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The Providence Service Corporation (NASDAQ:PRSC)

Q1 2013 Earnings Call

May 9, 2013 11:00 AM ET

Executives

Alison Ziegler - Cameron Associates

Warren Rustand - Interim Chief Executive Officer

Robert Wilson - Chief Financial Officer

Herman Schwarz - Chief Executive Officer, LogistiCare

Craig Norris - Chief Operating Officer, Providence Service Corporation

Analysts

Bob Labick - CJS Securities

Kevin Campbell - Avondale Partners

Walter Winnitzki - Nicusa Capital Partners

Jack Wallace - Sidoti & Company

Chris Brown - Aristides

Rick D'Auteuil - Columbia Management

Mike Petusky - Noble Financial

Operator

Good day, ladies and gentlemen, and welcome to the first quarter 2013 Providence Service Corporation earnings conference call. (Operator Instructions) I would now like to turn the conference over to your host for today, Ms. Alison Ziegler of Cameron Associates. Please go ahead, Alison.

Alison Ziegler

Good morning, everyone, and thank you for joining us this morning for Providence's conference call and webcast to discuss financial results for it's first quarter ended March 31, 2013. Press release was issued yesterday after the market close. If anyone would like to be added to our email list please call Cameron Associates at 212-554-5469.

Before we begin please note that a replay has been arranged for this call, the replay will be available approximately one hour after the call's conclusion and will remain available until May 16. The replay number is 888-286-8010 with the passcode 44683383. This call is also being webcast live with a replay available. To access the webcast go to www.provcorp.com and look under the Event Calendar on the IR page.

Before we get started, I'd like to remind everyone of the Safe Harbor statement included in the press release and that the cautionary statements apply to today's conference call as well. During the course of this call the company may make projections or our other forward-looking statements regarding future events or the company's beliefs about its financials results for 2013 and beyond.

We wish to caution you that such statements are just predictions and involve risks and uncertainties, actual results may differ materially. Factors which may affect actual results are detailed in the company's recent filings with the SEC, including the company's 10-K for the year ended December 31, 2012. The company's forward-looking statements are dynamic and subject to change. Therefore, these statements speak only as of the date of this webcast, May 9, 2013. The company may choose from time-to-time to provide updates and if they do we'll disseminate the updates to the investing public.

In addition to these financial results, prepared in the accordance with generally accepted accounting principles stated in the press release and provided throughout our call today, the company has also provided adjusted EBITDA and adjusted EBITDA non-GAAP measurements, which present its earnings on a pro forma basis. Providence's management utilizes these non-GAAP measurements as a means to measure overall operating performance and to better compare current operating results with other companies within its industry. Both EBITDA and adjusted EBITDA are measurements not determined in accordance with or an alternative for generally accepted accounting principles and maybe different from pro forma measures used by some companies. A definition, calculation and reconciliation to the financial statements of each can be found in our press release. The items excluded in the non-GAAP measures pertain to certain items that are considered to be material so that exclusion of these items word in managements belief enhance a readers ability to compare the results of the company's business after excluding these item.

I'd now like to turn the call over to Warren Rustand, Chief Executive Officer. Go ahead, Warren.

Warren Rustand

Thank you, Alison, and good morning. With us today on the call we have Bob Wilson, our CFO; Herman Schwarz, CEO of LogistiCare; and Craig Norris, COO of Social Services. We will be available to take your questions following our scripted remarks.

We are pleased with our first quarter 2013 results. Our revenues increased to nearly $282 million on the strength of our NET division. As Herman will discuss in more detail, NET revenue benefited from new contracts and program expansions in markets including New York and year-over-year gains in Georgia and South Carolina, as well as negotiated rate adjustments in selected programs.

In our Social Services segment, while revenue declined year-over-year and was mostly the result of changes to the workforce development business in Canada, and the expiration of contracts related to our educational tutoring business due to changes in the No Child Left Behind Act. Both of these factors have been discussed in prior quarters.

Overall, our Social Service contract base is solid going into the upcoming renewal cycle that begins July 1. We've recently started up several new contracts, including contracts in Texas and Wisconsin, and we anticipate renewal of our existing Social Services contracts.

While I will let Bob provide a more detail review of our financials, net income for the first quarter was up strongly and we generated a substantial amount of additional cash from operations. We saw continued improvements in our margins due to full implementation of NET contracts, but we were in start-up mode in last year's first quarter, as well as recent expansion of business in existing market and negotiated rate adjustments in select programs of both the NET and Social Services segments.

As we look ahead to the remainder of 2013 and beyond, our management team remains committed to improving operating efficiencies, growing organically, looking at opportunities for tuck-in acquisitions, investing in technology and implementing the corporate-wide performance-driven management system.

This will help to position Providence to benefit from emerging trends in healthcare, particularly the development of integrated models of healthcare delivery and increased outsourcing of transportation management. Our experience says, an in-home provider of services and our ability to manage large patient networks positions us nicely for these healthcare trends.

