America Service Group Inc. Q1 2009 Earnings Call Transcript

America Service Group Inc. (ASGR)

Q1 2009 Earnings Call

April 30, 2009; 11:00 am ET

Executives

Rich Hallworth - President and Chief Executive Officer

Mike Taylor - Chief Financial Officer

Jon Walker - Senior Vice President of Business Development

Analysts

Mike Lamb - Wealth Monitors

Wes Huffman - Avondale Partners

Presentation

Operator

Ladies and gentleman, thank you for standing by. Welcome to the America Service Group’s first quarter conference call. During the presentation all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. (Operator Instructions)

I would now like to turn the conference over to Mr. Rich Hallworth, President and Chief Executive Officer. Please go ahead sir.

Rich Hallworth

Thank you, Wayne. Good morning everyone. Welcome to our Q1, 2009 earnings call. A copy of our press release addressing our first quarter results can be found on our website www.asgr.com.

Before I talk about Q1, I’d like to comment on my first few months as CEO. I have been warmly received by our great employees and clients alike around the country. I’m so very proud of the way our management team has pulled together and dedicated themselves to achieving the goals we collectively set. Those goals are aimed at achieving the objectives which balance both the short and long term interest of our shareholders, clients and staff. I cannot be more pleased with the progress we are making.

As worth pausing to also note that we are in the minority of companies doing well in this economic recession. I spoke about this is in the last quarter and I’m pleases that we are still on track to deliver the income results we posted in our original 2009 guidance.

Beyond the financial results being generated, this company has the ability and continues to invest in processing technology improvement which are so important to our client service. These investments also differentiated us from our competitors. Again, I am pleased with the progress we are making.

After each of these calls, I get a report of the number of people listening to our presentation. Over the last two quarters, interest in the America Service Group has increased markedly. In fact the last two calls by nearly a 300% increase in participation over the prior two quarters.

We make very exhaustive disclosures and we openly talk about business issues on each of these calls. We recognized our leadership position in this industry and we think we are the strongest company. We have both size and financial stability. We have the operations leadership and the most developed technologies to meet clients’ needs. I hope clients and potential clients will ask for the same level of transparency from our non-public competitors.

Now, let’s discuss the first quarter. Our financial results for the quarter delivered the bottom line we expected. We are reaffirming our full year income guidance; let me emphasize that. In preparing our guidance for the full year, we anticipated certain quarterly variability, such as wage, taxes, contract renewal price escalations, seasonality etc., in addition to our startup cost related to Michigan contract. The income generated in Q1, met our expectations for the quarter and we are on track to meet our full year income guidance.

The way we got to meeting our bottom line goal was a bit different than we have projected. As noted in our press release, we took another $1.8 million charge in this quarter, related to the same professional liability case noted in our Q4 2008 call. In that quarter, we recorded the full jury verdict of $3.6 million. This quarter we recognized an additional $1.8 million when the same judge ruled our legal and core cost, largely in favor of the plaintiff. Although disappointing, this ruling was not entirely unexpected.

We continue to believe there were several errors made in the original court trial. We are appealing to verdict and seeking reversal in every trial. Despite this charge, our results met our targets. This is due to strong performance on our contract portfolio. On the whole, our contracts continue to outpace projections. While there is no guarantee that future results will continue this improved performance trend we produced over the past five quarters, it is pleasing to see more consistency.

During the first quarter and continuing much of management’s attention has been devoted to the start-up of our Michigan DOC contract, effective April, 1. To remind you, we incurred startup costs on this contract with no revenue being generated until April. In terms of revenue, this will be our second largest contract.

Hiring the employees and transitioning the care for the 48,000 inmates has been a major effort. We have formed a great partnership with our Michigan client and everyone involved just working toward helping the Michigan DOC achieve their objectives.

To be sure, there is much that needs to be done. We anticipate this in our guidance. It will take us sometime to ramp up the people, process and technology changes necessary to produce the clinical and financial results we are confident can be attained, we standby our original projections. I want to welcome our new Michigan employees to the company and thank the many, many PHS professional who have devoted compassable to this startup.

