ModivCare Inc (MODV) 2008 Q3 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Providence Service Corporation third quarter result conference call. My name is Camisha and I will be your operator for today. (Operator Instructions). I would now like to turn the call over to Miss Alison Ziegler from Cameron Associates. Please proceed.

Thanks Camisha. 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 third quarter ended September 30, 2008. You should have all received a copy of the press release. If you'd like to be added to our email list please call Devon Rhodes at Cameron Associates at 212-554-5461. Before we begin, please note that we have arranged for a replay of this call. The replay will be available approximately one hour after the call's conclusion and will remain available until November 12. The replay number is 888-286-8010 with the pass code 94181478. This call is also being webcasted live with a replay available. To access the webcast go to www.provcorp.com and look under the event calendar on the IR page.

Before we get started, I'd like to remind everyone of the Safe Harbor statement included in the press release, and that precautionary 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 regarded future events, or our Company's beliefs about its financial results 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 actual results are detailed in the Company's filings with the SEC. The Company's forecasts are dynamic and subject to change, therefore these forecasts speak only as of the date of this webcast, November 5, 2008. The Company may choose from time-to-time to update them, and if they do, we'll decimate the 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. In Tuscan today with me is Michael Deitch, our CFO, Craig Norris our Chief Operations Officer, John Shermyen is on the line in Atlanta, and immediately after the call I'm on my way to New York for the SunTrust Robinson Humphrey conference tomorrow.

These are indeed challenging times, and a very challenging market especially for leveraged companies. It's important for you to remember that most of our services are mandated by Congress and all those state and local governments can make and have made some short-term decisions that affect us. Ultimately we believe the federal courts and our Medicaid will intervene to assure beneficiaries receive mandated services.

In past recessions, namely 2003, as money tightened states allocated even more dollars to community based social services. Also in that year, Congress passed a $20 billion Medicaid supplemental. So far, the current administration has ignored state pleas to intervene and [medicate]. Medicaid enrollment is going up from 55 million to 57 million people. People are enrolling into poverty support programs now more desperate than ever. Many without a home, without a car, without a job.

We are more optimistic now that Congress has begun hearings to look at a Medicaid stimulus package. They center on budget and policy priorities has suggested $50 billion which is now in the Ways and Means committees in Congress.

When California cut Medicaid rates this year, the state was immediately sued in Federal Court. As is typical, that court found in favor of the Medicaid beneficiary and ordered the state to reverse its decision in order to comply with the federal mandates. The Governor determined to implement his 10% across the board cuts has attempted to avoid that ruling through the budget process, and the plaintiffs have now asked for a hearing for the judge to clarify her order. We expect that to occur in December.

The state budget crisis's came upon our payers very rapidly this year as real estate was devalued, property transfer taxes diminished, and finally, sales tax revenues declined. Challenged states were faced with unforeseen deficits. In California, the largest state with the largest deficit, the Governor attempted to unilaterally impose the 10% across the board cut. The Governor and the state legislature could not agree upon a budget which ultimately was reached with a compromise on the 10% across the board cut. Immediately upon signing the budget, the Governor vetoed an additional $500 million to Social Services programs primarily for the elderly.

We have seen two other states, and one Canadian province take steps to reduce expenses beginning in Q2 for us this year. Since then we have seen California increase our business which is typically what happens when money tightens. Unfortunately the unknown aspects of the budget and consequential lack of visibility has kept payers on the sidelines. Pennsylvanian has now accepted the Mercer recommendations and it appears they are increasing community based services. We have begun to fight back with payers that insist on balancing their budget on our backs, and have refused concessions where payers have offered us less than (inaudible) dollars or delayed rate increases.

Our Arizona rates now have not been cut in spite of a multi billion dollar deficit in Arizona, something we feared at the beginning of Q3. The state has indicated they expect to resolve the supplemental funds issue in Q1, now of 2009.

The performance to budge issues in Q3 are in part a result of payer initiated tactics that are designed to reduce expenses in this environment. We expect them to be entirely short-term in nature. There are favorable signs that the LogistiCare state that withheld its retroactive rate increase now recognizes our insistence on prompt and fair resolution of the rate increase. LogistiCare is negotiating rate in other states where utilization factors have changed due to the current economic environment.

Our primary issue since July has been our inability to predict the timing of any resolution to payer generated cost saving measures designed to maximize state revenue in the current year. We continue to believe and are beginning to see evidence that we will ultimately benefit from this recession. Our forecast, however rely on what our payers tell us, and there remains a real challenge for many of our states to predict 2009.

