AMERICA SERVICE GROUP INC /DE - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q


(Mark One)
[X]		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
		THE SECURITIES EXCHANGE ACT OF 1934

		For the quarterly period ended June 30, 2002

		OR

[ ]		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
		THE SECURITIES EXCHANGE ACT OF 1934

		For the transition period from to

Commission File Number: 0-20135

AMERICA SERVICE GROUP INC.

(Exact name of registrant as specified in its charter)


Delaware		51-0332317
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

105 Westpark Drive, Suite 200
Brentwood, Tennessee		37027
(Address of principal executive offices)		(Zip Code)

(615) 373-3100

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed under Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [x] No [ ]

There were 5,552,744 shares of Common Stock outstanding as of July 31, 2002.

AMERICA SERVICE GROUP INC.

QUARTERLY REPORT ON FORM 10-Q
INDEX


		Page Number

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

Condensed Consolidated Balance Sheets as of June 30, 2002 and December 31, 2001		3

Condensed Consolidated Statements of Operations for the quarter and six month period
ended June 30, 2002 and 2001.		4

Condensed Consolidated Statements of Cash Flows for the six month period ended June 30, 2002
and 2001.		5

Notes to Condensed Consolidated Financial Statements		6

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		14

Item 3. Quantitative and Qualitative Disclosures About Market Risk		24

PART II. OTHER INFORMATION

Item 1. Legal Proceedings		25

Item 4. Submission of Matters to a Vote of Security Holders		25

Item 6. Exhibits and Reports on Form 8-K		26

Signature page		27

PART I:

FINANCIAL INFORMATION

ITEM 1. — FINANCIAL STATEMENTS

AMERICA SERVICE GROUP INC.

CONDENSED CONSOLIDATED BALANCE SHEETS


		June 30,			December 31,
		2002			2001

		*(shown in 000's except share and per*
		*share amounts)*
ASSETS
Current assets:
	Cash and cash equivalents	$	250		$	10,382
	Accounts receivable: healthcare and other less allowances		64,422			64,691
	Inventories		7,845			7,747
	Prepaid expenses and other current assets		15,967			9,070

Total current assets			88,484			91,890
Property and equipment, net			7,025			7,827
Goodwill, net			43,896			43,896
Contracts, net			13,088			13,912
Other intangibles, net			1,583			1,683
Other assets			231			1,172

Total assets		$	154,307		$	160,380

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
	Accounts payable	$	38,350		$	31,159
	Medical claims liability		14,190			15,238
	Accrued expenses		33,461			30,148
	Deferred revenue		735			4,161
	Current portion of loss contract reserve		2,590			4,310
	Current portion of long-term debt		44,678			10,700

Total current liabilities			134,004			95,716
Noncurrent portion of accrued expenses			7,655			6,810
Noncurrent portion of loss contract reserve			8,424			14,008
Long-term debt, net of current portion			—			47,400

Total liabilities			150,083			163,934

Commitments and contingencies
Stockholders’ equity (deficit):
	Common stock, $.01 par value, 10,000,000 shares
	authorized; 5,450,000 and 5,437,000 shares issued and
	outstanding at June 30, 2002 and December 31, 2001, respectively		55			54
	Additional paid-in capital		31,457			31,377
	Stockholders’ notes receivable		(1,334	)		(1,383	)
	Accumulated other comprehensive loss		(284	)		(645	)
	Retained deficit		(25,670	)		(32,957	)

Total stockholders’ equity (deficit)			4,224			(3,554	)

Total liabilities and stockholders’ equity (deficit)		$	154,307		$	160,380

The accompanying notes to condensed consolidated financial statements
are an integral part of these balance sheets.

AMERICA SERVICE GROUP INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS


		Quarter Ended June 30,						Six Months Ended June 30,
		2002			2001			2002			2001

		(Amounts shown in 000's except share and per share amounts)

Healthcare revenue		$	138,505		$	140,779		$	276,360		$	278,720
Healthcare expenses			129,924			146,711			259,203			273,309

Gross margin			8,581			(5,932	)		17,157			5,411
Selling, general and administrative expenses			3,479			5,984			7,564			10,126
Depreciation and amortization			1,134			1,960			2,317			3,943
Strategic initiative expense			—			1,267			—			1,267
Impairment of long-lived assets			—			13,236			—			13,236
Reduction in loss contract reserve			(3,320	)		—			(3,320	)		—

