ModivCare Inc - Quarter Report: 2016 September (Form 10-Q)

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		September 30,				December 31,
		2016				2015
		(Unaudited)
Assets
Current assets:
Cash and cash equivalents		$	52,362			$	79,756
Accounts receivable, net of allowance of $4,249 in 2016 and $4,380 in 2015			170,723				156,932
Other receivables			9,329				16,298
Prepaid expenses and other			41,245				27,624
Restricted cash			2,475				4,012
Deferred tax assets			7,383				2,891
Current assets of discontinued operations held for sale			39,518				32,211
Total current assets			323,035				319,724
Property and equipment, net			57,451				46,158
Goodwill, net			126,167				129,958
Intangible assets, net			57,204				69,564
Other assets			15,460				27,312
Restricted cash, less current portion			12,664				16,044
Deferred tax asset			3,581				42
Non-current assets of discontinued operations held for sale			428,495				441,400
Total assets		$	1,024,057			$	1,050,202
Liabilities and stockholders' equity
Current liabilities:
Current portion of long-term obligations		$	322,898			$	31,375
Accounts payable			22,493				28,019
Accrued expenses			103,468				117,436
Accrued transportation costs			96,472				64,537
Deferred revenue			17,958				28,667
Reinsurance and related liability reserves			9,910				9,389
Current liabilities of discontinued operations held for sale			20,603				15,849
Total current liabilities			593,802				295,272
Long-term obligations, less current portion			-				268,696
Other long-term liabilities			27,683				22,855
Deferred tax liabilities			6,586				8,403
Non-current liabilities of discontinued operations held for sale			81,884				87,268
Total liabilities			709,955				682,494
Commitments and contingencies (Note 13)
Reedeemable convertible preferred stock
Convertible preferred stock, net: Authorized 10,000,000 shares; $0.001 par value; 803,398 and 803,518 issued and outstanding; 5.5%/8.5% dividend rate			77,565				77,576
Stockholders' equity
Common stock: Authorized 40,000,000 shares; $0.001 par value; 17,313,862 and 17,186,780 issued and outstanding (including treasury shares)			17				17
Additional paid-in capital			299,950				293,012
Retained earnings			73,408				69,209
Accumulated other comprehensive loss, net of tax			(27,971	)			(16,831	)
Treasury shares, at cost, 3,048,293 and 1,895,998 shares			(108,037	)			(54,823	)
Total Providence stockholders' equity			237,367				290,584
Noncontrolling interest			(830	)			(452	)
Total stockholders' equity			236,537				290,132
Total liabilities and stockholders' equity		$	1,024,057			$	1,050,202

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		Three months ended September 30,								Nine months ended September 30,
		2016				2015				2016				2015
Service revenue, net		$	412,512			$	379,568			$	1,192,930			$	1,104,799
Operating expenses:
Service expense			378,729				350,583				1,095,515				1,004,329
General and administrative expense			17,320				20,521				52,548				56,998
Depreciation and amortization			6,670				5,882				20,058				17,759
Total operating expenses			402,719				376,986				1,168,121				1,079,086
Operating income			9,793				2,582				24,809				25,713
Other expenses:
Interest expense, net			702				515				2,339				2,763
Equity in net loss of investees			1,517				4,465				5,693				8,008
Gain on foreign currency transactions			(482	)			(736	)			(1,332	)			(1,131	)
Income (loss) from continuing operations before income taxes			8,056				(1,662	)			18,109				16,073
Provision for income taxes			4,543				2,495				12,051				12,918
Income (loss) from continuing operations, net of tax			3,513				(4,157	)			6,058				3,155
Discontinued operations, net of tax			(2,562	)			(1,253	)			1,017				4,258
Net income (loss)			951				(5,410	)			7,075				7,413
Net (income) loss attributable to noncontrolling interests			(301	)			(161	)			433				(114	)
Net income (loss) attributable to Providence		$	650			$	(5,571	)		$	7,508			$	7,299
Net income (loss) available to common stockholders (Note 11)		$	(717	)		$	(6,687	)		$	3,697			$	3,014
Basic earnings (loss) per common share:
Continuing operations		$	0.13			$	(0.33	)		$	0.19			$	(0.05	)
Discontinued operations			(0.18	)			(0.08	)			0.06				0.24
Basic earnings (loss) per common share		$	(0.05	)		$	(0.41	)		$	0.25			$	0.19
Diluted earnings (loss) per common share:
Continuing operations		$	0.13			$	(0.33	)		$	0.19			$	(0.05	)
Discontinued operations			(0.18	)			(0.08	)			0.06				0.24
Diluted earnings (loss) per common share		$	(0.05	)		$	(0.41	)		$	0.25			$	0.19
Weighted-average number of common shares outstanding:
Basic			14,523,408				16,130,421				14,823,757				16,068,455
Diluted			14,634,483				16,130,421				14,943,024				16,068,455

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		Three months ended September 30,								Nine months ended September 30,
		2016				2015				2016				2015
Net income (loss)		$	951			$	(5,410	)		$	7,075			$	7,413
Net (income) loss attributable to noncontrolling interests			(301	)			(161	)			433				(114	)
Net income (loss) attributable to Providence			650				(5,571	)			7,508				7,299
Other comprehensive loss:
Foreign currency translation adjustments, net of tax			(2,808	)			(6,290	)			(11,140	)			(5,579	)
Other comprehensive loss			(2,808	)			(6,290	)			(11,140	)			(5,579	)
Comprehensive income (loss)			(1,857	)			(11,700	)			(4,065	)			1,834
Comprehensive income (loss) attributable to noncontrolling interests			(266	)			(160	)			378				(95	)
Comprehensive income (loss) attributable to Providence		$	(2,123	)		$	(11,860	)		$	(3,687	)		$	1,739