Staring in 2014, we continue to expect to see increases in our Medicaid population as states opt into the expanded Medicaid benefit as a result of the Affordable Care Act. To date, 27 states, plus the District of Columbia have opted-in, with 17 states currently anticipated to set it out.

We will remain cautious in our projections about the impact of this population on our business, until all states have made their decisions to opt in or out of the expanded Medicaid benefit. Some states in which we have operations and other states in which we do not, maybe affected quite differently based on our current operations and how the states react to the Medicaid benefit.

As we have stated before, to the extent this new Medicaid population is eligible for our services, we anticipate to benefit more rapidly on the NET side and more gradually on the Social Services side. Integrated care is also moving forward in multiple states, as we see accountable care organizations, health homes and services for dual eligibles becoming more pronounced.

We currently have pilot programs operating in California, which address unique populations. Early indicator in these pilot suggest that there is an opportunity to alter the cost curve and structure. This movement and these trends continue the opportunities for Providence and we remain focused on the positioning of the company to benefit from the future of healthcare.

Let me turn the call over to Bob Wilson now, to provide more detail on the first quarter results reported yesterday.

Robert Wilson

Thanks, Warren. As just mentioned, revenue for the first quarter of 2013 was $281.5 million, an increase of 8% from $260.1 million in the comparable period in 2012. Craig and Herman will provide more details about these results in a few moments. We had net income of $6.7 million or $0.49 per diluted share in the first quarter of 2013 compared to net income of $3 million or $0.23 per diluted share in the comparable period last year. Both business units had strong operating margins.

Adjusted EBITDA for the first quarter of 2013 was $16.8 million, up 64% from $10.3 million in the same period last year. Our effective tax rate for Q1 was 41.2% compared to 35.7% for the comparable period in 2012 and over 49% for the full year 2012. The quarter-over-quarter difference is really primarily related to the benefit of an adjustment booked in the first quarter of 2012 related to the planned determination of tax liabilities related to an acquisition in 2011.

On the quarter four 2012 call in March, we said that we anticipated that our effective tax rate for the full year 2013 would be between 42% and 44%. Even though, our effective tax rate in Q1 is slightly lower, we are not revising our view of the effective tax rate for the full year 2013 at this time.

Let me turn briefly for a couple of comments regarding the balance sheet. We continue to strengthen our balance sheet and as of March 31 compared to December 31, 2012, we did that by increasing our unrestricted cash by $27.2 million from $55.9 million to $83.1 million.

Further, we reduced our net accounts receivable by $9.5 million or almost 10% from $98.6 million to $89.1 million. And finally with respect to the balance sheet, we continue to reduce our long-term debt according to normal repayment schedules at this time.

I'll turn it over to Craig to discuss the performance of the Social Services business this quarter.

Craig Norris

Thank you, Bob, and good morning everyone. For the first quarter, our client census on the Social Services side was approximately 54,000 clients. This is a decrease from the prior-year quarter of roughly 7,000 clients. Our clients are being served from 339 local offices and 26 states, with District of Columbia and Canada. There are approximately 6,500 employees serving 565 contracts.

In the Social Services segment for the quarter, we did see revenue and census negatively impacted year-over-year by reductions in our workforce development programs and the ongoing reductions in our home based tutoring business, which has been significant impacted by changes in the No Child Left Behind Act. Additionally, weather in the Northeast impacted our year-over-year revenue due to the number of delays in the quarter weather-related events impacting the school attendance in Pennsylvania and Virginia.

In the quarter, however, we did see a number of markets begin to stabilize and we even saw a few rate increases in certain states. These are the first increases in many years. And while the impact of these rates is relatively minor, it's good news to at least see the start of some rate relief.

As has been mentioned, we are continuing to invest in our technology, specifically centered around electronic health records and billing system. We continue the investment in our technology. We are playing an important role in the emerging healthcare system, as we improve our ability to pursue opportunities in integrated care space.

We're continuing the start-up phase of our new contracts in Texas and Wisconsin. The initial stages of these contracts are on track, and we are working very closely with our state partners. Revenue should begin to ramp up in the second half of the year, assuming the start-up phase of these contracts continues as planned.

We are seeing increased consolidation in this space and Providence is in a good position to grow our market share, both through organic as well as tuck-in acquisitions. The pipeline of tuck-in acquisitions opportunities is finally increasing in a number of markets. We are necessarily being very deliberate in our M&A efforts in order to make sure the targets are both sound financially as well as strategically.

Now, I will hand out to Herman for more details on the LogistiCare operations. Herman?

Herman Schwarz

Thank you, Craig. Revenues in the NET segment grew to $193.1 million in the first quarter, a 17.3% increase compared to the same period last year. This growth was generated from a combination of factors that can be mostly attributed to the new revenues contributed by the operations, in which we incurred the significant start-up expenses in 2012.

These programs included expansion of government contracts in Georgia and South Carolina, new operations in Texas and New York City, and a number of managed care contracts across the country. In addition, during the quarter our revenues benefited from higher payment rates in several states, as a result of protracted negotiations.

