Good day, ladies and gentlemen, and welcome to the Q2 2018 Providence Service Corporation Earnings Conference Call. [Operator Instructions] As a reminder, this call is being recorded..

I would now like to turn the call over to Laurence Orton. You may begin. .

Thank you, Michelle. So good morning, everybody. This is Laurence Orton, Interim CAO and SVP of Finance for Providence. Thank you all for joining Providence's Second Quarter 2018 Conference Call and Webcast..

With me today from Providence are Carter Pate, Interim Chief Executive Officer; and Bill Severance, Interim Chief Financial Officer. .

During this call, Mr. Pate and Mr. Severance will be referencing the presentation that can be found on our investor website under the Event calendar and in the current Form 8-K, which was furnished to the SEC yesterday evening. .

But before we get started, as usual, I'd like to remind everyone that during the course of today's call, the company's management will make certain statements characterized as forward-looking statements under the Private Securities Litigation Reform Act.

And those statements involve risks, uncertainties and other factors which may cause actual results or events to differ materially. Information regarding the factors is contained in yesterday's press release and also 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, and a definition of these non-GAAP measures and reconciliation to the most comparable GAAP measures can be found in our press release, in our investor presentation and also in the Form 8-K. .

And finally, we've arranged for a replay of this call, which will be available approximately 1 hour after today's call on our website or it can be accessed via the phone numbers listed in the press release. .

So now I'd like to turn the call over to Providence's Interim CEO, Carter Pate. .

Well, thank you, Laurence. And good morning, everyone, and thank you for joining us this morning. .

Now I'm going to start the call by going straight into this quarter's financial results as well as some operational highlights before handing it over to Bill, who will then talk us through the earnings in more detail. .

So if you have the presentation in front of you, let's start on Page 3. As we had indicated to investors with an operational update during July that despite generating revenue growth, the second quarter saw us give back a little of the positive earnings momentum that we had demonstrated over several previous quarters.

Nevertheless, there were many positive operational highlights in the quarter that I want to share with you this morning. .

On a consolidated basis, revenue increased by 0.9% this quarter. The negative effect from the new revenue standard was $4.3 million, which was partially offset by positive foreign exchange in our WD Services segment of $3.8 million. Now taking these 2 into account, consolidated revenue grew by a little over 1.3%, with LogistiCare growing at 2.5%. .

Now segment-adjusted EBITDA was $18 million for the quarter compared to $20.6 million in the prior year and was impacted by the higher transportation costs in NET Services that I'm going to discuss in some more detail shortly. .

Now adjusted EBITDA for Providence was $11.5 million compared to $14.9 million in the second quarter of 2017. But we remain ahead on a year-to-date basis. Similarly, our adjusted EPS for the quarter was $0.13, was below the same period for last year but, on a year-to-date basis, we are still 16% higher than in 2017. .

Now let me move to NET Services. Turning to Page 4. LogistiCare grew reported revenue by 1.5% in the quarter. However, if you back out the change in accounting on one of our contracts due to that new revenue standard, LogistiCare achieved 2.5% year-over-year growth.

As we had indicated in our operational update, LogistiCare's adjusted EBITDA margins were lower than we had previously been expecting, finishing the quarter at 4.8% and also lower than the 6.1% last year. .

But let me recap on what we saw in the second quarter at NET Services that drove the short-term margin compression. Firstly, overall transportation costs were higher in Q2 as we saw a bit of a shift in the mix to some of our higher-cost offerings.

These higher-cost modes of transportation that I'm referring to include stretcher vans and nonemergency ambulances. In the case of ambulances, in particular, the cost of the service is so much higher that it really doesn't take much of a volume increase to have a noticeable financial impact.

Secondly, we also saw an increase in distance traveled per trip. As our MCO clients continue to emphasize and enforce a narrower network of health care providers for their members, we are seeing trip mileage increases. Additionally, some MCOs are promoting new services to their member base, which is driving volume above historical trends.

Now lastly, another phenomenon that we're seeing in certain states as they rally to respond to the opioid crisis is an increase in both mileage and trip volume as more treatment becomes funded and available to the members. The average mileage for an opioid treatment is higher than the average mileage for all trip types. .

The third and final impact that we observed this quarter was a slower-than-anticipated realization of cost savings under our transportation and call center value enhancement initiatives that we talked about in prior quarters. We are undoubtedly making progress in certain key markets.

