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Executives

Ralph G. Gronefeld - Chief Executive Officer and President

David W. Miles - Chief Financial Officer and Principal Accounting Officer

Derwin Wallace - Director of Investor Relations

Analysts

Kevin Ellich - RBC Capital Markets

(Eugene) - BB&T Capital Markets

Jim Macdonald - First Analysis

Kevin Campbell - Avondale Partners

Greg William - Sidoti and Co.

(Dana Hambly) - Jefferies & Co.

Michael Petusky - Noble Financial Group

Res-Care, Inc. (RSCR) Q4 2008 Earnings Call March 10, 2009 9:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Res-Care year end conference call. (Operator Instructions). As a reminder this conference is being recorded Tuesday, March 10, 2009. I would like now to turn the conference over to Mr. Ralph Gronefeld, President and Chief Executive Officer of Res-Care.

Ralph G. Gronefeld

Good morning and welcome to the conference call, reviewing Res-Care’s results for the fourth quarter and year ended, December 31, 2008. I am here today with David Miles, our Chief Financial Officer, and Derwin Wallace, our Director of Investor Relations, who will now present our forward-looking statement.

Derwin Wallace

We provided notice of this call in a public news release, and we welcome those joining us through the simulcast web transmission. Our fourth quarter and union 2008 earnings release has been distributed to the financial media, filed with the SEC, and are posted to our web site rescare.com.

From time to time, Res-Care makes forward-looking statements in its public disclosures, including statements relating to expected financial results, revenues that might be expected from new or acquired programs and facilities, its development and acquisition activities, reimbursement under federal and state programs, compliance with debt covenants and other risk factors, and various trends concerning privatization of government programs.

In our filings under the federal securities laws, including our annual, periodic, and current reports, we identify important factors that could cause Res-Care's actual results to differ materially from those anticipated in forward-looking statements. Please refer to the discussion of those factors in our filed reports. We also would note that the information being provided today is as of this date only and that Res-Care does not assume any responsibility to update those forward-looking comments.

Ralph G. Gronefeld

In a challenging environment, our business remains solid. We grew revenue, effectively controlled cost, managed working capital, and protected our balance sheet. Our solid operational financial results are evidence that we are executing and delivering as promised in a difficult reimbursement, regulatory, and general economic environment. We are successful because our employees are dedicated, demand for our services grows, our business strategy is sound, and we have diversified our services. Our strong balance sheet translates into financial stability and enables us to take advantage of opportunities for organic growth and strategic acquisitions.

In 2008, we completed 16 acquisitions with analyzed revenues of $72 million. Our pipeline remains robust and contains a mix of strategic and tuck-in opportunities. In the current economic climate, more providers who offer services with persons with developmental disabilities are becoming acquisition candidates. This is our core business, and we will continue to pursue this avenue of growth.

We will continue to focus on opportunities for tuck-ins and other organic growth in all lines of business including home care. In today’s environment, we have also seen more opportunities for growth in workforce services. In 2008, our employment training services division entered into 27 new contracts and renewed 26 existing contracts, totaling analyzed revenues of $79 million. Offset by contract losses and contracts taken in house with analyzed revenues of $17 million.

As you know, the current high rate of unemployment has increased the number of people who are eligible for education, vocational training, and job placement assistance, all areas in which we have years of experience and expertise. We expect the need for our services to grow in 2009.

Now, let’s briefly review the fourth quarter financials. Revenues increased 7.5% over the prior year period, $394.9 million. I am extremely proud to tell you that this quarter was the 68th consecutive quarter, a period of over 17 years in which our revenues increased over the prior year period. This major accomplishment is further evidence of our ability to achieve stable long-term growth. Income from continuing operations was $14.7 million or $0.44 per diluted common share which includes a reduction of legal reserves of $0.07 per share.

Revenues for the full year ended December 31, 2008, increased to $1.54 billion compared to $1.43 billion in 2007. Income from continuing operations was $36.9 million or $0.10 per diluted share versus $44.2 million or $0.32 per diluted share in 2007.