The financial performance in the quarter also was benefited by a much improved spend on transportation expense, as a percent of revenue. Unlike last year, during this quarter, we realized better economics as a function of trip cancellations due to cold temperatures and winter precipitation.

Additionally, steps executed in the second half of 2012 in several markets to improve the efficiency of our provider network paid dividends during this quarter. As a result of the normal winter weather and our management initiatives, our transportation expense ran at 76% of revenue in the quarter versus 81.1% last year.

While our operating expenses did go up as a percent of revenue, due to the growth in our ASL book of business, with no implementations taking place during the quarter, the dollar spent were directly tied to revenue generated during the period being reported.

With the new contracts added in 2012 and the completion of the last phase of the New York City program, we now manage transportation in 43 states and have a census of 16.8 million eligible members, which is up from 12.4 million a year ago.

As previously discussed, we terminated our contract in Wisconsin and we'll continue to provide service in the state until our new broker is in place. The good news is that state has signed a contract with a competitor and we expect transition activity to begin immediately with an ending date of July 31.

We received very positive news as well from Missouri, where we were awarded the new contract in the recent RFP process. This contract will replace the emergency service agreement we are presently operating under the state, but add a price that we believe more fairly compensates us for the level of utilization being experienced. We anticipate the new contract starting on or around beginning of July.

I am also pleased to announce that Utah has a designated LogistiCare as the winner of their RFP process. This is not a very big contract, probably less than $3 million a year, but it is a win of a state wide program nonetheless. As FYI that contract is under protest, that award is under the protest right now, but we are optimistic that the award for LogistiCare will be upheld.

We continue to await decisions in Rhode Island, North Carolina and upstate New York. There are no other open government RFP's in process currently, but there are significant activity in the managed care environment, particularly in association with the CMS demonstration projects for the dual eligible population ramping up in several states.

I'll now turn the call back over to Warren.

Warren Rustand

Herman, thank you very much. As you can see we have made progress improving our NET operation, as a result of the actions taken in our NET segment. Anticipate cost savings generated by increased operating efficiencies were a premium place and the anticipate improvement we see on the Social Services side, we continued to expect operating income gains in 2013 over 2012.

While we have made some progress operationally, we remain focused on repositioning the company and investing in technology in 2013. In preparation for 2014 and beyond, the entire management team remains cautiously optimistic about the opportunity we see today on both sides of our business.

We have a strong cash balance. And while we continue a normal course of debt reduction with our improving financial flexibility, we will look at tuck-in acquisitions to help further position our business for the changing healthcare trends.

With that, I'd like to open up this call to questions from any of you, who have those.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question today is from the line of Bob Labick was CJS Securities.

Bob Labick - CJS Securities

I want to start with the LogistiCare, very strong gross margins. How much of any was there from catch-up of prior contract replacing or is that still to come or where do we stand on that?

Warren Rustand

Bob, there was no retro recognition in the first quarter. So you're probably referring to what we've talked on the past regarding New Jersey. That is still to come. That amendment has finally been approved and is being processed, and we would expect that catch-up to occur either late in this quarter or early third quarter.

Bob Labick - CJS Securities

So then, the run rate in the quarter is very strong. And you mentioned, Wisconsin run through the second quarter and then at the end of July most likely. Warren, you highlighted in the beginning the 27 states opting in and 17 out. Can you give us a sense of what your population would be, if everything stayed the way it was right now, going into next year for LogistiCare?

Warren Rustand

Well, we were talking about that earlier today. And I think there is a false notion that there would be this enormous title wave of enrollee's that would hit us. The reality of it is, as we look at the various states in which we're engaged, it will be growth obviously, and there will be an increase, but it will be slightly smaller we think than what most people are projecting.

So we're a little bit cautious about the total numbers at the present time. I'd ask Herman, if he'd like, he's done some of that analysis and he'll lead the way in that as well. So I think the main point for us, Bob, is to be cautious and thoughtful about what that population look like in terms of their income, their help, what we think their proposed utilization will be. And then the absolute impact on our financial statements.

Herman Schwarz

Just to add to that, Bob, I think it's critical to understand how the yes states match up with where our business concentration is. And truthfully our larger state clients are in the no camp right now. So as we look out at the 27 or so states that have said yes, and that's not even clear yet, what yes means in some respect. So everyday it's changing.

But if you look at those 27 states and take the proportionate share of the new population coming in relative to what we have today in that state. So we only have 10% of the current Medicaid population, because we're dealing with managed care clients and not the state themselves. Just look at that, it's really not a substantial impact, we're looking in those 27 states about 2 million eligible members coming in at the beginning of 2014, so that's one assumption.

The next assumption would then be at what rate? And that's not clear yet, either. So from our perspective, we don't see it having a significant financial impact right off the back in 2014. That can change in the next three months, as states continue to adjust what they're doing.

If more states follow the model that's being proposed by Arkansas that could turn out to be a negative for us, because you're going to get the more acutely ill people going into traditional Medicaid, the healthy group into the exchanges, but don't have a transportation benefit. So we're going to get population with high utilization, we would then have to be up in front of that negotiating new rates.