But in others, the benefit of our transportation cost initiatives are requiring an additional time and network infrastructure development. These positive outcomes and the associated positive impact on our margin is being partially muted by the shifting service mix that I just addressed.

Thus, we are having to partially refocus our transportation rate negotiation efforts to align with the service mix we are now experiencing. .

Leading this renewed effort, we have recently hired a new COO, who is driving multiple initiatives to negate the changes we are seeing across the modes of transportation.

He is also tasked with bringing in a greater focus on our operational procedures across the different regions within the organization in the pursuit of best practice and additional efficiencies. The nature of this transportation business can lead to these periods of higher costs, which can adversely impact profitability, but in the short term.

But once a trend fully emerges and can be documented and presented back to our payers, we are generally able to bring our contractual rates back in line with the costs providing this critical service.

Our experience has been that working closely with the payers, we can achieve this, but this period of adjustment may span a number of quarters in order to get it put in place. .

Now when looking at our performance on a sequential basis and seeing second quarter margins decline after such a positive first quarter, we see another example of what I've just described as well as an element of seasonal utilization fluctuation.

As contracts renew or correct, usually by some form of rate adjustment, we can see these temporary fluctuations in our profitability. .

Going back to the first quarter, we did, in fact, benefit from a number of these rate adjustments as we have highlighted in our Q1 earnings comments.

In particular, there were a couple of states where we experienced startup costs and utilization challenges through most of 2017, but finally began to equalize those rates later in 2017 and realized further benefit in the first quarter of 2018. .

In Q2, we did not benefit from such rate adjustments as we did not incur any of them in the quarter. .

In summary, I do look forward to seeing a level of sequential margin improvement in the second half of the year as we're able to analyze and adapt to some of these more recent trends and we redouble our efforts in the underlying transportation cost initiatives. .

Now let me finish my discussion of NET Services with some really positive news. I'm particularly pleased to announce the recent award of the West Virginia state contract. Now this one is a completely new state contract for us. We expect to start performing under the contract by the end of the third quarter.

I previously expressed a great deal of confidence in terms of our pipeline of new opportunities and through the increased emphasis that the team is placing on the bidding process, and wins like this will underpin that confidence I have.

Furthermore, I can also share with you that we have won the rebid of the Oklahoma contract and now have recently learned that both Texas and Georgia will also extend their contracts for a further 12 months. .

Now moving on to WD Services, and we're now on Page 5. We generated adjusted EBITDA of $1.4 million in the quarter compared to a slight loss in 2017. There was very little profitability impact of the new revenue standard in this quarter with just $0.1 million negative adjustment impact to adjusted EBITDA.

We did see some minimal favorability related to foreign exchange, so the numbers this quarter are much more reflective of our underlying operational performance there..

The wind down of the legacy U.K. Work Programme remains as a headwind, but we are demonstrating growth that offsets this due to our diversification efforts outside of our core U.K. employability offering. In addition, the new U.K.

Work and Health Program, which is the successor to the Work Programme, continues to build momentum, with mobilization costs running at a lower rate than we initially anticipated. Our health program related to diabetes prevention also had another very positive quarter. .

I'm also pleased to share with you that in Q2, WD Services was awarded 2 new health-related contracts in the U.K. to deliver services for a combined mental health and employment support. These are worth a combined $20 million over 4 years but, more importantly, further develop a strategic presence in the large U.K.

preventative health care market and build on the growth already experienced in the segment's diabetes prevention program. .

Now there was another important recent development related to our offender rehabilitation program, we commonly refer to that as RRP. .

The U.K. Ministry of Justice just recently announced changes to the providers of the probation services contract. You may recall that there was concern across the entire industry about potential penalties under these contracts, particularly around the measure related to the frequency of reoffending.

While this recent announcement did trigger us to record a penalty in the quarter, which Bill is going to describe in detail later, it does offer a much more positive outlook for this contract period as a whole, and we will continue with our proactive work with the Ministry of Justice in terms of generating a sustainable level of funding. .

Now finally, I'm happy to report to you that during the quarter, we also entered into an agreement to sell our French operations, which subsequently closed during July. This is a very important first step in our review of strategic options related to the WD Services segment and helps reduce one aspect of complexity related to this business.

In terms of the broader review, we are now continuing to make progress. And we'll keep shareholders informed when we have something more definitive that we can report. .

Now on to our Matrix Investment. We also -- we'll touch really briefly on this equity investment in Matrix, which we recently indicated to investors that Q2 performance was a bit lower than we had anticipated. I want to start by emphasizing that the underlying Matrix business had a strong first half of the year.

Q2, in particular, saw the Matrix team generate organic revenue growth of over 10%, primarily driven by new clients and an expanded offering of in-home services.

It is the revenue growth for mobile assessments, our HealthFair acquisition, that is currently expected to be lower than originally planned and largely due to a small number of significant contracts not yet coming onstream.

Further exasperating this impact of the lower mobile assessment volume on EBITDA was a cost structure put in place earlier in the year to support the originally expected higher volume.

The Matrix team is now focused on onboarding new mobile assessment volume while also bringing their assessment capacity back in line with the actual demand while balancing the need to preserve the ability to serve the expected higher, longer-term volume requirements. .

Now in summarizing my comments on Matrix.

While there is a short-term setback in terms of growth in financial performance, I want to reemphasize that we view the combination of Matrix and HealthFair as an excellent strategic fit where the investment thesis holds solid and one that will generate significant value in the near to medium term once we start to see the increase in membership in HealthFair and develop the further cross-selling opportunities.

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Now finally, we talked at length on our last call about the strategic rationale behind our recently announced organizational consolidation plan. So I'm going to give you a very brief update on our progress.

Since that announcement, we've continued to lay the groundwork for this transition and have been in the process of building out our detailed transition plan.

We expect to have fully transitioned all of the activities and functions of our holding company to LogistiCare in Atlanta by the start of the second quarter of 2019, which is in line with our original time line. As previously mentioned, we are confident that from midyear 2019, we will demonstrate savings on a run-rate basis of at least $10 million. .

We are all extremely excited to be progressing along this transition path and the opportunities this will open up for us to further drive value creation for our shareholders by further sharpening our focus on the significant growth opportunities available to us in our core asset, LogistiCare. .

Now Bill, I'm going to turn the call back over to you to walk us through the financials. .

Thanks, Carter. .

I'll start on Page 4 of the presentation and focus my commentary on the segments as Carter has already taken you through our consolidated results. .

Starting with NET on Page 4. NET revenue increased 1.5% in Q2 2018 to $343.7 million. As we have discussed, the new revenue recognition standard resulted in 1 contract now being reported on a net basis. The impact of the new rule is a reduction in reported revenue of $3.5 million. So on an apples-to-apples basis, revenue growth was 2.5%. .

The change in presentation has no impact on adjusted EBITDA. The key revenue drivers in Q2 were new MCO contracts in several territories, including Indiana and Illinois, and new state contracts for certain regions in Texas.

These revenue increases were offset primarily by the ending of state contracts in Connecticut and New York, reduced membership of our Virginia contracts and certain MCO contracts in Florida and Louisiana as well as a significant retroactive rate increase recorded in Q2 of 2017 for a state contract based upon a review of utilization. .

Adjusted EBITDA margins were 4.8% in Q2 2018 compared to 6.1% last year. Carter covered the key drivers of the lower margin in Q2 2018 and the actions we are taking to retarget our value enhancement and other efforts to address the shift in service mix.

As we have discussed, we have experienced periods of higher transportation costs and/or utilization in the past, leading to a negative impact on margins in the short term.

However, as we have also experienced in the past, we are typically able to partner with our customers to realign rates in order to reflect these shifts in transportation costs and utilization, resulting in an improvement in margins in the medium to long term.

As context, when we set the rates, we partner with our customers, leaning heavily on historical data to determine expected utilization and costs. However, public policy decisions and other factors can result in a change of behavior and increased utilization and/or costs. .

Generally, we look over a period of multiple quarters to ensure it is truly a trend and not just a temporary or seasonal impact. A couple of examples from 2017 will highlight this further.

In 2017, we continue to see much higher costs in one of our large state contracts due to a public policy decision to address the opioid crisis, which led to increased utilization for our services. Once the trend had fully developed, we were able to negotiate new rates including a retrospective rate adjustment that was recorded in Q2 of 2017.

As another example, during 2016 and 2017, we entered into some significant new MCO contracts. As the contracts ramped to 2017, utilization was much higher than it had been under the state contracts, resulting in higher costs than originally anticipated by either us or the MCO.

During Q4 2017, we were able to realign our rates for the cost once again after the trend had fully developed. .

In 2018, we are seeing higher costs across a number of contracts. And we are analyzing the data to fully understand the key drivers in order to have fruitful discussions with the customers once the trend is developed. .

To the extent costs remain high, we are optimistic, based on our history, that we will be able to realign our rates with the costs. .

As we laid out in our operational update, we lowered our outlook for the 2018 full year adjusted EBITDA margin from 7% to a low 6% range. However, despite the short-term headwinds, we still view the long-term margin target for NET to be in the range of 7% to 8%.

Our estimate of 2018 full year revenue growth remains in the 3% to 5% range, which is below our long-term revenue target growth rate of 5% to 7%. .

Moving to WD Services on Page 5. Revenue for Q2 2018 was $68.1 million or a 1.6% decline. 2018 did benefit from favorable currency movement. So on an apples-to-apples basis, revenue declined approximately 4.4%, including a small impact from the new revenue recognition rules.

The decline in revenue was expected as we continue the wind down of the legacy U.K. Work Programme. However, we are very pleased with the progress of the diabetes prevention contracts, together with positive results across our international businesses and the U.S.

We also continue to see a gradual increase in referrals under the new Work and Health Program, as this contract ramps up. .

For our U.K. offender rehabilitation contract, which Carter spoke about the recent changes, we did -- the overall impact of the results of the changes are very positive. However, it did result in the recognition of a $1.9 million penalty based upon the rate of reoffending of our cohorts as compared to the established baseline.

Based upon current performance trends, we expect to incur some additional penalties through the contract termination in 2020. But once again, overall, the announcement puts us in a much better financial position with the opportunity to potentially provide additional services for which we would earn incremental revenue. .

WD Services reported adjusted EBITDA for the quarter was $1.4 million compared to a loss of $0.1 million last year. The adjusted EBITDA margin of 2% is slightly higher than we anticipated due primarily to timing impacts of the new revenue recognition standard.

For full year 2018, we expect an adjusted EBITDA margin of approximately 3%, which includes the impact of the new revenue recognition rules. Prior to the impact of the new rules, we expect margins to come in at approximately 5%. .

Turning to corporate. We incurred an adjusted EBITDA loss of $6.5 million in Q2 2018, which is $800,000 higher than the prior year. The major driver was an increase in expense for cash-settled awards of $1.2 million due to the significant increase in our stock price.

Additionally, in Q2 of 2017, we had a significant benefit from the release of loss reserves of our captive insurance company due to favorable claims history. Our captive is now in runoff and such actuarial gains are much lower. .

During Q2 2018, we incurred $2.6 million of costs related to the organizational consolidation, including $1.6 million from noncash costs. Our current estimate of the total cost of the program is approximately $9 million, with approximately 1/3 representing noncash costs.

For the full year 2018, we still expect adjusted EBITDA at corporate to be approximately negative $26 million, excluding organizational consolidation costs, which we currently estimate for the year of 2018 to be between $7 million and $8 million. .

Turning to Matrix on Page 6. Remember, Matrix is treated as an equity investment. And therefore, we don't consolidate its revenue or adjusted EBITDA to Providence.

Matrix closed the HealthFair acquisition in February of 2018, and the information on Page 6 only includes the results of HealthFair since acquisition, and none of the information is pro forma. .

In Q2 2018, Matrix revenue was $78.4 million. The core in-home assessment business performed very well, growing revenue over 10% organically due to increased volumes, primarily due to new customers and increased product offerings. .

Revenue from mobile assessments, which commenced as part of the HealthFair acquisition, is currently running below expectations due to a slower ramp in contracts resulting in a delay in the receipt of membership lists and, thus, the delivery of mobile assessments. .

Adjusted EBITDA margins for Matrix of 20.2% were negatively impacted by the slower ramp-up of contracts for mobile assessments as the cost structure was sized to support higher volumes. .

Now that Matrix management has a better line of sight on actual volumes for the year, the team is focused on aligning the cost structure to the demand while preserving the ability to scale quickly once the volume ramps up in 2019 as expected. We do expect results to improve over the remainder of 2018 due to the alignment of the cost structure. .

From a Providence income statement perspective, we recorded an equity loss of $0.2 million in the quarter compared to $1.1 million of income last year, driven by the lower adjusted EBITDA margin and increased integration costs, interest expense and depreciation and amortization as a result of the HealthFair acquisition. .

One other significant item in the quarter which I want to touch on is the impairment charge of $9.9 million. Carter spoke about the sale of Ingeus France, which was announced in Q2 2018 and closed in July.

From an accounting perspective, once a business is held for sale, we record the business at fair value based upon our expected proceeds and compare this value to the net assets of the business. .

Ingeus France has a fairly high level of assets, in part, due to a significant level of cash due to solvency requirements in France, which -- and this drove the impairment charge. Despite the charge, we are very pleased with the terms of the transaction and our exit from the French market. .

I also want to touch on the impairment related to the LogistiCare next-gen development. A new CTO came onboard to LogistiCare in Q1 of '18, and he performed a full review of the project.

Based on this review, he determined one specific element, which is related to the method of synchronizing data across applications, was not efficient and an alternative, more efficient method is now being developed. .

Moving to Page 9. We ended the quarter with just under $30 million in cash with no long-term debt. Our cash position reflects our buyback activities but also negative timing impacts for NET and WD Services working capital mainly related to receivables. .

Our book value for Matrix is approximately $166 million, which we believe is below its true market value. .

Even though HealthFair has not produced the expected results in the short time since acquisition, the thesis of a combined service offering of in-home and mobile assessments remains incredibly compelling, and we remain very optimistic in the long-term value of these complementary synergistic services.

The business and strategic rationale for the acquisition of HealthFair still makes a ton of sense. .

Our share count, which is common plus preferred on a converted basis as of June, was $14.8 million. In the quarter, we purchased an additional 256,000 shares for $18.8 million, taking our year-to-date purchases to 839,000 shares for a total of $55.8 million. Our current buyback capacity is approximately $81 million.

Finally, we extended our $200 million credit facility for an additional 12 months through August 2, 2019. In addition to the $200 million of borrowing capacity, the facility provides us with great flexibility to pursue our strategic options. .

With that, I will now open up the line for Q&A.

Operator?.

[Operator Instructions] Our first question comes from Bob Labick of CJS Securities. .

I wanted to start with WD Services. You highlighted the divestiture of the French operations and the clarity from the RRP contract.

How does this help the strategic alternative process, if at all, and just a little more details on where that stands and how you expect it to play out?.

Thanks, Bob. The -- I would basically describe, when we started down the path of the strategic review on Workforce Development, there were needs to build -- I guess I'll use the analogy of two legs of a ladder in order to get to our goal here.

The first leg was RRP, of nailing down the penalty section of that particular contract and limiting any future exposure. We've been working very hard on that. We're really pleased that we were able to sign an agreement with the government limiting that.

And the second leg of the ladder was France, which most of you may recall that the social cost for a division like that, that makes minimal contribution, was significant that if we ever wanted to shut that down or dispose of it, that we were going to have to deal with the significant cost that France mandates for its employees in protection and health care and all of that.

That French sale really unlocked the last part of what we believe is going to allow the strategic review to move forward. We're in the midst of that. I must tell you, I'm pretty optimistic and encouraged about the response in some of the detail that we've been able to accumulate [ and facts ].

So I'm probably more optimistic about that than I had been in some time. So that's why France was such an important component of this as well as the RRP contract. .

Okay. Great. That's very helpful. I appreciate that. And then one other from me.

Could you give us an update on the CFO search for LogistiCare, some color around what you're looking for, how that's progressing and when you might have some news for us?.

The -- most of you will recall that David Shackelton transitioned into the Chief Transition Officer, and he has been spearheading this effort in order to consolidate our offices in Arizona as well as up here in Connecticut with Atlanta. The CFO was a major point of focus. And I'm informed that David has narrowed the list of candidates.

This has been an ongoing process for now several months as we have taken our time to look through the market, do some intensive interviews, background checks, all of that. And what I can tell you is that I am optimistic that within the next 30 days, we'll be able to have an announcement on that choice of candidate. So stay tuned on that.

We think we found a terrific person. .

There are no further questions. I'd like to turn the call back over to Carter Pate for any closing remarks. .

Thank you so much, operator. Listen, thank you to all of my investors and shareholders that are on the call today. We appreciate your interest. We're excited about the 2 quarters in front of us. And hopefully, we're going to have some good and encouraging news in the coming days in front of us. Thanks, and have a good morning. .

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..