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		Nine months ended September 30,
		2016				2015
Operating activities
Net income		$	7,075			$	7,413
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation			17,039				15,287
Amortization			24,140				29,157
Provision for doubtful accounts			2,196				2,018
Stock-based compensation			3,204				8,822
Deferred income taxes			(15,446	)			(7,811	)
Amortization of deferred financing costs and debt discount			1,573				1,611
Excess tax benefit upon exercise of stock options			(276	)			(2,364	)
Asset impairment charge			-				1,593
Equity in net loss of investee			5,693				8,008
Other non-cash credits			(1,279	)			(433	)
Changes in operating assets and liabilities:
Accounts receivable			(22,116	)			(87,823	)
Other receivables			5,677				1,177
Restricted cash			-				43
Prepaid expenses and other			(15,577	)			12,719
Reinsurance liability reserve			984				5,174
Accounts payable and accrued expenses			32,530				(10,556	)
Income taxes payable on sale of business			(30,153	)			-
Accrued transportation costs			31,935				23,626
Deferred revenue			(7,460	)			17,896
Other long-term liabilities			5,242				248
Net cash provided by operating activities			44,981				25,805
Investing activities
Purchase of property and equipment			(33,928	)			(23,834	)
Net (increase) decrease in short-term investments			242				(14	)
Acquisitions, net of cash acquired			-				(3,433	)
Equity investments			(6,381	)			(13,785	)
Restricted cash for reinsured claims losses			4,917				(1,452	)
Net cash used in investing activities			(35,150	)			(42,518	)
Financing activities
Proceeds from issuance of preferred stock, net of issuance costs			-				80,667
Preferred stock dividends			(3,309	)			(2,814	)
Repurchase of common stock, for treasury			(53,214	)			(738	)
Proceeds from common stock issued pursuant to stock option exercise			4,099				4,490
Excess tax benefit upon exercise of stock options			276				2,364
Repayment of long-term debt			(23,250	)			(92,938	)
Proceeds from long-term debt			43,500				-
Payment of contingent consideration			-				(7,496	)
Other financing costs			(47	)			(288	)
Net cash used in financing activities			(31,945	)			(16,753	)
Effect of exchange rate changes on cash			(39	)			(463	)
Net change in cash and cash equivalents			(22,153	)			(33,929	)
Cash and cash equivalents at beginning of period			84,770				160,406
Cash and cash equivalents at end of period		$	62,617			$	126,477
Supplemental cash flow information:
Cash included in current assets of discontinued operations held for sale		$	10,255			$	31,515
Cash paid for interest			8,873				12,922
Cash paid for income taxes			50,037				16,600
Prepaid financing and subsidiary stock issuance costs			1,049				-
Accrued unfunded future equity investment capital contributions			1,590				8,501
Purchase of equipment through capital lease obligation			809				-

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1. Organization and Basis of Presentation

 

Description of Business

 

The Providence Service Corporation (“we”, the “Company” or “Providence”) is a holding company, which owns controlling and noncontrolling interests in companies which provide critical healthcare and workforce development services. In 2016, Providence, through its ownership of interests in subsidiaries and other companies, operated in three segments: Non-Emergency Transportation Services (“NET Services”), Workforce Development Services (“WD Services”) and Health Assessment Services (“HA Services”). As further discussed below, on October 19, 2016, the Company completed its CCHN Group Holdings Inc. (together with its subsidiaries, “Matrix” or “HA Services”) stock subscription transaction pursuant to which a third-party subscribed for a 53.2% equity interest in Matrix with Providence retaining a 46.8% equity interest in Matrix. Thus, the Company now owns a noncontrolling interest in Matrix, and the results of Matrix are presented within discontinued operations.

 

NET Services coordinates non-emergency transportation for individuals whose limited mobility and/or financial resources would otherwise hinder them from accessing necessary healthcare and social services. WD Services primarily provides employability and offender rehabilitation services to eligible participants of government sponsored programs. HA Services, which has been presented as a discontinued operation beginning with these financial statements, provides care optimization and delivery solutions, including comprehensive health assessments (“CHAs”) for health plans as well as in-home care management offerings. In addition, the Company completed the sale of the Human Services segment effective November 1, 2015, which also is presented as a discontinued operation.

 

Basis of Presentation

 

The Company follows accounting standards set by the Financial Accounting Standards Board (“FASB”). The FASB establishes accounting principles generally accepted in the United States (“GAAP”). Rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants, which the Company is required to follow. References to GAAP issued by the FASB in these footnotes are to the FASB Accounting Standards Codification (“ASC”), which serves as a single source of authoritative non-SEC accounting and reporting standards to be applied by non-governmental entities. All amounts are presented in US dollars in thousands, unless the context otherwise requires or otherwise noted.

 

The Company’s unaudited condensed consolidated financial statements have been prepared in accordance with GAAP for interim financial information, and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and disclosures required by GAAP for complete financial statements. In the opinion of management, all adjustments considered necessary for the fair presentation of the results of the interim periods have been included.

 

The Company has made estimates relating to the reporting of assets and liabilities, revenues and expenses and certain disclosures to prepare these unaudited condensed consolidated financial statements in conformity with GAAP. Actual results could differ from those estimates. Operating results for the three and nine months ended September 30, 2016 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2016. Management has evaluated events and transactions that occurred after the balance sheet date and through the date these unaudited condensed consolidated financial statements were filed, and considered the effect of such events in the preparation of these unaudited condensed consolidated financial statements.