I am sure it's frustrating for you, as it is for us. But the picture changes everyday. We're watching it. And I can tell you, hopefully by September, we'll have a better perspective on where to go on, because obviously they're going to have implement January 1, if they're moving forward.

Warren Rustand

And, Bob, we'll continue to model that internally, and we're happy to give you some sense to that as we go along, just to be sure that we're being very being transparent about what we think the impact will be on our numbers.

Bob Labick - CJS Securities

And then over for, Craig, on the Social Services side, you mentioned the Texas and Wisconsin contracts ramping up. Are there any other bids that you have out there or how do you see that market shaping up for the rest of this year?

Craig Norris

There aren't any bids of that nature on the RFP side. I think the segment as a whole as I mentioned in my remarks, I think you're seeing it start to stabilize. I won't say it's 100% stabilized at this point, Bob. There are still managed care implementations that are going on.

But as I've said before, I think that the states from my perspective need to kind of figure out, where they want to be by the end of the year, so that one Medicaid expansion does happen. They've made their changes. They have their systems set. Many of them have chosen their providers, if you will.

So I think there is some pockets of success. We've seen some rate increases finally, not huge increases, but anything is helpful, since we haven't had one in probably four years. So I am hopeful that as the year progresses, Bob, we continue to see these systems kind of reach a stabilization, and we can kind of get back to normal course once 2014 starts and the systems are stabilized.

So no big RFPs on the horizon, certainly like in Texas, that's a pretty unusual RFP. They are discussing potential other pilots in the state, similar to the one that we're running right now. We don't have any more information on that, but I do think they're looking at that in the future.

Warren Rustand

And one of the opportunities we see on the Social Service side that Craig is tracking very carefully is the tuck-in acquisitions and the opportunity to grow through those tuck-in acquisitions. What we're finding is that there's a lot of the smaller providers, under these new Medicaid requirements, are going to have difficulty investing in the technology and making the investment in technology that's necessary, and also an increase in heightened awareness around the regulatory compliance.

And so as a result of that is putting new demands on many of these smaller providers. As a result of that, we believe there is an opportunity and we're in discussions obviously with some of these. And we believe there is an opportunity for us to do some of the tuck-in acquisitions to get the growth where they may not be RFP opportunities.

Operator

Your next question is from the line of Kevin Campbell with Avondale Partners.

Kevin Campbell - Avondale Partners

Herman, I wanted to start with question on LogistiCare. Obviously, you had a nice decrease in the cost of services provided there and you mentioned sort of a benefit from trip cancellation. Have you guys tried to figure out, how much of a benefit that was in the quarter in terms of a decreased utilization by X percent and maybe lower costs by $1 million, or do you have any sense as to sort of what the impact of those, the better weather, I guess, was for you guys?

Herman Schwarz

Not really, Kevin. It's really hard to isolate. I mean we know cancellations obviously go up in bad weather and we try our best to try to get our hands around what that means, but the truth of matter is we don't always get the information and data, because we subcontract that transportation out, we just get a cancellation. And we don't always get the reason from the provider as to why that occurred.

So it's very difficult for us to always isolate out whether it's a weather-related cancellation or just a normal cancellation in the course of business. So we really don't have a great sense of the impact. I mean, we can kind of ballpark it based on if you look at what our transportation spend is in the year $600 million and kind of how many days in the year there are, what are days work, and kind of start breaking it down by operation.

For instance, you got to keep in mind that New York City, we don't get any benefit from weather, because it's an ASO contract. The same is true in Connecticut now, because we don't pay transportation. New Jersey, we obviously get a major impact when there is snow day. So in other states, Wisconsin, it doesn't matter when it snows, they still go to the doctor. So it's really difficult to kind of isolate it down. But we do obviously receive a large benefit when it happens.

Kevin Campbell - Avondale Partners

And if you had to ballpark it for the quarter, looking at maybe the year-over-year change, any sense sort of percentage-wise or dollar-wise as to what was from, maybe, weather versus reduced startup cost versus exiting underperforming contracts?

Herman Schwarz

As I mentioned in my comments, the 76% transportation expense versus 81% just for last year, I would say, 65%, 70% of that is probably weather related, the difference.

Kevin Campbell - Avondale Partners

Of the 5% delta, two-thirds of it looks like it was from weather and the rest was improvement maybe that you guys have made.

Herman Schwarz

Correct. Improvements for some rate increases that we've talked about in Missouri and Wisconsin.

Kevin Campbell - Avondale Partners

Can you give us a sense for the revenue run rate for LogistiCare, after you factor out the changes from exiting Wisconsin and I can't remember if there is other changes you are making that would have effected LogistiCare, but any sense of what sort of the normalize run rate revenue is there on a quarterly basis?

Herman Schwarz

Wisconsin is going to come out at about $18 million and $19 million for half the year, starting in August. So Wisconsin is about a $35 million, $36 million number. Missouri is going to stay in. So as we exit the year we're going to be, with the new businesses coming in and everything, we think we're going to be ahead of where we were coming out of last year.

