those markets, Richard. So again, this is primarily an issue to our forecast. Those markets have diminished their utilization while they go through these short-term strategies which we hope eventually help us.

And we began to see some of that, as you suggested, in Q2 and that may have been a penny or a penny and a half of our issue in 2, but it's much more material than that in 3 and 4 because we had assumed we would have volume and rate increases in those markets where now we are assuming in fact volume decreases in those three markets.

And then how closely do you guys track the volumes as you progress through a quarter?

To an individual employee. Productivity is the one benchmark that Craig has, so we can tell you to a city to an employee how many productive hours are being done, what the census is, what the census is by payer. So generally we're tracking to budget. Remember, our payers have to manage this system throughout the entire year. So we have pretty good volume predictability.

And in all but those three or four markets we've identified we're not having volume or authorization issues and that's what we tried to communicate in this current forecast and release is that these are really limited to a few markets that are undergoing some very complex issues. The rest of our business we're not facing these challenges and it's not a dismantling of the system or the system of reimbursement for us as much as it is a market-by-market specific issue.

So in mid-June you would have known that North Carolina, Pennsylvania I guess Canada are the three primary markets that you were having these decreased authorizations take place?

In mid-June.

You would have known that you were going to be short of your targets on those three areas?

In mid-June you would have had May numbers, that you would have only had the first month of the quarter and that's precisely what we knew in mid-June was what was happening in May. In July you have June's numbers and in August you have July's numbers. So this is not a material issue as it relates to Q2, nor did we know it was going to be a material issue until we really saw their '08/'09 budget which they are showing flatness in and we are budgeting substantial increases in.

Okay, that's helpful. And then sort of on this $1.5 million, just to be clear. I think in the opening comments you said you've never not received this before. What's the typical timing when you find out that you're going to receive it or not receive it, what has been the past history on that? Is it like the second week of July they say that they're sending the check or how does that work?

Most states with the fiscal year ending June 30th, they have to resolve and reconcile their budget by the end of the following quarter. Some state contracts provide for them to have 180 days to reconcile 6/30 numbers. So it's never gone beyond six months. Typically it doesn't go beyond a couple of weeks. But they have either contractually a quarter or two quarters, Richard, to resolve 6/30 numbers. At some point they close their books, the auditors close their books and then they go on to the next year. So this will be an issue and, again, what we've assumed in our base case is we have no resolution of this through December.

Okay. And the $1.5 million seems like -- well, you mentioned that you don't have many contracts that have this nuance to it. It seems like a pretty big number considering you have a ton of contracts that are relatively small in nature and that was one of the I guess positives of the investment thesis when we go back to your IPO that you weren't really at risk significantly to maybe one contract or two contracts.

But I guess the question I'm trying to get at is with respect to in the past you've had -- and you mentioned this is not at risk for being a write down or anything from that standpoint because you didn't book the revenue. You've had contracts in the past where you did book the revenue where you performed above the service levels of the contract. Did you in the past, I think it was specifically with CPSA, did you ever get that money from a couple years ago that they owed you?

We've always done well with our Arizona payer. You're right, we have only a few payers with the kind of scale that could produce a $1 million or $1 million plus incentive payment. So there are a handful of states where we have that kind of volume. Historically our payers have been loyal to us and indeed where we've suffered something like this attempted to make us whole. The challenge that we have with them is they really don't give a darn about my quarterly commitments, my year end which is different than our State payers. They are a fiscal 6/30 year end, we are a December year-end.

So while they may make things -- while they indeed have, Richard, done things to improve situations where we've had prior paying, they don't necessarily line up to years or quarters. Our Arizona contract for us has been an incredible contract; it's gone from $2.5 million to over $20 million in the time the Company has been in existence. When we had a supplemental payment issue with them in '06 we were going from a $12 million contract to a $16 million contract to now a $20 million contract.

And I think that's the point that we're making generally across any of our payers is that we've done really well in this environment; we've never had a payer stiff us. We've never had any serious bad debt issues with any of our payers. And ultimately we have a history and a legacy of working through these issues. So as we suggested to Gene, it's extremely unlikely that we would ever litigate a situation like this unless we were exiting the market. And our experience is we can work these things out. What it does is create timing and rev rec problems that we have as a public company.

Yes, and that's what I'm trying to do is somewhat gauge maybe the conservatism in your dollar guidance, $1.01 guidance here. And so the supplemental -- or I guess the write down that you took coming out of the fourth quarter of '06, was that ever paid, did you get whole on that?

Our contract was increased in the subsequent year -- we did not get a (multiple speakers).

So that was sort of the payback --?

We did not get a check for $4 million. And again, the manner in which they make us whole is often different than how we would otherwise wish we had received it.

So there's a high likelihood this $1.5 million could come in either as this bonus payment or you get an expanded contract possibly?

Richard, I can't tell you. This is crossing over their fiscal year, that's the difference is you've got a payer whose fiscal year is ending 6/30. When you have payers dealing with the end of our fiscal year they have less of an obligation or a concern to deal with this. But when it's crossing over their fiscal year, if this money is not recognized in their fiscal year it will reduce their fiscal year base and they run the risk of having their subsequent year basis reduced.

So they are strongly incentivized to get all of the commitments they made in that year out. I think it's highly unusual, it's highly unprecedented, as I said, we've never seen it before nor can I really tell you how I think it will be resolved. We've assumed no resolution of it in our base case model.

Okay, great. Thank you very much.

(OPERATOR INSTRUCTIONS). Kevin Ellich, RBC Capital Markets.

Just a quick follow-up here. Fletcher, what's your thoughts on your debt? I know the convertible is not callable at this point, but given where the bonds are trading have you guys given any consideration to outright buying some?

We're watching that, Kevin. As you suggest, the bonds are trading at a discount that would require both our Board and our lenders' approval for us to do anything in that regard. We are indeed looking at that. I have a Board meeting in a week and we can tell you probably more after we get through the Board meeting, but we would then have to approach our lenders.

My experience with that is they may approve that but not without a hefty price and it may not be worth what they ask for for us to try and take those out early. So we're looking at that. We've not obviously tried to guide to that because that would not be an operational gain for us. What we've tried to do is identify our payer challenges and communicate what we think we can do from an operational standpoint. But anything like that we would certainly look at if we thought it would help the Company.

Excellent. Thank you.

Ladies and gentlemen, at this time I'd like to turn the call over to Fletcher McCusker for closing remarks.

Thank you very much. Thank you, everyone. I will be in New York and Boston both next week. We are committed to continuing to communicate to you quickly and forthrightly. We are upbeat about our model of care and still expect to grow our business at historical levels. And if we did not get to your question today or you have a follow-up question, both Michael and I are in the office and you have the unusual circumstance of having both John and Tom in our office. So if you need anything please give us a call and thank you very much.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.