 

 

During the quarter ended September 30, 2016, the HA Services segment met the criteria for held for sale classification due to the execution on August 28, 2016 of a stock subscription agreement by the Company pursuant to which a third-party subscribed for an equity interest in Matrix. Therefore, the HA Services segment is presented as a discontinued operation in accordance with GAAP. The assets and liabilities of the HA Services segment are classified as held for sale in the condensed consolidated balance sheets for all periods presented. Additionally, the operating results of this segment, along with certain expenses associated with the Human Services segment sold on November 1, 2015, are reported as discontinued operations, net of tax, in the condensed consolidated statements of income for all periods presented. See Note 15, Discontinued Operations.

 

The condensed consolidated balance sheet at December 31, 2015 has been derived from the audited financial statements at that date, but does not include all of the information and disclosures required by GAAP for complete financial statements. The unaudited condensed consolidated financial statements contained herein should be read in conjunction with the audited financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

 

The Company holds investments that are accounted for using the equity method. The Company does not control the decision making process or business management practices of these affiliates. Accordingly, the Company relies on management of these affiliates to provide it with accurate financial information prepared in accordance with GAAP that the Company uses in the application of the equity method. In addition, the Company relies on audit reports that are provided by the affiliates' independent auditors on the financial statements of such affiliates. The Company is not aware, however, of any errors in or possible misstatements of the financial information provided by its equity affiliates that would have a material effect on the Company’s condensed consolidated financial statements.

 

Reclassifications 

 

          We have reclassified certain amounts relating to our prior period results to conform to our current period presentation. Effective January 1, 2016, the Company adopted Accounting Standards Update (“ASU”) No. 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03”) and reclassified debt issuance costs to a contra-liability account in the condensed consolidated balance sheet as of December 31, 2015. Additionally, the Company recast its condensed consolidated statement of other comprehensive income for the three and nine months ended September 30, 2015 to conform with the presentation of other comprehensive income included in the Company’s Form 10-K for the year ended December 31, 2015.

2. Accounting Changes and Recent Accounting Pronouncements

 

The Company adopted the following accounting pronouncements during the periods presented in these condensed consolidated financial statements:

 

In April 2015, the FASB issued ASU 2015-03, which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The Company capitalizes debt issuance costs incurred in connection with its credit facilities, line-of-credit, and other borrowings (“deferred financing costs”), and amortizes such costs over the life of the respective debt liability.

 

Upon adoption of ASU 2015-03 on January 1, 2016, the Company elected to present deferred financing costs for both its credit facilities and line-of credit arrangement as a direct deduction from the carrying amount of the respective debt liability. Accordingly, deferred financing costs, net of amortization, totaling $3,774 at December 31, 2015 have been reclassified from “Other assets” to “Long-term obligations, less current portion” in the condensed consolidated balance sheets. Deferred financing costs and debt discounts, net of accumulated amortization, totaling $2,302 and $1,050 at September 30, 2016 are included in “Current portion of long-term obligations” and “Other long-term liabilities”, respectively, in the condensed consolidated balance sheets. See Note 7, Long-Term Obligations, for additional information regarding current classification of this amount. Deferred financing costs and debt discounts, net of accumulated amortization, totaling $4,879 at December 31, 2015 are included in “Long-term obligations, less current portion” in the condensed consolidated balance sheets.

 

 

In February 2015, the FASB issued ASU No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis (“ASU 2015-02”), which changes the way reporting enterprises evaluate whether (a) they should consolidate limited partnerships and similar entities, (b) fees paid to a decision maker or service provider are variable interests in a variable interest entity (“VIE”), and (c) variable interests in a VIE held by related parties of the reporting enterprise require the reporting enterprise to consolidate the VIE. It also eliminates the VIE consolidation model based on majority exposure to variability that applied to certain investment companies and similar entities. The new guidance excludes money market funds that are required to comply with Rule 2a-7 of the Investment Company Act of 1940 and similar entities from the GAAP consolidation requirements. The new consolidation guidance is effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2015. The adoption of ASU 2015-02 on January 1, 2016 had no impact on the consolidation of the Company’s existing VIEs.

 

Updates to the recent accounting pronouncements as disclosed in the Company’s Form 10-K for the year ended December 31, 2015 are as follows:

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers: Topic 606 (“ASU 2014-09”). ASU 2014-09 introduced FASB Accounting Standards Codification Topic 606 (“ASC 606”). ASC 606 will supersede ASC 605, Revenue Recognition (“ASC 605”) and most of the industry-specific guidance on recognizing revenue. The FASB has since issued the following updates that clarify or supplement the guidance in ASU 2014-09:

 

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In May 2016, the FASB issued ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients (“ASU 2016-12”). ASU 2016-12 clarifies how an entity should assess collectability, present sales taxes, measure noncash consideration and apply some aspects of the transition guidance in ASU 2014-09.

 

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In April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing (“ASU 2016-10”). ASU 2016-10 clarifies the guidance in ASU 2014-09 for identifying performance obligations and recognizing revenue for licenses of intellectual property.

 

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In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net) (“ASU 2016-08”). ASU 2016-08 clarifies the implementation guidance in ASU 2014-09 on principal versus agent considerations and whether an entity should report revenue on a gross or net basis.

 

Each of these ASUs are effective for public companies for annual reporting periods (and interim reporting periods within those annual reporting periods) beginning after December 15, 2017 and permit entities to transition using either a full retrospective or modified retrospective methodology. The Company has developed an implementation plan, assembled a cross-functional project team and begun to assess the impacts of applying ASC 606 by completing an analysis of the Company’s contracts with its customers. The assessment of applying ASC 606 is ongoing and, therefore, the Company has not yet determined whether those impacts will be material to the Company’s consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”). ASU 2016-02 introduced FASB Accounting Standards Codification Topic 842 (“ASC 842”), which will replace ASC 840, Leases. Under ASC 842, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term.