Kevin Campbell - Avondale Partners

Actually, Craig, maybe the same question for you on the Social Services side, as you think about Texas and Wisconsin getting rolled into the mix. Once they are more fully ramped, any sense as to what the sort of normalized revenue run rate is there?

Craig Norris

I think we had said early on, it won't be this year, of course, but starting 2014 you're probably looking at $27 million, $28 million contract in full implementation mode. Wisconsin is fully implemented. It's probably around $10 million, Kevin.

Kevin Campbell - Avondale Partners

And what were the contributions this quarter from those. You said they are sort of still in the start-up phase or was it sort of de minimis this quarter?

Craig Norris

Yes. Very de minimis, mostly setup start-up phase.

Kevin Campbell - Avondale Partners

Bob, couple of questions for you, the G&A was $12.5 million this quarter, is that sort of a good run rate to use going forward?

Robert Wilson

The primary driver of that relative flat G&A, Kevin, there are several factors, of course, that our employee health costs were down below what we thought they might run in the first quarter. We are not unnecessarily anticipating that that represents as kind of a new run rate for our healthcare costs.

It may or may not be an aberration that is just specific to the quarter versus some kind of a step shift in how our employees are utilizing services. So I guess my best advice would to take in that first quarter as it is and whatever assumptions you might be making with respect to the rest of the year, I would continue with those assumptions.

Kevin Campbell - Avondale Partners

And then the cash flow obviously was fantastic, any sense as to what the normalize level of cash flow from op should be, after you've made all sort of the improvements you think you can from a working capital perspective? And then, secondly, what are your preferences for using that cash?

Robert Wilson

It was a very strong quarter obviously from a cash flow standpoint. Following my same comments, it would be, as the same as what I've said regarding the G&A cost that first quarter was very strong. I don't know if that necessarily represents a new trend for the balance of the year. I would continue with whatever assumptions you might have behind that for the balance of the year, but having said that obviously our cash position is building substantially.

Regarding uses, I think Warren, Craig and Herman have talked about the potential for tuck-in acquisitions, that certainly a use in the investments in technology. The first quarter of the year was really around technology investments, it was largely focused on the defining our IT investment requirements, really in both sides of our business.

So the first quarter represented kind of normal. I think we will see a ramp up in those investments, particularly in the last half of the year. It takes a while, as you know, to move from planning to staging to execution to spend. Then there is the converts that are out there and we will be evaluating that as well in the context of our overall debt structure in the next few months.

Kevin Campbell - Avondale Partners

And do you have order of preference for those or that the opportunities present themselves?

Robert Wilson

Cash is a frangible commodity, so I think it's a combination of our continuing build of operating cash plus the capacity under our current debt structure plus the potential for adding to that, all of those things I think will be set in motion in terms of priority. I would think they are all priorities frankly. It's a matter of timing in terms of which comes first and what the sequence of that is.

Kevin Campbell - Avondale Partners

One last question and this maybe goes back to Herman, if it's LogistiCare one. Is there any discussion in the Medicaid expansion at the state level about the additional beneficiaries not having the transportation benefit? You mentioned Arkansas would be a negative because if there aren't exchanges, they wouldn't have it. But just in general, is there any discussion about the folks that are on Medicaid from the 100% to 138% of poverty level. Any discussion of them not giving them that benefit?

Herman Schwarz

Yes, the state of Virginia that has been very specifically discussed by the legislature as they try to decide whether or not they want to adopt the ACA or not. So right now, the state has said no. The governor has said no. And they are not planning to do it in 2014, but they have indicated a willingness to potentially look at it at a later date, but the legislature has directed the department of Medicaid DMAS to look at ways to reduce the benefits to be provided to that population and transportation is specifically on that list.

Operator

Your next question is from the line of Walter Winnitzki with Nicusa Capital Partners.

Walter Winnitzki - Nicusa Capital Partners

Two questions for Herman. Herman, if you look at the awards that you have in hand right now and duration of those, is it possible to give us a ballpark as to what that total book of business that you have in LogistiCare would be right now? And then the second question is just in a general sense, maybe or more broad update relative to the competitive environment if there have been any changes both in who the players are and how they are competing with you?

Herman Schwarz

Like I mentioned, keep in mind, while the Missouri award is an award, we already have that run rate in our numbers right now. So what it's going to do is allow us to obviously maintain that going forward as opposed to losing that our of our run rate. Utah, like I indicated is a very, very small and really won't have a material impact.

So I would kind of go back to what I indicated in the earlier question, which says that we anticipate coming out of 2013, our revenues would be slightly ahead of where they were in 2012 because of the loss of Wisconsin and the change of Connecticut going from a capitated contract to an ASO, which means we have to record revenue on a much lower level. So there is growth in there, but it is offset by those takedowns.

And then, on the competitive environment, it's still the same players. I would say that we've talked a little bit a couple of years ago about access to care, and First Transit being worrisome. I think they've both kind of retrenched. We don't see First Transit being very aggressive these days in our space. Access to care is little more selective on what they go after and is being more careful in terms how they price.

If there is one slight change, is there is a small amount of non-profit out of Connecticut that we we're knocked out of Connecticut when we took the whole state from them actually. I mentioned them on the last call they did win six regions and main by going in and really cutting the price in the RFP and one surely on price. And we do think that they might be the cause for the very slow RFP award in Rhode Island. We do think that they way undercut pricing there and are now struggling with that decision as a result. So it would not surprise me honestly if the Rhode Island was given to them as well.

Walter Winnitzki - Nicusa Capital Partners

Following up on last question. Is there a trend moving more towards ASO contracts?

Herman Schwarz

I would not call it a major trend right now. Obviously, Connecticut just did it. They are really the only one that has changed and Connecticut has a history of liking to try new things every few year, whenever they get a new commissioner or director or secretary, I can't remember what they call it up there, but they kind of come in and put their own twist on things, thanks, the new director came out of the managed care environment, so those ASO, unlike the ASO.

New York is kind of going the other way from what they've laid out. We talked about New York is in ASO, but you got to remember New York was a fee-for-service contract managed by the state at the county level and this going to an ASO was the first step of going from a completely state-run contract to now using a broker with the stated intent of once they kind of get used to that of moving to a capitated model.

So I wouldn't say there is trend, I would say it's certainly something we have to watch and be careful of. I honestly think that with healthcare reform and all the structural changes going on in healthcare, we're going to jump right over ASO and be looking at a completely different incentive structure for folks like us, as you start talking about accountable care organizations, and medical homes and things like that, because we're not going to be able to get paid on keeping utilization down when access is going to be the buzzword in the day in terms of getting people to the doctor.

So we're going to have to find a different way to get paid in share and the outcome payments as opposed to on a capitated basis just for transportation. So Walter, I don't think I would get too concern that the ASO trend is going to take-off and reduce our revenues before the whole new structure comes through.

Operator

Your next question is from the line of Jack Wallace with Sidoti & Company.

Jack Wallace - Sidoti & Company

Quick question about the NET business, can you maybe talk a little bit about any more potential states where you can see some rate increases in '13?

Robert Wilson

Rate increases in '13. I think that's going to be a pretty short answer, Jack. I wouldn't say that there is really a lot of anything. There might be one as we renew or get the auction here in Mississippi. There is a possibility that we get slight increase their kind of an inflationary increase. Other than that we would expect that rates are going to be pretty stable, but the troubling spots we had in the past, Missouri was constant and New Jersey are all taking care of in one way or another. So we don't have a lot of justifications at this point. We're going in and asking for major rates, and our states given their financial situations don't have a lot of incentive to go and offer it.

Jack Wallace - Sidoti & Company

And then, again on the Social Services side, your organic gross numbers has been down for the last couple of quarters, and I know you guys have talked a little bit about tuck-in acquisitions and hint is that that could be a good use of capital. Just on the organic side maybe is there anything else kind of being done outside of working on your IT advantage. It's go ahead and grow business organically?

Craig Norris

Yes, of course, the Texas and Wisconsin contracts once they ramp up, probably starting in the second half, Jack, we'll start certainly adding to our organic growth numbers, I think in the areas that have transitioned through their managed care changes. One of our focus is really regrouping around those states that have kind of gone through the transition.

They've selected their providers. Their systems are in place and now we can kind of get out and get out ahead of growing census in those environments. There are other environments that are certainly still evolving their managed care systems, but some are past that process. And I think those are some of our target areas to sort of get out of ahead of the changes as the preferred providers in those areas.

The tuck-in acquisitions, we've mentioned, we're being very deliberate about that process. I would say that the pipeline is increasing substantially. But we want to be very selective about who we're going after and where we might make those deals, especially in this environment where you see providers downsizing through natural attrition let's call it. We certainly don't want to buy them on for the downside.

We want to be able to evaluate states that are going to be opting into the Medicaid expansion. So while our pipelines increasing, we are going through a very deliberate process strategically to try to figure out what's the best use of our acquisition strategy, so that we're kind of buying these companies on the outside. So I think it is going climb back up here at some point, but we are taking our time to make sure we're buying them in the right environment on the acquisition side.

Warren Rustand

I would also say that as we look at Social Services from a strategic perspective, we're also trying to discern how it is, that we proliferate our exceptional programs in one state across other states. And take a foster care program where we're very strong and experts, say in the state of Arizona and how do we move that to the state of Texas.

We have been able to do that now with the new contract in Texas for example. And so as we can sort of think ourselves as a transnational organization, meaning that we can move across geographic boundaries easily, it's the proliferation of these programs that's going to help us grow the Social Services side of the business. So we're paying a lot of attention to that as well.

Jack Wallace - Sidoti & Company

Maybe just kind of thinking about timing on when some of these tuck-in might come in, would it be safe to say that maybe the latter half of this year and early next year, maybe start seeing some activity on that front?

Craig Norris

I think that's a good assumption, Jack.

Operator

Your next question is from the line of Chris Brown with Aristides.

Chris Brown - Aristides

I just had kind of a long range question on financial targets. When you are bidding on business, are you looking to do tuck-in acquisition? Is return on invested capital kind of the most important metric for you or could you just speak to what metrics you look at and what your targets are?

Robert Wilson

You are absolutely right. We've got thresholds that we have in mind when we look at these things, so it's not just about creating more EBITDA. It's about, is this going to be accretive us from an maybe return standpoint. So that's, I think Craig was talking about the deliberateness of that. That's what he was really referring to, both strategic fit as well as financial fit for us. We recognize that we might be making potentially some acquisitions from the start that we may not have that. We will hit that a little, but the anticipation is through integration, consolidation, and so forth if we can meet those targets.

Chris Brown - Aristides

I can see where when it comes to bidding on business you wouldn't want to reveal that ROIC target. Can you speak to kind of the targeted returns you look for in tuck-in acquisition, accounting for synergies?

Robert Wilson

I think I'll better take that, really take that offline. I don't want to comment on the call here.

Operator

Your next question comes from the line of Rick D'Auteuil with Columbia Management.

Rick D'Auteuil - Columbia Management

First I'd like, Herman, on your side of the business, you threw out some metrics on the transportation expense when you compared this year to last year. I guess I'd be curious, last year was abnormally mild with weather and this year, I am not sure I have heard various things whether it's worse or normal or not. But how would that number have looked if we went back several years so we can get a more normalized sense of whether that 76% this year is more in line with what you historically had in this first quarter?

Herman Schwarz

I have to actually go back and look, Rick, but just in terms of where we kind of look at our gross margins normally, you'd probably be looking around normalized, about 78% to 80%.

Rick D'Auteuil - Columbia Management

I don't know if you want to speak anything to April, but we had an extended winter in some states and I am not sure to the extent that overlapped with your geographies. Did you see that trend continue in April?

Herman Schwarz

We didn't get a major weather impact in April given our states.

Rick D'Auteuil - Columbia Management

You didn't get a major help in April.

Herman Schwarz

Yes.

Rick D'Auteuil - Columbia Management

So the New Jersey Make-whole, I assume was retroactive. Can you quantify that? Is that around $1 million or better then that?

Herman Schwarz

I'd probably rather not talk about it publicly, but it's going to be a big number.

Rick D'Auteuil - Columbia Management

And that will come in, I think you've already said, some potentially in Q2 and some in Q3 or is it going to be Q1?

Herman Schwarz

No, it will all be at the same time. As you know because you ask every quarter, I can't really estimate the timing of how New Jersey does things? If it gets the process quickly and they can turn the payment around will get it this quarter. If its slips a little bit, it will be probably be early third quarter, but it will all be in one lump payment. And at that point of time, we'll recognize the revenue from it. We have not accrued for that because we were waiting to make sure that the agreement was signed.

Rick D'Auteuil - Columbia Management

Craig, historically I think acquisition pricing has been fairly tame for these tuck-ins, at least on a related competitor that would buy things three and four times EBITDA in your space. What would you expect, it's almost like they're selling defensively if they are acknowledging, if they can compete going forward either for technology or because of the increased level of regulation. You would think that would be a buyers market is pricing likely to be four times EBITDA or somewhere in that ballpark?

Craig Norris

Well, a couple of things on that. And I think the multiples, it's my impression they should be coming down as you indicate. The other issue is, as I said before, we got to be careful that we're not buying this providers that are sort of, how can I say it politely, kind of downsizing anyway, because we're just buying into a downward trend. So the trick is buy the right kind of providers that are not so behind the curve with where they've prepared themselves for these environments, but don't want to have to endure the future of other changes.

So there is narrow band, Rick, of whatever you call valuable providers that may not be going out of the states anyway like other providers would be where we might be pursuing more organics into this growth around providers who exit environments anyway.

So having said that I think the multiples, I would see probably coming down, but I think the targets that we really want to look for, although, the pipeline is increasing. I think the providers that we're going to probably target is probably going to narrow in that band, if that make sense.

Rick D'Auteuil - Columbia Management

And how about competition for acquisitions? Are you seeing yourself come up against anybody else that's trying to rollup the space or what do you think in that regards?

Craig Norris

We have seen a few others. We've even seen some private equity in some states ironically. We probably see the same opportunity in some of these evolving Medicaid expansion opportunities as we will perceive. But for the most part, we're not seeing heavy competition, but I was suspect as we get into this, sort of, nitty-gritty of the providers that are really strong and we've weeded out the others, there maybe competition that we don't know about at present.

Rick D'Auteuil - Columbia Management

And then one, how do you define a tuck-in, is this $5 million to $20 million in revenue or give me sense of what relative size range we're talking about?

Craig Norris

I'd say it's in $5 million to $15 million, $20 million range. I view it as an acquisition where we can easily reduce the administrative costs, consolidated that into our administration, easily sort of bring it over within on our operating regions. It's not a transformational reorganization around acquisition. We would certainly bring in our operating standards in the short-term our expense infrastructure, for example healthcare insurance. So something you can easily get your hands around in short-term, I mean that's probably a $5 million to $15 million, $20 million range.

Rick D'Auteuil - Columbia Management

And then lastly, Bob, this was a phenomenal quarter. I know you have answered questions related to the SG&A run rate. Give me a sense of how you're accruing for bonuses knowing that this is the first quarter or so?

Robert Wilson

We are accruing bonuses in accordance with the plans that are in place, I think are public information. So we're not withholding anything in terms of bonus accruals.

Rick D'Auteuil - Columbia Management

Again, I don't know what you're looking at the rest of the year, but you wouldn't expect to need to later in the year do a catch-up based on how we started off here?

Robert Wilson

Not as I see the rest of the year at this point in time, no.

Operator

Your next question is from the line of Mike Petusky with Noble Financials.

Mike Petusky - Noble Financial

First on the Social Services. What sort of actually any revenue associated with Texas and Wisconsin in the first quarter?

Craig Norris

None with Texas and there was a little bit with Wisconsin, Mike.

Mike Petusky - Noble Financial

And then on Texas, I have taken a note either last conference call, or maybe the previous one, where there was some expectations then in the first year revenue associated with Texas would be about $13 million. Is that still seem about right or is that too aggressive based on the early ramping, can you speak to that?

Craig Norris

I think that's probably a little aggressive. The contract actually started, I think it was a couple of months later, just for a number of contract start-up situation. So I would say that number is probably little heavy at this point, Mike.

Mike Petusky - Noble Financial

Maybe like 8 to 10 or something like that.

Craig Norris

I think that's a better range.

Mike Petusky - Noble Financial

And then moving on to the transportation business. North Carolina, Rhode Island, upstate New York are still out there. North Carolina, as I recall I think it was few different regions and then upstate New York, what's North Carolina and upstate New York? What's the revenue opportunity in aggregate associated with those two pieces of business?

Herman Schwarz

North Carolina, the whole state is probably in the $60 million range. If they ultimately come out, they had new Governor in November and he brought in a new head of the Health and Human Services Agency and she has turned it really upside down. And I think that's what's really slowed down that process. So in the aggregate, it was about $60 million odd contract. I think you will recall, we indicated we did not think we would win all three regions.

Two was, kind of, what we were hoping for. New York is very small, a couple of real small regions. I don't recall, Mike, off hand exactly how much it is, but it is not a big number. And Rhode Island, at around where we think it should be is $20 million to $25 million. But I believe CTS is going in lot slower than that.

Mike Petusky - Noble Financial

I think on the last conference call you expected a decision on Rhode Island and North Carolina somewhere around the first half of the year. I mean is that at this point given what's the current of two states, is that maybe too optimistic and maybe it's going to be more like third quarter, fourth quarter?

Herman Schwarz

We really don't have a lot of insight into what North Carolina is thinking right now. So at this point, they are not really putting out any real information. They even indicated it's just delayed, it's off the table. So I really can't give you any. Clearly, it's not going to happen in terms of being able to be implemented any time during the first part of this year.

So if you were to see any impact in 2013, it will be towards the very end of the year, given where we are. Rhode Island, if we're right in what's going on there, we think they are waiting for the main implementation to take place and they are probably making award sometimes in the fall, either a fall start or a start of 2014.

Operator

Your next question is a follow up question from the line of Kevin Campbell with Avondale Partners.

Kevin Campbell - Avondale Partners

Just wanted to make sure I understood some of the numbers that Herman gave in terms of the 76% to 81% numbers and what he said for response to Rick's questions. So those numbers as a percentage of revenues don't match up with sort of the cost of NET as a percentage of LogistiCare revenue. So maybe you could just tell us or maybe just help me understand exactly what that 76% or 81% number is?

Herman Schwarz

Well, when you say cost of NET, that's based up of the financials that we put out. We look at it a little bit differently internally, Kevin. Gross margin is revenue less transportation expense. Cost of NET includes some of our G&A and other expenses that you see in the published reports. So when I am talking about 76% and 81%, it's strictly what we pay out for transportation as percent of revenue. I am not including any of our people or any other cost to run the process to actually operate the call centers or anything like that.

Kevin Campbell - Avondale Partners

So it's just what you pay to the providers to provide that transport, and this quarter based on your response to the Rick's question was 200 basis points sort of short of what normalized gross margin would be?

Herman Schwarz

That's correct. It's what we really consider to be the cost of goods sold as transportation.

Operator

There are no further questions in the queue. So ladies and gentlemen, just we'll go ahead and conclude the question-and-answer portion of today's broadcast. I'll go ahead and turn the call back over to management for any closing remarks they would like to make.

Warren Rustand

Again, thank you all for being with us this morning. We're pleased with our progress, but we have a long way to go. We have a lot of hard work ahead of us. This is just one quarter of four and so we'll continue to focus on our business. We thank you for joining us on the call today and we continue to look forward to what we believe will be a good year for Providence and we look forward to updating you after the second quarter. Thank you all for your time today.

Operator

Ladies and gentlemen, thank you for your participation in today's webcast. This concludes the presentation. You may now all disconnect. Have a great day.

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