Income (loss) from operations			7,288			(28,379	)		10,596			(23,161	)
Interest, net			1,905			1,237			3,404			2,525

Income (loss) before income tax provision (benefit)			5,383			(29,616	)		7,192			(25,686	)
Income tax provision (benefit)			75			(11,237	)		(95	)		(9,645	)

Net income (loss)			5,308			(18,379	)		7,287			(16,041	)
Preferred stock dividends			—			—			—			163

Net income (loss) attributable to common shares		$	5,308		$	(18,379	)	$	7,287		$	(16,204	)

Net income (loss) per common share:
	Basic	$	0.97		$	(3.39	)	$	1.34		$	(3.14	)

	Diluted	$	0.95		$	(3.39	)	$	1.31		$	(3.14	)

Weighted average shares outstanding:
	Basic		5,450,000			5,420,000			5,445,000			5,153,000

	Diluted		5,576,000			5,420,000			5,551,000			5,153,000

The accompanying notes to condensed consolidated financial statements are an
integral part of these statements.

AMERICA SERVICE GROUP INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


			Six Months Ended June 30,
			2002			2001

			*(Amounts shown in 000's)*
Operating activities:
Net income			$	7,287		$	(16,041	)
Adjustments to reconcile net income to net cash provided by operating activities:
	Depreciation and amortization			2,317			3,943
	Amortization of deferred financing costs			505			190
	Impairment of long-lived assets			—			13,236
	Reduction in loss contract reserve			(3,320	)		—
	Deferred income taxes			—			(8,736	)
	Interest on stockholders’ notes receivable			(34	)		(40	)
	Other comprehensive loss amortized to interest expense			361			—
	Changes in operating assets and liabilities:
		Accounts receivable		269			(5,463	)
		Prepaid expenses and other current assets		(6,995	)		(9,501	)
		Other assets		930			(27	)
		Accounts payable		7,191			4,691
		Accrued expenses		3,190			16,303
		Reserve for loss contracts		(3,984	)		—
		Deferred revenue		(3,426	)		—

Net cash provided by operating activities				4,291			(1,445	)

Investing activities:
Capital expenditures				(608	)		(1,337	)
Other				17			—

Net cash used in investing activities				(591	)		(1,337	)

Financing activities:
Net advances (payments) on line of credit				(13,422	)		1,980
Payment of deferred financing costs				(493	)		—
Proceeds from stockholder notes receivable				83			81
Payment of preferred stock dividends				—			(61	)
Exercise of stock options				—			578

Net cash used in financing activities				(13,832	)		2,578

Net increase (decrease) in cash and cash equivalents				(10,132	)		(204	)
Cash and cash equivalents, beginning of period				10,382			256

Cash and cash equivalents, end of period			$	250		$	52

The accompanying notes to condensed consolidated financial statements are an
integral part of these statements.

AMERICA SERVICE GROUP INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002
(shown in 000’s except share and per share amounts)

1. Basis of Presentation

The interim condensed consolidated financial statements as of June 30, 2002 and for the quarter and six month period then ended are unaudited, but in the opinion of management, have been prepared in conformity with accounting principles generally accepted in the United States applied on a basis consistent with those of the annual audited consolidated financial statements. Such interim condensed consolidated financial statements reflect all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of the financial position and the results of operations for the quarter and six month period presented. The results of operations for the quarter and six month period presented are not necessarily indicative of the results to be expected for the year ending December 31, 2002. The interim condensed consolidated financial statements should be read in connection with the audited consolidated financial statements for the year ended December 31, 2001.

2. Description of Business

America Service Group Inc. and its consolidated subsidiaries (the “Company”) provide managed healthcare services to correctional facilities under capitated contracts (with certain adjustments) with state and local governments, certain private entities and medical facilities operated by the Department of Defense and Veterans Administration. The health status of inmates may impact results of operations under such contractual arrangements.

3. Recently Issued Accounting Pronouncements

In June 1998, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS 133”), as amended in June 2000 by SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities (“SFAS 138”), which requires the Company to recognize all derivatives as assets or liabilities measured at fair value. Changes in fair value are recognized through either earnings or other comprehensive income dependent on the effectiveness of the hedge instrument. The Company currently maintains three interest collar agreements with three of its syndicate banks for a notional amount of $24,000. The collar agreements expire between October 2002 and May 2003.

On January 1, 2001, the Company adopted SFAS 133 and SFAS 138 resulting in a charge to other comprehensive income of approximately $212, net of tax, as the cumulative effect of a change in accounting principle representing the fair value of the collar agreements on the date of adoption.