The operating results for 2008 included a charge of $0.37 per share related to 4 legal matters that had been resolved. We are confirming full year 2009 guidance of revenues of $1.61 billion to $1.67 billion, and the earnings per common share from continuing operations in the range of $0.52 to $0.58.

The 2009 guidance assumed a decrease of approximately one-half of 1% in aggregate reimbursement rates for the second half of 2009 within the company’s community services group. Additionally, the guidance assumed an income tax rate of 37% and acquisition related costs of approximately $0.03 per diluted common share associated with planned 2009 acquisitions as a result of the adoption of a new accounting standard.

Before I turn it over to David for more detailed review of the fourth quarter, I would like to comment on the American Recovery and Reinvestment Act of 2009. The Act addresses funding for many of the programs to which Res-Care provides services, including state Medicaid, work force services, and job corps. Many federal, state, and local officials; payers; and service providers are still trying to understand the details of the act, and how it affects them. We are working with our partners to ensure that they have the best chance of accessing funding and related programs created under the act. At this point, we can’t quantify the impact on Res-Care. We are well positioned to address our customer’s needs and to assist them in serving their populations. Regardless of the impact of the act, we will continue to grow, control cost, and maintain a culture of fiscal discipline throughout the company.

There have always been good reasons to invest in Res-Care. That is true now more than ever. The demographics of our markets, our strong balance sheet, fiscal responsibility, diversified revenues, and experienced leadership are traits that have proven successful in the past and will again in the future. Now, I would like to turn the call over to David. David.

David W. Miles

Before I discuss our financial results for the quarter, I would like to note that our comments make reference to EBITDA, a non-GAAP measure. A reconciliation of this non-GAAP measure can be found on the investor relations section of our corporate website.

Revenues for the fourth quarter of 2008 increased 7.5% over the prior year period to $394.9 million. The increase was due to acquisitions, new contracts, and improved performance in existing contracts in the employment trading services segments. Income from continuing operations was $14.7 million or $0.44 per diluted common share. Income from continuing operations includes a $4.1 million or $2.5 million net tax or $0.07 per diluted common share, reduction of the legal reserves established during the second quarter of 2008.

Income from continuing operations for the fourth quarter of 2007 was $12.1 million or $0.36 per diluted common share. EBITDA for the fourth quarter of 2008 was $35.1 million versus $27.6 million in the same period last year. The company recorded share based compensation expense for the fourth quarter 2008 and 2007 of $1.3 million or $0.03 per diluted common share. The effective income tax rate for the fourth quarter 2008 was 36.2% versus 32.5% in the fourth quarter of 2007. The 2007 fourth quarter rate included the impact of certain taxable changes and taxes.

Our community services group reported revenues for the fourth quarter of $284.1 million, up from $270.6 million last year. The 5% increase can be attributed to the impact of acquisitions. Operating income for the community services group was $34.9 million, a margin of 12.3% for the fourth quarter of 2008, compared with $29.2 million, a margin of 10.8% a year ago. The 150 basis point improvement in margin was due primarily to the reduction in legal reserves mentioned previously. Operating income includes depreciation and amortization attributable to the operations.

Job portraying services revenues for the quarter were $41.7 million compared to prior year period revenues of $41.3 million. The slight increase was due to increased spending. Operating income per job corps was $2.9 million and operating margin was 7.1% in the fourth quarter of 2008 compared with operating income of $2.9 million and a margin of 7% in the prior year period.

Employment training services revenues were $55.8 million compared with $50.5 million in the fourth quarter of 2007. The 10.4% increase in revenues came from new contracts and improved performance in existing contracts. Operating income was $5.3 million for the quarter compared with $3.7 million in the prior year period. Operating margins increased 220 basis points to 9.4% compared with 7.2% in the prior year. The increase was driven in large part by the timing of performance incentives. The other segment which includes alternative education and international operations posted revenues of $13.4 million compared with $4.9 million in the 2007 period. The significant increase in revenue was primarily from growth in our schools and the international acquisitions in Maatwerk and Biscom in late 2007.

