ModivCare Inc (MODV) 2016 Q2 法說會逐字稿

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-- ladies and gentlemen, and welcome to the Q2 2016 Providence Service Corporation's earnings conference call. (Operator Instructions) And as a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Bryan Wong. Sir, you may begin.

Good morning and thank you for joining Providence's second-quarter 2016 conference call and webcast. On the call from Providence today is Jim Lindstrom, Chief Executive Officer, and David Shackelton, Chief Financial Officer.

We have arranged for replay of this call which will be available approximately one hour after today's call on our website, www.prscholdings.com. A replay will also be available until August 16 by dialing 855-859-2056 or 404-537-3406 and using the pass code 56389155.

Before we get started, I would like to remind everyone that during the course of this call, the Company may make comments which may be characterized as forward-looking statements under the Private Securities Litigation Reform Act. Those statements involve risks, uncertainties and other factors which may cause actual results or events to differ materially. Information regarding these factors is contained in yesterday's press release and the Company's filings with the SEC.

The Company will also discuss certain non-GAAP financial measures in an effort to provide additional information to investors. A definition, calculation and reconciliation to the most comparable GAAP measures can be found in our press release and our current report on Form 8-K furnished to the SEC on August 1, 2016.

Finally, for simplicity, we will be speaking in US dollars when referring to such things as contracts and revenues. Amounts translated from other currencies, including the British pound, have been translated at the exchange rates and the fact for the corresponding time period.

I would now like to turn the call over to Jim Lindstrom.

Thanks, Bryan, and thank you all for joining today's call, and thank you to my Providence colleagues around the world for their dedication to our core values, particularly around providing the highest-quality, customer-centered care. I'm going to spend a few minutes on a few strategic highlights on the call and then hand it over to David Shackelton, our CFO, to cover the financial highlights.

As always, our focus during the quarter was on creating intrinsic value on a per-share basis through, most importantly, operational excellence and, second, towards deploying capital towards repurchasing shares instead of deploying capital towards acquisition candidates this quarter, which largely continue to have valuation expectations that are inconsistent with our investment criteria.

Our US Healthcare Services segments had another quarter of solid performance, with overall revenue growth of north of 10%, slightly exceeding our long-term growth expectations for this area.

First, I will start with Matrix. Matrix continues to be a leader in the comprehensive risk assessment field. In order to drive growth above the 5% expected industry growth in the Medicare Advantage population over the next several years, we are pursuing a number of avenues outside the traditional risk assessment field for Medicare Advantage.

First, as I've mentioned before, we are continuing to invest in chronic care. We are also ramping up other new offerings to further improve the quality of care delivered in the home and to better identify and close gaps in care. For example, last year, Matrix introduced pediatric assessments for the managed Medicaid market and also launched two chronic care pilots. This year, the team continues to introduce new offerings such as Matrix diabetes care intervention, where we will use predictive analytics to identify members who may be at risk of diabetes and would benefit from in-home and telephonic contact with our extensive nurse practitioner network.

Second, as we have talked about before, we have ramped up our investment in sales and marketing over the last two to three quarters, culminating with the hiring of a new Chief Growth Officer in Q2.

While Matrix's revenue declined on a year-over-year basis versus a very strong first half of 2015, volumes outside of our largest client in 2015 actually increased north of 30%. So while we think that our 8% to 10% 2016 stretch revenue growth target is unlikely to be achieved in the full year, our second half is expected to show year-over-year growth in this 8% to 10% range thanks to our sales team adding seven new clients this year, support from our existing clients and a target list that now has over 150 companies on it.

As you can see, operational excellence also led to stronger margins, higher than we expected, and should contribute to full-year margins consistent with last year's approximately 24%.

We remain favorable on the operating fundamentals of Matrix and, as mentioned, look forward to adding this very well-run in-home healthcare platform -- or adding to this very well-run in-home healthcare platform through both organic and inorganic growth.

Moving on to NET Services, or LogistiCare. First, the quarter's performance was highlighted by new client wins and contract starts in California and improved financial performance in Florida and Pennsylvania due to such -- items such as utilization levels.

While our existing Missouri contract was renewed, South Carolina remains under appeal, and we have not heard yet on New Jersey. We have little insight as to when we will hear on New Jersey, although the existing contract was extended through the end of August.