The House has now asked for an increase in the state Medicaid match, and state governors are asking Congress for prompt relief. The federal budget should be known by Christmas, state legislative sessions begin in January. Most of our Social Service contracts renew in July 2009.

Let me say a few words about our debt which combined with some business uncertainty has created a real issue among many of our equity holders. This has been exacerbated by analysts and others speculating that we will violate our covenance. Our credit agreement definition of EBITDA, EBITDA is very complex and much of the current speculation about a breach is the result of incorrect calculations. We currently maintain $166 million of senior debt. We have paid off $6.5 million so far this year at LIBOR plus 350, a very good rate in this market with very modest principal repayment requirements.

As of September 30 we have almost $37 million in cash and cash equivalence. We've reduced this debt by over $6 million and we will further reduce it in Q4. The Company issues our to budget. We remain able to service this debt. Our covenance indeed tightened in Q4, and like any good management team, we are watching our numbers carefully, and are in regular discussions with our lenders, and we intend to consider all options to remain in compliance including among other things, renegotiating the covenance and are paying down additional debt.

Our compliance in Q4, indeed our earnings in Q4, depends upon a number of factors. Resolution of the withheld rate increase, rate negotiations, the South Carolina contract start date, mediation in Canada, business volume in Pennsylvania and North Carolina, and other issue.

Finally, we need to talk about the goodwill impairment. A lot of consolidating companies are or will face this issue as the emanating environment deteriorates. With the credit markets substantially tightened, and deal activity off dramatically, multiples have come down substantially. An impairment analysis is required and outsourced by us in this market and is a non cash charge and does not influence our bank covenant compliance calculations.

With that, I'll turn it over to Michael to go through the (inaudible).

Thank you Fletcher, good morning everyone. Our third quarter of 2008, revenue totaled almost $167 million up from $63.7 million for the third quarter of 2007, a 162% increase. 12.3% of this increase was from organic growth. 1.7% of the increase was from acquired company in Pennsylvania, and 148% of the growth resulted from the LogistiCare acquisition transaction, both acquisitions occurring in the fourth quarter of 2007.

For the three months ended September 30, 2008, as compared to the three months ended September 30, 2007, home based revenue grew 15.2%. We grew 13.1% organically, and 2.1% from acquisitions. Foster Care revenue grew 6.7% all organically. Management fee revenue grew 11.8%, all organically.

Our third quarter operating loss totaling $138 million included an asset impairment charge totaling $141 million of which $107 million relates to our Transportation segment and $34 million relates to our Social Services segment. Third quarter net loss including the impairment charge totaled almost $141 million.

At the end of our third quarter our accounts receivable days sales outstanding was 42 days, up from 39 days at the end of our second quarter this year, down from 76 days at the end of our third quarter of last year. The DSO decrease is primarily due to the LogistiCare acquisition since the majority of LogistiCare's payment streams are collected on a current month basis.

Management fee DSO was 118 days at September 30, 2008 down from 191 days at June 30, 2008. The reduction was due to the Company acquiring assets in Illinois and Indiana from one of the not-for-profit entities we manage. The Company used its management fee receivable as partial consideration for the acquired assets.

During the third quarter we generated approximately $949,000 cash provided from operations. We had about a $5.5 million collection slowdown from our payers during the quarter. At the end of our third quarter we had approximately $36.8 million in cash. Our total leverage ratio was 4.73 at September 30, 2008. Our net loss excluding the asset impairment charge was approximately $1.4 million for the third quarter.

And with that I'll turn the call over to Craig Norris, our Chief Operations Officer.

Thanks Michael. For the quarter we ended with a total combined census between our owned and managed entities of 74,114 clients. Compared to Q3 of 2007 this represents a total census increase of close to 3,600 clients. In addition, over 6 million individuals are eligible to receive services under our non-emergency transportation program through LogistiCare. All clients are being served from 425 local offices in 44 states, the District of Columbia, and Canada. We have added 79 new local offices since Q3 of 2007. Combined between our own and managed entities there are over 9,000 employees serving 810 government contracts. This represents an increase of 37 contracts as compared to Q3 of 2007.

On the Social Services side, we are starting to see our business stabilized in the states that have gone through changes in their delivery systems we have adapted our operations and we are seeing improved budget performance. We expect 2009 to continue to see some continued challenges to payer visibility, but we also know that client demand will likely increase. We have strong stable leadership teams managing these difficult environments and our outcomes are continuing to prove the effectiveness and efficiency of community based services.