 

ASU 2016-02 is effective for publicly held entities for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted. Lessees must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach does not require transition accounting for leases that expired before the earliest comparative period presented. Lessees may not apply a full retrospective transition approach. The Company has not entered into significant lease agreements in which it is the lessor; however, the Company does have lease agreements in which it is the lessee. The Company is in the preliminary stages of assessing the impact of applying ASC 842 to its lease agreements. The assessment of applying ASU 2016-02 is ongoing and, therefore, the Company has not yet determined whether the impacts will be material to the Company’s consolidated financial statements.

 

 

In March 2016, the FASB issued ASU No. 2016-07, Investments - Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting (“ASU 2016-07”). ASU 2016-07 eliminates the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods that the investment had been held. ASU 2016-07 instead specifies that the investor should add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and apply the equity method of accounting as of the date the investment became qualified for equity method accounting. ASU 2016-07 is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016 and should be applied prospectively. The adoption of ASU 2016-07 will impact the Company’s accounting and disclosures for investments for which it begins applying the equity method after the effective date.

 

In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). ASU 2016-09 is intended to improve the accounting for employee share-based payments and affect all organizations that issue share-based payment awards to their employees. Several aspects of the accounting for share-based payment award transactions are simplified, including income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. For public companies, the amendments are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted for any organization in any interim or annual period. The Company currently is evaluating the impact of the adoption of ASU 2016-09 on the Company's consolidated financial statements and has determined it will not early adopt ASU 2016-09.

 

In May 2016, the FASB issued ASU No. 2016-11, Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815); Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 EITF Meeting (“ASU 2016-11”), which rescinded certain SEC Staff Observer comments that are codified in Topic 605, Revenue Recognition, and Topic 932, Extractive Activities-Oil and Gas, effective upon adoption of Topic 606. The Company does not expect the adoption of this section of ASU 2016-11 to have an impact on its consolidated financial statements. Additionally, ASU 2016-11 removed from the Codification the SEC Staff Announcement, “Determining the Nature of a Host Contract Related to a Hybrid Instrument Issued in the Form of a Share Under Topic 815,” which is codified in FASB ASC Topic 815, Derivatives and Hedging, and is effective on adoption of ASU No. 2014-16, Derivatives and Hedging (Topic 815) (“ASU 2014-16”). The Company adopted ASU 2014-16 effective January 1, 2015. The adoption of this section of ASU 2016-11 did not have an impact on the Company’s consolidated financial statements.

 

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326) (“ASU 2016-13”). The amendments in ASU 2016-13 will supersede or clarify much of the existing guidance for reporting credit losses for assets held at amortized cost basis and available for sale debt securities. For assets held at amortized cost basis, ASU 2016-13 eliminates the probable initial recognition threshold in current GAAP and instead requires an entity to reflect its current estimate of all expected credit losses. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial assets to present the net amount expected to be collected. The amendments in ASU 2016-13 affect loans, debt securities, trade receivables, net investments in leases, off balance sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash. ASU 2016-13 is effective for financial statements issued for fiscal years beginning after December 15, 2019, with early adoption permitted for fiscal years beginning after December 15, 2018. The Company has not evaluated the impact of ASU 2016-13 on its consolidated financial statements.

 

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”). ASU 2016-15 provides guidance for eight targeted changes with respect to how cash receipts and cash payments are classified in the statements of cash flows, with the objective of reducing diversity in practice. ASU 2016-15 is effective for financial statements issued for fiscal years beginning after December 15, 2017, with early adoption permitted. The Company currently is evaluating the impact the adoption of this ASU will have on the presentation of the Company's statements of cash flows.

 

 

There were no other significant updates to the new accounting guidance not yet adopted by the Company as disclosed in its Form 10-K for the year ended December 31, 2015.

 3. Equity Investment

 

The Company entered into a joint venture agreement in November 2014 to form Mission Providence Pty Ltd (“Mission Providence”). Mission Providence delivers employment services in Australia. The Company has a 60% ownership in Mission Providence, and has rights to 75% of Mission Providence’s distributions of cash or profit surplus twice per calendar year. The Company provided to Mission Providence $6,381 in capital contributions during the nine months ended September 30, 2016, and may continue to provide further contributions in exchange for its equity interests.

 

The Company determined it has a variable interest in Mission Providence. However, it does not have unilateral power to direct the activities that most significantly impact Mission Providence’s economic performance, which include budget approval, business planning, the appointment of key officers and liquidation and distribution of share capital. As a result, the Company is not the primary beneficiary of Mission Providence. The Company accounts for this investment under the equity method of accounting and the Company’s share of Mission Providence’s losses are recorded as “Equity in net loss of investees” in the accompanying condensed consolidated statements of income. Cash contributions made to Mission Providence in exchange for its equity interests are included in the condensed consolidated statements of cash flows as “Equity investments”.

 

The following table summarizes the carrying amounts of the assets and liabilities included in the Company’s condensed consolidated balance sheets and the maximum loss exposure related to the Company’s interest in Mission Providence as of September 30, 2016 and December 31, 2015:

 

 

Accrued expenses relate to future funding commitments required under the joint venture agreement pursuant to the Company’s 60% equity interest that have been approved by the Mission Providence joint venture board of directors.

 

Summary financial information for Mission Providence on a standalone basis is as follows:

 

 

 

 

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4.     Prepaid Expenses and Other

 

Prepaid expenses and other were comprised of the following:

 

 

 

Escrow funds relate to the sale of the Human Services segment, which was completed on November 1, 2015. The escrow funds are scheduled to be released fifteen months following the closing, although the amount to be released is subject to reduction to the extent indemnified representation and warranty claims are identified and agreed with the buyer.