Second, Q2 profit was negatively impacted by investments in personnel and in a longer-term value enhancement project. As mentioned in our recent shareholder letter, this value enhancement project is centered on deploying call center best practices, which will improve productivity and increase the use of technology in our client communications amongst other areas.

We will also focus on better utilizing our network of over 5,000 transportation providers. Through a variety of initiatives in these very large buckets of spend, we expect to enhance our service levels and extend our strategic competitiveness over the next six to 24 months. We are not yet prepared to size the opportunity for you, but we view this area as one of the biggest opportunities for organic value creation over the next two years.

Moving on to WD Services, a segment which is largely comprised of the May 2014 acquisition of Ingeus. First, while not yet consistent with our long-term profitability goals, WD's adjusted EBITDA before Mission Providence was positive this quarter. Our continuing countries, with the exception of France and the startup costs in our offender rehabilitation program, were all profitable and, overall, generated an EBITDA margin profile at or above our long-term target of 8% to 10% for the second quarter in a row.

Second, WD's overall profitability remained under pressure due to losses in France where the startup phase of a large contract remained subject to lower than anticipated volumes and an oversized infrastructure. On France, Ingeus has deployed an operational improvement team to help turn this country profitable by year-end.

Results were also pressured by startup costs in our offender rehabilitation programs, otherwise known as [ORP]. This program is operating under a seven-year contract, and we expect to have annual revenues in the $75 million to $100 million range and acceptable margins by the end of the year. To support the anticipated margin expansion of our offender rehabilitation program as well as to ensure high-quality services, we recently hired a former senior leader from MAXIMUS as the program's COO.

Third, the Mission Providence JV, which was formed in late 2014, won incentive contracts since April 2015 that was smaller than expected and commenced operations in July 2015. Mission Providence's volumes under these contracts that we did win have been lower than expected, resulting in Mission Providence having a larger infrastructure than appropriate. In response, our Ingeus operational improvement team was recently deployed to Australia for the quarter -- in the second quarter and is in the process of implementing a plan to both increase volumes, outcomes and productivity. While we are acting with urgency, we hope to see breakeven profitability sometime in the fourth quarter of 2016.

In conclusion, on WD, we will reiterate that outside Mission Providence in France, our core WD operations were profitable despite the noise around such areas such as Brexit. I'm sure that we'll see some short-term effects from Brexit due to government indecision and some smaller contracts that have some funding exposure from the European Social Fund.

However, the secular trends remain in our favor. And, as we have with LogistiCare, we at Providence have started to work more closely with the Ingeus team around longer-term value enhancement strategies, which we intend to report more on over the next few quarters, to ensure our long-term goal of 8% to 10% margins. These value enhancement strategies will not only support Ingeus' financial goals but also enable improved client service.

I will now hand the call over to David.

Thank you, Jim. Consolidated revenue in the second quarter of 2016 was $450.6 million, a 7.7% increase over the second quarter of 2015. Adjusted EBITDA was $30.7 million, or 6.8% of revenue, compared to $31.6 million, or 7.5% of revenue, in the second quarter of 2015. This 70-basis-point margin contraction was primarily driven by transportation utilization returning to more normalized levels within NET Services and continued new program investment within WD Services partially offset by productivity improvements within HA Services.

Income from continuing operations net of tax was $4 million or $0.21 per diluted common share versus $0.16 last year. Adjusted net income was $13.1 million or $0.70 per diluted common share versus $0.67 last year. In addition to a lower income tax provision and lower share count resulting from our share buyback activity, a 50-basis-points reduction in G&A expense as a percentage of revenue helped contribute to an increase in EPS and adjusted EPS in Q2 2016 versus Q2 2015.

CapEx in Q2 was $13.8 million, bringing first-half CapEx spend to $23.6 million. Approximately 50% of year-to-date CapEx has gone to WD Services, primarily for IT and new facility investments related to the offender rehabilitation program as well as other new programs in the UK and France. The other 50% of year-to-date CapEx spend went towards IT investments aimed at transportation, provider and call center efficiencies within our US Healthcare Services segments.