In the first quarter, we purchased 140,000 shares of stock under our repurchase program. I know some investors wanted us to be more aggressive, while some desire other forms of capital utilization to enhance shareholder value. Management and our Board agreed that this level of repurchase was appropriate for the first quarter.

At the end of Q1, our balance sheet continues to be very strong. We have $28 million of cash on hand and no debt; rest assured, we continue to look at the best use of our cash. The new business pipeline is strong. We have new bids pending or in process totaling $21 million. Over the next twelve months, we anticipate after $300 million of new RFPs, several DOC systems are expected to come out to bid, although there is no assurance that RFPs will be issued in all the cases.

I’d now like to ask Mike Taylor, our Executive Vice President and Chief Financial Officer to just speak in more detail about financial matters. Following Mike’s remarks, Jon Walker, our new Senior Vice President of Business Development will also be available for questions. Mike

Mike Taylor

Thank you, Rich. Good morning everyone. The company’s first quarter financial performance was generally inline with expectations contained within our initial 2009 guidance which we announced in early March. Our strong cash flow from operations of $5 million in the first quarter allowed us to fund capital expenditure and share repurchases, as well as increase our cash balances to over $28 million.

While startup costs were a bit less than anticipated the ultimate financial performance of our new contract with the State of Michigan Department of Corrections which commenced April 1 and is now our second largest contract. We’ll obviously have a significant impact on financial results as we move forward through the remainder of this year.

Let’s review some of the financial details related to our first quarter results. Healthcare revenues were $130.5 million in the first, an increase of 5.7% over the prior year quarter. As a reminder, healthcare revenues only include those revenues from healthcare service contracts that continue to operate subsequent to the end of the first quarter of 2009, through the accounting requirement of FAS 144.

FAS 144 requires us to percent expired healthcare service contracts as discontinued operations and collapse the revenues and direct expenses of those contracts into the line item on our income statement that is titled, Income or Loss from Discontinued Operations Net of Taxes.

When you include revenues generated by our expired healthcare service contracts, total revenues were $130.9 million in the first quarter, an increase of 2% from the prior year quarter. Healthcare expenses from continuing contracts were $120.9 million in the first quarter.

Included in healthcare expenses in the first quarter, was a March award of approximately $1.8 million of court costs and attorney fees, related to an adverse jury verdict against the company in November 2008. The company believes that there were several reversible errors made at the trial court level and has filed its appeal seeking a reversal of the verdict and a remand for a new trial.

Also included in healthcare expenses in the first quarter was $313,000 of direct incremental startup expenses related to the company’s new contract with the State of Michigan Department of Corrections. Total healthcare expenses, which includes healthcare expenses from expired healthcare service contracts and excludes share based compensation expense, were $121.7 million in the first quarter.

Gross margin from continuing contracts was $9.5 million in the first quarter. This is 7.3% of healthcare revenues. This compares with 7.4% in the prior year quarter. Total gross margin, which includes revenues and expenses from expired healthcare service contracts and excludes share based compensation expense, was $9.2 million or 7% of total revenues in the first quarter. This compares with 7.4% in the prior year quarter.

Selling, general and administrative expenses were $7.2 million in the first quarter as compared with $6.5 million in the prior year quarter. Included in selling, general and administrative expenses is $464,000 and $554,000 of share based compensation expense in the first quarters of 2009 and 2008 respectively.

Excluding share-based compensation expense, selling, general and administrative expenses were approximately $856,000, greater than the prior year first quarter, primarily due to an increase in accrued incentive compensation expense of $453,000, combined with an increase in consulting expense of $348,000, primarily related to information technology. Excluding share-based compensation expense; selling, general and administrative expenses were 5.2% of total revenues for the first quarter, as compared with 4.6% in the prior year quarter.

Adjusted EBITDA was $2.4 million in the first quarter, this compares with $3.6 million in the prior year quarter. Depreciation and amortization expense was $638,000 in the first quarter. This was reduced significantly from $915,000 in the prior year quarter. Net interest expense was $64,000 in the first quarter. This has compared to $272,000 in the prior year quarter.

The income tax provision related to continuing operations for the first quarter was $663,000. This compares with $635,000 in the prior year quarter. Income from continuing operations after taxes was $885,000 in the first quarter, as compared with $820,000 in the prior year quarter.

The loss from discontinued operations, net of taxes was $186,000 in the first quarter. This compares with income from discontinued operations, net of taxes of $162,000 in the prior quarter. Net income for the first quarter of 2009 was $699,000 or $0.08 per common share, basic and diluted. This compares with $982,000 or $0.11 per common share basic and diluted in the prior year quarter.

Cash balances increased to $28 million at March 31, 2009 from $24.9 million at the end of 2008. The company remained debt free as of March 31, 2009. Day sales outstanding and accounts receivable were 32 days at March 31, 2009, up slightly from 31 days at December 31, 2008. Net cash provided by operating activities was $5 million in the first quarter as compared with $2.7 million in the prior year quarter.

During the first quarter, the company repurchased and retired 140,000 shares of its common stock for approximately $1.6 million. Since the inception of the current $15 million repurchase program, the company has repurchased and retired 386,900 shares of its common stock for approximately $4 million.

The company reaffirmed its guidance for 2009 financial results yesterday, while allowing for the impact of the current higher prices of its common stock on diluted shares outstanding. The company still anticipates net income for 2009 of approximately $7.8 million, on total revenues of between $600 million and $610 million. The average stock price leads us to anticipate $0.88 of net income per diluted common share in 2009. This compares with the $0.42 per diluted common shares earned by the company in 2008.

Consistent with past practice, the company’s guidance for full year 2009 results does not reflect the impact of any potentially contracts with new customers. Contracts currently in operation are included in the guidance through the end of the year, unless the company has been notified otherwise by our clients.

Operator at this time we’d welcome questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Mike Lamb, please go ahead.

Mike Lamb – Wealth Monitors

Good morning gentlemen and great quarter again. Quick question; I guess this should go to Jon regarding the outlook on the new business. You said there is just about $300 million we’re looking for as possible come outs over the next 12 months. Can you be a little it more specific and are you seeing a growing trend due to budgetary issues?

Jon Walker

Thanks Mike. The answer to your question, there’s some current contracts of our competitors that will be coming out in Delaware, Tennessee, Idaho and we’re anticipating to come out, although there is no guarantee, in Delaware, Tennessee, Idaho, Indiana and Maryland over the next 12 months.

In your question around the budgets, I had nothing affirmative to tell me that it will. Although, there are some agencies out there, self-op agencies today who do, health department does their healthcare and were the share has to pay for through that budget and some of those shares are now looking out to other avenues to make sure that they’re getting a good deal from their own county.

Mike Lamb - Wealth Monitors

What about on a state basis, for the state DOCs. Jon, are we seeing the commissioners there dealing with budget deficits and at least inquiring at a greater pace than we’ve seen in the past?

Jon Walker

Mike what I’ve seen so far is really Arizona, is the only state that’s really taken it to a serious level and having serious discussions about contracting it out.

Mike Lamb - Wealth Monitors

Okay. How about region for Florida status there?

Jon Walker

As far as I know right now, either still so far and I had not heard anything in my six weeks to tell me that it’s coming on anytime soon.

Mike Lamb - Wealth Monitors

Okay. Mike Taylor, regarding the charge on the legal expense, what ongoing legal expense do you anticipate in challenging this verdict?

Mike Taylor

It should be relatively minimal at this point, Mike. I mean basically as you noted we booked the judgment and now this award of court cost and legal fees against us. We will have some fairly minimal cost as we move through the appeal process in Idaho. As we’ve said, we think there are some very appeal able issues of this case and it’s a unique situation that we find ourselves in.

We’ve not really had a case comparable to this historically and we do intend to go through that appeal process as long as it takes to get this brought back to trial again, which we think is what should happen and let all the evidence be heard. So, there will be a little bit; there is the potential things that don’t go our away, and there’s also some interest on the judgment itself, but right now we feel pretty good about our appeal process.

Mike Lamb - Wealth Monitors

What you’ve reserved so far for the worst case?

Mike Taylor

We reserved for the judgment. We have not reserved for our cost internally of going through the appeal process and then interest only comes into play if it becomes a confirmation of the judgment that’s already there.

Mike Lamb - Wealth Monitors

Time table on completion of this; do you think it’s going to be within ’09 or drag out for another couple of years?

Mike Taylor

My guess is it doesn’t get fully dealt with in ’09. Could it? Yes, but my best guess would be we’re looking at something that’s later half of 2010 honestly.

Mike Lamb - Wealth Monitors

Regarding your cash position, we’ve talked about this before as it continues to grow and given your guidance ex any extraordinary events that will continue to grow. Can you give a little bit of flavor on the thought process? Since you’re now on the board, maybe the Boards view point of use of those funds?

Rich Hallworth

Well, we do spend a good bit of time on that at the Board level really, almost every time we’re together as a Board. We do look for the highest return deployment of that capital that we’re creating as a business. That’s taken the form historically of share repurchases; it’s been several years since the company’s done an acquisition as a use of capital.

We’ve also reinvested in the business an initiative such as our catalyst program and dividends are also a discussion point for us. So, I would described it as a dynamic of tying to come together as a group every time we’re together, as to what is the highest return likelihood to benefit shareholders.

That’s been the process; there hasn’t been a magic number that says we want to have ex million dollars of cash at any point of time on the balance sheet. We’re certainly pleased to have $28 million at the end of March and it’s been a similar number really throughout April. Collections; it remained good and that’s been watch items for us because of the budgetary concerns that you referenced earlier, but we have to-date; knock on wood, not same significant impact on our AR collections, related to those budget issues.

We’re trying to move through this budgetary environment cautiously. We’re cognizant of the budget pressures and even at $28 million, that’s 2.5 weeks of operating expenses for us. So it’s not like on the size of business of ours, it’s just a huge part of cash.

Mike Lamb - Wealth Monitors

Well Mike, what I was wondering with the DSOs where they are, which is great. We haven’t seen that in, maybe what a decade. That we’re seeing, I believe the contracts being structure to basically match the outflow, is that correct?

Mike Taylor

We are trying to do so Mike and that’s actually a good point. Our business traditionally was a pay in arrears type of business. However, the managed care industry has always been a pay your providers very quickly. So we’re trying to match our contracts similar to the reminder of the managed care industry.

So, we have structured wherever we have the opportunity, to push the payment process of sooner in the contract; our preference would be to get paid within the month of service and we’ve had some success on adding some larger contracts and that has helped in this DSO equation, and you’re right, it’s the best we’ve seen; the last two quarters have been the best we’ve seen in the 7.5 years, I’ve been here.

Mike Lamb - Wealth Monitors

For modeling purposes, what should we look at as an ongoing legal liability expense per quarter …?

Mike Taylor

The professional liability expense, the development factor of that, and just to put it in perspective a little bit, we brought this function of managing our professional liability claims in-house in mid-year ’07, because we were disappointed with the level of that worst development we have been experiencing in the two and half to three years prior to that. We did, I think see some catch up of development in the second half of ‘07.

Since we’ve gone through that process for the last five quarters or so, it’s averaged about $1.7 million a quarter Mike, but really absent this one case in Idaho, it’s been closer to $600,000 a quarter on average. So I think that is absent large case impacts, is something that I would hope for to see on a recurring basis, if not a little better.

Michael Lamb - Wealth Monitors

Okay, great. Thanks, gentlemen.

Operator

Our next question comes from the line of Kevin Campbell of Avondale Partners, please go ahead.

Wes Huffman - Avondale Partners

Hi, good morning gentlemen. This is Wes Huffman, speaking for Kevin Campbell. I have a couple of questions for you, as it relates to the Michigan contracts and the startup expenses for the quarter. Given the size of the contract, we though that there would be some higher cost involved, how did that compared to your own internal expectations?

Mike Taylor

Wes, it was a little better than we have anticipated. We had thought, probably closer to $600,000 on the direct incremental cost. I’m using that term, because in addition to the $313,000 of direct incremental startup costs we have, there is at least another $200,000 of other cost where we’ve had people from throughout the company on the ground at Michigan helping us get the startup done. So, those weren’t incremental costs, but they were certainly opportunity costs, where we didn’t spent time in other area.

So between the two, roughly a little over $0.5 million for the startup. We would have thought it would have been a little bit higher, so it was a pretty effective startup process with our team did up there and so that’s kind of where we are in the startup phase.

Rich Hallworth

One other thing I’d add to that Wes is that if you recall the incumbent had protested the award of the contract to us, which did short in the timeline that we had on the ground up there for doing the startup until we ended up using internal resources and condensing these startup into a shorter period of time than we normally would have and that we projected, so that was a factor as well.

Wes Huffman - Avondale Partners

Okay, do you see any carryover from that into the second quarter?

Rich Hallworth

I wouldn’t and in terms of true startup costs I would expect very little to have been carried over into April, because at that point the full scope of the contract started. We have said repeatedly, we would expect the profitability of the contract overall to improve overtime as we get in and instill our own process is in procedures on the ground, but in terms of true startup I don’t anticipate a large carryover into Q2.

Wes Huffman - Avondale Partners

Okay, so far in April, what has profitability been like there relative to your expectations?

Rich Hallworth

Well, it’s honestly too early to say. Obviously, we haven’t closed the month of April as yet; it’s the last day of the month as we sit here today. So, it’s too early to draw any conclusions about initial month one profitability issue versus expectations.

At this point, I would say one of the items we always watch closely is the inpatient hospitalization days and they are tracking roughly inline with volume that we expected based on the data that was put out with this RFD. So, the volume of all site care, where it had to go into the hospital stay appears to be in line with that data book initially.

Wes Huffman - Avondale Partners

Okay, that’s very helpful and I’m sure you’ll noticed this week, there was a proposal put out by some state senators there to move prison healthcare to where it was provided by universities. I wanted to get your thoughts on that and if you talk that was likely to happen in the future.

Jon Walker

Sure, I will address that one. We’re well aware of the proposal that has been promoted this week. We are in touch with officials in the state. It does not change our contract; in fact the university had the chance to bid on the last RFP and chose not to and so that’s pretty indicative of the situation up there.

It’s fair to say that there is a significant focus within the State of Michigan on their entire budget woes, including the increase in corrections costs over the year and so I think we’ll continue to see debate over what opportunities there are to improved cost structure across the entire system.

Within the provider side though, while the university had no appetite to bid on this in the past, we do partner with that to provide our network and if the university has a desire to participate in that network, that’s certainly something that we would entertain.

Wes Huffman - Avondale Partners

Okay and I guess as it relates to obtaining new RFPs, has there been any new issue this past quarter?

Mike Taylor

Not at the state level. There has been some volume in the county outside of the business, and that’s part of that, which really makes up the entire $21 million that we talked about in the pipeline that of responses that we have made and we’re waiting on decisions forward. The state systems we would anticipate would be coming over the next several months and Jon I don’t know if you want to comment roughly on the timing of some of the states you’ve mentioned or not.

Jon Walker

Sure, I can do that. I think we’re expecting Tennessee DOC to be out sometime this summer, the July timeframe. Maryland we would expect to be out in the late fall October, November timeframe. Delaware and Idaho, we’re anticipating first of ‘10 hitting the street. That’s what we’ve got for state opportunities at this point.

Wes Huffman - Avondale Partners

Okay, great. Thank you.

Operator

Mr. Taylor, there are no further questions at this time. I’ll turn the call back over to you.

Mike Taylor

Thank you. This call may contain forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. As such, they involve risk and uncertainty that actually results may differ materially from those projected in the forward-looking statements.

A discussion of the important factors and assumptions regarding the statements and risks involved is contained in the company’s annual report on Form 10-K and other filings with the Securities and Exchange Commission. These forward-looking statements are made as of the date of this call. The company assumes no obligations to update or revise them, or provide reasons why actual results may differ.

We have posted schedules on our company website at www.asgr.com, which reconcile our results as reported under Generally Accepted Accounting Principles to certain non-GAAP measures which may be referred to by our senior executives in our discussions today and from time-to-time in discussing our financial performance. These schedules can be found on the website in financial press releases and investor presentations.

Thank you for joining us today and we look forward to reporting second quarter results.

Operator

Ladies and gentlemen that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.

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