5.     Accrued Expenses

 

Accrued expenses consisted of the following:

 

 

6.    Restructuring and Related Reorganization Costs

 

In the fourth quarter of 2015, WD Services approved two redundancy plans.  The first plan relates to the termination of employees currently delivering services under an offender rehabilitation program.  The second plan primarily relates to the termination of employees delivering services under the Company’s employability and skills training programs and certain other employees in the United Kingdom (the “UK”).   The Company recorded severance and related charges of approximately $4,741 during the nine months ended September 30, 2016 relating to the actualization of termination benefits for specifically identified employees impacted as well as an increase in the number of individuals impacted by these plans. The initial estimate of severance and related charges at December 31, 2015 was based upon the employee groups impacted, average salary and benefits, and redundancy benefits pursuant to the existing policies. The final identification of the employees impacted is subject to customary consultation procedures. The severance charges incurred are recorded as “Service expense” in the accompanying condensed consolidated statements of income.

 

 

Summary of Severance and Related Charges

 

 

The total of accrued severance and related costs of $3,875 and $8,597 are reflected in “Accrued expenses” in the condensed consolidated balance sheets at September 30, 2016 and December 31, 2015, respectively. The amount accrued as of September 30, 2016 is expected to be settled by the end of the first quarter of 2017.

7. Long-Term Obligations

 

          The Company’s long-term obligations were as follows:

 

 

  

 

On August 28, 2016, the Company entered into the Fourth Amendment and Consent to the Amended and Restated Credit and Guaranty Agreement (the “Amendment”), amending that certain Amended and Restated Credit and Guaranty Agreement dated as of August 2, 2013 (as amended to date, the “Credit Agreement”). The Amendment provided for the lenders’ consent to the Matrix stock subscription transaction and additionally required the net cash proceeds received by the Company be applied first, to the prepayment of outstanding term loans, second, to the prepayment of outstanding revolving loans and third, for any purpose not prohibited by the Credit Agreement. Additionally, effective following the repayment of the outstanding term loans in full, the Amendment further reduced the aggregate revolving commitments under the Credit Agreement to $200,000. The term loans and revolving credit facility were fully paid on October 20, 2016, and are classified, along with the unamortized discount on debt, as current liabilities in the accompanying condensed consolidated balance sheet at September 30, 2016.

 

The fair value of the long-term obligations approximated its carrying value at September 30, 2016 because the fair value period was reduced to one month as a result of the repayment of the long-term obligations on October 20, 2016. The fair value of the long-term obligations approximated $308,892 at December 31, 2015. The December 31, 2015 fair value of the Company’s long-term obligations was determined based on an income approach to discount the future debt payments using current market yields and was categorized within Level 3 of the fair value hierarchy.

 

 

Capital Leases

 

The Company has a three-year capital lease for information technology equipment with a termination date of May 2019. Minimum monthly lease payments of $24 are due under the terms of the lease. The total capital lease obligation at September 30, 2016 is $809, of which $359 is reflected in “Accrued liabilities” and $450 is reflected in “Other long-term liabilities” in the condensed consolidated balance sheet.

8. Convertible Preferred Stock, Net

 

The Company completed a rights offering on February 5, 2015 (the “Rights Offering”) providing all of the Company’s existing common stock holders the non-transferrable right to purchase their pro rata share of $65,500 of convertible preferred stock at a price equal to $100.00 per share. The convertible preferred stock is convertible into shares of Providence’s common stock at a conversion price equal to $39.88 per share, which was the closing price of the Company’s common stock on the NASDAQ Global Select Market on October 22, 2014.

 

Stockholders exercised subscription rights to purchase 130,884 shares of the Company's convertible preferred stock. Pursuant to the terms and conditions of the Standby Purchase Agreement (the “Standby Purchase Agreement”) between Coliseum Capital Partners, L.P., Coliseum Capital Partners II, L.P., Coliseum Capital Co-Invest, L.P. and Blackwell Partners, LLC (collectively, the “Standby Purchasers”) and the Company, the remaining 524,116 shares of the Company’s preferred stock were purchased by the Standby Purchasers at the $100.00 per share subscription price. The Company received $65,500 in aggregate gross proceeds from the consummation of the Rights Offering and Standby Purchase Agreement. Additionally, on March 12, 2015, the Standby Purchasers exercised their right to purchase an additional 150,000 shares of the Company’s convertible preferred stock, at a purchase price of $105.00 per share or a total purchase price of $15,750, of the same series and having the same conversion price as the convertible preferred stock sold in the Rights Offering.

 

The Company may pay a noncumulative cash dividend on each share of convertible preferred stock, if and when declared by its Board of Directors, at the rate of five and one-half percent (5.5%) per annum on the liquidation preference then in effect. On or before the third business day immediately preceding each fiscal quarter, the Company must determine its intention whether or not to pay a cash dividend with respect to that ensuing quarter and will give notice of its intention to each holder of convertible preferred stock as soon as practicable thereafter.

 

In the event the Company does not declare and pay a cash dividend, the Company will declare a paid in kind (“PIK”) dividend by increasing the liquidation preference of the convertible preferred stock to an amount equal to the liquidation preference in effect at the start of the applicable dividend period, plus an amount equal to the liquidation preference then in effect multiplied by eight and one-half percent (8.5%) per annum, computed on the basis of a 365-day year and the actual number of days elapsed from the start of the applicable dividend period to the applicable date of determination. All holders of the Company’s convertible preferred stock are able to convert their convertible preferred stock into shares of common stock at a rate of approximately 2.51 shares of common stock for each share of convertible preferred stock. As of September 30, 2016, 1,602 shares of convertible preferred stock have been converted to 4,015 shares of common stock.