Although we expect CapEx to decline in the second half of the year, we now expect full-year CapEx to be above the top end of our previously estimated $30 million to $40 million range. The additional spend is coming out of WD Services, where IT and facilities costs relating to new programs are higher than originally anticipated. Looking forward to 2017, we are focused on reducing WD Services CapEx as we put spend associated with new large programs behind us.

Working capital in Q2 was a $13.6 million cash drain, primarily the result of prepaid income taxes, insurance policies and expenses for WD Services youth summer programs. A reversal of the AR decline experienced by NET Services in Q1 also contributed to the increase in working capital. Year to date, excluding taxes on the sale of human services, working capital has actually provided a $32.6 million cash benefit.

On taxes, our effective rate remained elevated and came in for the quarter at 56.9% due to losses in foreign jurisdictions for which we are not seeing a benefit due to their history of losses. We expect to see a similar elevated effective tax rate throughout the remainder of the year.

On our share repurchases, during Q2 we bought over 273,000 shares for $12.9 million, or $47.36 per share. Since we began repurchasing shares in 2015 and through today, we have spent approximately $74 million to repurchase approximately 1.7 million shares, or just over 10% of our total shares, at an average price of $43.86.

Moving to our US Healthcare Services segment, NET Services revenue increased approximately 14% to $309.2 million in Q2 2016 versus Q2 2015, driven by new contracts and membership growth. As anticipated, this growth rate is expected to decrease during the remainder of the year, bringing full-year revenue growth into the high single-digit, low double-digit range.

Adjusted EBITDA at NET Services in the second quarter of 2016 was $20.7 million, or 6.7% of revenue, versus $21.2 million, or 7.8% of revenue, in the second quarter of 2015. While increased utilization contributed to this year-over-year margin contraction, a shift of long-term incentive plan costs from Corporate to NET Services as well as investments into the value enhancement project that Jim mentioned earlier also contributed to the decline. While we expect additional quarter-over-quarter margin pressure in Q3, driven by seasonally high utilization in the summer months, we are aiming to deliver a full-year margin closer to 7%.

At HA Services, also part of US Healthcare Services, volume increased slightly in Q2 2016 versus Q2 of last year, while our ASP decreased largely due to customer mix. In the first half of 2016, revenue declined 8.8%, primarily due to reduced demand from a client who drove a significant portion of our volumes in the first half of 2015. Outside of this customer, as Jim mentioned, volume increased over 30% in the first half. Because demand for this customer fell in the second half of 2015, we expect positive year-over-year volume and revenue growth in the second half.

Adjusted EBITDA for HA Services increased in Q2 to $14.6 million due to a 375-basis-point margin expansion. In addition to continued efficiency gains, a number of other factors contributed to this unusual expansion for the quarter, including favorable geographic and customer mixes as well as a $1 million pickup from forfeited long-term incentive awards, which has since been reallocated to new employees and will thus be expensed over time going forward. Although we do not expect to achieve this level of [EBITDA] margin we saw in the first half, and particular in Q2 going forward, our full-year outlook on adjusted EBITDA margin continues to improve, which is offsetting the dollar impact to adjusted EBITDA of volume growth being below our stretch goal.

In Q3, we are expecting margins to contract into the low 20% range as we build additional capacity ahead of an expected uptick in volumes in Q4, resulting in full-year margins consistent with what we achieved in 2015.

Within our global workforce development segment, revenue declined 3.1% in Q2. However, on a constant currency basis, revenue increased 1.6%. Prior to the impact in Mission Providence, adjusted EBITDA for the quarter was $2.3 million, or 2.6% of revenue, versus $4.7 million, or 5.1% of revenue, last year. This decline was due to startup activities at our offender rehabilitation program that were delayed from 2015 into the first half of 2016. For the full year, we still expect adjusted EBITDA margins prior to impacting Mission Providence to be in the mid-single-digit range, which implies improved margins in the second half of the year.

Mission Providence's adjusted EBITDA in Q2 was negative $1.2 million. Although losses narrowed on a quarter-over-quarter basis, we are implementing measures aimed at increasing job advisor productivity and improving job verification processes. Our team has also started to reduce the cost side of the equation in an effort to turn the JV profitable by year-end.

Adjusted EBITDA at Corporate for the quarter was negative $5.8 million and included a $1.2 million benefit from cash-settled equity awards. Remember that such awards are effectively marked to market each quarter, so increases and decreases in our share price result in expenses and benefits, respectively, to our P&L.