Our recent acquisition of American Work in Georgia is in its 90 day transition period. This is an exceptional Georgia provider at the forefront of deinstitutionalization for adults. We have brought over very strong management team, and we look forward to continuing our growth in Georgia.

Thank you, and I'll turn it over to John Shermyen.

Thank you Craig. The Transportation segment of our business has many of the same challenges as the Social Service segment, and like the Social Service segment, our underperforming contracts are in a few states. Increased utilization of the non-emergency transportation benefit to unprecedented levels has been the primary contributor to under performance in those contracts. Our financial projections and performance are based on lagging indicators. This means that we forecast utilization and thereby our costs based on historic experience and trends.

During the economic challenges of 2008, we have seen a significant jump in unemployment and unprecedented increase in gas prices which have driven utilization to levels higher than forecast. Fortunately, gas prices have moderated in recent months, which may lead to lowered utilization levels in 2009.

For the first half of the year in spite of their increased operating costs, we were able to work with our transportation providers to improve efficiency and managed demand to stay within budget. Unfortunately, as fuel prices continued to rise throughout the summer, both our supply chain, and the Medicaid recipients were negatively impacted.

In many markets we had to supplement our existing rates for transportation providers in order to keep vehicles running, while increased operating cost for personal vehicles meant that more eligible recipients could no longer transport themselves, or rely on family members for transportation. These recipients therefore become first time users of the non-emergency transportation system. This increased utilization outstripped the capacity of our provider networks as many of them were unable to expand their operations in the current financing environment. While we were able to direct most of this increased demand to lower cost forms of transportation, such as gas reimbursement, or public transit passes, the absolute increase in demand drove utilization to beyond budgeted levels.

We have not yet seen a significant decline in utilization as the cost of fuel has dropped. We are watching this indicator very closely. The potential future offset is that utilization experience is a measure used by the actuaries to set rates for our future contract periods.

Part of the current challenge in one of our large contracts is the fact that our utilization experience exceeds any of the risk band that were contemplated at the time the contract was awarded. Our client was hoping that this trend was an aberration and therefore was slow to engage and substantive discussions around establishing new actuarially sound risk bands. We are nearing the end of a protracted negotiation with this client which should have a positive impact on our 2008 performance. The ultimate resolution should also guide our decisions with respect to continuing to service this contract in the future.

I continue to have an upbeat outlook for our business. There have been delays in award of new contracts, but no lessening of the desire for the positive impacts that our model provides to our clients. A difficult revenue environment, state governments want to achieve budget predictability, prove service quality and eliminate fraud, the three primary components of our success over the past decade.

I'm pleased that in spite of very tight budgets, and forecasts of even lower revenue for state governments the coming year, we have not experienced nor have been asked to take a rate decrease in a per member per month [capitated] contract.

Now, I will turn it back over to Fletcher.

John, thank you very much. What we want you take away from this is every benchmark that we monitor, census, organic growth, contracts, demand, enrollment, is indeed up. However when a pair stalls or challenges a rate issue with us, it's a direct challenge to EBIT because we have already enjoyed the expenses. This is occurring, let me remind you, in only a handful of our 44 markets. And again, we believe these to be remedied in the short-term. However, as we've suggested last quarter and this quarter, we've lost what has been a continued strength for us, our ability to predict our payer's environment or behavior.

With that Camisha, we'll go ahead and open the line for questions.

Ladies and gentlemen, (Operator Instructions). Your first question comes from the line of Bob Labick from CJS Securities. Please proceed.

Good morning.

Hi, Bob.

Hi, first question I wanted to ask relates to the covenance issue. You obviously are in compliance as of the end of the quarter, and you have a $50 million revolver, so I wanted to understand, can you use that revolver for working capital purposes, and then take your cash and pay down debt of go forward basis? Or what other measures are you considering taking to stay in compliance with future covenance?

In answer to your question, as long as we are compliance with our covenance, there are no restrictions on our use of the credit line. If we were in breach, we would not be able to draw on it. So that does remain available to us which gives us both our cash and the availability of our credit line for working capital purposes.

I think we tried to address our intent with the covenance. They do indeed step down and a lot of the cushion that we had negotiated this time last year, therefore is challenging for us. We continue to monitor this very closely, and we will work with our payers because many of these events that we've described provide cushion to the covenance.

We also will work with our lenders to create some flexibility to those covenance. In this environment, Bob, that comes with a price. Our research indicates to us to expect if we engage in a negotiation to reset the covenance, that we might be looking at an arrangement fee of some sort, and probably some additional yield. And we'd be willing to do that I think assuming that was reasonable. And we do remain -- maintain the option to pay debt down in order to stay in compliance.

Okay, great. Just following up on that. Are you actively in negotiations right now to amend the waivers? Or what would be the timing for such amendments to be taken? How long would that take for you to accomplish and when could you get that done?

We have been involved in a dialog with our lenders which we believe is prudent. We have asked them what would it take to reset the covenance, create some flexibility for us. So what we can't respond to today with any accuracy is what that would cost the Company.

So I think the next step in that process, Bob, is to identify the opportunity there, the cost to the Company, weigh that against paying debt down, and it would also give us some more time to see how some of these other payer issues play out.

Okay, great. And then just one other question that relates to LogistiCare. In Q1 gross margins were roughly $9 million, and in Q3 just reported gross margin was about $3 million. And obviously you've discussed some of the causes. I was hoping you could quantify a little bit more is the difference in that gross margin level, and particularly as it relates to one payer that in negotiations with, where that stands, and what we could -- should expect going forward.

You should take that -- what we've said publicly about the payer is only that it's a multimillion dollar item. So a big piece of that, Bob, is one payer rate increase. John, Michael, you might have some other details for Bob. I'd also think there's some seasonality in this quarter. John?

Yes, there's really two primary factors. Our business does have a seasonality to it, and the third quarter of the year is our -- traditionally our worst quarter. We are paid on a per member per month basis. So our revenue is driven by census, and our demand, the amount of services we actually have to provide are a direct function of the number of actual service days that occur in a period, and Q3 is one of those periods where we have a significantly greater number of service days. So Q3 is always our lowest quarter.

On top of that, we have experienced an increase in utilization that we saw beginning to pick up at the end of Q2, and has stayed with us through Q3. Those two issues definitely have impacted us. The additional reason Q3 is "bad" seasonality, plus we have a demand that's driven by school children being out of school, and services needing to provided in a different environment which increases our utilization. So it's primarily seasonality plus this incremental additional utilization, and that utilization really occurred as -- I know you all are tired of hearing about fuel, but it was a real factor.

Under the Medicaid program, if there is a family member, someone in the household who has a car, they are the appropriate mode of transportation for a client. Conversely, if there's someone in that home that has a car, but can't afford to put gas in it, or has recently lost their job, and lost their car, those clients then become eligible for the system. So it's been a bit of a double whammy for the system. So those are the two primary elements.

Your last part of your question about the rate negotiation, we do have a contract that at the time it was signed had predefined per member per month rates tied to utilization bands. We have exceeded, we're above any of those bands that were originally in the contract, and the way that contract works, we have mechanism to have actuaries come in and look at the actual performance of the contract, the actual utilization, and since we are above any of the predefined levels, it's opened it up to a negotiation which is significantly more complex than simply an audit to a set of predefined rate. And that's why this has appeared to have gone on a significant amount of time. And it is a fairly significant delta, but at this time we're probably not -- don't have enough information to really discuss what that would be, but it would -- as it is resolved, it will have an impact in 2008.

Okay, and just so the negotiation's been ongoing. It sounds like you expect it to be resolved before yearend. Is that --

That is correct.

Okay.

Absolutely.

And that should be a retroactive for the entire period discussed, or --

Yes, this particular contract has a rate setting mechanism, and the way it works, we actually operate the contract for six months based on the performance in that six month period. The rate is set for the six months we just completed and the forward-looking six months, and so that is why it will have an impact if you will, retro back to the period which would also include (technical difficulty) setting the rate for the going forward period.

As a caveat I would add to that Bob, is resolved and recognized maybe two different things. For it to rise to the revenue recognition level, our auditors are going to want to see a contract amendment, something in writing where the payers agree to this rate.

So again, the timing is crucial in that regard in terms of when that is delivered to us. And that's been some of our challenge in forecasting Q4 is they could resolve that verbally, but not get it documented in time for us to book it in the quarter.

Got it, and if it's resolved in a way that you view is unfair, not fair, can you and would you walk from that contract?

There are basically two answers. Just so everyone understands, because we are above those rates, we are working through a process to set those rates, if we feel that those are not rates that we're comfortable with we can then move to another level of negotiation/arbitration, but we do not intend to stay in that market, provide the high level of service we do at a loss. And there is an opportunity for us to transition out of that contract if we can't resolve it. So this would not be a long-term contract that we'd be subsidizing.

Great, thank you very much. I'll get back in queue.

Ladies and gentlemen, (Operator Instructions). And your next question comes from the line of Kevin Campbell from Avondale Partners. Please proceed.

Thank you, good morning, and thanks for taking my questions. Just to ask one last question about this LogistiCare renegotiation. What sort of impact -- of the $0.15,when you guys guide it down in the third quarter, you said $0.15 was related to LogistiCare. Can you give us an idea of the breakdown of how much was related to this one customer and these negotiations, versus these other issues with utilization increasing and gas prices, etc.

To ballpark it for you, it's roughly half. And it could go one or two pennies either way, but it's basically half utilization, half retroactive (inaudible).

Okay, and then Fletcher, John had mentioned that the LogistiCare side hasn't had any customers come back to ask for rate cuts. Is that something you guys have seen on you're -- the Social Services side?

No, we have not.

Okay, perfect. Could you talk a little bit about the South Carolina contract. I know that was one that you won here recently. It was supposed to start effective November 3, unless there was some sort of protest. That seemed pretty aggressive start date, but where do we think that's actually more realistically going to start?

There has been a protect, Kevin, so John, you might comment on the timeframe typical in resolving those protests. We were not surprised. Often with the size of LogistiCare's contracts, they're more often than not protested. That was some of our ambivalence about the start date. And John, how long does it take to resolve?

Kevin, that was a contract -- typically there's a 10 day period. There was a disappointed bidder protest. The beginning of those protest hearings, I think the first hearing date is latter part of next week. Our experience in South Carolina based on the prior protest process that we went through on our existing business, we're assuming it could be as long as quarter or more just because of the holidays.

So I think realistically if you want to be very conservative, assume our start date sometime in the second quarter. Our client, in this case the group that awarded us the contract did want to very aggressively start the business because they are looking forward to higher level service, and some cost savings that were going to be delivered, and they are aggressively defending their decision. But it's not -- it's sort of out of their hands now. It's an administrative process. So somewhere between one and two quarters is probably, unfortunately, what we're looking at.

Okay, and Fletcher, perhaps you can give us some additional color on the California, North Carolina, Pennsylvania, British Columbia, and Arizona issues. California you mentioned that you had some new wins there that's going to offset that. Could you give us some detail there, and maybe what other opportunities there are in California? And likewise, just sort of go down the list and flush out a little more detail for us?

Sure, happy to do that, Kevin. What we've seen which is encouraging in terms of how this market typically works, is once the decisions were kind of starting to be made at a provider/payer level, our California business has indeed benefited even in a tight market. So the 10% cut issue probably will not be resolved until the Federal Court intervenes, in the meantime, our California operation has won enough business that we would not be affected year-over-year by the cuts and still remain optimistic that they do not prevail in that environment.

So you're starting to see bureaucratic decisions that benefit us as it moves out of a political arena. On the same token, we're seeing the Mercer recommendations not only identified but approved in Pennsylvania. They have only started that deinstitutionalization program, Kevin, in one county, but that's clearly one of the drivers to our business, and our desire to stay in that market.

Now, likewise North Carolina has progressed from Q2 to Q3. It's slower than we would like, and more challenging than we had expected, but some of what we elected to gamble on is proving up for us. In Canada, we have asked to mediate the disputes there and probably that will occur sometime in Q4. We remain optimistic that under a strict adherence to the contract that the outcome there will be a little better than otherwise we had expected.

So I think two things you can kind of take away from this is you are starting to see the ice thaw as it relates to lower level payers, procurement people, department heads, social workers, now having some flexibility in how they allocate dollars. That has always benefited us. We have challenged ourselves regarding our historical good nature with our payers, and have elected to be a little more difficult to deal with in some markets where we thought that our good natured history and demeanor might be taken advantage of. There's a little bit of a challenge that you're biting the hand that feeds you there, but we believe, Kevin, that if we had taken the serious concession in one state in a very unstable economic environment, that we'd be likely to hear from 43 other states that would expect us to deliver similar concessions.

So as John indicated, I think because of where we are strategically and where the market is moving, we have not had a rate cut imposed on us in either sector of the business. And I think that speaks to how we're handing this political process that's coincidental to the economic crisis.

Last question. Just is more of a modeling question, but for G&A, what sort of level might we expect for the fourth quarter, and how should we think about performance accruals, and I'm assuming given some of these issues that have happened this year, that they might be different than might have been originally anticipated for G&A.

It's been pretty consistent from Q2 and Q3 you'll see, so I don't know much of a big change in Q4. I mean, Sarbanes-Oxley [work] gears up and we may have some more accounting fees there, but other than that, there's nothing that I am aware of or can think of that would significantly impact it.

And expense and support, Kevin, should run about the same as they have. The issues are going to be on the revenue side regarding some of these windfall events that may or may not occur in Q4.

Okay, thank you very much.

And your next question comes from the line of Jack Sherck from SunTrust. Please proceed.

Thank you very much. A quick question about -- Fletcher, does it seem to be that the (inaudible) that you're seeing in your markets seem to coincide with the credit markets? Kind of improving or is there anything else being the driver there?

The visibility is getting better, Jack. A large part of our challenge this year which we had never seen in our Company's history was that most states were projecting budget forecasts, budget surpluses as late as June and July. And things deteriorated very rapidly, and you had some panicky decisions being made that were designed to react to that in the short-term.

Our costs are 90% variable. So we've always designed the Company that if a payer does reduce our contract, or we lose a contract, or they reduce our rate, we can react to that and reduce our expenses. We were not in a position to do that because what payers were doing was basically just attacking rate.

We do see predictability retuning to this environment. The states are anxious to see what congress does in the fall. The legislatures will determine their budget based upon better predictions from their budget office about tax revenues. It doesn't look any better. We don't see necessarily an improvement, but it should be more predictable. That's an environment historically that's favored us, where people are making planned decisions on how to better spend tight dollars.

Two things are important catalyst for this state. One is the Federal Court decision in California. If the Federal Court waivers to any degree, it might encourage the states to make further cuts to human services. And then the mood of Congress and the desire for Congress to provide some sort of Medicaid stimulus package as part of the overall bailout mentality -- remember states cannot operate under budget deficits, so all of our state payers, 44 of them, are obligated to balance their budget. The federal government on the other hand can operate at a deficit, and could make money available through one of the political scenarios that are developing to enhance state Medicaid spending.

So those are the kind of things that we'd not heard talk about, Jack, prior to literally the last few weeks.

Great. So Fletcher, if I'm following you correct, then really none of your payers were complaining about the commercial paper market or anything along those lines?

You've had some rhetoric in that regard at the highest levels of state government. Governor Schwarzenegger's made a comment, you've heard other comments say that they are quite concerned about their ability to issue commercial paper, and I do believe that part of our payment slowdown is to some extent states bracing for cash flow issues. But we've not had anyone really translate that into contractual conversations regarding rate or volume.

Great. Thanks very much.

And your next question comes from the line of Rick D'Auteuil from Columbia Management. Please proceed.

Yes, it's Rick D'Auteuil. Just my question's if we go back to when you reset the guidance to no worse than $1, there were some details in that announcement that included states that -- North Carolina, Pennsylvania, Canada, that had either put ceilings on your services, or were capping your services. And you had, I think, at the time said on a temporary basis you were willing to accept poor margins in those geographies, but longer term, you expected to gain something. I think today on this call you said North Carolina, Pennsylvania looked like you might have some of that -- the pluses coming. Where have you adjusted your expenses because the metrics don't work on -- with the caps that have been put on you?

We have made expense adjustments in each of those markets, Canada, Pennsylvania, North Carolina. We are running expenses higher than we otherwise would because we've made a commitment to the payer to stay open in some markets, Rick, while they work through these issues. The new business in California will offset any risk of an operating loss in that state. So we've avoided having to deal with any expense issues in California. We have frozen salaries, we have frozen hiring, we have reduced corporate overhead in this environment, but again, most of this -- the volume has not dissipated. So we have contractual obligations regarding the ratio of counselors to clients, hours spent with clients, and those kind of things. So there's not a lot of opportunity particularly if they're attacking rate retroactively that we have to reduce expenses until that's resolved.

The issue in Canada was a concern that we were too profitable in those contracts, and we've had to react to that. And that is one of the things that this Company has always bumped up against. One of the reasons that we've talked about our intent to keep our margins low is that occasionally we will bump up against a payer tolerance issue as it relates to profitability. But each of those markets, and we identified them specifically to give some transparency to the issues that we were facing, is that it's not the across the board, and now in those markets that we've identified on the Social Services side, we're seeing improvement, Rick, in all of those.

We don't currently contemplate exiting any of our Social Services markets.

Just to drilldown a little bit. North Carolina went out I think with Mercer and did a very detailed analysis of some of the suppliers or vendors or outsourcers they were using. You guys were one that passed the test. The overwhelming majority didn't. What are going on with those people that didn't make the cut. Are they in fact still providing services to North Carolina?

The state has cut back services to everybody as they work through the consolidation recommendations. You're doing your homework. You really onto the issue exactly in North Carolina. The Mercer recommendations recommended a serious consolidation of providers. In our experience, that is politically slow. There are a number of constituents associated with providers that the state may opt not to contract with. They have Boards of Directors, they have legislative friends, they have clients and constituents. So it's not something where you just overnight change your provider group. But the process is ongoing. You are right, that we did benefit from the Mercer recommendations and the state audit, and that's part of the reason we've elected to hang in there.

We've seen enough momentum there to give us hope and a strong commitment to stay in that market.

Okay. California, you're update today is you were now unaffected by the cuts because you've got some offsets. That sounds like a top line review. It doesn't to me sound like a bottom line review. I mean, other words, it feels like earnings are still affected. Maybe you're not running losses, but you're not getting a fair margin there. Is that correct?

The core book of business is about $40 million. About half of that, $20 million, is effected by the Governor's cuts. They did exempt the -- and have exempted the referendum dollars from that which we were concerned about a quarter or so ago. So the current impact if implemented of the 10% cuts is about $2 million of revenue, and our profit there, Michael if I'm wrong correct me, is about 7%, 8%. So that's the true impact of the cuts.

We have won enough business, more than enough business, Rick, to offset the revenue losses associated with that, but you're right. We still have $2 million at risk there, and the margins associated with that.

So I mean, is the shortfall at the maximum in California at $2 million times 7% or 8%? And that's it?

That's it now. Yes, I mean, it was much greater than that. The additional cuts were designed to affect everything. They have released new business in our sector which was frozen while the budget was not enacted. And the only consideration now for the cuts is to Medi-Cal, the California Medicaid program. That's where the federal Court has intervened and said, the Governor does not have the authority to implement those cuts. But assume that if that was implemented, it would affect about $2 million of revenue growth.

Okay, so I guess, bottom line, just the Social Services side of the business, margins have historically been around 7%, I think you guys have guided to. Today they're less than that. I don't know if you can provide that today. And where do you expect them to be a couple of quarters from now when things stabilize?

We don't see any reasons we don't ultimately get back to our historical margins which are at a minimum 7%. They've actually been 7% to 9% on the Social Services side. As we work to these rate issues, the withholding of rate, which again punishes EBIT, we're not having any margin pressure except for California. And these other states that we've discussed where we have margin erosion, Rick, because we've elected to keep an expense level a little higher than we otherwise might waiting for the state to come to us. In all of our other markets, in 40 of our other markets, we are not having a rate nor a margin issue in the Social Services seg.

Okay, thank you.

Ladies and gentlemen, (Operator Instructions). And we have a follow-up question from Kevin Campbell from Avondale Partners. Please proceed.

Thanks. Could you talk a little bit about your exposure by state? So we have sense for maybe who your top five or ten states are, and so we have a better sense of what's going on in each of those individual state levels budge wise. I think that would be helpful.

It's not sitting on the desk with us, and I'd probably need some help from John, Kevin, but there's no single state where we have an incredible concentration of risk. I think our largest states are maybe Virginia, which is maybe a $50 or $60 million book of business. California we talked about. Arizona is $25, Florida is $50-ish. Pennsylvania is $40-ish. John, you have concentration in a couple of states, but nothing really bigger than $50 million, $60 million.

That's correct. and one of the (inaudible) impact is a portion of -- for example Virginia, is managed care business not state business, but you are correct, Virginia today all in is around $80 million book of business which is a combination of commercial and our date payers. Pennsylvania's a significant one in the mid $30s. South Carolina, and Connecticut is not that large relatively in that one is a real combination of managed care and state business. So I think our concentration is really not that significant and as we said earlier, even though those -- some of those states do have some revenue issues and budget issues, they've not come back to us with any rate negotiations and also should probably remind everybody, none of those state that we just mentioned, or in fact very few of any of the states that we have will be up for a re-compete in 2009, so that we have a lot of visibility going forward on the business that we have.

I recollect in fact, I think John, there's only one state that's up for renewal in '09, right?

Yes, and that's one of those states that frankly created one of our challenges this year which was the state of Connecticut which was -- we were awarded the contract and there were some issues with the state, and the state decided to pull that back, keep us at our existing contract, and we expect that will be back out for bid probably in the first or second quarter of next year.

Okay, and just to get back to a comment that you had made Fletcher, with one of Rick's questions in California. Previously you've said, again, $20 million would be impacted going from 7% margin -- a 10% cut there is $2 million and that was kind of the risk, $2 million in EBIT. And I was confused based on what your response at one Rick's questions, is it still $2 million in EBIT that's at risk there?

Kevin, if they make the rate cut retroactive there's nothing we can do about our historical level of expense. So from July through October, you've got a quarter or a third of that revenue in place. Then if they make the cut retroactive which is the Governor's current plan, it will have a greater impact on earnings than it does on a prospective basis. If the cuts are in place prospectively, we can reduce our expenses and maintain our margins at $18 million of revenue. But you're correct, is that there is more risk to us if the rate is retroactive to that, and we won't know that probably until the end of year.

But I mean, I would think you guys obviously are already booking those expenses in the current quarter, and --

It's cost based contract, so yes, you're right. We are.

And so there really was -- there's only I would think potential upside from it going forward. Is that the right way to think about it?

Yes, that's appropriate comment.

Okay. And then lastly, obviously getting back to your leverage and your ways to reduce debt, have you guys given any consideration to some sales of particular lines of business or exiting -- selling Canada or something like that to reduce debt, and get much -- well, below the required covenance, or is that not really on the table?

We have not discussed that. I mean, (inaudible) we haven't discussed it we have not tried to implement any plan that would breakup the Company or sell any assets. We believe the debt is resolvable through conversations with the lenders. That some deleveraging of the debt, and that's pretty much been the focus of our conversations. And our cash position helps us play offense in that regard, Kevin. It would be more challenging environment clearly if we were in breach, and had less cash, and working capital available. But so far we've not entertained any notion of breaking the Company up, or selling any of our assets.

Okay, and then looking at that -- the debt ratio, the 4.73 times, and you were refereeing to your senior debt of $166 million. Does this not include any analysis of the convertible debt? The total debt to leverage ratio at 4.73 as the total debt. Does that include the convertible debt as well?

There's two ratios. There a total debt and then there's the senior debt ratio. I think the 4.7 one, Michael, is --

Is the total debt.

Total debt ratio, yes, and that's the one we're the closest on. So any opportunity to deleverage even on the converse side, I think we have talked about this, any desire on our part to deal with our converts which are trading would have to be approved by the senior lenders. So it's not as simple as us just buying those back. That would have to be part of a package that the senior lenders approved.

How much then -- how much working capital would you need to maintain just sort of for normal business operations because the idea of you paying down cash to reduce that debt, but then borrowing against your credit facility kind of offsets because then you're just raising your debt levels back again.

With LogistiCare prospectively paid, they can operate actually with networking capital, negative working capital. So something under $20 million. Somewhere between $10 and $20 is all we need to run the business.

Okay, so theoretically then, in terms of reducing that debt, you have capacity to go from the 37 to the $10 to $20 million, so whatever those numbers end up being, $17 to $27 million total.

And depending on how you collect in Q4.

Right, exactly. Okay. Well, what are your thoughts on collections? I mean, obviously it was a slow quarter for what is typically a seasonally strong one for you. Have you already seen improvements here through October? Do you expect it to recuperate what you didn't have here in the third? Do you expect to recuperate that and more in the fourth?

What I can tell you there is we've borrowed nothing from the working capital line to fund operations. So we're [self funding]. And I did (inaudible) check in treasury, or I do a couple times a week, and they're saying that collections have improved early on in this quarter, so -- Q4, so. I cannot give you a number, but our treasurer said yes, we have improved our collections so far this quarter.

Okay. Thank you very much.

Thank you, Kevin.

At this time there are no questions in queue.

Thank you, Camisha, thank you everyone. Jack, I'll see you tonight, I guess. I'm headed to the airport right after the call. We remain very optimistic about the long-term design of our business. We believe we are braced for these short-term challenges. The need for our services has never been greater. We are extremely proud of our staff's accomplishments this very difficult time for us in the equity market. The quality of our care has never been better, and ultimately, that is what attracts our payers, and what they are willing to pay for.

The management team is committed to stabilizing our payer environment, returning predictability to this business, and we'll be properly incentivized to create shareholder value.

If we did not get to our question today, please call Michael or I, and I'll see some of you in New York tomorrow. Thank you very much.

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