Revenues from our international operations were $5.8 million during the quarter with limited contribution due to continued integration and start-up costs. Other segment operating margin in the fourth quarter of 2008 was 1.4% because of limited contribution from the international operations somewhat offset by school operations which had increased operating margins because of growth.

For the company as a whole, net interest expense for the fourth quarter was $5.5 million compared with $4.5 million last year, an increase driven by borrowings for acquisitions and working capital needs during the fourth quarter of 2008. Corporate, general, and administrative expenses for the fourth quarter were $14.5 million or 3.7% as a percentage of total revenue compared with $13.7 million or 3.7% of total revenues in the fourth quarter of 2007. Cash used in operations for the quarter totaled 800,000. Cash provided by operations for the year totaled $46.6 million, and we closed the year with cash of $13.6 million. Total capital expenditures were $5.2 million for the fourth quarter of 2008 consistent with our plan and day sales outstanding were 51.1 days on December 31, 2008.

That completes our prepared remarks. Tommy, please open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from line of Kevin Ellich - RBC Capital Markets.

Kevin Ellich - RBC Capital Markets

I guess first, David, could you talk a little bit about the operation cash flow, it looked a little weak and there was definitely a big shift in working capital changes. Can you talk about what’s going on, on that end?

David W. Miles

There are a couple of drivers on the cash flow for the quarter. I will speak to the quarter first and then come back on the year. We had about $15 million of net income and then we had growth in revenues, and we also had an increase of about a day in day sales outstanding, primarily attributable to just a couple of States and one federal agency that we saw cut some delays in. That attributed to about $12 million of cash used during the quarter. We have our semiannual interest payment on the bonds that is due in the fourth quarter that is about $6 million. We had an unusually high estimated tax payment in the fourth quarter due in large part to the credit that we took on the legal reserves, that was another $6 million, offset by DNA. Then there are other factors moving back and fourth, but at the end of the day, it was mostly timing on just the interest and the tax. If you look at the year as a whole, we had an anticipated operating cash flow was between $60 million and $65 million for the year. Taken out the $15 million that we paid on the four legal cases, that brings you back to about the $45 million worth of cash flow that we recorded, so it is in line with our estimates, ex the legal charge.

Kevin Ellich - RBC Capital Markets

So, I guess going forward in 2009, should we expect things to normalize, kind of a reverse trend, since this is kind of a one-time phenomenon?

David W. Miles

Yes, we should. I think that is what we will probably talk about in a bit. We do anticipate experiencing some delays in payments from States, just given the budget issues that many of the States are dealing with despite the stimulus package. We would expect to see some payment delays but nothing that should cause a material impact on cash flows.

Kevin Ellich - RBC Capital Markets

So then, we could see DSO take up a little bit?

David W. Miles

That is correct. That is one thing, yes.

Kevin Ellich - RBC Capital Markets

Then on the interest expense, do you plan to pay down any of the short-term borrowings should that come back down or is this what we should expect in 2009?

David W. Miles

Well, it will be a combination, Kevin, of paying down the revolver and deploying the capital in the form of our tuck-ins and our more strategic acquisitions, but to the extent that we don’t deploy the capital for acquisitions, it certainly will be used to pay down the revolver and maintain a $10 million to $15 million cash balance.

Kevin Ellich - RBC Capital Markets

Ralph, going back to your prepared remarks about the stimulus package, could you talk a little bit more about how it might benefit you guys and what you’re seeing? I know it is hard to quantify at this point, but just any more color on that end?