Given the higher anticipated audit and SOX costs experienced in Q1, higher legal fees in the first half and the burden of approximately $1.1 million of remnant human services expenses so far this year, we are now expecting adjusted EBITDA at Corporate for this year to be roughly in line with last year.

I will now turn it back over to Jim to close the call.

All right. Thanks, David. Hopefully as you have heard in today's call, we are very focused on supporting our segments' leadership positions without only capital, but also by supporting our CEOs and their teams who are leaders in their industry domains.

As we enter the second half of 2016 and improve our cash generation through reduced CapEx in 2017 and 2018, reduce startup costs at Ingeus, and we start to see the benefits of our value enhancement projects, we feel pretty good about our financial profile over the next few years. We also believe that Providence will increasingly become a preferred partner and attractive option for companies and leaders who are seeking an alternative to traditional private equity or strategic owners.

In order to prepare for these potential partnerships, we added to our Board of Directors and holding company team during the quarter. We added three new directors with current or prior CEO experience and demonstrated success in both investing and operations at institutions such as Warburg Pincus, GCA Savvian, Robertson Stephens and Alexion Pharma. We have also rounded out our holding company investment capabilities with team members who have previously worked at world-class institutions such as Cravath, Swaine & Moore, Blackstone Private Equity, and GE.

Finally, as I said in our shareholder letter, I would like to thank each of our Providence colleagues for their dedication and focus on client care. I also said capital allocation is a major focus at Providence. But what truly sets Providence apart is our team of leading experts in healthcare and workforce development services. Our people are passionate about working with clients and patients to help them better manage their health and improve their quality of life.

We would like to thank you for your support of our long-term -- continued long-term focus on value creation. We have a strong sense of urgency around short-term achievements and believe that our culture of operational excellence will drive exceptional client outcomes in 2016 and beyond.

I will now open it up to questions.

(Operator Instructions) Bob Labick, CJS Securities.

Good morning. Congratulations on a nice quarter.

Thank you, Bob. Good morning.

Thanks for all the details. Just wanted to follow up a little bit on a couple things. And you are starting with LogistiCare. Obviously, very strong sequential growth. Can you talk a little bit about the pipeline going forward? You obviously raised the expectation in terms of sales this year. But is the growth coming mostly from MCOs? Is it state outsourcing? How do you look at that over the next few years?

Going forward -- and also a lot of our growth that we experienced in Q2 was coming, as we mentioned, from new contracts, particularly in the managed care -- the MC arena. And as we look forward, although we do have renewals and RFPs related to some of our current state programs, we look at growth more coming from the MCO contracts, which tend to be smaller dollar value than a state contract. But we do see quite a few of those contracts coming out.

Okay, great. And then in relation to the value enhancement project, can you talk a little bit about the timing of the benefits. And also, will the savings be reinvested in more competitive bidding, in other words, like revenue drivers? Or should we expect higher margins over time or both?

Sure. I will take this one. We've had a team of approximately -- a core team of approximately seven to 10 people working on this program for the last two months just to identify the big buckets and then drill down into some smaller segments within those buckets to identify the opportunities. What we're moving towards now is actually coming up with the plan to actually roll those out. Some of the improvements have actually started, and actually started coinciding or even before sort of the larger program came into play.

We are not prepared to talk about the timing of the benefits yet, but I will say that we are -- I would say -- we've seen any -- minimal benefits from this year. And really it's going to be more focused on 2017 and 2018. We would like to do some more work on it internally. It is going to take some investment, as it has this past quarter, around areas such as hiring process improvement talent, which we don't have a huge deep bench right now like we do at Matrix.

So it is going to take some time to recruit those people, do some training within our ranks around some of these changes, and then also come up with the workforce management plan, which hopefully we will be able to communicate more about this fall and relay some of the -- some examples of some of the sizes of the opportunities that we're looking at. Sorry I can't be more specific.

No, of course. And in terms of -- well, no, it's fine. So just moving on then, in terms -- you just mentioned this a little bit in terms of capital expenditures and above the prior guidance for this year but coming down in 2017. Can you give us just a sense of what the normalized CapEx should be in 2017 and beyond?

Sure. Within the US Healthcare Segment areas, outside of this value enhancement project, we should be sub $20 million. We're going to have some elevated CapEx from this project at LogistiCare, but it's not huge by any means. So next year, we are probably talking in the $20 million to $25 million range, and this is all very preliminary because we haven't gone through our budgeting process yet.

Then over at WD, it should be fairly minimal in the core operations. The one thing that would drive it up is the next phase of the Work Programme, which we will be hopefully bidding later this fall. And we could see some CapEx spend around that. And at this point, we are expecting to be in the single digits, but we just don't know much beyond that. So I think when you add that up, maybe you are somewhere around -- and this is very preliminary -- $30 million for next year. And I think overall, we would like to get it closer to $20 million to $25 million in 2018.

So, Bob, approximately -- we are, again, preliminary, hoping to bring down CapEx next year by $10 million to $15 million. And then 2018 forward, bring it down by even more.

Okay, great. And then last one for me and just -- on WD Services, obviously you have discussed how you are attacking it operationally. Can you talk a little bit about the lessons learned so far and how you view the maybe three- to five-year opportunity now versus a year ago how you thought about it; if it's changed at all?

Sure. I think the -- a lot of the success or failure for some of these longer-term contracts starts in the bidding phase. It really -- how you bid the opportunity -- the commitments that you make to the infrastructure to deliver those services start actually before you even submit the bid, really even in the design phase.

So I think we are being much more disciplined about that now under Jack Sawyer's leadership. We have added a new business development head from Circo and Capita. Capita is a company we respect quite a bit and has been very disciplined around their operational and financial strategy. So we are shifting to operate more under those disciplined areas of practice.

I think what we will probably see over the next couple of years is perhaps a little bit of -- not so much growth on the top line, but we could even see some areas shrink a little bit, and that is also contributed to by the Work Programme. Expecting -- we are expecting that to be smaller than it has been in the past.

Offsetting that is we expect to see higher profitability. We're still pretty focused on that 8% to 10% margin. And then longer-term, we are already starting to build -- plant the seeds to diversify in some smaller contracts, like a diabetes prevention contract that just -- we just launched, which don't have the large upfront capital costs and P&L hits that we have seen in some other contracts, and are less subject to underwriting estimates that don't fall in line with reality when the projects come to fruition.

And I think if we do do anything larger, we are being a lot more disciplined on how we model out opportunities. So we will run a lot more sensitivities to the downside to protect ourselves. Now, that obviously means that we will probably not -- our win percentage will go down as well. But when we do win, I think we will all feel a lot more confident in our ability to execute profitably.

Just to sum up, I don't see a lot of top-line growth. We could even see some shrinkage over the next year or two -- modest shrinkage. However, profitability we see moving the other way, as exemplified by our core businesses outside of the start-up costs two quarters in a row being at or north of our 8% to 10% margin profile. So I think, all in all, we feel -- we're working hard on it, and I think longer-term, we feel good about the business.

Okay, great. Thank you very much.

Mike Petusky, Barrington Research.

Just following up, I guess, on that WD area, it seems like most of that business is actually working pretty well with the exceptions of Mission Providence and France. I guess I was wondering -- I think you alluded to infrastructure being not completely right-sized in both of those contracts. Is it difficult to fix issues around that within those contracts in a short period of time, or are those fixable over the course of a couple -- two, three quarters? And then just are there opportunities to renegotiate aspects of those contracts given the volumes not being there? I guess, what can you do with the problem contracts in the near term and then over the longer term?

Sure. We attack it on a few different fronts. The biggest thing that we can do in a place like Australia as we drill down into what's driving the profitability is driving more throughput. So, that is really what our Ingeus team is focused on. How can we improve client engagement, getting people in the front door but then also improving outcomes? One of the areas that we're trying to improve outcomes is around the verification process, which across the industry down there is not -- is showing some teething issues. So, that's one area.

On the cost side, that varies by area. We have already started some cost reduction down in Mission Providence recently. In France, I think most people are aware that it's a little bit more difficult to right-size your infrastructure, so that can take a little bit more time.

Then the third area -- but clearly, we are focused on it. And then the third area is around contract renegotiations. In Australia, I think most of our peers that we have talked to and some have said publicly -- and there is trade body out there who has talked about it around some of the issues that we are talking about.

Obviously, we are working closely with the government down there to improve areas such as the verification process, around outcomes, looking at volumes coming through. I can't comment on any restructuring of contracts anywhere while they are in process, but obviously we're going to try our best to get the best outcome with these long-term government partners. But that's got to work for both parties. We've seen it happen in the past in some areas, but again, we're not prepared to talk about it until we have an outcome.

Okay. All right. Great. And then I guess just in terms of capital allocation, obviously you guys have been fairly aggressive with the share repurchase. In terms of what you guys are seeing, though, on the M&A front, would you expect -- obviously, you guys generate good cash flows. You expect to generate good cash flows and have the firepower to do something on external growth initiatives. Would you expect to be more active over the next, say, 12 to 18 months in terms of M&A?

We do. Yes, we do. That's -- we wouldn't be building the expertise at the Board and then also the holding company level unless we expected to. We feel that our financial firepower will step up, and so that's something that we're looking forward to.

It's been, as I have mentioned, difficult with valuations where they are; us clearly not wanting to use stock because of -- I said we are actually buying it back. So, yes, we are hopefully waiting for valuations to get more reasonable and then also for our financial firepower to pick up as well, so --

Are there any areas of particular interest that you would be willing to share just in terms of the types of assets you are interested in or looking at or having discussions around?

Sure. One of the -- our big focus areas is in in-home care or care coordination. We've got a fantastic operating model in Matrix with a lot of potential to do other things. So we see -- by having these NPs in the home, we see a lot of different chronic conditions, whether it be issues with diabetes, heart issues, vascular issues. We see environmental issues as well -- so, areas around fall protection or just people having trouble with their activities from daily living; we see opportunities in -- or weaknesses in a lot of members' nutritional capabilities. So, there's just a lot of work that needs to be done there. And I think, obviously, a lot of other people see the opportunity there, too, so it's -- we've looked at a lot of potential partnerships. But, again, it has been difficult due to valuations.

Outside of that area, we have looked at a few opportunities, very high level and on a preliminary basis connected to LogistiCare. But we are much more focused on the value enhancement project there; that's going to soak up a lot of our time over the next 12 to 24 months. And then occasionally we do look at some other opportunities and call it -- in areas such as training in human capital areas, which we just view as big areas that are consistent with our -- what we're seeing in terms of secular trends.

Ingeus is being asked to do a lot more not only on the health side, but on the education and training. Again, there, we just feel like we have so much to tackle over the next six months in terms of getting these start-up projects profitable that we really don't want to distract there with any acquisitions. So --

Got you. Just (multiple speakers) -- go ahead, sorry.

I would just say we are -- what we are trying to, I guess, minimize is -- on the other hand is -- what we're trying to stay away from is probably some areas around big, concentrated exposure to -- whether it be more exposure to certain governments that we already have exposure to or clients as well. We are focused on more diversification around the client base.

Got you. And then just, I guess, a quick one for David. You mentioned that you expect the effective tax rate to remain elevated for the remainder of the year. Do you see that? I know you are not giving 2017 guidance or anything like that. But do you see that returning to more normal-ish 40%, 42% ranges in 2017, or will that stay elevated as you look out beyond 2016?

Yes, I think it will be a combination of factors: one, where our profitability is on a geographic basis; and then two, our ability to demonstrate profitability in certain areas where we are currently generating losses. So, until you are able to -- for example, in France -- demonstrate ongoing profitability, you can't -- it's difficult to use those losses to offset profitability, offset gains.

So, I do expect that, over time, as certain geographies where we are currently losing money, as those become profitable, that we will start to see the tax rate approach more the 42% range. But it will -- it could take time.

Okay, so maybe even elevated for a period of time in 2017 sounds like what I'm hearing. Is that fair?

Yes, possibly.

All right. Guys, think you so much. I appreciate it.

Thank you. And I'm showing no further questions at this time. I would just like to turn the call back over to Jim Lindstrom for closing remarks.

Great. Thank you. Thank you, everyone, for your participation. As always, David and I are here to answer any questions or to visit in person. We see a lot of familiar names on the call this morning and think of each of you as long-term partners, so we welcome your participation and welcome your calls going forward. So, thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.