 

Cash dividends are payable quarterly in arrears on January 1, April 1, July 1 and October 1 of each year, which commenced on April 1, 2015, and, if declared, begin to accrue on the first day of the applicable dividend period. PIK dividends, if applicable, accrue cumulatively on the same schedule as set forth above for cash dividends and are also compounded at the applicable annual rate on each applicable subsequent dividend date. Cash dividends totaling $3,309 and $2,814 were distributed to convertible preferred stockholders for the nine months ended September 30, 2016 and 2015, respectively.

 

The convertible preferred stock is accounted for outside of stockholders’ equity as it may be redeemed upon certain change in control events that are not solely in the control of the Company. Dividends are recorded in stockholders’ equity and consist of the 5.5%/8.5% dividend. At the time of issuance of the convertible preferred stock, the Company recorded a discount on convertible preferred stock related to beneficial conversion features that arose due to the closing price of the Company’s common stock being higher than the conversion price of the convertible preferred stock on the commitment date. The amortization of this discount was recorded in stockholders’ equity. The discount was fully amortized as of June 30, 2015.

 

 

The following table summarizes the convertible preferred stock activity for the nine months ended September 30, 2016:

 

 

As of September 30, 2016, the 803,398 outstanding shares of convertible preferred stock are convertible into 2,014,538 shares of common stock.

9.    Stockholders’ Equity

 

The following table reflects changes in common stock, additional paid-in capital, retained earnings, accumulated other comprehensive loss, treasury stock and noncontrolling interest for the nine months ended September 30, 2016:

 

 

10.    Stock-Based Compensation and Similar Arrangements

 

The Company provides stock-based compensation to employees and non-employee directors under the Company’s 2006 Long-Term Incentive Plan (“2006 Plan”). Awards issued under this plan include stock option awards, restricted stock awards (“RSAs”), restricted stock units and performance based restricted stock units (“PRSUs”). In addition, the Company has a long-term incentive plan designed to provide long-term performance based awards to certain executive officers of the Company which also falls under the 2006 Plan. On July 27, 2016, the Company’s stockholders approved the adoption of an amended 2006 Plan, which, among other things, increased the number of shares available under the 2006 Plan to 5,400,000 shares.

 

 

The following table reflects the amount of stock-based compensation for share settled awards recorded in each financial statement line item for the three and nine months ended September 30, 2016 and 2015:

 

 

 

Stock-based compensation, for share-settled awards, includes benefits from forfeitures of stock-based compensation awards. At September 30, 2016, the Company had 368,765 stock options outstanding with a weighted-average exercise price of $33.55. The Company also had 47,309 shares of unvested RSAs outstanding at September 30, 2016 with a weighted-average grant date fair value of $46.90 and 49,208 unvested PRSUs outstanding.

 

The Company also awards stock equivalent unit awards (“SEUs”) and stock option equivalent units that are cash-settled awards and are not included as part of the 2006 Plan. These awards are accounted for as liability awards and are remeasured to fair value as of each reporting date. Changes in fair value are classified as operating expenses. During the three and nine months ended September 30, 2016, respectively, the Company recorded expense of $422 and $305 for stock-based compensation related to these cash settled awards. During the three and nine months ended September 30, 2015, respectively, the Company recorded expense of $37 and $1,798 for stock-based compensation related to these cash settled awards. This benefit and expense is included in “General and administrative expense” in the accompanying condensed consolidated statements of income. At September 30, 2016 the Company had 8,092 SEUs and 200,000 stock option equivalent units outstanding.

 

The Company also provides cash settled long-term incentive plans for key employees of its operating segments which were put into place in the fourth quarter of 2015. For the three and nine months ended September 30, 2016, $1,157 and $3,151, respectively, of expense is included as “Service expense” in the condensed consolidated statements of income related to these plans.     

 

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11.    Earnings Per Share

 

The following table details the computation of basic and diluted earnings per share:

 

 

 

Basic and diluted earnings per share are calculated for both continuing and discontinued operations. The accretion of convertible preferred stock discount in the table above is related to a beneficial conversion feature of the Company’s convertible preferred stock that was fully amortized as of June 30, 2015. Income allocated to participating securities from continuing operations is calculated by allocating a portion of net income attributable to Providence from continuing operations, less dividends on convertible preferred stock and accretion of convertible preferred stock discount, to the convertible preferred stockholders on a pro-rata as converted basis; however, the convertible preferred stockholders are not required to absorb losses. Income allocated to participating securities from discontinued operations is calculated by allocating a portion of net income attributable to Providence from discontinued operations to the convertible preferred stockholders on a pro-rata as converted basis, with no absorption of losses by the convertible preferred stockholders.

 

 

The following weighted average shares were not included in the computation of diluted earnings per share as the effect of their inclusion would have been anti-dilutive:

 

 

12.    Income Taxes

  

The Company’s effective tax rate from continuing operations for the three and nine months ended September 30, 2016 was 56.4% and 66.5%, respectively. The effective tax rates for these periods exceeded the United States (“US”) federal statutory rate of 35% primarily due to foreign net operating losses (including equity investment losses) for which the future income tax benefit currently cannot be recognized, significant losses in foreign jurisdictions with tax rates lower than the US rate of 35%, state income taxes and certain non-deductible expenses.

 

The Company recognized an income tax provision from continuing operations for the three months ended September 30, 2015 despite having a pretax loss from continuing operations because of significant nondeductible expenses recognized during the three-month period ended September 30, 2015 and the reduction of pretax income from continuing operations resulting from the HA Services and Human Services segments being presented as discontinued operations as of September 30, 2015. The Company’s effective tax rate from continuing operations for the nine months ended September 30, 2015 was 80.4%. The effective tax rate for this period exceeded the US federal statutory rate of 35% primarily due to foreign net operating losses (including equity investment losses) for which the future income tax benefit currently cannot be recognized, state income taxes, and certain non-deductible expenses including stock compensation expense.

