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 The leading web portal for pharmacy resources, news, education and careers November 14, 2018
Pharmacy Choice - Pharmaceutical News - PROVIDENCE SERVICE CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations. - November 14, 2018

Pharmacy News Article

 11/8/18 - PROVIDENCE SERVICE CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and accompanying notes for the three and nine months ended September 30, 2018 and 2017, as well as our consolidated financial statements and accompanying notes and management's discussion and analysis of financial condition and results of operations included in our Form 10-K for the year ended December 31, 2017. For purposes of "Management's Discussion and Analysis of Financial Condition and Results of Operations," references to Q3 2018 and Q3 2017 mean the three months ended September 30, 2018 and the three months ended September 30, 2017, respectively, and references to YTD 2018 and YTD 2017 mean the nine months ended September 30, 2018 and the nine months ended September 30, 2017, respectively.

Overview of our business

Providence owns subsidiaries and investments primarily engaged in the provision of healthcare services in the United States and workforce development services internationally. The subsidiaries and other investments in which the Company holds interests comprise the following segments:

?      Non-Emergency Transportation Services ("NET Services") - Nationwide
       manager of non-emergency medical transportation ("NET") programs for state
       governments and managed care organizations. On September 21, 2018,
       LogistiCare Solutions, LLC ("LogistiCare") completed its acquisition of
       Circulation Inc. ("Circulation"). Circulation is a company that offers a
       full suite of logistics solutions to manage non-emergency transportation
       across all areas of healthcare.


?      Workforce Development Services ("WD Services") - Global provider of
       employment preparation and placement services, legal offender
       rehabilitation services, youth community service programs and certain
       health related services to eligible participants of government sponsored
       programs. On November 6, 2018, the Board of Directors of Providence
       approved the sale of the WD Services segment. On November 7, 2018, the
       Company and Ingeus UK Holdings Limited ("Holdings"), the Company's direct
       wholly-owned subsidiary, entered into a share purchase agreement with
       Advanced Personnel Management Global Pty Ltd and APM UK Holdings Limited
       (together the "Purchasers") and International APM Group Pty Limited, as
       Purchasers' Guarantor (the "Guarantor"), pursuant to which we have agreed
       to sell substantially all of the operating subsidiaries of our WD Services
       segment with the exception of our operations in Saudi Arabia, for which we
       are pursuing alternative strategies which are expected to result in no
       longer providing services in the country beyond the end of the year. The
       transaction is subject to approvals from certain of Ingeus' government
       customers and the satisfaction of customary closing conditions.


?      Matrix Investment - Minority interest in CCHN Group Holdings, Inc. and its
       subsidiaries ("Matrix"), accounted for as an equity method investment.
       Matrix offers a national network of community-based clinicians who deliver
       in-home services for members, including comprehensive health assessments
       ("CHAs"), and a fleet of mobile health clinics with advanced diagnostic
       capabilities. On February 16, 2018, Matrix acquired HealthFair.


In addition to its segments' operations, the Corporate and Other segment includes the Company's activities at its corporate office that include executive, accounting, finance, internal audit, tax, legal, public reporting, certain strategic and corporate development functions and the results of the Company's captive insurance company. We are currently in the process of an organizational consolidation to integrate substantially all activities and functions performed at the corporate holding company level into LogistiCare. This strategic process is expected to be completed by the middle of 2019, over which time implementation costs will negatively impact earnings.

Business Outlook and Trends

Our performance is affected by a number of trends that drive the demand for our services. In particular, the markets in which we operate are exposed to various trends such as healthcare industry and demographic dynamics in the U.S. and international government outsourcing and employment dynamics. Over the long term, we believe there are numerous factors that could affect growth within the industries in which we operate, including: ? an aging population, which will increase demand for healthcare services;


?      a movement towards value-based versus fee for service care and budget
       pressure on governments, both of which may increase the use of private
       corporations to provide necessary and innovative services;


?      increasing demand for in-home care, driven by cost pressures on
       traditional reimbursement models and technological advances enabling
       remote engagement;



                                       34


?      technological advancements, which may be utilized by us to improve service
       and lower costs, but also by others which may increase industry
       competitiveness;


?      changes in UK government policy driven by opposition to the government's
       outsourcing of the services provided by WD Services to private companies,
       which opposition may increase in light of recent events in the UK,
       including the liquidation of the UK government contractor Carillion plc;


?      the results of the referendum on the UK's exit from the European Union and
       related political and economic uncertainty in the UK related to the
       finalization of Brexit; and


?      proposals by the President of the United States, Congress and/or the
       Centers for Medicare and Medicaid Services' ("CMS") to change the Medicaid
       program, including considering converting the Medicaid program to a block
       grant format, capping the federal contribution to state Medicaid programs
       to a fixed amount per beneficiary, and CMS' grant of waivers to states
       relative to the parameters of their Medicaid programs, including
       limitations in benefits or enrollment such as enacting eligibility
       limitations or imposing eligibility work requirements. Enactment of
       adverse legislation, regulation or agency guidance may reduce the demand
       for our services, our ability to conduct some or all of our business
       and/or reimbursement rates for services performed within our segments.