Ralph G. Gronefeld

On the Medicaid provision, the FMAC increase, right now the way that we understand the act is that States have to maintain spending, going back to July 1, 2008, and they have to maintain eligibility, and they also cannot have any certification issues with CMS in order to access the dollars, and basically what the focus of the stimulus package is, is to provide additional dollars for States to serve more people in the Medicaid rows because those populations are increasing in the current economic climate, and so because of that, what we may benefit from the stimulus is the lack of rate decreases. We may benefit from the stimulus with an increase in folks being eligible for the services that we provide. What we are not going to see is an increase in rates, because the plan does not call for that, so it could help buttress up some of the deficits that the States are facing because of the increases rows, therefore, could help us from the standpoint of any potential rate cuts. It is still unknown how many States are going to take advantage of this and how many States are not, and we are working through that. There are some pretty detailed opportunities that we have within this plan on the Medicaid side, that relate to rest assured that we are just going to have to make sure we completely understand and make sure we work with our partners and our States to see if there is a way to access those dollars, so this is not a huge windfall for us, but at the same time it is good news from the standpoint that more dollars are going into the system and it could help buttress up the 43 plus States that currently have budget deficits and the majority of that is being driven by Medicaid at this point in time.

Regarding the other areas that, we have funding of about $4 billion, we expect to have an opportunity to get our fair share of that, as far as some additional contracts and that. Again, we are not sure how States are going to allocate those dollars, but we are happy with everything that we have seen as far as it is all about training new people and of course that’s our space, so we think that is going to be beneficial to us. The TANF funding which is about $5 billion, I’m not sure that that is really going to come our way based on what we’re seeing, that is again primarily there to deal with the increased people needing those dollars, food stamps and the like, so we are not sure that is going to be of real benefit to us, but it is not going to be a detriment either, it is again, the more dollars that are going into the programs, the more reliable the programs are going to be and I think that will board well for us, long term.

In our job corps piece which is about $250 million, about 85% of that is going to go to building requirements, infrastructure requirements, and so we will not have a significant impact on operations, but to balance the 15% could be there for increased populations in some of the centers which again, we will have access to those folks, so it is not a negative for us by any stretched imagination, it is not a huge windfall either. I think it will help us manage through the environment and help stay still with the issues that they are dealing with, and it is just a question of which States that are going to be willing to take advantage of this and which States may choose not to.

Kevin Ellich - RBC Capital Markets

Then, what type of visibility do you have on the 0.5% rate decrease that you’re guiding for MCFC?

Ralph G. Gronefeld

Well, I will say that our visibility right now is strictly based on experience, what we have seen happen in the past. As we mentioned, I think, in the third quarter call, we are probably not going to see any real visibility on that until the second quarter as States start going through their budget process, but right now based on our experience, based on what we have seen in the past, although this economic environment is worse than anybody’s scene, but based on what we know today and our experience, that 0.5%, we are still comfortable with.

Kevin Ellich - RBC Capital Markets

Last question, on the international front, I guess what opportunities are you looking at and then when do you expect that business to be breakeven or profitable?

Ralph G. Gronefeld

Well, again, in the last quarter, we talked about the fact that the fourth quarter would look a lot like the third from the standpoint from us adding infrastructure and adding physicians to buttress those operations up to get those into position to grow. That is exactly what occurred. Our quality of services and our international operations are very high. I did make a trip over there late in the fourth quarter and spend some time with our operators, and I’m very pleased with where we are and again I think that the opportunity for growth will come in the second half of the year and some may be in the second quarter that may start showing up April 1, 2009, and so forth as far as some new contracts that we are looking to bet on, but the real impact we are looking for is in the second half of 2009.

Operator

We will proceed to our next question from the line of (Eugene) - BB&T Capital Markets.

Eugene - BB&T Capital Markets

David, can you just talk about some of the States that you’re seeing delay in payments. I am assuming California was one of them, and are most of the delays coming on the CSG side of the business or are you seeing some delays on the ETS as well?

