ModivCare Inc (MODV) 2011 Q3 法說會逐字稿

Good day ladies and gentlemen and welcome to the third quarter 2011 Providence Service Corp. earnings conference call. My name is Brian and I will be your operator for today's call. (Operator Instructions). As a reminder to this call is being recorded for replay purposes. I would like to now turn the call over to Ms. Alison Ziegler of Cameron Associates. Please proceed.

Thank you Brian. Good morning everyone and thank you for joining us this morning for Providence's conference call and webcast to discuss financial results for the third quarter ended September 30, 2011. The press release was issued last night. If anyone would like to be added to our e-mail list, please call Cameron 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 10. The replay number is 888-286-8010 with the passcode 84992425. This call is also being webcast live with the 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 would like to remind everyone of the Safe Harbor statement included in today's press release, yesterday's 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 financial results for 2011 and beyond. 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, including the Company's 10 K. for the year ended December 30, 2010. The Company's forecasts are dynamic and subject to change. Therefore, these forecasts speak only as of the date of this web cast, November 3, 2011. The Company may choose from time to time to update them, and if they do, will disseminate the updates to the investment investing public.

I'd now I like to turn the call over to Fletcher McCusker, Chairman and CEO. Go ahead, Fletcher.

Thank you, Allison, and good morning everyone. Here in Tucson, on my immediate left is Michael Deitch, our Chief Financial Officer; Craig Norris, our Chief Operating Officer; and with us this morning from Atlanta is Herman Schwarz, the CEO of LogistiCare.

As we indicated in our release, no company, especially this management team, likes to miss an earnings forecast. But as you can see from our top-line revenue, client and contract growth, our issues are growth pains, not symptomatic of a business in decline. The tax true-up represents business volume in states with higher tax rates and the startup cost in our new contracts in Wisconsin, South Carolina and the expansion in New Jersey represent nearly a $0.5 billion book of new business and is reflective of our client service priority, part of what we believe enhances our reputation with our clients, particularly for states in transition to outsourced nonemergency transportation.

By themselves, none of the items that contributed to our miss were material, about $0.02 to $0.03 each. But with three unbudgeted hits to our miss, it totaled $0.08. $0.02 of that is related to the tax true-up, approximately $0.03 in contract reconciliation issues unique to Q3 and $0.02 to $0.03 in additional startup costs.

As you've heard, the Missouri contract is coming back to us, partly because of a bad startup there by a competitor and we will have to restart and restaff in that state, but that also represents nearly a $75 million opportunity. We expect and will now budget startup costs in two more new states in Q4 that have yet to announce finalized awards.

Herman will have more detail on our win-loss record, but of nine incumbent contracts we won four. Three are still pending. We've lost two. New bids in four states we believe we will win in all new outsourced contracts. I'll let Michael give you the details for the quarter.

Thanks, Fletcher, and good morning everyone. In our third quarter of 2011, revenue totaled approximately $235.6 million, up from approximately $217.2 million for the third quarter of 2010, an 8.5% increase. For the three months ended September 30, 2011 as compared to the three months ended September 30, 2010, social services segment revenue increased 10.2% and transportation segment revenue grew 7.4%. Third quarter operating income totaled $5.9 million, which was 2.5% of our revenue. This compares with approximately $9.2 million and 4.2% of revenue for the third quarter of last year.

Third-quarter net income totaled approximately $2 million, which was 0.8% of our revenue. This compares with $2.9 million and 1.3% of revenue for the third quarter of last year. Third-quarter diluted earnings per share totaled $0.15 on approximately 13.3 million diluted shares outstanding compared with $0.22 for the third quarter of last year.

You will note that our effective tax rate was 48.5% in Q3, 2011 which was higher than our projected 42.5% rate. During the quarter, we finalized our state tax liabilities for 2010 by completing the filing of our state tax returns. Also influencing the Q3 rate was the effect of our nondeductible permanent tax item, the largest of which is the tax treatment for incentive stock options. When these permanent differences between book and tax expenses are considered and applied to a lower than expected pre-tax income amount, the effect was to magnify our overall effective tax rate. For the analysts modeling our business and in consultation with our tax advisors, I am projecting a 45.5% effective tax rate for Q4 and a 42% effective tax rate for the 2011 year.