Circulation was acquired in September 2018, and is a company that offers a full
suite of logistics solutions to manage non-emergency transportation across all
areas of healthcare, powered by its HIPAA-compliant digital platform.
Circulation enables administration of transportation benefits, proactively
monitors for fraud waste and abuse, and integrates all transportation
capabilities (e.g. outsourced transportation, owned fleets, and other medical
logistics services), while emphasizing patient convenience and satisfaction.
Circulation's proprietary platform simplifies ordering, improves reliability and
efficiency, and reduces transportation spend. LogistiCare believes the
acquisition advances their central mission of reducing transportation as a
barrier to healthcare, and will help deliver a differentiated user experience
and provide a core technology and analytics platform that better positions them
for growth. LogistiCare may seek to utilize the Circulation platform to service
legacy or new LogistiCare contracts, which may result in a decrease in the usage
of the LogistiCare technology platform. The evaluation of the technology
platforms and how the functionality of the systems will interact is ongoing, and
subject to continued evaluation of the scalability of the Circulation platform
to meet the required processing levels of transactions under the LogistiCare
contracts.
On June 11, 2018, the Company entered into a Share Purchase Agreement to sell
the shares of Ingeus France for a de minimis amount. The sale was effective on
July 17, 2018, after court approval. As a result, an impairment charge of $9.2
million was recorded during the nine months ended September 30, 2018 and a loss,
primarily related to the release of the effects of historic cumulative
translation adjustments, of $0.7 million was recorded during the three months
ended September 30, 2018.
On November 6, 2018, the Board of Directors of Providence approved the sale of
the WD Services segment. On November 7, 2018, the Company and Holdings entered
into a share purchase agreement with the Purchasers and the Guarantor, pursuant
to which we agreed to sell substantially all of the operating subsidiaries of
our WD Services segment with the exception of our operations in Saudi Arabia,
for which we are pursuing alternative strategies which are expected to result in
no longer providing services in the country beyond the end of the year. The
total cash consideration is approximately $46.1 million, including approximately
$19.5 million of cash on the balance sheet as of September 30, 2018. In addition
to the purchase consideration, the Company expects to be able to realize cash
tax benefits of between approximately $25.0 million to $50.0 million as a result
of tax deductions triggered by the sale, over a period of three to five years
dependent on the timing of taxable income or loss and the close of the
transaction. The transaction is subject to approvals from certain of Ingeus'
government customers and the satisfaction of customary closing conditions. The
transaction is expected to close by the end of 2018, although the Company can
give no assurance the transaction will close in a timely manner.  In addition,
upon the finalization of the transaction and the alternative strategies for
Saudi Arabia it is possible the Company may be required to record a charge in
future periods.

Critical accounting estimates and policies

As discussed in Note 2, Significant Accounting Policies and Recent Accounting Pronouncements, and Note 3, Revenue Recognition, of our condensed consolidated financial statements, as of January 1, 2018 the Company adopted the new standard on revenue recognition. Other than this standard, there have been no significant changes in our critical accounting policies to our condensed consolidated financial statements. For further discussion of our critical accounting policies, see management's discussion and analysis of financial condition and results of operations contained in our Form 10-K for the year ended December 31, 2017.

Results of operations

Segment reporting. Our operations are organized and reviewed by management along our segment lines. We operate in two principal business segments: NET Services and WD Services. Our investment in Matrix is also a reportable segment referred to as the "Matrix Investment". Segment results are based on how our chief operating decision maker manages our business, makes operating decisions and evaluates operating performance. The operating results of the two principal business segments include


                                       35

revenue and expenses incurred by the segment, as well as an allocation of direct expenses incurred by our corporate segment on behalf of the business segment, which primarily relate to insurance and stock-based compensation allocations. Indirect expenses, including unallocated corporate functions and expenses, such as executive, accounting, finance, internal audit, tax, legal, public reporting, certain strategic and corporate development functions and the results of the Company's captive insurance company and elimination entries recorded in consolidation are reflected in "Corporate and Other".

Effective November 1, 2015, we completed the sale of our Human Services segment. Subsequent to the sale of our Human Services segment, we have incurred additional expenses and benefits in certain periods related to the settlement of indemnification claims and associated legal costs, which are recorded to "Discontinued operations, net of tax".

Q3 2018 compared to Q3 2017


Consolidated Results. The following table sets forth results of operations and
the percentage of consolidated total revenues represented by items in our
unaudited condensed consolidated statements of income for Q3 2018 and Q3 2017
(in thousands):
                                                Three months ended September 30,
                                                2018                         2017
                                                    Percentage                   Percentage
                                          $         of Revenue         $         of Revenue
Service revenue, net                   421,319         100.0  %     409,517         100.0  %

Operating expenses:
Service expense                        391,608          92.9  %     378,032          92.3  %
General and administrative expense      16,203           3.8  %      18,629           4.5  %
Depreciation and amortization            6,641           1.6  %       6,547           1.6  %
Total operating expenses               414,452          98.4  %     403,208          98.5  %

Operating income                         6,867           1.6  %       6,309           1.5  %

Non-operating expense:
Interest expense, net                      347           0.1  %         302           0.1  %
Other loss                                 669           0.2  %           -             -  %
Equity in net loss of investees          1,558           0.4  %         460           0.1  %
Gain on sale of equity investment            -             -  %     (12,606 )        -3.1  %
Gain on remeasurement of cost method
investment                              (6,577 )        (1.6 )%           -             -  %
Loss (gain) on foreign currency
transactions                              (178 )           -  %         200             -  %
Income from continuing operations
before income taxes                     11,048           2.6  %      17,953           4.4  %
Provision for income taxes               4,259           1.0  %       2,989           0.7  %
Income from continuing operations,
net of tax                               6,789           1.6  %      14,964           3.7  %
Discontinued operations, net of tax        542           0.1  %         (16 )           -  %
Net income                               7,331           1.7  %      14,948           3.7  %
Net income attributable to
noncontrolling interest                   (177 )           -  %         (95 )           -  %
Net income attributable to
Providence                               7,154           1.7  %      14,853           3.6  %


Service revenue, net. Consolidated service revenue, net for Q3 2018 increased $11.8 million, or 2.9%, compared to Q3 2017. Revenue for Q3 2018 compared to Q3 2017 included an increase in revenue attributable to NET Services of $18.9 million and a decrease in revenue attributable to WD Services of $7.1 million. Excluding the effects of changes in currency exchange rates, consolidated service revenue increased 3.0% for Q3 2018 compared to Q3 2017. The results for Q3 2018 reflect the impact of the adoption of FASB Accounting Standards Codification Topic 606 ("ASC 606"). The Company began recognizing revenue under ASC 606 effective January 1, 2018. As a result of applying ASC 606, NET Services recorded $3.8 million less revenue in Q3 2018 than would have been recorded under our historical revenue recognition policy due to one contract now being accounted for as net versus gross. However, WD Services recorded $2.1 million more of revenue in Q3 2018 than would have been recognized under the previous accounting standard due primarily to the timing and delivery under certain contracts.


                                       36

Total operating expenses. Consolidated operating expenses for Q3 2018 increased $11.2 million, or 2.8%, compared to Q3 2017. Operating expenses for Q3 2018 compared to Q3 2017 included an increase in expenses attributable to NET Services of $18.5 million. Operating expenses for Q3 2018 compared to Q3 2017 included a decrease in expenses attributable to WD Services of $4.6 million and Corporate and Other of $2.7 million. The impact on Q3 2018 of adopting ASC 606 effective January 1, 2018 was $3.8 million less in operating expenses recorded by NET Services, as one contract is now being recorded on a net versus gross basis, and $1.7 million more in operating expenses recorded by WD Services, as these costs were deferred in relation to the deferral of revenue, which was primarily recognized in Q3 2018.

Operating income. Consolidated operating income for Q3 2018 increased $0.6 million, or 8.8%, compared to Q3 2017. The increase was primarily attributable to an increase in operating income in Q3 2018 as compared to Q3 2017 at NET Services of $0.4 million and a decrease in operating loss for Corporate and Other of $2.7 million, which was partially offset by an increase in operating loss for WD Services of $2.5 million. The impact of adopting ASC 606 on operating income in Q3 2018 was zero for NET Services and positive $0.4 million for WD Services.

Interest expense, net. Consolidated interest expense, net for Q3 2018 and Q3 2017 remained relatively consistent.

Other loss. On June 11, 2018, we entered into a Share Purchase Agreement to sell the shares of Ingeus France, our WD Services operation in France, for a de minimis amount. The sale was effective on July 17, 2018, after court approval. A loss totaling $0.7 million, primarily related to the release of historic cumulative translation adjustments, was recognized on the sale during Q3 2018.

Equity in net loss of investees. Equity in net loss of investees primarily relates to our investments in Matrix in both periods and Mission Providence in Q3 2017. Our investment in Mission Providence, which was part of our WD Services segment, was sold effective September 29, 2017. Our equity in net loss of investees for Q3 2018 of $1.6 million primarily related to our equity in net loss for Matrix. Included in Matrix's Q3 2018 standalone results are depreciation and amortization of $9.6 million, interest expense of $6.2 million, equity compensation of $0.5 million, management fees paid to certain of Matrix's shareholders of $0.6 million, merger and acquisition related diligence costs of $0.1 million, integration costs of $1.9 million, and an income tax benefit of $0.4 million. Our equity in net loss of investees related to WD Services and Matrix totaled $0.5 million and $1.0 thousand, respectively, for Q3 2017. Included in Matrix's standalone Q3 2017 results were equity compensation of $0.6 million, management fees paid to certain of Matrix's shareholders of $0.6 million, depreciation and amortization of $8.5 million, interest expense of $3.7 million and an income tax benefit of $45.0 thousand.

Gain on sale of equity investment. The gain on sale of equity investment of $12.6 million for Q3 2017 relates to the sale of our equity interest in Mission Providence effective September 29, 2017. The investment in Mission Providence was part of the WD Services segment.

Gain on remeasurement of cost method investment. On September 21, 2018, we acquired all of the outstanding equity of Circulation. The purchase price was comprised of cash consideration of $45.1 million paid to Circulation's equity holders (including holders of vested Circulation stock options), other than Providence. Our initial investment in Circulation was $3.0 million. As a result of the transaction, the fair value of this pre-acquisition interest increased to $9.6 million, and thus we recognized a gain of $6.6 million.

Loss (gain) on foreign currency transactions. The foreign currency gain of $0.2 million for Q3 2018 and foreign currency loss of $0.2 million for Q3 2017 were primarily due to translation adjustments of our foreign subsidiaries in the WD Services segment.

Provision for income taxes. Our effective tax rate from continuing operations for Q3 2018 and Q3 2017 was 38.6% and 16.7%, respectively. The Q3 2018 effective tax rate was higher than the U.S. federal statutory rate of 21% primarily due to foreign net operating losses for which the future income tax benefit cannot be currently recognized, state income taxes and certain non-deductible expenses. The impact of these items was partially offset by no income tax provision being recorded on the gain on remeasurement of cost method investment of $6.6 million. The effective tax rate was lower than the U.S. federal statutory rate of 35% for Q3 2017 primarily due to no provision for income taxes related to the gain on sale of equity investment of $12.6 million due to the substantial difference in tax basis versus book basis in the investment.

Discontinued operations, net of tax. Discontinued operations, net of tax, includes the activity related to our former Human Services segment. For Q3 2018, discontinued operations, net of tax, was a benefit of $0.5 million for our Human Services segment which primarily reflects a reduction of the accrued settlement amount for indemnified legal matters, based on the final settlement agreement, partially offset by legal costs incurred. Although the matter is settled, the Company may incur additional legal costs


                                       37

in the future as it seeks insurance coverage for a portion of the settlement. For Q3 2017, discontinued operations, net of tax for our Human Services segment reflects expenses incurred for an indemnified legal matter, which were minimal. See Note 18, Discontinued Operations, to our condensed consolidated financial statements for additional information.

Net income attributable to noncontrolling interests. Net income attributable to noncontrolling interests primarily relates to a minority interest held by a third-party operating partner in our company servicing the offender rehabilitation contract in our WD Services segment.

YTD 2018 compared to YTD 2017

The following table sets forth results of operations and the percentage of consolidated total revenues represented by items in our unaudited condensed consolidated statements of income for YTD 2018 and YTD 2017 (in thousands):

                                                     Nine months ended September 30,
                                                  2018                             2017
                                                    Percentage of                    Percentage of
                                          $            Revenue             $            Revenue
Service revenue, net                 1,239,159         100.0  %       1,216,994         100.0  %

Operating expenses:
Service expense                      1,147,914          92.6  %       1,124,478          92.4  %
General and administrative expense      53,894           4.3  %          53,705           4.4  %
Asset impairment charge                  9,881           0.8  %               -             -  %
Depreciation and amortization           20,317           1.6  %          19,716           1.6  %
Total operating expenses             1,232,006          99.4  %       1,197,899          98.4  %

Operating income                         7,153           0.6  %          19,095           1.6  %

Non-operating expense:
Interest expense, net                      918           0.1  %             983           0.1  %
Other loss                                 669           0.1  %               -             -  %
Equity in net loss of investees          4,026           0.3  %             991           0.1  %
Gain on sale of equity investment            -             -  %         (12,606 )        (1.0 )%
Gain on remeasurement of cost method
investment                              (6,577 )        (0.5 )%               -             -  %
Loss (gain) on foreign currency
transactions                              (807 )        (0.1 )%             600             -  %
Income from continuing operations
before income taxes                      8,924           0.7  %          29,127           2.4  %
Provision for income taxes               7,755           0.6  %           8,391           0.7  %
Income from continuing operations,
net of tax                               1,169           0.1  %          20,736           1.7  %
Discontinued operations, net of tax        485             -  %          (6,000 )        (0.5 )%
Net income                               1,654           0.1  %          14,736           1.2  %
Net income attributable to
noncontrolling interest                   (285 )           -  %            (295 )           -  %
Net income attributable to
Providence                               1,369           0.1  %          14,441           1.2  %


Service revenue, net. Consolidated service revenue, net for YTD 2018 increased $22.2 million, or 1.8%, compared to YTD 2017. Revenue for YTD 2018 compared to YTD 2017 included an increase in revenue attributable to NET Services of $36.5 million. This increase in revenue was partially offset by a decrease in revenue attributable to WD Services of $14.4 million. Excluding the effects of changes in currency exchange rates, consolidated service revenue increased 1.1% for YTD 2018 compared to YTD 2017. The Company began recognizing revenue under ASC 606 effective January 1, 2018. As a result of applying ASC 606, NET Services recorded $11.2 million less revenue in YTD 2018 than would have been recorded under our historical revenue recognition policy due to one contract now being accounted for as net versus gross. Additionally, WD Services recorded $4.0 million less revenue in YTD 2018 than would have been recognized under the previous accounting standard.



                                       38

Total operating expenses. Consolidated operating expenses for YTD 2018 increased $34.1 million, or 2.8%, compared to YTD 2017. Operating expenses for YTD 2018 compared to YTD 2017 included an increase in expenses attributable to NET Services of $32.2 million, WD Services of $0.6 million and Corporate and Other of $1.2 million. The impact of adopting ASC 606 effective January 1, 2018 was $11.2 million less in operating expenses recorded by NET Services, as one contract is now being recorded on a net versus gross basis, and $0.9 million less in operating expenses recorded by WD Services, as these costs were deferred in relation to the deferral of revenue. Total operating expenses include asset impairment charges for YTD 2018 of $9.2 million for WD Services and $0.7 million for NET Services.

Operating income. Consolidated operating income for YTD 2018 decreased $11.9 million compared to YTD 2017. The decrease was primarily attributable to an increase in the operating losses for WD Services of $15.0 million and Corporate and Other of $1.2 million, as compared to YTD 2017, which were partially offset by an increase in operating income attributable to NET Services of $4.3 million. The impact of adopting ASC 606 on operating income in YTD 2018 was zero for NET Services and negative $3.2 million for WD Services.

Interest expense, net. Consolidated interest expense, net for YTD 2018 decreased $0.1 million compared to YTD 2017.

Other loss. On June 11, 2018, we entered into a Share Purchase Agreement to sell the shares of Ingeus France for a de minimis amount. The sale was effective on July 17, 2018, after court approval. A loss totaling $0.7 million, primarily related to the release of historic cumulative translation adjustments, was recognized on the sale during YTD 2018.

Equity in net loss of investees. Our equity in net loss of investees for YTD 2018 of $4.0 million primarily includes an equity in net loss of Matrix of $4.1 million. Included in Matrix's standalone YTD 2018 results are depreciation and amortization of $28.0 million, interest expense of $22.5 million, including $6.6 million related to the amortization of deferred financing costs primarily resulting from the refinancing of Matrix debt facility, equity compensation of $2.1 million, management fees paid to Matrix's shareholders of $4.3 million, merger and acquisition diligence related costs of $2.3 million primarily related to the first quarter acquisition of HealthFair, integration costs of $4.3 million, and income tax benefit of $3.4 million. Our equity in net loss of investees for YTD 2017 included a loss of $1.4 million for WD Services and gain for Matrix of $0.4 million. Included in Matrix's standalone YTD 2017 results were transaction bonuses and other transaction related costs of $3.5 million, equity compensation of $1.9 million, depreciation and amortization of $24.6 million, interest expense of $11.0 million and an income tax benefit of $0.1 million.

Gain on sale of equity investment. The gain on sale of equity investment of $12.6 million for YTD 2017 relates to the sale of our equity interest in Mission Providence effective September 29, 2017. The investment in Mission Providence was part of the WD Services segment.

Gain on remeasurement of cost method investment. On September 21, 2018, we acquired all of the outstanding equity of Circulation. The purchase price was comprised of cash consideration of $45.1 million paid to Circulation's equity holders (including holders of vested Circulation stock options), other than Providence. Our initial investment in Circulation was $3.0 million. As a result of the transaction, the fair value of this pre-acquisition interest increased to $9.6 million, and thus we recognized a gain of $6.6 million.

Loss (gain) on foreign currency transactions. The foreign currency gain of $0.8 million and foreign currency loss of $0.6 million for YTD 2018 and YTD 2017, respectively, were primarily due to translation adjustments of our foreign subsidiaries.

Provision for income taxes. Our effective tax rates from continuing operations for YTD 2018 and YTD 2017 were 86.9% and 28.8%, respectively. The YTD 2018 effective tax rate was higher than the U.S. federal statutory rate of 21% primarily due to foreign net operating losses for which the future income tax benefit cannot be currently recognized, state income taxes and certain non-deductible expenses, as well as the WD Services impairment charge of $9.2 million, which contributes to the tax basis in WD Services but does not generate a current tax benefit. The impact of these items was partially offset by no income tax provision being recorded on the gain on remeasurement of cost method investment of $6.6 million. The effective tax rate was lower than the U.S. federal statutory rate of 35% for YTD 2017 primarily due to no provision for income taxes related to the gain on sale of equity investment of $12.6 million due to the substantial difference in tax basis versus book basis in the investment.

Discontinued operations, net of tax. Discontinued operations, net of tax, includes the activity related to our former Human Services segment. For YTD 2018, discontinued operations, net of tax, was a benefit of $0.5 million for our Human Services segment which primarily reflects a reduction of the accrued settlement amount for indemnified legal matters, based on the final settlement agreement. For YTD 2017, discontinued operations, net of tax for our Human Services segment was a loss of $6.0 million, primarily related to the additional accrual for the settlement of indemnified legal matters. See Note 18, Discontinued Operations, to our condensed consolidated financial statements for additional information.


                                       39

Net income attributable to noncontrolling interests. Net income attributable to noncontrolling interests primarily relates to a minority interest held by a third-party operating partner in our company servicing the offender rehabilitation contract in our WD Services segment.

Segment Results. The following analysis includes discussion of each of our segments.

NET Services


NET Services segment financial results are as follows for Q3 2018 and Q3 2017
(in thousands):
                                                    Three Months Ended September 30,
                                                  2018                             2017
                                                      Percentage of                   Percentage of
                                           $             Revenue            $            Revenue
Service revenue, net                   343,771             100.0 %       324,824           100.0 %

Service expense                        320,697              93.3 %       304,454            93.7 %
General and administrative expense       4,900               1.4 %         2,899             0.9 %
Depreciation and amortization            3,543               1.0 %         3,286             1.0 %
Operating income                        14,631               4.3 %        14,185             4.4 %



Service revenue, net. Service revenue, net for NET Services for Q3 2018 increased $18.9 million, or 5.8%, compared to Q3 2017. The increase was primarily related to the impact of new contracts, including managed care organization ("MCO") contracts in Indiana, Illinois and West Virginia and new state contracts for additional regions in Texas, which contributed $27.1 million of revenue for Q3 2018, as well as net increased revenue from existing contracts of $7.1 million due to the net impact of membership and rate changes, including increased rates agreed after Q3 2017 on certain other contracts related to increased costs to serve the contracts. These increases were partially offset by the impact of contracts we no longer serve, including a state contract in Connecticut and certain MCO contracts in Florida and Louisiana, which resulted in a decrease in revenue of $11.4 million. In addition, the adoption of ASC 606 resulted in a decrease in revenue of $3.8 million in Q3 2018 as compared to revenue under the previous accounting standard, as one contract is now accounted for on a net basis.

Service expense, net. Service expense for our NET Services segment included the following for Q3 2018 and Q3 2017 (in thousands):

                                         Three Months Ended September 30,
                                        2018                             2017
                                             Percentage of                Percentage of
                                 $              Revenue          $           Revenue
Purchased services          262,661                76.4 %     250,282           77.1 %
Payroll and related costs    45,569                13.3 %      40,753           12.5 %
Other operating expenses     12,258                 3.6 %      13,299            4.1 %
Stock-based compensation        209                 0.1 %         120              - %
Total service expense       320,697                93.3 %     304,454           93.7 %



Service expense for Q3 2018 increased $16.2 million, or 5.3%, compared to Q3 2017 due primarily to higher purchased services and payroll and related costs. Purchased services expense increased primarily as a result of new contracts, which was partially offset by the impact of terminated contracts. Purchased services as a percentage of revenue decreased from 77.1% in Q3 2017 to 76.4% in Q3 2018 primarily as a result of ongoing initiatives to better align the rates we pay to our transportation provider partners with local market conditions and the fees paid to us by our customers. Payroll and related costs as a percentage of revenue increased from 12.5% in Q3 2017 to 13.3% in Q3 2018 due to increased corporate staffing and increased health insurance expenses. These increases were partially offset by a decrease in other operating expenses primarily attributable to a decrease in costs targeted at operational improvement from $2.2 million in Q3 2017 to $1.1 million in Q3 2018.



                                       40

General and administrative expense. General and administrative expense in Q3 2018 increased as a percentage of revenue, from 0.9% for Q3 2017 to 1.4% for Q3 2018. General and administrative expense for Q3 2018 includes $1.6 million of transaction expenses related to the acquisition of Circulation.

Depreciation and amortization. Depreciation and amortization increased $0.3 million primarily due to the addition of long-lived assets relating to information technology projects. As a percentage of revenue, depreciation and amortization remained constant at 1.0% for Q3 2017 and Q3 2018.


NET Services segment financial results are as follows for YTD 2018 and YTD 2017
(in thousands):
                                                    Nine Months Ended September 30,
                                                 2018                            2017
                                                    Percentage of                   Percentage of
                                          $            Revenue            $            Revenue
Service revenue, net                 1,024,203           100.0 %       987,662           100.0 %

Service expense                        955,796            93.3 %       927,082            93.9 %
General and administrative expense      10,940             1.1 %         8,879             0.9 %
Asset impairment charge                    679             0.1 %             -               - %
Depreciation and amortization           10,548             1.0 %         9,763             1.0 %
Operating income                        46,240             4.5 %        41,938             4.2 %



Service revenue, net. Service revenue, net for NET Services for YTD 2018 increased $36.5 million, or 3.7%, compared to YTD 2017. The increase was primarily related to the impact of new contracts, including managed care organization ("MCO") contracts in Indiana, Illinois and New York and new state contracts in Texas, which contributed $87.3 million of revenue for YTD 2018, as well as net increased revenue from existing contracts of $11.8 million due to the net impact of membership and rate changes, including the impact of increased rates agreed after YTD 2017 on certain contracts related to increased costs to serve the contracts, which was partially offset by the impact of a retroactive rate adjustment recorded in YTD 2017 related to increased utilization activity under a significant contract. These increases were partially offset by the impact of contracts we no longer serve, including state contracts in New York and Connecticut, certain MCO contracts in Florida and Louisiana, and decreased membership in Virginia, which resulted in a decrease in revenue of $51.3 million. In addition, the adoption of ASC 606 resulted in a decrease in revenue of $11.2 million in YTD 2018 as compared to revenue under the previous accounting standard, as one contract is now accounted for on a net basis.

Service expense, net. Service expense for our NET Services segment included the following for YTD 2018 and YTD 2017 (in thousands):

                                         Nine Months Ended September 30,
                                        2018                            2017
                                            Percentage of                Percentage of
                                $              Revenue          $           Revenue
Purchased services          785,776               76.7 %     766,303           77.6 %
Payroll and related costs   133,535               13.0 %     122,784           12.4 %
Other operating expenses     36,187                3.5 %      37,584            3.8 %
Stock-based compensation        298                0.0 %         411            0.0 %
Total service expense       955,796               93.3 %     927,082           93.9 %



Service expense for YTD 2018 increased $28.7 million, or 3.1%, compared to YTD 2017 due primarily to higher purchased services and payroll and related costs. Purchased services expense increased primarily as a result of new contracts, which was partially offset by the impact of terminated contracts. Purchased services as a percentage of revenue decreased from 77.6% in YTD 2017 to 76.7% in YTD 2018. This was due primarily to lower transportation costs on a per trip basis in certain geographies as a result of ongoing initiatives to better align the rates we pay to our transportation provider partners with local market conditions and the fees paid to us by our customers. This was partially offset in the second quarter of 2018 by higher transportation costs on a per trip basis due to a shift in service mix from lower to higher cost modes of transportation and an increase in the average mileage per trip. Payroll and related costs as a percentage of revenue increased from 12.4% in YTD 2017 to 13.0% in YTD 2018


                                       41

due to increased corporate staffing and increased health insurance expenses. These increases were partially offset by a decrease in other operating expenses primarily attributable to a decrease in costs targeted at operational improvement from $4.9 million in YTD 2017 to $2.3 million in YTD 2018. This decrease was partially offset by increased software and hardware maintenance costs associated with new technology initiatives.

General and administrative expense. General and administrative expense in YTD 2018 increased as a percentage of revenue from 0.9% for YTD 2017 to 1.1% for YTD 2018. General and administrative expense for YTD 2018 includes $1.6 million of transaction expenses related to the acquisition of Circulation.

Asset impairment charge. Asset impairment charge of $0.7 million was incurred in YTD 2018 in relation to the decision to abandon specific development work intended to synchronize data across applications of the proprietary LCAD Nextgen system, based on the determination of an alternative method to accomplish this task.

Depreciation and amortization. Depreciation and amortization increased $0.8 million primarily due to the addition of long-lived assets relating to information technology projects. As a percentage of revenue, depreciation and amortization remained constant at 1.0%.

WD Services


WD Services segment financial results are as follows for Q3 2018 and Q3 2017 (in
thousands):
                                                    Three Months Ended September 30,
                                                  2018                             2017
                                                      Percentage of                   Percentage of
                                          $              Revenue            $            Revenue
Service revenue, net                    77,548            100.0  %        84,693           100.0 %

Service expense                         70,911             91.4  %        73,581            86.9 %
General and administrative expense       5,348              6.9  %         6,980             8.2 %
Depreciation and amortization            2,861              3.7  %         3,166             3.7 %
Operating (loss) income                 (1,572 )           (2.0 )%           966             1.1 %



Service revenue, net. Service revenue, net for Q3 2018 decreased $7.1 million, or 8.4%, compared to Q3 2017. Excluding the unfavorable effects of changes in currency exchange rates, service revenue decreased 7.9% in Q3 2018 compared to Q3 2017. The decrease in revenue was primarily attributable to the sale of Ingeus France, the ongoing wind-down of the segment's legacy UK employability program, a decrease in revenue from our Saudi Arabia operations due partially to the deferral of revenue for the August and September 2018 contract period due to delays in executing this contract, and a reduction in revenue related to the offender rehabilitation program. These decreases were partially offset by increased revenue under the segment's health program, as well as the segment's operations in the U.S. and certain other international operations and the impact of the adoption of the new revenue standard, which resulted in $2.1 million more revenue in Q3 2018 than would have been recognized under the previous accounting standard due primarily to the timing and delivery under certain contracts.

Service expense. Service expense for our WD Services segment included the following for Q3 2018 and Q3 2017 (in thousands):

                                         Three Months Ended September 30,
                                         2018                            2017
                                              Percentage of               Percentage of
                                 $               Revenue          $          Revenue
Payroll and related costs   38,036                  49.0 %     41,575           49.1 %
Purchased services          19,655                  25.3 %     21,946           25.9 %
Other operating expenses    13,220                  17.0 %     10,046           11.9 %
Stock-based compensation         -                     - %         14              - %
Total service expense       70,911                  91.4 %     73,581           86.9 %




                                       42

Service expense in Q3 2018 decreased $2.7 million, or 3.6%, compared to Q3 2017. Payroll and related costs decreased primarily as a result of the sale of Ingeus France, as well as the impact of the restructuring plans initiated in 2017. Payroll and related costs include $0.3 million in Q3 2017 of termination benefits related to redundancy plans. Purchased services decreased in Q3 2018 compared to Q3 2017 primarily as a result of the ongoing wind-down of the legacy UK employability program, which resulted in a decline in the use of outsourced services. Other operating expenses for Q3 2018 include an indirect tax in Korea related to prior periods totaling $0.7 million. Additionally, the adoption of ASC 606 resulted in WD Services recording $1.7 million more service expense in Q3 2018 than would have been recognized under our historical revenue recognition policy, as these costs were deferred in relation to the deferral of revenue, which were primarily recognized in Q3 2018.

General and administrative expense. General and administrative expense in Q3 2018 decreased $1.6 million compared to Q3 2017 due primarily to the sale of Ingeus France as well as office closures associated with restructuring of the UK operations.

Depreciation and amortization. Depreciation and amortization for Q3 2018 decreased $0.3 million compared to Q3 2017, primarily due to the sale of Ingeus France as well as asset disposals as a result of office closures associated with the restructuring of UK operations.



WD Services segment financial results are as follows for YTD 2018 and YTD 2017
(in thousands):
                                                    Nine Months Ended September 30,
                                                 2018                            2017
                                                    Percentage of                   Percentage of
                                          $            Revenue            $            Revenue
Service revenue, net                   214,956          100.0  %       229,332          100.0  %

Service expense                        192,390           89.5  %       199,665           87.1  %
General and administrative expense      20,151            9.4  %        20,944            9.1  %
Asset impairment charge                  9,202            4.3  %             -            0.0  %
Depreciation and amortization            9,210            4.3  %         9,695            4.2  %
Operating loss                         (15,997 )         (7.4 )%          (972 )         (0.4 )%



Service revenue, net. Service revenue, net for YTD 2018 decreased $14.4 million, or 6.3%, compared to YTD 2017. Excluding the effects of changes in currency exchange rates, service revenue decreased 10.4% in YTD 2018 compared to YTD 2017. The decrease was primarily related to the sale of Ingeus France, the ongoing wind-down of the segment's legacy UK employability program and the impact of lower contractual adjustments under the offender rehabilitation program, as YTD 2018 included $1.5 million of revenue related to a contractual adjustment whereas YTD 2017 included the impact of $5.2 million of revenue related to the finalization of a contractual adjustment for the contract year ended March 31, 2017. Additionally, the impact of the adoption of the new revenue standard resulted in $4.0 million less revenue in YTD 2018 than would have been recognized under the previous accounting standard. YTD 2018 also includes a reduction in revenue related to the offender rehabilitation program of $1.7 million for estimated penalties related to the measurement of frequency and binary recidivism measures, and a decrease in revenue from our Saudi Arabia operations primarily as a result of an unsigned contract. These revenue decreases were partially offset by increased revenue under the segment's health programs as well as the segment's operations in the U.S. and certain other international operations.

Service expense. Service expense for our WD Services segment included the following for YTD 2018 and YTD 2017 (in thousands):

                                         Nine Months Ended September 30,
                                        2018                            2017
                                            Percentage of                Percentage of
                                $              Revenue          $           Revenue
Payroll and related costs   127,748               59.4 %     130,538           56.9 %
Purchased services           34,097               15.9 %      39,949           17.4 %
Other operating expenses     30,539               14.2 %      29,136           12.7 %
Stock-based compensation          6                0.0 %          42            0.0 %
Total service expense       192,390               89.5 %     199,665           87.1 %



                                       43

Service expense in YTD 2018 decreased $7.3 million, or 3.6%, compared to YTD 2017. Payroll and related costs decreased from YTD 2017 to YTD 2018 primarily as a result of the sale of Ingeus France and the impact of our restructuring programs. Payroll and related costs increased as a percentage of revenue from 56.9% in YTD 2017 to 59.4% in YTD 2018. Payroll and related costs include $2.4 million and $1.1 million in YTD 2018 and YTD 2017, respectively, of termination benefits related to redundancy plans. Purchased services decreased in YTD 2018 compared to YTD 2017 primarily as a result of a decline in client referrals under our primary employability program in the UK, which resulted in a decline in the use of outsourced services. Other operating expenses for YTD 2018 include an indirect tax in Korea related to prior periods totaling $0.7 million. Additionally, the adoption of ASC 606 resulted in WD Services recording $0.9 million less service expense in YTD 2018 than would have been recognized under our historical revenue recognition policy, as these costs were deferred in relation to the deferral of revenue.

General and administrative expense. General and administrative expense in YTD 2018 decreased $0.8 million compared to YTD 2017 primarily as a result of the sale of Ingeus France and office closures associated with restructuring of the UK operations. These decreases were partially offset by $0.5 million of transaction related costs incurred for the sale of the segment's operations in France.

Asset impairment charge. Due to the disposition of Ingeus France in July 2018, the carrying value of its assets and liabilities were reduced to their estimated fair value less selling costs during the second quarter of 2018. As a result, an impairment charge of $9.2 million was recorded during YTD 2018.

Depreciation and amortization. Depreciation and amortization for YTD 2018 decreased $0.5 million compared to YTD 2017, primarily as a result of office closures associated with the restructuring of UK operations as well as the sale of Ingeus France.



Corporate and Other

Corporate and Other includes the headcount and professional service costs incurred at the holding company level, at the Captive, and elimination entries to account for inter-segment transactions. Corporate and Other financial results are as follows for Q3 2018 and Q3 2017 (in thousands):

                                           Three Months Ended September 30,
                                                   2018                      2017
                                                     $                         $
Service expense                    $         -                             $    (3 )
General and administrative expense       5,955                               8,750
Depreciation and amortization              237                                  95
Operating loss                           6,192                               8,842



Operating loss. Corporate and Other operating loss in Q3 2018 decreased by $2.7 million, or 30.0%, as compared to Q3 2017. Included in "General and administrative expense" for Q3 2018 are $1.9 million of organizational consolidation related costs. Additionally, included in "Depreciation and amortization" is $0.1 million of accelerated depreciation expense incurred in relation to the organizational consolidation.

The decrease in operating loss is primarily due to a decrease in cash settled stock-based compensation expense of $2.6 million, primarily as a result of a decrease in the Company's stock price in Q3 2018 as compared to an increase in Q3 2017. Other costs in Q3 2018 decreased, as compared to Q3 2017, as a result of costs incurred in Q3 2017 associated with strategic initiatives.



                                       44



Corporate and Other financial results are as follows for YTD 2018 and YTD 2017
(in thousands):
                                        Nine Months Ended September 30,
                                         2018                   2017
                                           $                      $
Service expense                    $        (272 )       $          (2,269 )
General and administrative expense        22,803                    23,882
Depreciation and amortization                559                       258
Operating loss                            23,090                    21,871



Operating loss. Corporate and Other operating loss in YTD 2018 increased by $1.2 million, or 5.6%, as compared to YTD 2017. Included in "General and administrative expense" for YTD 2018 are $4.9 million of organizational consolidation related costs. Additionally, included in "Depreciation and amortization" is $0.3 million of accelerated depreciation expense incurred in relation to the organizational consolidation. YTD 2018 and YTD 2017 both include a reduction in insurance loss reserves in "Service expense" due to favorable claims history of our Captive reinsurance program.

The operating loss included $1.4 million and $1.6 million, respectively, of cash settled stock-based compensation expense for YTD 2018 and YTD 2017. Additionally, there was a decrease in incentive compensation, legal costs and consulting costs in YTD 2018 as compared to YTD 2017.

Seasonality

Our quarterly operating results and operating cash flows normally fluctuate due in part to seasonal factors, uneven demand for services and the timing of new contracts, which impact the amount of revenues earned and expenses incurred. NET Services experiences fluctuations in demand during the summer and winter seasons. Due to higher demand in the summer months, lower demand during the winter months, and a primarily fixed revenue stream based on a per-member, per-month payment structure, NET Services normally experiences lower operating margins during the summer season and higher operating margins during the winter. WD Services is impacted by both the timing of commencement and expiration of major contracts. Under many of WD Services' contracts, we may invest significant sums of money in personnel, leased office space, purchased or developed technology, and other costs, and generally would incur these costs prior to commencing services and receiving payments. This can result in significant variability in financial performance and cash flows between quarters and for comparative periods. It is expected that future contracts may be structured in a similar fashion. However, the Company does not expect a large variability in financial performance upon the commencement of WD Services' newly secured Work and Health Programme contracts as the upfront implementation investments needed for these contracts are expected to be significantly less than those associated with other large contract commencements undertaken in the past, such as the offender rehabilitation program in 2016. In addition, under the majority of WD Services' contracts, the Company relies on its customers, which include government agencies, to provide referrals, for which the Company can provide services and earn revenue. The timing and magnitude of referrals can fluctuate significantly, leading to volatility in revenue.

Liquidity and capital resources

Short-term capital requirements consist primarily of recurring operating expenses and new contract start-up costs, including restructuring costs. We expect to meet any cash requirements through available cash on hand, cash generated from our operating segments, and borrowing capacity under our Credit Facility (as defined below).

Our balance of cash and cash equivalents was $47.5 million and $95.3 million at September 30, 2018 and December 31, 2017, respectively, including $18.2 million and $40.1 million held in foreign countries, respectively. Such cash held in foreign countries is generally used to fund foreign operations, although it may also be used to repay intercompany indebtedness existing between Providence and its foreign subsidiaries.

We had restricted cash of $4.8 million and $6.3 million at September 30, 2018 and December 31, 2017, respectively, primarily related to contractual obligations and activities of our captive insurance subsidiary. Our Captive is currently in run-off, as we did not renew the policies which expired in May 2017, and we expect our restricted cash balances to decline over time as we pay claims. These restricted cash amounts are not included in our balance of cash and cash equivalents, although they are included in the cash, cash equivalents and restricted cash balance on the statement of cash flows, as a result of the adoption of Accounting Standards Update No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, as of January 1, 2018. At September 30, 2018 we had $36.0 million outstanding under our Credit Facility. No amounts were outstanding under the Credit


                                       45

Facility as of December 31, 2017. The amount outstanding at September 30, 2018 was drawn from our revolving credit facility to fund the acquisition of Circulation and is expected to be repaid from the Company's cash flow from operations.

We may, from time to time, access capital markets to raise equity or debt financing for various business reasons, including acquisitions. We may also raise debt financing to fund future repurchases of our common stock. The timing, term, size, and pricing of any such financing will depend on investor interest and market conditions, and there can be no assurance that we will be able to obtain any such financing. During the second quarter of 2018, we extended the term of our Credit Facility to expire in August 2019, as further discussed below.

On March 29, 2018, the Company's Board of Directors amended our ongoing stock repurchase program to add an additional $77.8 million of capacity and extend the expiration date of the program from December 31, 2018 to June 30, 2019. As of November 5, 2018, the Company has approximately $81.2 million of share repurchase availability. During the nine months ended September 30, 2018, the Company repurchased 838,719 shares for $55.8 million.

The cash flow statement for all periods presented includes both continuing and discontinued operations. Discontinued operations for YTD 2018 and YTD 2017 include the activity of our Human Services segment. The benefit from discontinued operations totaled $0.5 million for YTD 2018 and the loss from discontinued operations totaled $6.0 million for YTD 2017. For YTD 2017, the loss from discontinued operations primarily related to the accrual of a contingent liability of $9.0 million related to the future settlement of indemnification claims associated with our former Human Services segment, partially offset by a related tax benefit. The settlement amount of $14.5 million was paid during Q3 2018, of which $10.0 million was paid through the release of escrow funds, and $4.5 million was paid in cash.

YTD 2018 cash flows compared to YTD 2017


Operating activities. Cash provided by operating activities was $22.5 million
for YTD 2018, a decrease of $14.5 million of cash used in operating activities
as compared with YTD 2017. YTD 2018 and YTD 2017 cash flow from operations was
driven by net income of $1.7 million and $14.7 million, respectively, non-cash
adjustments to reconcile net income to
						



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