David W. Miles

Well, we typically we don’t get State specific, but I will say that we did experience some delays in job corps at the end of the year that have been caught up. We did, in certain States, for example, when States change their systems, it often causes a delay. We had that occur in the fourth quarter in one of our larger States for CSG, and we also had some delays in one our States for Arbor, so it is not CSG specific, and it is not any indication at this point in time for things to come in terms of the economy and so forth, it is just one-off incidences of having to delay payment.

Eugene - BB&T Capital Markets

Another question I have is one the DNA in the quarter, we saw almost a $1 million spike on the sequential basis and usually it has been tracking along pretty steady, can you just provide some additional color in that?

David W. Miles

We made some adjustments to our amortization of intangible assets taking them to an accelerated amortization method versus straight line in the fourth quarter so you’ll start to see on a steady state basis that it’ll come down over the years as those intangibles and more specifically, I’m talking about customer relationships and trademarks and the like that we assign in purchase accounting, it is a bit unusual for having those items in the quarter.

Eugene - BB&T Capital Markets

I have a few others, but I will take them off of line.

Operator

We will proceed to our next question from the line of Jim Macdonald - First Analysis.

Jim Macdonald - First Analysis

On the education trending segment, could you talk a little bit about the dynamics there? You made an acquisition there, and plus I expected some growth in Indiana, but it didn’t seem to grow much sequentially.

David W. Miles

Actually, we did have Indiana grow a little bit in the fourth quarter. Again, the issue with the employment training is going to be the timing of the incentives, and when those incentives occur, so from our standpoint, we received the bulk of those incentives in the second quarter. We received a little bit more there in the third quarter, and the fourth quarter was relatively flat based on those incentives, so from our standpoint, revenue was right in line with where we anticipated as far as those incentives are concerned and also the Indiana project continues to ramp as we have communicated during the course of the year. I guess we are comfortable with where we ended up as far as where we thought we would, based on those incentives and the timing of them.

Ralph G. Gronefeld

Jim, just to provide some clarity, that acquisition that we did during the quarter was in the education space in our other segment, the care resources deal.

Jim Macdonald - First Analysis

Okay, so that went to other.

Ralph G. Gronefeld

That’s in schools.

Jim Macdonald - First Analysis

On Indiana and Arizona, so is Indiana mostly ramped now and how about Arizona?

Ralph G. Gronefeld

Arizona is fully ramped from our revenue perspective and Indiana, we will continue to ramp up through the course of 2009, and at this point, we anticipate to be fully ramped by mid year, however, again that is subject to the state and the timing of opening up offices for working with the state.

Jim Macdonald - First Analysis

Just one more other thing on your interest expense, was your interest rate higher or was it just higher balances during the quarter.

David W. Miles

Balances Jim, primarily. The interest rate was generally stable during the year.

Operator

We will proceed to our next question from the line of Kevin Campbell - Avondale Partners.

Kevin Campbell - Avondale Partners

I wanted to talk to you about your employment training services and some of the incentives that you received there. Do you think that in the current environment, it will be more difficult to achieve those thresholds that you’ll need to get to in order to get those incentives?

Ralph G. Gronefeld

The short answer is yes. We are going to work very, very hard with our customers to ensure that they are successful and consequently were successful, but there is no doubt that on those incentives, they are based on job placements, it is a little bit more difficult right now. We have seen about a 35% increase in traffic coming through our offices compared to a year ago and yet, we have seen about a 30% reduction in placements because the jobs are not available, so that is a really risk for us. We are working through it. We again believe that we are positioned well to help our customers and solve some of those issues. We are working hard to identify additional training that can be done for folks that have jobs that those industries no longer exist as an example. We are seeing an increase of traffic for the higher end wage folks which we have not seen in the past that is going to take a different type of training than what we are accustomed to, so we definitely understand what the challenges are and what the dynamics of the current environment represent, and we are going to continue to work hard to manage through, but I mean again, the short answer is there is no doubt that in the current economic climate, that there is risk on our incentives, because a lot of it is based on putting people to work and the jobs just aren’t available right now.

Kevin Campbell - Avondale Partners

Looking back at the last 2 years, you have had one quarter in 2007, I think it was third quarter, and in 2008, it was second quarter, where you had really good receipts of performance incentives in those quarters, so does your guidance at this point assume any one quarter where you have that sort of increase or is it more going to be in line with what we have seen in the other quarters where it has been 9.4% or 9.5 % in your guidance.

David W. Miles

We’re anticipating that in the 9% to 9.5% margin range; this is what we’re anticipating, and we’re anticipating that will be relatively flat during the course of the year. We’re anticipating that that on those incentives that we may not receive, it’s going to be offset by increased contract awards, and those types of things. So, we really got a mixed bag as far as what’s in our guidance against the way we manage our business. It’s never going to be a silver bullet and those challenges that come our way will find other ways to address on the opportunities and that’s the way we’re looking at our business going forward.

Kevin Campbell - Avondale Partners

Looking at the revolver real quick; how much capacity do you have left on that for further acquisitions?

David W. Miles

I have to take into consideration working capital needs somewhere in the $60 million to $70 million range.

Kevin Campbell - Avondale Partners

The legal reserves; I might have missed this earlier, but what was the rationale for reducing them here; was there a settlement of some sort that perhaps I missed in your discussion earlier?

David W. Miles

Kevin, we settled in January and brought the reserve down as of year end based on that settlement of one of the cases.

Kevin Campbell - Avondale Partners

Then, I noticed on the cash flow statement; it looked like there is a small impairment charge in the quarter, a couple of hundred thousand dollars, $300,000; what was that related to?

David W. Miles

It was related to a large building, one of the few facilities that we actually own, and as you know from our company and our industry, that the larger facilities have historically been downsized out into the community and we have one facility that is currently on the market that we impaired down to its net realizable value or estimate of that net realizable value, and that was about $300,000 during the quarter.

Kevin Campbell - Avondale Partners

Then, a couple of question just getting back to the DNA; again, I know it picked up sequentially and you said you had the accelerated schedule; should we expect it to remain at that higher rate over the course of this year and then come down in subsequent years or should it start to come down even as early as 1Q’09?

Ralph G. Gronefeld

No, it won’t be that soon. It would be in the out years; 2009 would be generally in line with 2008 given the amortization period that we have assigned to those customer relationships and other intangible assets.

Kevin Campbell - Avondale Partners

’09; taking the 4Q number you did of $6.5 million, that should be rough estimate around going forward?

Ralph G. Gronefeld

Rough run rate.

Kevin Campbell - Avondale Partners

Lastly, on the G&A, tick down a little bit sequentially, and I think it was the lowest point for the course of the year. So, what are your thoughts on that; what drove that change from 3Q to 4Q and about where should we expect that going forward?

David W. Miles

It was driven in part by adjustments to certain accruals. For example, incentive payments to management. No real driver. Continued cost management with travel, with supplies; we’re in the mode like most companies, despite the opportunities that we see in front of us we’re going to be physically responsible and we’re going to contain cost and that means everybody. So, here at the resource center we have a number of measures in place to make sure people are prudently deploying the company’s assets in the form of travel and consulting and the like, and I think it was reflected in the fourth quarter and we’ll continue to see that going into 2009.

Kevin Campbell - Avondale Partners

Do you think it’ll come down from current levels? Do you expect there to be any big cost savings initiatives or should they be pretty close to where we are now?

Ralph G. Gronefeld

From our standpoint we expect it to hold steady. The offset to what Dave referred to as far as our physical management is going to continue to grow the infrastructure to support our growth. So, it’s probably going to maintain this level. Some areas will actually decrease, other areas will increase such as the area of IT and some other areas as we continue to grow and put in the infrastructure to support that growth.

Kevin Campbell - Avondale Partners

Lastly, on the Rest Assured comments you made earlier; is that as it relates to some of the funding for healthcare IT and you’re trying to perhaps use Rest Assured to get additional funding for that via that funding in the stimulus package?