13.    Commitments and Contingencies

 

Legal proceedings

 

On June 15, 2015, a putative stockholder class action derivative complaint was filed in the Court of Chancery of the State of Delaware (the “Court”), captioned Haverhill Retirement System v. Kerley et al., C.A. No. 11149-VCL.

 

On October 10, 2016, the Court granted an extension of the stay of the proceeding from November 20, 2016 until January 20, 2017, to allow a special litigation committee, created by the Company’s board of directors, additional time to investigate, review and evaluate the facts, circumstances and claims asserted in or relating to this action and determine the Company’s response thereto. The special litigation committee’s review of the facts is ongoing.

 

For further information regarding this legal proceeding see Note 19, Commitments and Contingencies, in the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, Note 13, Commitments and Contingencies, in the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2016 and Note 13, Commitments and Contingencies, in the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2016.

 

 

The Company has indemnified the Standby Purchasers from and against any and all losses, claims, damages, expenses and liabilities relating to or arising out of (i) any breach of any representation, warranty, covenant or undertaking made by or on behalf of the Company in the Standby Purchase Agreement and (ii) the transactions contemplated by the Standby Purchase Agreement and the 14.0% Unsecured Subordinated Note in aggregate principal amount of $65,500, except to the extent that any such losses, claims, damages, expenses and liabilities are attributable to the gross negligence, willful misconduct or fraud of such Standby Purchaser.

 

The Company has also indemnified other third parties from and against any and all losses, claims, damages, expenses and liabilities arising out of or in connection with the Company’s acquisition of CCHN Group Holdings, Inc. (operating under the tradename Matrix, and formerly included in HA Services) in October 2014 and related financing commitments, except to the extent that any such losses, claims, damages, expenses and liabilities are found in a final, non-appealable judgment by a court of competent jurisdiction to have resulted from the gross negligence, bad faith or willful misconduct of such third parties, or a material breach of such third parties’ obligations under the related agreements.

 

The Company recorded $791 and $935 of such indemnified legal expenses related to this case during the three and nine months ended September 30, 2016, respectively, which is included in “General and administrative expenses” in the condensed consolidated statements of income. Of these amounts, $360 and $504 for the three and nine months ended September 30, 2016, respectively, were indemnified legal expenses of related parties. The Company recorded $1,283 and $3,090 of insured legal expenses related to this case during the three and nine months ended September 30, 2016, respectively, which is included in “General and administrative expenses” in the condensed consolidated statements of income and has been reduced partially by an insurance receivable. The Company has recognized an insurance receivable of $2,195 and $2,210 in “Other receivables” in the condensed consolidated balance sheets at September 30, 2016 and December 31, 2015, respectively, which is related to reimbursement of legal costs through insurance proceeds related to this legal proceeding.

 

In addition to the matter described above, in the ordinary course of business, we are a party to various lawsuits. Management does not expect these lawsuits to have a material impact on the liquidity, results of operations, or financial condition of Providence. We also evaluate other potential contingent matters, including ongoing matters of our acquired companies that arose prior to our date of purchase. Our indemnification agreements or other agreements may not protect us from liability, even where the relevant matter existed prior to our ownership of the acquired companies. As of September 30, 2016, HA Services has certain malpractice claims that arose prior to our date of purchase. We believe it is reasonably possible that a loss has occurred; however, we are not able to reliably estimate the amount of such loss. Although we do not believe that the aggregate amount of liability reasonably possible with respect to these matters would have a material adverse effect on our financial results, litigation is inherently uncertain and the actual losses incurred in the event that our legal proceedings were to result in unfavorable outcomes could have a material adverse effect on our business and financial performance.

 

Other Indemnifications

 

The Company has provided certain standard indemnifications in connection with the sale of the Human Services segment effective November 1, 2015. All representations and warranties made by the Company in the Membership Interest Purchase Agreement (the “Purchase Agreement”) to sell the Human Services segment survive through the 15th month following the closing date. However, certain representations, including tax representations, survive until the expiration of applicable statutes of limitation, and healthcare representations survive until the third anniversary of the closing date. The Company has received indications from the purchaser of the Human Services segment regarding potential indemnification claims. One potential indemnification claim relates to Rodriguez v. Providence Community Corrections, a complaint filed in the District Court for the Middle District of Tennessee, Nashville Division (the “Rodriquez Litigation”), against Providence Community Corrections, Inc. (“PCC”), an entity sold under the Purchase Agreement. The purchaser of the Human Services segment has announced that in September 2016, the parties to the Rodriguez Litigation accepted a mediation proposal for settlement pursuant to which PCC would pay the plaintiffs $14,000, and the parties are in the process of finalizing the settlement agreement. The outcome of any indemnification claim is uncertain but we believe that a significant portion of the settlement amount will be paid by PCC and/or PCC’s insurance carriers.

 

The Company has established an accrual of $6,000 with respect to an estimate of loss for potential indemnification claims related to our former Human Services segment, which is included in “Discontinued operations, net of tax” in the condensed consolidated statements of income for the three and nine months ended September 30, 2016. It is reasonably possible losses may be incurred in excess of the $6,000 accrued, given the mediation proposal for settlement described above.

 

Litigation is inherently uncertain and the actual losses incurred in the event that the related legal proceedings were to result in unfavorable outcomes could have a material adverse effect on our business and financial performance.

  

 

The Company has provided certain standard indemnifications in connection with its Matrix stock subscription transaction whereby Mercury Fortuna Buyer, LLC (“Subscriber”), Providence and Matrix entered into a stock subscription agreement (the “Subscription Agreement”), dated August 28, 2016.  The representations and warranties made by the Company in the Subscription Agreement survive through the 15th month following the closing date; however, certain fundamental representations survive through the 36th month following the closing date.  The covenants and agreements of the parties to be performed prior to the closing survive through the 15th month following the closing date, and all other covenants and agreements survive until the expiration of the applicable statute of limitations in the event of a breach, or for such lesser periods specified therein.  The Company is not aware of any indemnification liabilities that require accrual at September 30, 2016.