In June 2001, the FASB issued SFAS No. 141, Business Combinations (“SFAS 141”), and SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS 142”). SFAS 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. SFAS 141 also specifies criteria which intangible assets acquired in purchase method business combinations after June 30, 2001 must meet to be recognized and reported apart from goodwill. SFAS 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS 142 requires that intangible assets with finite useful lives be amortized, and that goodwill and intangible assets with indefinite lives no longer be amortized, but instead be tested for impairment at least annually.

The Company adopted SFAS 141 on July 1, 2001. Such adoption had no effect on the Company’s financial position or results of operations. The Company adopted SFAS 142 effective January 1, 2002, at which time the amortization of the Company’s existing goodwill ceased. Other than the effect on net income of not amortizing goodwill, the adoption of SFAS 142 had no effect on the Company’s results of operations or financial position. Amortization expense related to goodwill during the quarter and six month period ended June 30, 2001 was $794 and $1,598, respectively.

The following table reflects unaudited pro forma results of operations of the Company for the quarter and six month period ended June 30, 2002 and 2001, giving effect to SFAS 142 as if it were adopted on January 1, 2001:


		Quarter ended					Six months ended
		June 30,					June 30,
		2002		2001			2002		2001

Net income (loss) attributable to common shares, as reported		$	5,308	$	(18,379	)	$	7,287	$	(16,204	)
Add back: amortization expense, net of tax			—		492			—		991

Pro forma net income (loss) attributable to common shares		$	5,308	$	(17,887	)	$	7,287	$	(15,213	)

Basic net income (loss) per common share:
	As reported	$	0.97	$	(3.39	)	$	1.34	$	(3.14	)

	Pro forma	$	0.97	$	(3.30	)	$	1.34	$	(2.95	)

Diluted net income (loss) per common share:
	As reported	$	0.95	$	(3.39	)	$	1.31	$	(3.14	)

	Pro forma	$	0.95	$	(3.30	)	$	1.31	$	(2.95	)

In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS 144”) effective for fiscal years beginning after December 15, 2001. SFAS 144 establishes a single accounting model for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and broadens the presentation of discontinued operations to include more disposal transactions. The Company adopted SFAS 144 effective January 1, 2002. Such adoption had no impact on the Company’s financial position or results of operations.

4. Reduction In Loss Contract Reserve

During 2001, the Company completed a comprehensive review of its portfolio of 145 contracts for the purpose of identifying loss contracts and developing a contract loss reserve for succeeding years. As a result of this review, the Company identified five non-cancelable contracts with combined 2001 annual revenues of $59,653 and negative gross margin of $4,714. Based upon management’s projections, these contracts were expected to continue to incur negative gross margin over their remaining terms. In December 2001, the Company recorded a charge of $18,317 to establish a reserve for future losses under these non-cancelable contracts. The five contracts covered by the charge had expiration dates ranging from June 30, 2002 through June 30, 2005. Ninety percent of the charge related to the State of Kansas contract, which expires June 30, 2005, and the City of Philadelphia contract, which was renewable annually, at the client’s option, through June 30, 2004. The remaining ten percent of the charge related to the State of Maine contract, which expired June 30, 2002, and two county contracts, which expire August 15, 2002 and June 30, 2005. Negative gross margin and overhead costs charged against the loss contract reserve related to these five contracts totaled $2,078 for the quarter ended June 30, 2002 and $3,984 for the six months ended June 30, 2002.

In June 2002, the Company and the City of Philadelphia reached a mutual agreement that the contract between the Company’s subsidiary and the City of Philadelphia would expire effective June 30, 2002. As a result of the early expiration of this loss contract, the Company performed a reassessment of its loss contract reserve requirements. This reassessment included a review of management’s projected future losses under the remaining three loss contracts as well as a comprehensive review of the Company’s portfolio of contracts at June 30, 2002 for the purpose of identifying any additional loss contracts. No new loss contracts were identified as a result of this review. Based upon the reassessment, the Company recorded a gain of $3,320 to reduce its reserve for loss contracts to $11,014 at June 30, 2002.

The Company will continue to provide services to the State of Maine under a cost plus a fixed management fee transition agreement through December 31, 2002. The Company has also entered into a transition agreement with the City of Philadelphia under which it will continue to provide services through September 30, 2002 under modified contract terms.

5. Strategic Initiative Expense

During the second quarter of 2001, the Company incurred cer