David W. Miles

Yes, that’s correct. And again, we don’t have enough details to know exactly what qualifies and what doesn’t qualify, but that’s exactly right.

Operator

We’ll proceed to our next question from the line of Greg William - Sidoti and Co.

Greg William - Sidoti and Co.

I just had a quick question on the state payer delay in the fourth quarter; I am a little confused, is it more of a one-time issue because they changed their systems or was it from state budget pressures?

David W. Miles

It was a one time because of a state system change.

Greg William - Sidoti and Co.

But going forward you’ll see delay perhaps in the year because of state budget pressures?

David W. Miles

That is correct, in 2009.

Greg William - Sidoti and Co.

Is there a reason maybe to the increasing provisions for bad debt from state payer delays or are there any other delays there?

David W. Miles

We’ll obviously keep an eye on making sure that everything that we do is bill is ultimately collectible and we obviously review that on a quarterly basis. There is nothing as it stands now that would lead me to recommend that we increase our provision for bad debts. We are anticipating some delays in paying this, but ultimately collection.

Greg William - Sidoti and Co.

When I think of your acquisition pipeline and how the rate cuts are affecting your profile for acquisitions; are you looking still more towards home care of are your going to shift more to the MR/DD space; when it comes in the face of this weak environment?

David W. Miles

Our focus is our sweet spot which is tuck-ins, and since we’ve got the critical mass in home care, home care will be part of that. We’ve got about 155 offices now across United States. Each one of those offices has the opportunity to tuck in some existing businesses in home care. We’ve got 170 plus core offices for serving people with disabilities; those offices are also available to do the same thing. So, really, we’re looking at it from all of our lines of business; the comments in my prepared remarks relate to the fact that we have seen an increase; and providers of developmental and disability services in our pipeline. We expect that to continue in the current economic environment with the issues with state budgets and the timing of funding and those types of things that the smaller operators will have a difficult time of managing through, but as far as focus one way or the other, really our focus is to do those tuck-ins which are high-margin, low-multiple acquisitions, and that’ll help us really combat cost increases and lack of rate increases and the other things that we’re facing in the economic environment.

Greg William - Sidoti and Co.

And home care, I mean, a lot of it is out of pocket; are you seeing any pressures in that space?

David W. Miles

Yes and no. Yes, it is discretionary spending and folks are pulling back a little bit, but that’s being offset by the demographics by the growth. The population and the needs of that population is growing so quickly that while you’ve got some folks that are saying, “you know, we don’t have these dollars to spend,” the need is growing to where the actual business is growing. So, yes, we’re having customers say, “you know, I can’t afford five days a week; I need to go down to three,” yes, that’s occurring, but we’re also seeing that replaced by new business coming in because of the increased needs.

Greg William - Sidoti and Co.

And when I think of SG and the very impressive margins this quarter, a lot due to the removal of the legal reserves; going forward, how should I look at that. Legal matters are always inherent in your business; so is it more of a one-time benefit or just a normalized rate going forward?

David W. Miles

No, this was a one-time benefit. We’re going to have our margins. I think without that we would have been about 10.9. We’re going to be in the 10.5 or 10.9 range; 10.9 is absolutely the high end in the current environment. So, if you want to go along in between to 10.7, that may be a better area to be than where we ended up in the quarter.

Operator

Our next question comes from the line of (Dana Hambly) - Jefferies & Co.

Dana Hambly - Jefferies & Co.

A quick question on the Florida ETS. I know last quarter you talked about maybe half of those contracts going inhouse. Have you seen any more go inhouse? At this point you also talked about maybe the pendulum swinging back the other way. Have you seen that happen at all yet?

David W. Miles

No Dan, during the fourth quarter we didn’t see any additional contracts from Florida go inhouse, and at this point there are still risks that that could occur and we really haven’t seen any indication that the pendulum has swung in the state of Florida. They still have significant budget issues that they’re dealing with across all of our lines of business. So, at this point it’s pretty much status quo and we’re playing defense in Florida right now because of where they are with their budget.

Dana Hambly - Jefferies & Co.

You haven’t seen in any other states, the going inhouse?

David W. Miles

No, we have not.

Dana Hambly - Jefferies & Co.

On the remote monitoring; I know you’re still waiting on some details there, but last quarter you talked about Kansas and Oklahoma and Texas where we’re looking at that; any progress there or any other states more interested now with the budgetary pressures?

David W. Miles

We actually saw an increase in people they were serving with the Rest Assured system in Texas during the quarter; added a couple people in service; Kansas, we’re moving forward with; Oklahoma is moving forward; and actually to contradict myself a little bit, we’re starting to see some movement in Florida on using the technology to provide services, and that’s a pretty recent development within the last 10 days or so; still early as far as in our discussions, but I think that the current economic environment is really going to help us with this service model because of the fact that it actually improves quality, increases independence, and does it at much cheaper dollars than the old model. So, we’re still very optimistic about this and we think that we’re well positioned as far as having the technology ready today to roll out and to move forward. We continue to see activity and we believe that during the course of ’09 that activity is going to turn into revenue.

Dana Hambly - Jefferies & Co.

Finally, on the pharmacy initiatives; how many states are in now?

David W. Miles

We’re in Kentucky, West Virginia, Virginia, North Carolina, Indiana, Ohio, and Texas; seven states.

Operator

We’ll proceed to our next question comes from the line of Michael Petusky - Noble Financial Group.

Michael Petusky - Noble Financial Group

A number of my questions have been asked and answered, but let me just make sure I understand in terms of the reversing of these legal reserves; going forward David, can we essentially take Q4 and go forward from that level in terms of gross margins or will there be a need to reserve additional dollars there in terms of legal matters going forward?

David W. Miles

You should not factor in that $4.1 million credit into your run rate going forward, if I understand your question correctly. You’ll need to back that out in calculating gross margin on a normalized basis. As Ralph mentioned, all of that’s sitting in the Community Services Group; so the 12.3% margin that we reported includes the entire $4.1 million.

Michael Petusky - Noble Financial Group

Let me just ask because I didn’t get a chance to chat with you last week on this; can you guys give any further color on the acquisition you made in California last week; the Friendship Developmental Services, it seems like a fairly modest acquisition; are there any chances to grow that business, can you just talk about that a little bit?

David W. Miles

Actually that business is DD and there’s really not any real chance to grow the business per se because again it’s just like the rest of our core DD business. It runs 97% to 98% occupancy; the homes are fairly stable, but what it does do is that it allows us to operate in a different region and area in California like what we’ve done in the past. It was purchased right from a multiple standpoint and it gives us a bigger footprint in the state, which will help us in the future from a tuck-in perspective because we now have got another geographic presence.

Michael Petusky - Noble Financial Group

Forgive me if you guys talked about this earlier; I was momentarily off the call, but did you guys talk about the latest budget that was passed in California, any specifics in terms of impact on your guys, either in terms of ID/DD or your other businesses?

David W. Miles

We hadn’t discussed that, but there is a minimal impact on our business with the passage of the California budget.

Michael Petusky - Noble Financial Group

So there was nothing new there that you weren’t aware of prior to the passing of that budget?

David W. Miles

No.

Operator

Mr. Gronefeld, there are no further questions at this time. I’ll now turn the call back to you. Please continue with the presentation and closing remarks.

Ralph G. Gronefeld

Our pioneers continued to face difficult conditions and our company will have more challenges in 2009. However, we feel we’re well positioned to address these challenges. Our strong balance sheet enables us to take advantage of our pace for growth and we’ll continue to focus on quality services in this environment. Thank you for participating in our call today.

Operator

Thank you very much. Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you disconnect your lines. Have a good day every one.

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Source: Res-Care, Inc., Q4 2008 Earnings Call Transcript

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