 

Deferred Compensation Plan

 

The Company has one deferred compensation plan for highly compensated employees of NET Services as of September 30, 2016. The deferred compensation plan is unfunded, and benefits are paid from the general assets of the Company. The total of participant deferrals, which is reflected in “Other long-term liabilities” in the condensed consolidated balance sheets, was $1,440 and $1,247 at September 30, 2016 and December 31, 2015, respectively.

 

14.    Transactions with Related Parties

 

The Company incurred legal expenses under an indemnification agreement with the Standby Purchasers as further discussed in Note 13, Commitments and Contingencies. Convertible preferred stock dividends earned by the Standby Purchasers during the three and nine months ended September 30, 2016 totaled $1,059 and $3,154, respectively. Convertible preferred stock dividends earned by the Standby Purchasers during the three and nine months ended September 30, 2015 totaled $1,062 and $2,678, respectively.

 

15.    Discontinued Operations

 

Effective October 19, 2016, the Company completed its Matrix stock subscription transaction whereby Subscriber, Providence and Matrix entered into the Subscription Agreement, dated August 28, 2016. On October 19, 2016, the Company, Matrix and Subscriber entered into Amendment No. 1 (the “Amendment”) to the Subscription Agreement. The Amendment, among other things, implemented certain changes to the Subscription Agreement (1) with respect to a new term loan facility entered into by Matrix at the closing, on October 19, 2016, and the subscription for shares contemplated by the Subscription Agreement (the “Closing” and the date on which the Closing occurred, the “Closing Date”), (2) with respect to a representations and warranties insurance policy obtained in connection with the Closing, and (3) to reflect that Subscriber subscribed for a 53.2% equity interest in Matrix and Providence retained a 46.8% equity interest in Matrix.

 

At the Closing, (i) cash consideration of approximately $180,614 was paid by the Subscriber to Matrix based upon an enterprise value of $537,500 and (ii) Matrix borrowed approximately $198,000 pursuant to a credit and guaranty agreement providing for term loans in an aggregate principal amount of $198,000 and revolving loan commitments in an aggregate principal amount not to exceed $10,000, which was not drawn at the Closing. At the Closing, Matrix distributed $381,163 to Providence, in full satisfaction of a promissory note and accumulated interest between Matrix and Providence. Prior to the Closing, Providence made a $5,663 capital contribution to Matrix, as described in the Subscription Agreement, as amended, to fund the near-term cash needs of Matrix. On the day that is fifteen days following the Closing Date, Providence may, to the extent payable pursuant to the terms of the Subscription Agreement, as amended, be entitled to receive from Matrix, or required to pay to Matrix, subsequent working capital adjustment payments. We estimate that Providence is entitled to receive a working capital adjustment payment of $5,172 from Matrix.

  

In accordance with ASC 205-20, Presentation of Financial Statements-Discontinued Operations, a component of an entity is reported in discontinued operations after meeting the criteria for held for sale classification if the disposition represents a strategic shift that has (or will have) a major effect on the entity's operations and financial results. The Company analyzed the quantitative and qualitative factors relevant to the Matrix stock subscription transaction resulting in the Company no longer owning a controlling interest in Matrix, and determined that those held for sale conditions for discontinued operations presentation have been met during the third quarter of 2016. As such, the historical financial results of Matrix, the Company’s HA Services segment, and the related income tax effects have been presented as discontinued operations for all periods presented in the accompanying condensed consolidated financial statements.

 

 

The Company will have continuing involvement with Matrix through its retention of 46.8% of the equity interests in Matrix. Prior to the Matrix stock subscription transaction, the Company owned 100% of the equity interest in Matrix. Subsequent to the Matrix stock subscription transaction, the Company will account for its investment in Matrix under the equity method of accounting. The Company’s 46.8% share of Matrix’s gains or losses will be recorded as “Equity in net loss (gain) of investees” in its consolidated statements of income.

 

Additionally, on November 1, 2015, the Company completed the sale of the Human Services segment. For further information regarding the sale of the Human Services segment, see Note 22, Discontinued Operations, in the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015. During the nine-months ended September 30, 2016, the Company recorded additional expenses related to the Human Services segment, principally related to legal proceedings as described in Note 13, Commitment and Contingences, related to an indemnified legal matter. The operating results of these segments are reported as discontinued operations, net of tax, in the condensed consolidated statements of income for the three and nine months ended September 30, 2016 and 2015, respectively.

 

Results of Operations

 

The following table summarizes the results of operations classified as discontinued operations, net of tax, for the three and nine months ended September 30, 2016 and 2015:

 

 

 

 

 

 

The Company allocated interest expense to discontinued operations based on the portion of the debt that was required to be paid with the proceeds from the sale of the Human Services segment and the relinquishment of its controlling interest in Matrix, which constituted the HA Services segment. The total allocated interest expense is included in “Interest expense, net” in the table above. The total allocated interest expense for the three and nine months ended September 30, 2016 and 2015 is as follows:

 

 

 

The following table summarizes the carrying amounts of the major classes of assets and liabilities held for sale in the condensed consolidated balance sheet as of September 30, 2016 and December 31, 2015:

 

 

 

 

The reserve for the estimated loss under the indemnifications in connection with the sale of the Human Services segment, as described in Note 13, Commitments and Contingencies, is included within “Accrued expenses” on the condensed consolidated balance sheet at September 30, 2016.

 

Cash Flow Information

 

The following table presents depreciation, amortization and capital expenditures of the discontinued operations for the nine months ended September 30, 2016 and 2015: