MODIVCARE INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with Item 6. "Selected Financial Data" and our consolidated financial statements and related notes included in Item 8. "Financial Statements and Supplementary Data" of this report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and other factors that may cause actual results to differ materially from those projected in any forward-looking statements, as discussed in "Disclosure Regarding Forward-Looking Statements". These risks and uncertainties include but are not limited to those set forth in Item 1A. "Risk Factors". Overview of Our Business
Please refer to Item 1. "Business" of this Annual Report on Form 10-K for a discussion of our services and corporate strategy.
We are aDelaware Corporation formed in 1996 that is the largest manager of NET programs for state governments and MCOs in theU.S. which operates under the brand namesLogistiCare and Circulation. In addition, our NET Services segment includes our activities related to executive, accounting, finance, internal audit, tax, legal, certain strategic and corporate development functions and the results of our captive insurance company. During 2018, we announced the Organizational Consolidation to integrate substantially all activities and functions performed at the corporate holding company level into our wholly-owned subsidiary,LogistiCare . EffectiveJanuary 1, 2019 , the consolidation was substantially complete.LogistiCare retained its name and continues to be headquartered inAtlanta, GA , and we continue to be namedThe Providence Service Corporation and be listed on NASDAQ under the ticker symbol "PRSC". See Note 10, Restructuring and Related Reorganization Costs, and Note 24, Segments, in our accompanying consolidated financial statements for further information on the Organizational Consolidation. Our Matrix segment consists of a minority investment inCCHN Group Holdings, Inc. and its subsidiaries. Matrix is a nationwide provider of a broad array of assessment and care management services that improve health outcomes for individuals and financial performance for health plans. Matrix's national network of community-based clinicians deliver in-home services while its fleet of mobile health clinics provides community-based care with advance diagnostic capabilities. These solutions combined with Matrix's advanced engagement approach, help health plans manage risks, close care gaps and connect members to care. Business Outlook and Trends Our performance is affected by a number of trends that drive the demand for our services. In particular, the markets in which we operate are exposed to various trends such as healthcare industry and demographic dynamics. Over the long term, we believe there are numerous factors that could affect growth within the industries in which we operate, including: •an aging population, which will increase demand for healthcare services and transportation; •a movement towards value-based versus fee for service care and budget pressure on governments, both of which may increase the use of private corporations to provide necessary and innovative services; •increasing demand for in-home care provision, driven by cost pressures on traditional reimbursement models and technological advances enabling remote engagement; •technological advancements, which may be utilized by us to improve service and lower costs, but also by others which may increase industry competitiveness; •MCOs that provide MA plans are increasingly offering non-emergency medical transportation services as a supplemental benefit in accordance with current social trends; •proposals by the President ofthe United States andCongress to change the Medicaid program, including considering regulatory changes to make the non-emergency medical transportation benefit optional for states, and CMSs' grant of waivers to states relative to the parameters of their Medicaid programs. Enactment of adverse legislation, regulation or agency guidance, or litigation challenges to the Patient Protection and Affordable Care Act, state Medicaid programs, or other governmental programs may reduce the eligibility or demand for our services, our ability to conduct some or all of our business and/or reimbursement rates for services we perform; and •a trend among MCO Medicaid and Medicare plans to offer value-add transportation benefits in order to promote social determinants of health. 37 --------------------------------------------------------------------------------
Revenues and Expenses
Service Revenue, net
Service Revenue, net includes contracts predominately with state Medicaid agencies and MCOs for the coordination of their members' non-emergency transportation needs. Most contracts are capitated, which means we are paid on a per-member, per-month basis for each eligible member. For most contracts, we arrange for transportation of members through our network of independent transportation providers, whereby we negotiate rates and remit payment to the transportation providers. However, for certain contracts, we assume no risk for the transportation network, credentialing and/or payments to these providers. For these contracts, we only provide administrative management services to support the customers' efforts to serve its clients.
Classification of Operating Expenses
"Service expense" includes purchased transportation, operational payroll and other operational related costs. Purchased transportation includes the amounts we pay to third-party service providers and is typically dependent upon service volume. Operational payroll predominately includes our contact center operations, customer advocacy and transportation network team. Other operating expenses primarily include operational overhead costs, and operating facilities and related charges.
"General and administrative expense" primarily includes the expenses of our administrative functions, including executive, information technology, finance and accounting, human resources and legal departments.
"Depreciation and amortization expense" includes depreciation of our fixed assets and amortization expense related primarily to our intangible assets.
38
--------------------------------------------------------------------------------Critical Accounting Policies and Estimates
We prepare our consolidated financial statements and accompanying notes in accordance with GAAP. Preparation of the consolidated financial statements and accompanying notes requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the consolidated financial statements as well as revenue and expenses during the periods reported. We base our estimates on historical experience, where applicable, and other assumptions that we believe are reasonable under the circumstances. Actual results may differ from our estimates under different assumptions or conditions. There are certain critical estimates that require significant judgment in the preparation of our consolidated financial statements. We consider an accounting estimate to be critical if:
•it requires us to make an assumption because information was not available at the time or it included matters that were highly uncertain at the time the estimate is made; and
•changes in the estimate or different estimates that could have been selected may have had a material impact on our financial condition or results of operations.
For more information on each of these policies, see Note 2, Significant Accounting Policies and Recent Accounting Pronouncements, to our consolidated financial statements. We discuss information about the nature and rationale for our critical accounting estimates below.
Accrued Transportation Costs
We generally pay our transportation providers for completed trips based upon documentation submitted after services have been provided. We accrue transportation costs yet to be adjudicated based on requests for services we have received and the amount we expect to be billed by our transportation providers. The transportation accrual requires significant judgment, as it is based upon contractual rates and mileage estimates, as well as an estimated rate for unknown cancellations, as members may have requested transportation but not notified us of cancellation. Based upon historical experience and contractual terms, we estimate the amount of transportation expense incurred for invoices which have not yet been submitted. Actual expense could be greater or less than the amounts estimated due to member or transportation provider behavior that differ from historical trends.
Business Combinations
We assign the value of the consideration transferred to acquire a business to the tangible assets and identifiable intangible assets acquired and liabilities assumed on the basis of their fair values at the date of acquisition. Any excess purchase price paid over the fair value of the net tangible and intangible assets acquired is allocated to goodwill. When determining the fair values of assets acquired and liabilities assumed, management makes significant estimates and assumptions, especially with respect to intangible assets. Critical estimates in valuing certain intangible assets include but are not limited to future expected cash flows from customer relationships, developed technology and trade names, and discount rates. Management's estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. As a result, actual results may differ significantly from estimates.
Recoverability of
Goodwill . In accordance with ASC 350, Intangibles-Goodwill and Other, we review goodwill for impairment annually, or more frequently if events and circumstances indicate that an asset may be impaired. Such circumstances could include, but are not limited to: (1) the loss or modification of significant contracts, (2) a significant adverse change in legal factors or in business climate, (3) unanticipated competition, (4) an adverse action or assessment by a regulator, or (5) a significant decline in our stock price. We perform our annual goodwill impairment test as ofOctober 1 . First, we perform qualitative assessments for each reporting unit to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the qualitative assessment suggests that it is more likely than not that the fair value of a reporting unit is less than its carrying value amount, we then perform a quantitative assessment and compare the fair value of the reporting unit to its carrying value. 39 -------------------------------------------------------------------------------- We adopted ASU No. 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment ("ASU 2017-04") effectiveApril 1, 2017 . ASU 2017-04 removes the requirement to compare the implied fair value of goodwill with its carrying amount as part of step two of the goodwill impairment test. Instead, if we deem it necessary to perform the quantitative goodwill impairment test in an annual or interim period, we recognize an impairment charge equal to the excess, if any, of the reporting unit's carrying amount over its fair value, not to exceed the total amount of goodwill. Long-Lived Assets Including Intangibles. In accordance with ASC 360, Property, Plant, and Equipment, we review the carrying value of long-lived assets or groups of assets to be used in operations whenever events or changes in circumstances indicate that the carrying amount of the assets may be impaired. Factors that may necessitate an impairment assessment include, but are not limited to, significant adverse changes in the extent or manner in which an asset or group of assets is used, significant adverse changes in legal factors or the business climate that could affect the value of an asset or group of assets or significant declines in the observable market value of an asset or group of assets. The presence or occurrence of those events indicates that an asset or group of assets may be impaired. In those cases, we assess the recoverability of an asset or group of assets by determining whether the carrying value of the asset or group of assets exceeds the sum of the projected undiscounted cash flows expected to result from the use and eventual disposition of the assets over the remaining economic life of the asset or the primary asset in the group of assets. If such testing indicates the carrying value of the asset or group of assets is not recoverable, we estimate the fair value of the asset or group of assets using appropriate valuation methodologies, which would typically include an estimate of discounted cash flows. If the fair value of those assets or groups of assets is less than carrying value, we record an impairment loss equal to the excess of the carrying value over the estimated fair value.
The use of different estimates or assumptions in determining the fair value of our goodwill and intangible assets may result in different values for those assets, which could result in an impairment or, in the period in which an impairment is recognized, could result in a materially different impairment charge.
Income Taxes
We record income taxes under the asset and liability method. Deferred tax assets and liabilities reflect our estimation of the future tax consequences of temporary differences between the carrying amounts of assets and liabilities for book and tax purposes. We determine deferred income taxes based on the differences in accounting methods and timing between financial statement and income tax reporting. Accordingly, we determine the deferred tax asset or liability for each temporary difference based on the enacted tax rates expected to be in effect when we realize the underlying items of income and expense. We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including our recent earnings experience by jurisdiction, expectations of future taxable income, and the carryforward periods available to us for tax reporting purposes, as well as other relevant factors. We may establish a valuation allowance to reduce deferred tax assets to the amount we believe is more likely than not to be realized. Due to inherent complexities arising from the nature of our businesses, future changes in income tax law, tax sharing agreements or variances between our actual and anticipated operating results, we make certain judgments and estimates. Therefore, actual income taxes could materially vary from these estimates. We record liabilities to address uncertain tax positions we have taken in previously filed tax returns or that we expect to take in our current tax returns. The determination for required liabilities is based upon an analysis of each individual tax position, taking into consideration whether it is more likely than not that our tax position, based on technical merits, will be sustained upon examination. For those positions for which we conclude it is more likely than not the position will be sustained, we recognize the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with the taxing authority. The difference between the amount recognized and the total tax position is recorded as a liability. The ultimate resolution of these tax positions may be greater or less than the liabilities recorded. OnDecember 22, 2017 , the Tax Reform Act was enacted, which significantly changedU.S. tax law by, among other things, lowering corporate income tax rates, implementing a territorial tax system and imposing a repatriation tax on deemed repatriated earnings of foreign subsidiaries. The Tax Reform Act permanently reduced theU.S. corporate income tax rate from a maximum of 35% to a flat 21% rate, effectiveJanuary 1, 2018 . The Tax Reform Act also provided for a one-time deemed repatriation of post-1986 undistributed foreign subsidiary earnings and profits through the year endedDecember 31, 2017 . OnDecember 22, 2017 , theSEC staff issued Staff Accounting Bulletin No. 118 ("SAB 118") to address the application of GAAP in situations when a registrant did not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Reform Act. We recognized the provisional tax impacts related to deemed repatriated earnings and the benefit for the revaluation of deferred tax assets and liabilities, and included these amounts in our consolidated financial statements for the year endedDecember 31, 2017 . The financial reporting impact of the Tax Reform Act was completed in the fourth quarter of 2018 and an additional benefit of$0.3 million was recorded. 40 --------------------------------------------------------------------------------
Reinsurance and Self-Insurance Liabilities
We historically reinsured a substantial portion of our automobile, general and professional liability and workers' compensation costs under reinsurance programs through our wholly-owned subsidiary,Social Services Providers Captive Insurance Company ("SPCIC"), a licensed captive insurance company domiciled in theState of Arizona . In conjunction with the policy renewals onMay 16, 2017 , SPCIC did not renew the expiring policies. However, SPCIC continues to resolve claims under the historical policy years. In addition, under the current policies, we retain liability up to the policy deductibles.
We maintain self-funded health insurance programs for employees with a stop-loss umbrella policy with a third-party insurer to limit the maximum potential liability for individual claims and for a maximum potential claim liability based on member enrollment.
We utilize independent actuarial reports to determine the expected losses and in order to determine the appropriate reserve associated with our reinsurance and self-insurance liabilities. We regularly analyze our reserves for incurred but not reported claims, and for reported but not paid claims related to our reinsurance and self-funded insurance programs. We believe our reserves are adequate. However, significant judgment is involved in assessing these reserves such as evaluating historical paid claims, average lag times between the claims' incurred date, reported dates and paid dates, and the frequency and severity of claims. There may be differences between actual settlement amounts and recorded reserves and any resulting adjustments are recorded once a probable amount is known. Revenue Recognition We provide non-emergency transportation services pursuant to contractual commitments over defined service delivery periods. For most contracts, we arrange for transportation of members through our network of independent transportation providers, whereby we invoice our customers and remit payment to our transportation providers. However, for certain contracts, we only provide administrative management services to support the customers' efforts to serve its clients, and the amount of revenue recognized is based upon the management fee earned. Our contracts typically include single performance obligations under which we stand ready to deliver management, fulfillment and record-keeping related to non-emergency transportation services. Transportation management services include, but are not limited to, fraud, waste, and abuse and utilization review programs as well as compliance controls. Our performance obligations consist of a series of distinct services that are substantially the same and which are transferred to the customer in the same manner. In most cases, we are the principal in our arrangements because we control the services before transferring those services to the customer. We primarily use the 'as invoiced' practical expedient to recognize revenue because we typically have the right to consideration from customers in an amount that corresponds directly with the value of our performance to date. This is consistent with our historical revenue recognition policy. We recognize revenue for some of our contracts that include variable consideration using a time-elapsed measure when the fees earned relate directly to services performed in the period. Because most contracts include termination for convenience clauses with required notice periods of less than one year, most of our contracts are deemed to be short-term in nature. Some of our contracts include provisions whereby we must provide certain levels of service or face potential penalties or be required to refund fees paid by the customer. For those contracts, we record a provision to reduce revenue to reflect the amount to which we expect we will ultimately be entitled. Deferred Revenue
At times we may receive funding for certain services in advance of services being rendered. These amounts are reflected in the consolidated balance sheets as "Deferred revenue" until the services are rendered.
Stock-Based Compensation
Our primary forms of employee stock-based compensation are stock option awards and restricted stock awards, including certain awards which vest based upon performance conditions. We measure the value of stock option awards on the date of grant at fair value using the appropriate valuation techniques, including the Black-Scholes andMonte Carlo option-pricing models. We recognize the fair value as stock-based compensation expense on a straight-line basis over the requisite service period, which is typically the vesting period. The pricing models require various highly judgmental assumptions including volatility and expected option term. If any of the assumptions used in the models change significantly, stock-based compensation expense may differ materially in the future from that recorded in the current period. We do not record stock- 41 -------------------------------------------------------------------------------- based compensation expense net of estimated forfeitures and the tax effects of awards are treated as discrete items in the period in which the tax event occurs. See additional discussion included in Note 2, Significant Accounting Policies and Recent Accounting Pronouncements, to our consolidated financial statements. Our tax rate is subject to quarterly volatility from the effects of stock award exercises and vesting activities, including the adverse impact on our income tax provision for awards which result in a tax deduction less than the amount recorded for financial reporting purposes based upon the fair value of the award at the grant date. Results of Operations
Segment reporting. Our segments reflect the manner in which our operations are organized and reviewed by management.
We operate in one principal business segment, NET Services. Our investment in Matrix is also a reportable segment referred to as the "Matrix Investment ". Segment results are based on how our chief operating decision maker manages our business, makes operating decisions and evaluates operating performance. The operating results of our principal business segment include revenue and expenses incurred by the segment, as well as, effectiveJanuary 1, 2019 , include our activities related to executive, accounting, finance, internal audit, tax, legal, certain strategic and corporate development functions and the results of our captive insurance company. Results prior toJanuary 1, 2019 were reclassed to conform with our new segment presentation. See Note 24, Segments, in our accompanying consolidated financial statements for further information on our change in segments.
Discontinued operations. During the periods presented, we completed the following transactions, which resulted in the presentation of the related operations as Discontinued Operations.
•OnNovember 1, 2015 , we completed the sale of our Human Services segment. However, since the completion of the sale, we have recorded additional expenses related to legal proceedings related to an indemnified legal matter. •OnDecember 21, 2018 , we completed the sale of substantially all of the operating subsidiaries of the WD Services segment toAPM and APM UK Holdings Limited , an affiliate of APM, except for the segment's employment services operations inSaudi Arabia . Our contractual counterparties inSaudi Arabia , including an entity owned by the Saudi Arabian government, assumed these operations beginningJanuary 1, 2019 . Wind down activities of our Saudi Arabian entity are included in our discontinued operations. Additionally, onJune 11, 2018 , we entered into a Share Purchase Agreement to sell Ingeus France for a de minimis amount. The sale was effective onJuly 17, 2018 . 42 --------------------------------------------------------------------------------
Year ended
The following table sets forth results of operations and the percentage of consolidated total revenues represented by items in our consolidated statements of operations for 2019 and 2018 (in thousands):
Year ended December 31,
2019 2018
Percentage Percentage
$ of Revenue $ of Revenue
Service revenue, net 1,509,944 100.0 % 1,384,965 100.0 %
Operating expenses:
Service expense 1,401,152 92.8 % 1,253,608 90.5 %
General and administrative expense 67,244 4.5 % 77,093 5.6 %
Asset impairment charge - - % 14,175 1.0 %
Depreciation and amortization 16,816 1.1 % 15,813 1.1 %
Total operating expenses 1,485,212 98.4 % 1,360,689 98.2 %
Operating income 24,732 1.6 % 24,276 1.8 %
Non-operating expense:
Interest expense, net 850 0.1 % 1,783 0.1 %
Other income (277) - % - - %
Equity in net loss of investee 29,685 2.0 % 6,158 0.4 %
Gain on remeasurement of cost method investment - - % (6,577) (0.5) %
(Loss) income from continuing operations before
income taxes (5,526) (0.4) % 22,912 1.7 %
(Benefit) provision for income taxes (573) - % 4,684 0.3 %
(Loss) income from continuing operations (4,953) (0.3) % 18,228 1.3 %
Income (loss) from discontinued operations, net of tax
5,919 0.4 % (37,053) (2.7) %
Net income (loss) 966 0.1 % (18,825) (1.4) %
Net loss from discontinued operations attributable to noncontrolling interest
- - % (156) - %
Net income (loss) attributable to Providence 966 0.1 % (18,981) (1.4) %
Service revenue, net. Service revenue, net for 2019 increased $125.0 million , or
9.0%, compared to 2018. Service revenue increased by $148.0 million as a result
of increased volume within existing contracts as well as rate changes, including
retroactive revenue benefits, in addition to $103.1 million in new contracts,
including the acquisition of Circulation in the fourth quarter of 2018, MCO
contracts in Minnesota and Louisiana and a new state contract in West Virginia .
These increases were partially offset by $126.1 million for contracts we no
longer serve, including a state contract in Rhode Island and certain MCO
contracts in California , Florida , New Mexico , New York and Louisiana .
Service expense. Service expense components are shown below (in thousands):
Year Ended December 31,
2019 2018
Percentage of Percentage of
$ Revenue $ Revenue
Purchased services 1,191,062 78.9 % 1,054,788 76.2 %
Payroll and related costs 160,506 10.6 % 152,974 11.0 %
Other operating expenses 49,584 3.3 % 45,846 3.3 %
Total service expense 1,401,152 92.8 % 1,253,608 90.5 %
43-------------------------------------------------------------------------------- Service expense for 2019 increased$147.5 million , or 11.8%, compared to 2018 due primarily to higher purchased transportation costs and operational payroll and related costs. Transportation costs increased as a result of both higher utilization across multiple contracts and higher per unit cost. Payroll and related costs increased in our call centers as a result of higher volume as well as the acquisition of Circulation. General and administrative expense. General and administrative expense for 2019 decreased$9.8 million or 12.8%, compared to 2018. The decrease was primarily a result of net cost savings associated with the Organizational Consolidation. Asset impairment charge. During 2018, following the acquisition of Circulation, we recorded a$14.2 million asset impairment as a result of the abandonment of our internal software project NextGen. There was no such impairment during 2019. Depreciation and amortization. Depreciation and amortization for 2019 increased$1.0 million or 6.3% compared to 2018 primarily as a result of increased intangible assets associated with the Circulation acquisition, and net capital expenditures during the comparative periods. Interest expense, net. Consolidated interest expense, net for 2019 decreased$0.9 million , or 52.3%, compared to 2018, as a result of lesser borrowings on the Credit Facility during 2019 as compared to 2018. Funds were borrowed under the Credit Facility during 2018 to fund the acquisition of Circulation and repaid prior toDecember 31, 2018 . Equity in net loss of investee. Our equity in net loss of investee for 2019 and 2018 represents our proportional share of the net loss of Matrix. Included in Matrix's 2019 full standalone net loss of$69.4 million was$55.1 million of asset impairment charges. Included in Matrix's 2018 full standalone net loss of$20.0 million were integration related costs of$6.5 million , and merger and acquisition diligence related costs of$2.3 million . Gain on remeasurement of cost method investment. OnSeptember 21, 2018 , we acquired all of the outstanding equity of Circulation. The purchase price was comprised of cash consideration of$45.1 million paid to Circulation's equity holders (including holders of vested Circulation stock options), other than Providence. Our initial investment in Circulation was$3.0 million . As a result of the acquisition, the fair value of this pre-acquisition interest increased to$9.6 million , and thus we recognized a gain of$6.6 million during 2018. Provision for income taxes. Our effective tax rates from continuing operations for 2019 and 2018 were 10.4% and 20.4%, respectively. The effective tax rate for 2019 was substantially lower than the federal statutory rate of 21.0% primarily due to state taxes and certain nondeductible expenses partially offset by the favorable impact of stock option deductions and tax credits. The effective tax rate for 2018 was slightly lower than theU.S. federal statutory rate of 21.0% due to tax credits and no income tax provision on the$6.6 million gain on the remeasurement of cost method investment, offset in part, by state taxes and certain nondeductible expenses. Income (loss) from discontinued operations, net of tax. Income (loss) from discontinued operations, net of tax, includes the activity related to our former WD Services and Human Services segments. See Note 23, Discontinued Operations, to our accompanying consolidated financial statements for additional information. For 2019, income from discontinued operations, net of tax, for our former Human Services segment was$6.0 million as a result of an insurance settlement related to an indemnification matter, net of costs to obtain the settlement. Loss from discontinued operations, net of tax, for WD Services was$0.1 million for the year endedDecember 31, 2019 . We incurred costs related to the wind-down of the WD Services Saudi Arabian entity, offset by cash distributions from WD Services. The operations inSaudi Arabia , including personnel, leased facilities and certain assets necessary to provide the employment services, were transferred to a third party as ofJanuary 1, 2019 , and thus we are no longer providing services inSaudi Arabia ; however, we continue to incur costs related to the shut down of our remaining Saudi Arabian entity. For 2018, the loss from discontinued operations, net of tax, includes the loss of our former WD Services segment of$37.0 million and of our former Human Services segment of$0.1 million . Included in the loss was a loss on disposition, net of tax, of$1.8 million as well as an asset impairment charge of$9.2 million related to the sale of WD Services operations inFrance in the second quarter of 2018. Net loss attributable to noncontrolling interest. For 2018, net loss attributable to non-controlling interest related to a minority interest held by a third-party operating partner in our company servicing the offender rehabilitation contract within our historical WD Services segment. We held no such interest in 2019. 44 --------------------------------------------------------------------------------
Year Ended
The following table sets forth results of operations and the percentage of consolidated total revenues represented by items in our consolidated statements of operations for 2018 and 2017 (in thousands):
Year ended December 31,
2018 2017
Percentage Percentage
$ of Revenue $ of Revenue
Service revenue, net 1,384,965 100.0 % 1,318,220 100.0 %
Operating expenses:
Service expense 1,253,608 90.5 % 1,197,211 90.8 %
General and administrative expense 77,093 5.6 % 69,907 5.3 %
Asset impairment charge 14,175 1.0 % - - %
Depreciation and amortization 15,813 1.1 % 13,618 1.0 %
Total operating expenses 1,360,689 98.2 % 1,280,736 97.2 %
Operating income 24,276 1.8 % 37,484 2.8 %
Non-operating expense:
Interest expense, net 1,783 0.1 % 1,204 0.1 %
Other income - - % (5,363) (0.4) %
Equity in net loss (gain) of investee 6,158 0.4 % (13,445) (1.0) %
Gain on remeasurement of cost method investment (6,577) (0.5) % - - %
Income from continuing operations before income
taxes 22,912 1.7 % 55,088 4.2 %
Provision for income taxes 4,684 0.3 % 4,003 0.3 %
Income from continuing operations 18,228 1.3 % 51,085 3.9 %
(Loss) income from discontinued operations, net of tax
(37,053) (2.7) % 2,735 0.2 %
Net (loss) income (18,825) (1.4) % 53,820 4.1 %
Net loss from discontinued operations attributable to noncontrolling interest
(156) - % (451) - %
Net (loss) income attributable to Providence (18,981) (1.4) % 53,369 4.0 %
Service revenue, net. Service revenue for our NET Services segment for 2018
increased $66.7 million , or 5.1%, compared to 2017. The increase was primarily
related to the impact of new contracts, including MCO contracts in Illinois ,
Indiana , Oregon and New York and new state contracts in Texas and West Virginia ,
which contributed $112.8 million of revenue for 2018, as well as net increased
revenue from existing contracts of $39.2 million , due to the net impact of
membership and rate changes, including the impact of increased rates agreed
after 2017 on certain contracts related to increased costs to serve the
contracts, which was partially offset by the impact of a retroactive rate
adjustment recorded in 2017 related to increased utilization activity under a
significant contract. Revenue additionally increased $2.2 million due to the
acquisition of Circulation in the fourth quarter of 2018. These increases were
partially offset by the impact of contracts we no longer serve, including state
contracts in New York and Connecticut , certain MCO contracts in Florida and
Louisiana , and decreased membership in Virginia , which resulted in a decrease in
revenue of $72.0 million . In addition, the adoption of ASC 606 resulted in a
decrease in revenue of $15.5 million in 2018 as compared to revenue under the
previous accounting standard, as one contract is now accounted for on a net
basis.
Service expense. Service expense for our NET Services segment included the following for 2018 and 2017 (in thousands):
45
--------------------------------------------------------------------------------
Year Ended December 31,
2018 2017
Percentage of Percentage of
$ Revenue $ Revenue
Purchased services 1,054,788 76.2 % 1,005,716 76.3 %
Payroll and related costs 152,974 11.0 % 141,483 10.7 %
Other operating expenses 45,846 3.3 % 50,012 3.8 %
Total service expense 1,253,608 90.5 % 1,197,211 90.8 %
Service expense for 2018 increased $56.4 million , or 4.7%, compared to 2017. The
increase in service expense was primarily due to higher purchased services and
payroll and related costs. Purchased services expense increased primarily as a
result of new contracts, which was partially offset by the impact of terminated
contracts. Purchased services as a percentage of revenue decreased from 76.3% in
2017 to 76.2% in 2018. This was due primarily to lower transportation costs on a
per trip basis in certain geographies as a result of ongoing initiatives to
better align the rates we pay to our transportation provider partners with local
market conditions and the fees paid to us by our customers. Transportation costs
on a per trip basis fluctuate from period to period. Payroll and related costs
as a percentage of revenue increased from 10.7% in 2017 to 11.0% in 2018 due to
increased expenses within our call centers associated with higher volume.
General and administrative expense. General and administrative expenses in 2018
increased $7.2 million , or 10.3%, as compared to 2017, primarily due to $1.7
million of expenses related to the acquisition of Circulation in 2018, as well
as increased software expenses.
Asset impairment charge. Following the acquisition of Circulation and the
Circulation platform, we determined to abandon the development of our internally
developed software, NextGen, and thus recorded an asset impairment charge of
$14.2 million in 2018. There was no such impairment in 2017.
Depreciation and amortization expense. Depreciation and amortization expense
increased
Interest expense, net. Interest expense, net for 2018 increased
Other income. Other income in 2017 of$5.4 million represents the settlement received from our litigation with Haverhill Retirement System. There was no such activity in 2018. Equity in net loss (gain) of investee. Our equity in net loss of investee for 2018 of$6.2 million represents our proportionate share of the Matrix stand alone$20.0 million net loss for 2018, compared to our$13.4 million net gain in investee for 2017 relating to our proportionate share of the Matrix$26.7 million stand alone net income for 2017. Gain on remeasurement of cost method investment. OnSeptember 21, 2018 , we acquired all of the outstanding equity of Circulation. The purchase price was comprised of cash consideration of$45.1 million paid to Circulation's equity holders (including holders of vested Circulation stock options), other than Providence. Our initial investment in Circulation was$3.0 million . As a result of the transaction, the fair value of this pre-acquisition interest increased to$9.6 million , and thus we recognized a gain of$6.6 million . Provision for income taxes. Our effective tax rate from continuing operations for 2018 was 20.4%. The effective tax rate was relatively consistent with theU.S. federal statutory rate of 21%, reflecting the benefit of stock option exercises and tax credits, partially offset by the impact of state income tax. Our effective tax rate from continuing operations for 2017 was 7.3%. The effective tax rate was lower than theU.S. federal statutory rate of 35% primarily due to the impact of the Tax Reform Act. The tax provision includes a benefit of$15.9 million related to the enactment of the Tax Reform Act during the fourth quarter of 2017, consisting of a net tax benefit of$19.3 million from the re-measurement of deferred tax liabilities from the lowerU.S. corporate tax rate, partially offset by additional tax expense of$3.4 million due to an increase in our equity in net gain of Matrix as a result of Matrix's re- 46 -------------------------------------------------------------------------------- measurement of deferred tax liabilities. In addition, we incurred tax expense of$3.6 million related to the HoldCo LTIP, for which expense was recorded for financial reporting purposes based upon fair value of the award at the grant date, but no shares were issued due to the market condition of the award not being satisfied. This tax expense was the result of the adoption of Accounting Standards Update No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting ("ASU 2016-09"), which subjects our tax rate to quarterly volatility from the effects of stock award exercises and vesting activities, including the adverse impact on our income tax provision for awards which result in a tax deduction less than the amount recorded for financial reporting purposes. (Loss) income from discontinued operations, net of tax. (Loss) income from discontinued operations, net of tax, includes the activity of our former WD Services segment and our former Human Services segment. For 2018, the loss from discontinued operations, net of tax, for our former WD Services segment was$37.0 million . Included in the loss was a loss on disposition, net of tax, of$1.8 million as well as an asset impairment charge of$9.2 million related to the sale of WD Services operations inFrance in the second quarter of 2018. For 2017, income from discontinued operations, net of tax for our WD Services segment was$8.7 million , which included a gain on sale of our equity interest in Mission Providence of$12.4 million . For 2018, the loss from discontinued operations, net of tax for our Human Services segment was$0.1 million , which primarily reflects a reduction of the accrued settlement amount for indemnified legal matters, based on the final settlement agreement, offset by the related income tax impact. For 2017, the loss from discontinued operations, net of tax for our Human Services segment was$6.0 million , which primarily related to the accrual of a contingent liability of$9.0 million related to the settlement of indemnification claims and associated legal costs of$0.7 million , partially offset by a related tax benefit. Net loss from discontinued operations attributable to noncontrolling interests. Net loss from discontinued operations attributable to noncontrolling interests primarily relates to a minority interest held by a third-party operating partner in our company servicing the offender rehabilitation contract in our historical WD Services segment. Seasonality Our quarterly operating income and cash flows normally fluctuate as a result of seasonal variations in our business, principally due to lower transportation demand during the winter season and higher demand during the summer season.
Liquidity and Capital Resources
Short-term capital requirements consist primarily of recurring operating expenses, new revenue contract start-up costs and costs associated with our strategic initiatives. We expect to meet our cash requirements through available cash on hand, cash generated from operations, net of capital expenditures, and borrowing capacity under our Credit Facility (as defined below). Cash flow from operating activities was$60.9 million in 2019. Our balance of cash, cash equivalents and restricted cash was$61.7 million and$12.4 million atDecember 31, 2019 and 2018, respectively, which includes cash of discontinued operations. Our restricted cash of$0.2 million and$4.4 million atDecember 31, 2019 and 2018, respectively, primarily related to contractual obligations and activities of our captive insurance subsidiary. As we wind down our captive insurance subsidiary, our restricted cash balance has declined over time. Restricted cash amounts are not included in our balance of cash and cash equivalents in the condensed consolidated balance sheets, although they are included in the cash, cash equivalents and restricted cash balance on the accompanying condensed consolidated statements of cash flows. At bothDecember 31, 2019 andDecember 31, 2018 , we had no amounts outstanding under our Credit Facility. We may, from time to time, access capital markets to raise equity or debt financing for various business reasons, including acquisitions. We may also raise debt financing to fund future repurchases of our common stock. The timing, term, size, and pricing of any such financing will depend on investor interest and market conditions, and there can be no assurance that we will be able to obtain any such financing. The cash flow statements for all periods presented include both continuing and discontinued operations. Discontinued operations include the activity of our historical WD Services and Human Services segments. The income (loss) from discontinued operations totaled$5.9 million ,$(37.1) million and$2.7 million for the years endedDecember 31, 2019 , 2018 and 2017, respectively.
2019 cash flows compared to 2018
47
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Operating activities. Cash provided by operating activities was $60.9 million
for 2019 compared to $7.9 million in 2018. The increase of $53.0 million was
primarily a result of the receipt of $30.8 million in income tax refunds
associated with the sale of WD Services during 2018, higher net income during
the comparative periods, and changes in accounts payable and accrued expenses,
partially offset by the timing of prepaid expenses.
Investing activities. Net cash used in investing activities of $10.9 million in
2019 compared to $45.3 million in 2018. The decrease of $34.4 million was
primarily attributable to $30.9 million net cash outflow for the acquisition of
Circulation in 2018 and sale of WD Services, as well as a decrease in the
purchase of property and equipment of $6.7 million due to discontinued
operations.
Financing activities. Net cash used in financing activities of $0.8 million in
2019 decreased $50.8 million as compared to 2018 primarily as a result of lesser
Common Stock repurchases.
2018 cash flows compared to 2017
Operating activities. Cash provided by operating activities was$7.9 million for 2018 compared to$55.0 million in 2017. The decrease of$47.1 million was primarily a result of lesser net income, changes in accounts receivable and accounts payable and accrued expenses, specifically related to the settlement of a legal claim, and accrued transportation costs. Investing activities. Net cash used in investing activities was$45.3 million in 2018 compared to$7.0 million in 2017. The increase was primarily attributable to the purchase of Circulation resulting in cash used for acquisition, net of cash acquired, of$43.7 million , which was partially offset by$12.8 million of proceeds on the sale of WD Services. 2017 also includes the impact of$15.6 million in proceeds from the sale of our equity investment in Mission Providence. Financing activities. Net cash used in financing activities was$51.6 million in 2018 compared to$33.8 million in 2017. The increase of$17.8 million was primarily a result of greater Common Stock repurchases and an increase in proceeds from Common Stock issued pursuant to stock option exercises of$10.5 million . Obligations and commitments Credit Facility. We are a party to the amended and restated credit and guaranty agreement, dated as ofAugust 2, 2013 (as amended, the "Credit Agreement"), withBank of America, N.A ., as administrative agent, swing line lender and letter of credit issuer, and the other lenders party thereto. The Credit Agreement provides us with a$200.0 million revolving credit facility (the "Credit Facility"), including a sub-facility of$25.0 million for letters of credit. As ofDecember 31, 2019 , we had no borrowings outstanding; however, we had letters of credit outstanding in the amount of$13.5 million . As ofDecember 31, 2019 , our borrowing availability under the Credit Facility was$186.5 million . OnJuly 12, 2019 , we and certain of our subsidiaries entered into an amendment to the Credit Agreement, by and among us, the guarantors from time to time party thereto, the lenders from time to time party thereto andBank of America, N.A . as administrative agent that extended the maturity date of the Credit Agreement toAugust 2, 2020 . Under the Credit Agreement, we have an option to request an increase in the amount of the revolving credit facility or in a term loan facility from time to time (on substantially the same terms as apply to the existing facility) in an aggregate amount of up to$75.0 million with either additional commitments from lenders under the Credit Agreement at such time or new commitments from financial institutions acceptable to the administrative agent in its reasonable discretion, so long as no default or event of default exists at the time of any such increase. We may not be able to access additional funds under this increase option as no lender is obligated to participate in any such increase under the Credit Facility. We may from time to time incur additional indebtedness, obtain additional financing or refinance existing indebtedness subject to market conditions and our financial condition. We may prepay any outstanding principal under the Credit Facility in whole or in part, at any time without premium or penalty, subject to reimbursement of the lenders' breakage and redeployment costs in connection with prepayments of London Interbank Offered Rate ("LIBOR") loans. The unutilized portion of the commitments under the Credit Facility may be irrevocably reduced or terminated by us at any time without penalty. Interest on the outstanding principal amount of any loans accrues, at our election, at a per annum rate equal to LIBOR, plus an applicable margin or the base rate plus an applicable margin. The applicable margin ranges from 2.25% to 3.25% in the case of LIBOR loans and 1.25% to 2.25% in the case of the base rate loans, in each case, based on our consolidated leverage ratio as defined in the Credit Agreement. Interest on any loans is payable quarterly in arrears. In addition, we are obligated to 48 -------------------------------------------------------------------------------- pay a quarterly commitment fee based on a percentage of the unused portion of each lender's commitment under the Credit Facility and quarterly letter of credit fees based on a percentage of the maximum amount available to be drawn under each outstanding letter of credit. The commitment fee and letter of credit fee range from 0.25% to 0.50% and 2.25% to 3.25%, respectively, in each case based on our consolidated leverage ratio. As ofDecember 31, 2019 , our current commitment fee and letter of credit rates were 0.25% and 2.25%, respectively. The Credit Facility also requires us (subject to certain exceptions as set forth in the Amended and Restated Credit Agreement) to prepay the outstanding loans in an aggregate amount equal to 100% of the net cash proceeds received from certain asset dispositions, debt issuances, insurance and casualty awards and other extraordinary receipts. Our obligations under the Credit Facility are guaranteed by all of our present and future domestic subsidiaries, excluding certain domestic subsidiaries, such as, our insurance captive. Our obligations under, and each guarantor's obligations under its guaranty of, the Credit Facility are secured by a first priority lien on substantially all of our respective assets, other than our equity investment in Matrix, including a pledge of 100% of the issued and outstanding stock of our domestic subsidiaries, excluding our insurance captive. The Credit Agreement contains customary affirmative and negative covenants and events of default. The negative covenants include restrictions on our ability to, among other things, incur additional indebtedness, create liens, make investments, give guarantees, pay dividends, repurchase shares, sell assets, and merge and consolidate with certain exceptions. We are subject to financial covenants, including consolidated net leverage and consolidated interest coverage covenants. Our consolidated net leverage ratio may not be greater than 3.00:1.00 as of the end of any fiscal quarter and our consolidated interest coverage ratio may not be less than 3.00:1.00 as of the end of any fiscal quarter. We were in compliance with all covenants as ofDecember 31, 2019 . Preferred Stock. Following (i) the completion of a rights offering inFebruary 2015 , under which certain holders of our Common Stock exercised subscription rights to purchase Preferred Stock, and (ii) the purchase of Preferred Stock byColiseum Capital Partners, L.P. ,Coliseum Capital Partners II, L.P. ,Blackwell Partners, LLC -Series A and Coliseum Capital Co-Invest, L.P. (collectively, the "Coliseum Stockholders"), pursuant to the Standby Purchase Agreement between the Coliseum Stockholders and us, we issued 805,000 shares of Preferred Stock, of which 798,788 shares are outstanding as ofDecember 31, 2019 . We may pay a noncumulative cash dividend on each share of Preferred Stock, when, as and if declared by a committee of our Board, at the rate of 5.5% per annum on the liquidation preference then in effect. On or before the third business day immediately preceding each fiscal quarter, we determine our intention whether or not to pay a cash dividend with respect to that ensuing quarter and give notice of our intention to each holder of Preferred Stock as soon as practicable thereafter. In the event we do not declare and pay a cash dividend, the liquidation preference will be increased to an amount equal to the liquidation preference in effect at the start of the applicable dividend period, plus an amount equal to such then applicable liquidation preference multiplied by 8.5% per annum, computed on the basis of a 365-day year and the actual number of days elapsed from the start of the applicable dividend period to the applicable date of determination. Cash dividends are payable quarterly in arrears onJanuary 1 ,April 1 ,July 1 andOctober 1 of each year, and, if declared, will begin to accrue on the first day of the applicable dividend period. Payment-in-kind ("PIK") dividends, if applicable, will accrue and accumulate on the same schedule as set forth above for cash dividends and will also be compounded at the applicable annual rate on each applicable subsequent dividend date. PIK dividends are paid upon the occurrence of a liquidation event, conversion or redemption in accordance with the terms of the Preferred Stock. Cash dividends were declared each quarter for the years endedDecember 31, 2019 and 2018 and totaled$4.4 million each year. 49 --------------------------------------------------------------------------------
Reinsurance and Self-Funded Insurance Programs
Reinsurance
We historically reinsured a substantial portion of our automobile, general and professional liability and workers' compensation costs under reinsurance programs primarily through our wholly-owned captive insurance subsidiary,Social Services Providers Captive Insurance Company , or SPCIC. As ofMay 16, 2017 , SPCIC did not renew the expiring reinsurance policies. SPCIC will continue to resolve claims under the historical policy years. AtDecember 31, 2019 , the cumulative reserve for expected losses since inception of these historical automobile, general and professional liability and workers' compensation reinsurance programs was$0.8 million ,$0.5 million and$3.0 million , respectively. Based on an independent actuarial report, our expected losses related to workers' compensation, automobile and general and professional liability, net of expected receivables for losses in excess of SPCIC's historical insurance limits atDecember 31, 2019 was$4.3 million . We recorded a receivable from third-party insurers and liability atDecember 31, 2019 for these expected losses, which would be paid by third-party insurers to the extent losses are incurred. Further, we had restricted cash of$0.2 million and$4.4 million atDecember 31, 2019 andDecember 31, 2018 , respectively, which was primarily restricted to secure the reinsured claims losses under the historical automobile, general and professional liability and workers' compensation reinsurance programs.
We offer our employees an option to participate in self-funded health insurance programs. During the year endedDecember 31, 2019 , health claims were self-funded with a stop-loss umbrella policy with a third-party insurer to limit the maximum potential liability for individual claims generally to$300,000 per person, subject to an aggregating stop-loss limit of$400,000 . In addition, the program has a total stop-loss limit for total claims, in order to limit our exposure to catastrophic claims. Health insurance claims are paid as they are submitted to the plan administrator. We maintain accruals for claims that have been incurred but not yet reported to the plan administrator, and therefore, have not been paid. The incurred but not reported reserve is based on an established cap and current payment trends of health insurance claims. The liability for the self-funded health plan of$1.9 million and$2.2 million as ofDecember 31, 2019 and 2018, respectively, was recorded in "Self-funded insurance programs" in our consolidated balance sheets. We charge our employees a portion of the costs of our self-funded group health insurance programs. We determine this charge at the beginning of each plan year based upon historical and projected medical utilization data. Any difference between our projections and our actual experience is borne by us, up to the stop-loss limit. We estimate potential obligations for liabilities under this program to reserve what we believe to be a sufficient amount to cover liabilities based on our past experience. Any significant increase in the number of claims or costs associated with claims made under this program above what we reserve could have a material adverse effect on our financial results. 50 --------------------------------------------------------------------------------
Contractual Cash Obligations
The following is a summary of our future contractual cash obligations as ofDecember 31, 2019 : At December 31, 2019 Less than 1-3 3-5 After 5 Contractual cash obligations (000's) Total 1 Year Years Years Years Finance leases$ 353 $ 308 $ 45 $ - $ - Interest (1) 458 458 - - - Purchased services commitment (2) 8,321 4,782 3,539 - - Guarantees (3) 44,160 44,160 - - - Letters of credit (3) 13,523 13,523 - - - Operating leases (4) 23,350 7,586 13,604 1,330 830 Total$ 90,165 $ 70,817 $ 17,188 $ 1,330 $ 830 (1)Future interest payments have been calculated at the current rates as ofDecember 31, 2019 . (2)The purchased service commitment includes the maximum penalty we would incur if we do not meet our minimum volume commitment over the remaining term of the agreement under certain contracts. (3)Letters of credit ("LOCs") are guarantees of potential payments to third parties under certain conditions. Guarantees include surety bonds we provide to certain customers to protect against potential non-delivery of our non-emergency transportation services. Our LOCs are provided by our Credit Facility and reduce our availability under this agreement. The surety bonds and LOC amounts in the above table represent the amount of commitment expiration per period. (4)The operating leases are for office space and related office equipment. Certain leases contain periodic rent escalation adjustments and renewal options.
We do not have any off-balance sheet arrangements as of
Stock repurchase programs OnOctober 26, 2016 , our Board authorized a repurchase program, under which we could repurchase up to$100.0 million in aggregate value of our Common Stock during the twelve-month period followingOctober 26, 2016 . OnNovember 2, 2017 , our Board approved the extension of our prior stock repurchase program, authorizing us to engage in a repurchase program to repurchase up to$69.6 million (the amount remaining from the$100.0 million repurchase amount authorized in 2016) in aggregate value of our Common Stock throughDecember 31, 2018 . Subsequently, onMarch 29, 2018 , our Board authorized an increase in the amount available for stock repurchases under our existing stock repurchase program by$77.8 million , and extended the existing stock repurchase program throughJune 30, 2019 . A total of 1.8 million shares were repurchased under this repurchase program. The share repurchases were made through a combination of open market repurchases (including Rule 10b5-1 plans), privately negotiated transactions, accelerated share repurchase transactions and other derivative transactions. As ofJune 30, 2019 , this repurchase program expired. OnAugust 6, 2019 , the Board authorized a new stock repurchase program under which we could repurchase up to$100.0 million in aggregate value of our Common Stock, subject to the consent of the holders of a majority of the our Series A convertible preferred stock, throughDecember 31, 2019 , at which time it expired. A total of 105,421 shares were repurchased under this program.
Off-balance sheet arrangements
As ofDecember 31, 2019 and 2018, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities referred to as structured finance or special purpose entities, which were established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
New Accounting Pronouncements
The new accounting pronouncements that impact our business are included in Note
2, Significant Accounting Policies and Recent Accounting Pronouncements, to our
consolidated financial statements and are incorporated herein by reference.
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