At the end of our third quarter, our days sales outstanding was 33 days and our management fee days sales outstanding was 104 days. Cash provided by operating activities was good in Q3, totaling approximately $10 million, allowing us to report cash provided by operations of $31.9 million for the first nine months of this year. At the end of our third quarter, we had $48.5 million in unrestricted cash and short-term and long-term debt obligations totaling approximately $153 million. When you review our Form 10-Q for Q3 of 2011, which is expected to be filed tomorrow, you will find that we reduced our convertible debt obligation by approximately $10 million during the quarter.

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

Thanks, Michael. For the quarter, our direct client census on the social service side was a little over 57,000 clients. This is an increase from the prior year quarter of roughly 2400 clients. We had over 10 million individuals eligible to receive services under our LogistiCare division, an increase of over 2 million eligible members compared to the same quarter in 2010. All direct and indirect clients are being served from 510 local offices in 42 states, the District of Columbia and Canada. Combined between our owned and managed entities, there are approximately 10,400 employees serving over 850 government contractors' contracts.

For the quarter, we did have two small contractual payment issues that impacted the Q. These are a rare contract reconciliation activities and are no other contractual payment issues affecting the operations. With the summer behind us, the social service division has completed the 2012 contract renewal cycle with substantially all contracts renewed with relatively stable rates as a whole. In states where there has been rate pressure, we have and will continue to adjust operations to account for such changes. Externally, we are seeing some states evolve their use of managed care as a means to improve efficiencies. We're not unfamiliar with managed care by any means and will adapt where necessary to meet these increased demands.

Now I will turn it over to Herman for more details on the LogistiCare operations. Herman?

Thanks, Craig. As Fletcher indicated, 2011 has been an extremely busy year with respect to rebids as nine states where we either have the statewide contract or a portion of the state issued RFPs. Three of these states, Nevada, Georgia, and Arkansas, which in aggregate represent approximately $45 million in revenue, are still in the RFP process and no decision has yet been made.

We won four contracts, including our two largest states at risk, Virginia and Pennsylvania. Along with wins in South Carolina and Delaware, these states account for nearly $160 million in annual revenue. While I would prefer to tell you that we won every one of the other rebids, increasing competition, state budget pressures, and general vendor fatigue will generally cause an incumbent to lose a portion of its business. I'm pleased to say that, as of today, only two smaller contracts accounting for close to $25 million of revenue have been lost and one of these, Connecticut, where we were the highest-ranked bidder in the process, is still being contested. In fact, in both Connecticut and Colorado, the winning price was significantly below ours and at a level we consider to be non-compensatory.

Additionally, during 2011, we have implemented new outsourced NET programs in Michigan and Wisconsin as well as just this past week have gone back into Missouri to take over that NET contract. You will recall that, at this time last year, we lost the Missouri contract when a national competitor headquartered in that state bid significantly below our price and won the award by a 0.017-point margin. It turns out that they could not continue in the program at that price so, at the end of September, Missouri called and asked us to come back with only one months' lead time.

It has not been easy, but in the last four weeks we have hired a new staff, trained them, set up offices in St. Louis, contracted with a statewide transportation network, started taking reservation calls and on Sunday began managing trips for the state. It's a real testimony to our management team and our associates that we were able to pull it together and make it happen.

Our New Jersey expansion continues to present a challenge for us as we are working with the transportation network to get costs under control and build an efficient system. Keep in mind that the growth in this program is of a scale larger than most entire state programs. Our revenue from the New Jersey contract through the third quarter was $21 million more than the same period last year. We continue to work through the issues presented by this opportunity and are confident that in the near term we will again have the program on a steady course.

Finally, we are still finalizing the contractual arrangements with a large state in the south to begin management of the NET program in one region of that state. We expect that contract to be signed in the near term and implementation efforts to begin prior to year end.

So, while the extra staffing, travel, and telecom associated with implementing new programs plagued us in the third quarter and will continue to do so in the fourth, I echo Fletcher's sentiments that I will always take on the challenge of dealing with the issues associated with growth. Back to you, Fletcher.

Herman, thank you and congratulations on a great run.

Externally, the Medicaid budget pressure seems mostly elsewhere and is not currently directed toward our business models. At least two states recently have asked Medicaid to limit our cap hospital days. 65% of Medicaid is still spent on out-of-home care and we have continued to advocate for a reallocation of some of those funds with the states we work for and at the super Congress level. The President's budget only asks for a 1.5% cut to Medicaid and we do not see serious risks in the program from the so-called super Congress.

However, our NET competitors continue to attempt to under-bid us, and while this has not been successful in procurement it has pressured us to reduce rates in some states and given states leverage in negotiating with us. Overall it could cost us 100 basis points in net margin. We continue to win bids in overall scoring, and in one state, in our lose column has apparently been stopped from ignoring our superior technical scores. We were under-bid in Missouri last year, and as Herman indicated, the outcome of that contract was not good for either the state or our competitor. Shareholders should be pleased that we have pushed back on states that have announced an intent to award but have unrealistic rate expectations.

The collapse of the Missouri program and the requirement to rebid in the Northeast should help other states see that they cannot make decisions exclusively about rate. As indicated in our release, we expect startup issues to linger through Q4, probably about $0.02 of EPS we have budgeted now to reinitiate the Missouri contract and left some room for two new contracts where we expect to announce award announcements in the near term.

Combined with our tax increase rate that Michael went through, this could reduce our earnings in Q4 by $0.06. We will guide for 2012 after we complete our annual budget process and after the outstanding LogistiCare bids have been determined.

We continue to use free cash to delever. We will not initiate any sort of buyback so long as we are in private confidential conversations with payers.

And, Brian, with that we're ready to open the line for questions.

(Operator Instructions). Wes Huffman, Avondale Partners.

I just wanted to first touch on LogistiCare, a few questions related to that segment. What sort of startup expenses do you account for in LogistiCare to continue into 2012, if any?

Herman, go ahead. You're probably best.

Basically, what the startup costs that we incur are -- really revolve around tremendous travel expense where we bring in resources either from corporate or other locations to help kind of get a new staff and a new group up and running to deal with network development. So we'll send folks in from out of state, Wes, to work on creating that network and travel the state trying to sign up new providers. And a lot of times the states when we're taking over don't have tremendously strong data. So we do our best, but there are always times where we find pockets where they underestimated the volume or just had no clue that that volume was happening in that area. And we don't have enough providers in the system. So we have to scramble and get out there and kind of blanket the market looking for transportation providers to sign up. We do a lot of meeting with facilities, so a lot of it revolves around travel and personnel cost.

There is also just the cost of -- in startup, we generally, in order to cover off on all of those trips, we might pay what we call overrides for short term so we are paying more than what we had estimated the trip cost might cost in the long run, but to try to get the trip to run. We want to do everything we can to kind of make it as smooth as possible, understanding that there will be problems, but we don't want to end up in the newspapers. We don't want to end up on the TV. Certain the Governor and the Medicaid agency want to avoid that. So they will also ask us at times to do things that are not really contractually obligated to do that cost us money but we do it in the spirit of customer service and keeping the client happy.

And I think, Wes, what we are seeing, especially in Q4 are two types of startup costs. One is investment spending in a region before we actually have revenue and we're going to do that probably in two locations in four, and then the kind of things that Herman described that are cost overruns basically in terms of what we might have budgeted just to make certain that we have a smooth transition and a startup. They tend to be small. These are -- on a contract-by-contract basis, we're talking about a few hundred thousand dollars, not millions of dollars of startup costs.

And Fletcher, let me just add, in the first bucket where we are there ahead of the revenue, we do account for that in our underwriting. We do know that there are costs associated with starting up a contract. The problem is, we don't always know the timing of when that program is going to start, so -- and when those costs are going to actually be incurred for budget purposes.

So while we built it into the underwriting from a standpoint of pricing over the life of the contract, we can't always predict very accurately when it's actually going to hit our P&L, because we don't know when it's going to start. For instance, the state that we talked about in the south, if you had asked me early in the year we will we would've thought it would've started sometime in the summer. But it's gotten pushed off all the way to where now the start date is probably February of next year, which means we'll now start incurring those startup costs in the fourth quarter.

Okay, so what you're saying is, basically that some of those startup costs may bleed over into the beginning of next year?

Oh, absolutely -- again, depending on the timing of the start. The two contracts that we referred to that we expect announcements on, both of those at this point would likely not start until sometime next year. Depending on the timing of that, we may incur costs in the fourth quarter. We may not. If they get pushed back a month or two and let's say they go to an April start, we wouldn't start incurring those costs until the fourth quarter -- I'm sorry -- until the first quarter of next year, and in which case we'd again have no revenue from either one of those in the first quarter, but we would have costs being incurred that we have to expense for P&L purposes.

Okay, that's very helpful. And given all the moving parts that's going on in LogistiCare right now with the various contract wins and losses and retentions, is there any way that you can give us some sort of guidance on expected fourth-quarter revenues for that segment?

I think we expect revenue to be what we've previously guided to or maybe a little better. Missouri will come online; that's $6 million and change. That's probably really the only change to revenue, and most of this is going to probably occur on the expense side, Wes, a couple of cents of additional tax and $0.03 or $0.04 of additional startup costs.

Okay. And then once we kind of get past the upcoming startup expenses, what do you guys think would be a normalized gross margin range for LogistiCare?

What have we said historically, Michael? We are in the 7.5 to (multiple speakers)

6.5 range.

-- range and then -- yes, so it's going to be 6.5 to 7.5 kind of expected margins -- overall margins.

Okay, so that's still kind of a good range there.

Yes we are comfortable in that. And, again, we're not chasing contracts that are going to dramatically affect it.

And then on the -- another -- or just a question on debt paydowns. Should we kind of expect you guys to repay some of that debt early, and will you have a preference on paying down the convertible debt over the other?

We are contractually obligated to have our sub-debt reduced to $25 million before the senior debt terms. So, our current preference is exactly as you described. We're going to continue to pay down the convert, certainly at least until it hits $25 million. And it's -- what is it now Michael? It's under -- right at 50.

Just one last question. On social services, I was wondering if you could give us a few details on the M&A pipeline out there for that segment.

Nothing big and sexy. I think there are proprietary smaller businesses in that space. We continue to be challenged properly pricing them. We do not expect a lot of acquisition activity in that space until the external issues kind of stabilize. And there is -- our acquisition interests have been more of a diversification nature, Wes, than continuing to consolidate in our core business.

Okay, great, that's it for me, thank you very much.

Jack Sherck, SunTrust.

The organic growth in social services, was that everything you reported in the top line? No acquisitions in there?

That's all census related, yes.

Okay, and then the census down to [57-1]. Last year, it was the workforce development. Was it the same this quarter or something else that was a drag there? Was it nonrenewal last quarter or work force development contract, if I recall?

Are you talking about year-over-year, Jack? The census is actually up I think

No, I was just talking sequentially from 2Q.

That's generally -- I think what you are seeing there is the effect of the school programs reducing in the summer. That's a typical sort of up and down we have during the school years.

Okay. And then just following up on Wes's questions, regarding LogistiCare and the atypical expenses there, are those really going to be atypical or are you budgeting for those in the future and are we eventually going to see a return more to normalized levels?

That's a great question. We've been surprised by the contract volume. When we guide, we do not guide to new wins. So, we don't guide to new win revenue and we don't guide to new win expense. So what's caught us by surprise here is, one, some overages, but those would not be material, but just the unbelievable win record that LogistiCare is enjoying that we did not contemplate when we developed our budget. There are four states currently seeking new outsourced nonemergency transportation. We likely will win in all four of those bids. None of that, Jack, was contemplated when we developed our guidance.

Right, so then, Fletcher, if I'm following you correctly, it's more of the absolute amount of business in terms of number of states, number of new contracts that you're signing up versus if we were running at a lower rate, you know -- let me put it this way, I guess. The per-contract expenses would be the same. It's just the fact that you are adding on so many contracts you know over time other stuff you're getting in with that.

We have up and down issues on a contract-by-contract vertical basis, but we are not concerned about overall our blended margin. We will continue to experience some competitive issues in states that are being refit. Remember, most of our contracts are long-term in nature. So the margin pressure only occurs in a rebid environment and in a new bid environment. And we've had a couple of very large competitors be very bold vocal and very boastful about their intent to underbid us and that seems to be a strategy that's not working very well. But it has encouraged states, particularly in the best and final process with us, to push on price. So, I think it's safe to say that as we renew and as we win, we would expect those to be at a lower than historical margin.

Great, thank you very much.

James Kumpel, BB&T Capital Markets.

Can you talk a little bit about the nature of the pricing and the expected margins from the Missouri contract as it relates to your original bid? In other words, are the terms that you now have comparable and consistent with the terms you had bid, or did you have to take a haircut versus your original bid?

We are dangerously close there to giving away a pricing information, but, Herman, is there some kind of high-level --?

No. We did not -- remember, the competitor that kind of blew up, blew up because of their pricing which is significantly below ours. So I would never have -- I made that clear when they called I would never walk in there and take it at their price. We did -- we were able to maintain the pricing that we had bid, which did represent a takedown from historical levels because of the price competition that we knew we were going to face in that bid. But we've also benefited from membership growth that has occurred the last year.

And in terms of the terms, James, we were able to secure the Missouri contract at a little bit different structure than has happened in the past. Missouri always did -- even when they awarded a five-year contract, let's say, they always did it in a series of five one-year agreements. So you had to kind of go through a renewal each year, even though they weren't really going to put it out to bid. That's why they were able to in midstream last time to decide they needed the price savings and they went out to bid early on us. But, this time, we were able to secure the term of the contract and won long-term. So we know we were set there for close to three years.

Okay. And because you had operated there, through 2010, presumably your network and your providers and some of the folks who had worked with you before would be natural sources of re-upping I guess, right?

Correct, which is the only reason why we were able to pull it off in four weeks' time. And, normally, an implementation of this type would take a minimum of 90 days. Like I said, we are able to get up and running in 30 days. I'm not going to say everything is going as smoothly as we might hope, but that -- our relationship that we had in place in and our ability to pick up the phone and call people that we knew certainly has helped get us up and running. We did not go back -- our office in Missouri previously was in Kansas City. We've opened this new one in St. Louis. So while we were able to hire back a few folks that we had used when were there before, the staff is generally all new. But, from a provider network, yes, we are using many of the same providers.

But it's still required going through, and frankly, some of them decided that they wanted to try to take advantage of the switch and try to leverage that gap for an opportunity to ask for rate increases. So it's still required, negotiation and push back.

In the case of the two contracts you lost, I guess you covered Connecticut as much as you could. Can you give a sense of how you compared to your peers in the RFP process in Colorado from a technical score or a consolidated overall score?

I'm trying to remember, to be honest. We've had so many of these going on, I don't want to mix them up. I probably tend to focus on the price point, which First Transit, who won one that, was significantly below our price point. That was a fixed fee contract that they then asked you to -- fixed fee monthly that they then asked you to basically bid at a percentage of what they were starting at. We declined to go any lower than what they had put in the RFP, which was actually less than what we were getting paid today. First Transit went significantly below that.

Technically, it was close. That's all I can say. First Transit is active in Colorado. They have a lot of transit contracts there. So they are well-known in that state, and I do believe that in that situation from a technical perspective, we were fairly close together. I can't tell you who was one and two. I don't recall. It's a very small contract. So, once we lost it, I didn't spend a ton of time analyzing that one because we felt like First Transit had an inside edge going in because of their relationships in the other areas.

And no protests there, right Herman?

No, we chose not to protest on that one just because, again, because of the relationship that First Transit has there. And, frankly, the pricing just -- we weren't going to ever want to give that price. We couldn't make money at that price if we wanted to. We think that they are going to share some of those resources that they had with their other parts of their business which allows them to price below us there.

I see, so kind of a bundling.

Exactly.

Are there states where you are the incumbent NAT provider where they have that potential to bundle services in future bids?

Well, they actually -- sure. They are active -- they're a huge company and they're active in many of our states. Had it been worth it in Colorado, we might've been able to push harder on the conflict of interest rules that are out there from CMS. That is if you've read any of the articles coming out of Connecticut, that's obviously one of the areas that's been questioned quite heavily up in Connecticut where they do have a lot of contracts.

So, we think we can use that to our advantage to kind of make them have to at least propose on a separate basis. But again, Colorado, it was such a small contract and really was just not one we wanted to invest the legal fees and everything else in to try to protect.

Now, Fletcher, did I hear you right, that you said that pressure from certain states may weigh on net margins by as much as 100 basis points in 2012? Is that what you said, or did you say something different?

I think that's safe as you think about modeling. We build our budgets on a contract-by-contract basis, state-by-state basis, so we haven't completed that process yet Jim. But, in these states that have had bidding activity, Missouri is an example. Virginia is an example. We have lost a margin there as it compares to prior years. So, we do expect that you could see -- and we've tried to handicap that for you maybe an overall 100-basis-point kind of reduction in LogistiCare's blended margin. We don't have any real basis other than those isolated incidents so far. Again, we only see that in the bidding environment. This was an unusual year in terms of the number of rebids. I don't think -- Herman, what do we have coming up in '12 that we know is an incumbent rebid? I think just a couple of contracts.

Yes, nothing that stands out in my mind right now is being a significant contract.

So, as we budget and as we get closer to guiding, we'll try to address that overall margin issue. And we've got some things we can do on the overhead level and other kind of things to try and preserve overall Company margin. That would be our intent going into the budget side.

And just, finally, on the four new states that are now outsourcing NET contracts, you said you expect to win all four. Is that because you have already won in the RFP process and you are in the process of negotiating, or is it because technical scoring has already happened, or is it just because the level of competition there is different from maybe what you experienced in 2011?

In those four states, two have announced, one has announced us as the awardee, the other state has yet to announce. So I think in three or four of those situations, it's more than wishful thinking. In the other one, it's basically our level of confidence that we will prevail in their bid which we would expect to be announced shortly.

Fair enough, thank you so much.

(Operator Instructions). Rick D'Auteuil, Columbia Management.

I've got a number of questions. So on the social service side, the contractual payment issues, it sounded like in the pre-release that you had lost business. But I think you've just said here that you haven't lost any. Can you dive into a little bit of detail on that?

Yes. If you go back a couple of quarters, you'll remember that we did announce two very small social services contracts that were not renewed. Those contracts had a reconciliation feature to them, Rich, that has drove on beyond the end of the close of our books for Q3. It's not a material amount. It's $600,000 or $700,000. We've picked up some of that. You noticed in our pre-release we had a range as low as $0.13. We've been able to pick up some portion of that. The rest of that is still being argued over and may or may not be collectible in the near term. We'll continue to press with two payers out of Craig's 850 contracts where we have a reconciliation issue as it relates to June 30 contract rollovers.

So whatever you just collected since the pre-release, it was not a settlement on the matter. You're still pursuing it?

I would think it's safe to say, it was a partial payment.

Okay. Most of my -- so on the social service side of the business, are -- you called out I guess margin pressure on the NET side of the business. You really didn't on the social service side. You said that contracts were renewed at stable pricing I think. Is that right?

No, the only see place we've seen pressure on the social service side is in the very public Arizona issues where our Governor has reduced enrollment. We have seen a decrease in our Arizona revenue and consequently Arizona margin. But as Craig suggested, most every other place we are not seeing the kind of pressure you'd see on the transportation segment. There are isolated incidents of that, nor are we seeing census pressure. As Medicaid kind of stables and the stimulus gets behind us, states are looking more and more toward home base as a solution to some of their budgetary issues, not part of their problem. So we do not expect a lot of business pressure on that side of our business.

What about your cost side? So, if you're not really getting any pricing, can you maintain costs flat too?

It's all FTE related. We are actually probably going to reduce our benefit costs in 2012. We can maintain flatness in staff salaries. Our staff are not material in that regard. So, generally, we pass on what happens to us. If we get a cost-of-living increase, we pass that on to the staff. If we don't get one, they may not enjoy one. And, Rick, that's kind of on a region-by-region basis. We do not mandate a COLA at the corporate level. We allow each state to develop their own FTE budget and that's reflective of what's going on in their market.

So, bottom line is, where you expect margins? You expect margins to stay in what range?

No change on the social services side.

Okay. On -- I guess many of these questions will be for Herman, but what's the status of Georgia?

I'd love for you to tell me. That bid -- that RFP has been in there for months. They are not very receptive in terms of giving any real guidance as to what's going on. They just keep saying it's open and they are still working on it. The Governor here has initiated a whole study of Medicaid, brought in an outside consulting firm to help the agency restructure and think about restructuring the whole managed care side of Medicaid. So we have some suspicion that that may have slowed this down and that they're trying to decide whether or not they want to continue to operate transportation through their fee-for-service population basis or do they want to carve it into the managed care organizations like some states do. But we really don't know what's going on right now, Rick. So far they just have been extending our existing contract.

Okay. On New Jersey, my recollection is the issues popped up when you expanded into the rural area of New Jersey and a couple of quarters ago it depressed margins. I thought we got some compensation or adjustment to our rates for the experience of the actuarial kind of review. And I thought that was fixed last quarter, and now all of a sudden we're hearing about New Jersey as a carve-out again. Maybe you can help me understand that.

I think what I said at the time or I should have said at the time was we did get a rate increase. That did go into effect in July, but we knew at the time that it was only a partial fix, that we were going to have to work on the cost side of the equation as much as the help would come from the rate increase.

So, while the problem was 100%, the rate increase took care of half and the other half had to come from reworking the whole transportation network and rates going on there which we started back when I told you that we would. But it is a gigantic program. It required meeting with every single provider and negotiating all over again with every single provider and readjusting who got what trips assigned to them and how to go about it without disrupting this very massive program to such an extent that the state client would go crazy on us.

So, it's been a little bit slower than I had hoped. We are working on it and we have made progress. We're seeing -- each month, we are seeing that cost come down. But we do anticipate that it's still going to take through the fourth quarter to kind of get it in range with where we want to see it and where we expected to see it.

I think to clarify that, Rick, we actually lost money on that contract and to -- as we spent ahead of the rate increase. We're not losing money in New Jersey, but it's obviously not achieving our guided results. So, it's an issue to budget, not a contract that's actually losing money.

Okay, but just to go back, you are doing business in New Jersey and I thought it all was okay there until you took on the incremental work. So, the incremental work is that unattractive that it made a profitable business that was unchanged go to a loss position?

For that quarter, yes. What happened is, by going to those new markets or to new populations or new geographies, what the state didn't know -- because they had no data; it was all being managed out at the county level. And, frankly, what we didn't know was the transportation cost associated with that new population was much higher. Because these were more rural areas, as we talked about, they were much longer distances to go to get to Medicaid doctors that are associated with the Medicaid program there. So the trip distances were much longer, therefore the unit cost is much longer.

So, when we realized that, we went back to the state and said, look, we can't just incorporate this population into our program at the current PMPM rates. We have to get an adjustment. That's the negotiation that occurred. You know when we went through that negotiation, the state absolutely insisted given their fiscal situation that this was all they could do. We knew that wasn't enough to make us whole where we wanted to be or need to be. So we said, look, if we're going to do that, then we've got to go back into the transportation network and renegotiate. We've got to reduce that cost. And that's what we've been in the process of doing.

And I think it's safe to say, Herman we do that gingerly.

We have to do that gingerly, because despite the fact that it's our contract and our supply chain, this is still a public program and members call us -- if we have to move a member from ABC Transportation to Adams Transportation and we go to do that because Adams is a lower-cost or it makes more sense from an efficiency standpoint, if that member doesn't like it, they are calling up the state and complaining that they've been moved. They've been on ABC for 22 years and why did they have to go through this. Everyone of those calls is a ripple effect if it goes to a politician, if it goes to the Governor, if it goes to the Medicaid agency and our clients don't like to have their phones ring.

So we had to do this very gingerly and very carefully. And in spite of all of that effort and everything, we still have had to deal with those kind of calls and had to sit down with the agency multiple times to walk through it again and explain what we're doing and how we're doing it and why this is necessary. And we have their full support, but it -- had we done it overnight and blown up the system, we would not have had their support. So it's just taken a much longer time than I had hoped to kind of push this through the whole network in New Jersey.

The year-over-year numbers in New Jersey are really ugly. And, the other thing here, you are trying to make money not just on the base business you had there to begin with, but hopefully were not in the -- I said this on another call recently -- not going to a not-for-profit model. You need to make money on the rural business as a standalone, don't you?

Well, what I really need to do is make money on the program as a whole, which we are going to do, and which, as Fletcher indicated in the third quarter, we were much better than the second quarter. Where we did lose money in the second quarter we did not in the third and we expect to make money in the fourth. Will it return to the levels of margins that we enjoyed before? Probably not, and probably -- and I think we told you guys, or we told a lot of people last year, those weren't sustainable margins that we made last year and New Jersey was a big reason for that. New Jersey, we were benefiting from kind of the second year in a program where all the fraud and abuse is out. Membership was growing and transportation had gone down. So, we definitely benefited last year in New Jersey above where we should and, as we gave guidance for this year, when we brought it down and everyone wanted to know why, we said those margins weren't sustainable. So, we knew New Jersey was going to come down. As we look to next year, I would expect New Jersey to get back to about what we had hoped it would be.

I think that's the (Multiple speakers)

With incremental -- with the incremental (multiple speakers)

With the incremental growth, yes.

That's the take away from this, Rich. This is a $500 million contract for us. Our options are to walk away from it because it's got short-term issues. We believe those are fixable. And, we're basically going to spend some profit in the near term to, A, endear ourselves to the payer, not create the kind of situation that our competitors have seen in other states where they were too aggressive to create margin and ended up losing the contract. So, we think this will resolve itself. We don't intend to run it for free. We would never subsidize any states' business in that regard, but we do think that it's going to take us a couple of quarters, as Herman said, to work through those issues.

Okay. The -- if you look at the issues that could hurt you guys, utilization is one. What are you seeing on trends in utilization? And now, Herman, I'm talking about network-wide, not just one state

Yes, it's mixed. Some states we are seeing an uptick in utilization. Other states, it's kind of leveled off. I think where we have to watch as we look to 2012 is utilization compared to membership growth, because that's usually the trade-off. In many cases, we can get -- if we're getting membership growth, it covers for what we might see in a little bit of a utilization spike. In membership steadies or doesn't grow and utilization creeps up, then it puts pressure on us. And that's when we have to look at rates and reconfiguring the network.

So, I think that's going to be the real key as we try to get through the budgeting for next year. We do know of some states where utilization has shown a tendency to increase this year and will have to try to decide whether that's going to continue or are there other reasons for that. And, again, we've still got, as Fletcher said time and time again, we have to look and see what's going to happen with healthcare form and the membership trends that are going to occur if that moves forward. So, that will also be something to take into account.

Utilization -- when gas prices are up, utilization tends to go up. As gas prices moderate, we start seeing utilization tend to fall off a little bit as people get back in their own cars or have family members drive them. But I would say, it's -- we look at it really state-by-state. We do have a handful of states that have experienced utilization increases this year. It is not an environment where we can go and ask for a rate increase because of that, and it usually is a lag anyway. So if we had a utilization increase this year, we wouldn't see an impact to our PMPM probably until next July when they look at their next fiscal year.

I thought there were contractual things for an actuarial review to account for that, and it's not that you're asking for it, it's that it's in your contract.

Well, right, but that's going to be a lag. So, for instance, Oklahoma went through and did their actuarial review this year based on last year's number where utilization actually went down slightly, so the rates came down slightly. This year, utilization in Oklahoma has crept up a little bit. They won't review that again until next year, in which case we would hope we could see rates go up or at least argue that rates should go up if they -- look, let's face it. Actuaries have clients. The states are their clients. The states don't want to pay more. They're going to push the actuaries down to the lower end of that range. And we are going to push back and say no. It becomes a negotiation in some form every time.

The other element is -- fuel has been up and down and I guess more recently down from the highs, but what are the drivers? Are you getting pushback from the drivers on -- to get compensated for higher gasoline?

We get pushback from the transportation subcontractors every time we speak to them for any reason whatsoever that they need a rate increase. So --

What's your average trip cost now, Herm?

I don't know, honestly (multiple speakers). It has not -- we have not seen a massive increase and we have not given any big rate -- we have not given any big rate increases and we haven't given any major gas supplements this year like we did the last time gas got big.

I think that's the point to this, Rick, is -- I think it's like $21 -- it's been $21 all year. We are not -- we do have to constantly nurture our drivers, put programs in place that help them manage their business, but we've not seen a direct impact to our costs of trips.

So the reason I'm digging into these things is, it doesn't feel like -- I understand we've got sort of a higher than average operating margin last year because of new people under-utilizing the network that were coming on. And, it wasn't sustainable at that level. I guess I'm questioning the operating margin at 6.5 to 7.5. I mean, honestly, startup costs have to really be embedded in there. You have to make 6.5 or to 7 -- if it's really -- that's a legitimate expense, the startup costs. It's not something you just carve out. But, Herman, do you feel like you can make somewhere in that range, with the utilization and the driver pushbacks and all the other elements that you're dealing with?

In the 6.5, 7.5?

Yes.

Yes.

Okay, alright (Multiple Speakers)

I mean, but you know, I would never tell you I could make what we made last year. I mean, again, I would tell you that was just that we benefited from a lot of good things the last year. But yes, I think we can make -- look, I'm going to be conservative and tell you, yes, I think we can towards the low end of that range.

Yes, okay. I appreciate the answers, thanks.

Gentlemen, there are no more questions in the queue at this time.

Thank you everyone. Please call myself or Michael if you have a question that you didn't get answered. We are very proud of the accomplishments this year, particularly in a very difficult year. There are a few companies that are seeing that kind of top line growth we are, and certainly no one that's enjoying the win rate that we currently enjoy. We will be out and about. Call Alison if you'd like to see us and if you have any follow-up questions, please give us a call. Thank you and good day.

Ladies and gentlemen, that concludes today's conference call. You may now disconnect your lines and have a nice day.