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EX-32.1 - EX-32.1 - AMERICA SERVICE GROUP INC /DE | g22313exv32w1.htm |
EX-32.2 - EX-32.2 - AMERICA SERVICE GROUP INC /DE | g22313exv32w2.htm |
EX-23.2 - EX-23.2 - AMERICA SERVICE GROUP INC /DE | g22313exv23w2.htm |
EX-21.1 - EX-21.1 - AMERICA SERVICE GROUP INC /DE | g22313exv21w1.htm |
EX-23.1 - EX-23.1 - AMERICA SERVICE GROUP INC /DE | g22313exv23w1.htm |
EX-31.1 - EX-31.1 - AMERICA SERVICE GROUP INC /DE | g22313exv31w1.htm |
EX-31.2 - EX-31.2 - AMERICA SERVICE GROUP INC /DE | g22313exv31w2.htm |
EX-10.17 - EX-10.17 - AMERICA SERVICE GROUP INC /DE | g22313exv10w17.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTIONS 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OF THE SECURITIES EXCHANGE ACT OF 1934
(Mark One)
þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2009
or
o | 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: 0-19673
America Service Group Inc.
(Exact name of registrant as specified in its charter)
Delaware (State or other jurisdiction of incorporation or organization) |
51-0332317 (I.R.S. Employer Identification No.) |
|
105 Westpark Drive, Suite 200 Brentwood, Tennessee (Address of principal executive offices) |
37027 (Zip Code) |
Registrants telephone number, including area code: (615) 373-3100
Securities Registered Pursuant to Section 12(b) of the Act:
Securities Registered Pursuant to Section 12(b) of the Act:
Title of each class | Name of each exchange on which registered | |
Common Stock, par value $.01 per share | Nasdaq Global Select Market |
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule
405 of the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section
13 or Section 15 (d) of the Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by 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 þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer or a smaller reporting company. See the definitions of large
accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the
Exchange Act. (Check one)
Large Accelerated Filer o | Accelerated Filer þ | Non-Accelerated filer o | Smaller Reporting Company o | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
The aggregate market value of the Common Stock held by non-affiliates of the registrant as of
June 30, 2009 (based on the last reported closing price per share of Common Stock as reported on
the Nasdaq Global Select Market on such date) was approximately
$144,137,583. As of March 1,
2010, the registrant had 8,947,370 shares of Common Stock outstanding.
Documents Incorporated by Reference
Portions of the Companys Annual Report to Stockholders for fiscal year 2009 and portions of
the Companys Definitive Proxy Statement relating to the 2010 Annual Meeting of Stockholders to be
held on June 8, 2010 are incorporated by reference in Part II and Part III of this Annual Report on
Form 10-K.
TABLE OF CONTENTS
Table of Contents
PART I
Cautionary Statement Regarding Forward-Looking Information
This Annual Report on Form 10-K contains statements that are forward-looking statements as
defined within the meaning of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements give the Companys current expectations of forecasts of future events.
All statements other than statements of current or historical fact contained in this annual report,
including statements regarding the Companys future financial position, business strategy, budgets,
projected costs and plans and objectives of management for future operations, are forward-looking
statements. The words anticipate, believe, continue, estimate, expect, intend, may,
plan, projects, will, and similar expressions, as they relate to the Company, are intended to
identify forward-looking statements. These statements are based on the Companys current plans and
anticipated future activities, and its actual results of operations may be materially different
from those expressed or implied by the forward-looking statements. Some of the factors that may
cause the Companys actual results of operations to differ materially from those expressed or
implied by forward looking statements including, among other things:
| the Companys ability to retain existing client contracts and obtain new contracts at acceptable pricing levels; | ||
| whether or not government agencies continue to privatize correctional healthcare services; | ||
| risks arising from governmental budgetary pressures and funding; | ||
| the possible effect of adverse publicity on the Companys business; | ||
| increased competition for new contracts and renewals of existing contracts; | ||
| risks arising from the possibility that the Company may be unable to collect accounts receivable or that accounts receivable collection may be delayed; | ||
| the Companys ability to limit its exposure for medical malpractice claims in excess of amounts covered under contracts or insurance coverage and for catastrophic illnesses or injuries; | ||
| the Companys ability to maintain and continually develop information technology and clinical systems; | ||
| the outcome or adverse development of pending litigation, including professional liability litigation; | ||
| the Companys determination whether to continue the payment of quarterly cash dividends, and if so, at the current amount; | ||
| the Companys determination whether to repurchase shares under its stock repurchase program; | ||
| the Companys dependence on key management and clinical personnel; | ||
| risks arising from potential weaknesses or deficiencies in the Companys internal control over financial reporting; | ||
| risks associated with the possibility that the Company may be unable to satisfy covenants under its credit facility; | ||
| the risk that government or municipal entities (including the Companys government and municipal customers) may bring enforcement actions against, seek additional refunds from, or impose penalties on, the Company or its subsidiaries as a result of the matters investigated by the Audit Committee in prior years or the previous restatement of the Companys financial results; and |
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| the risk that recent legal settlements, including settlement in principle of the shareholder litigation, are not approved by the respective courts. |
Any or all of the Companys forward-looking statements in this annual report may turn out to
be inaccurate. They can be affected by inaccurate assumptions the Company might make or by known
or unknown risks, uncertainties and assumptions, including the risks, uncertainties and assumptions
described below in Item 1A. Risk Factors.
In light of these risks, uncertainties and assumptions, the forward-looking events and
circumstances discussed in this annual report may not occur and actual results could differ
materially from those expressed or implied in the forward-looking statements. When considering
these forward-looking statements, keep in mind these risk factors and other cautionary statements
in this annual report, included in Managements Discussion and Analysis of Financial Condition and
Results of Operations and Business, and in other documents that the Company files from time to
time with the Securities and Exchange Commission (SEC).
The Companys forward-looking statements speak only as of the date made. The Company
undertakes no obligation to publicly update or revise forward-looking statements, whether as a
result of new information, future events or otherwise. All subsequent written and oral
forward-looking statements attributable to the Company or persons acting on its behalf are
expressly qualified in their entirety by the cautionary statements contained in this annual report.
Item 1. Business
General
America Service Group Inc. (ASG or the Company), through its subsidiaries Prison Health
Services, Inc. (PHS) and Correctional Health Services, LLC (CHS), contracts to provide and/or
administer managed healthcare services to over 160 correctional facilities throughout the United
States. Prior to May 1, 2007, the Company, through its subsidiary Secure Pharmacy Plus, LLC
(SPP), was also a distributor of pharmaceuticals and medical supplies. The Company is a leading
non-governmental provider and/or administrator of correctional healthcare services in the United
States.
On April 12, 2007, SPP and PHS, as guarantor, entered into an asset purchase agreement with
Maxor National Pharmacy Services Corporation (Maxor) whereby SPP agreed to sell certain of its
assets at net book value (the Transaction). The closing of the Transaction occurred on May 3,
2007, with an effective date as of April 30, 2007. The net book value of the assets included in
the Transaction was approximately $3.8 million as of April 30, 2007, which consisted of
approximately $1.9 million in inventory and approximately $2.0 million in fixed assets, offset by
approximately $0.1 million of liabilities for accrued vacation assumed by Maxor. Additionally, as
a condition to the closing of the Transaction, Maxor and PHS entered into a long-term pharmacy
services agreement (the Services Agreement) pursuant to which Maxor became the provider of
pharmaceuticals and medical supplies to PHS. The Services Agreement commenced effective May 1,
2007 and will remain in effect until October 31, 2014 (unless terminated earlier in accordance with
the terms of the Services Agreement). During the term of the Services Agreement, PHS will utilize
Maxor on an exclusive basis to provide pharmaceuticals and medical and surgical supplies to PHS,
except in certain specified situations, including when a PHS client elects or requires PHS to
utilize another pharmacy services provider.
The following table sets forth certain information regarding the Companys correctional
healthcare and, prior to May 1, 2007, pharmacy contracts.
Historical December 31, | ||||||||||||||||||||
2009 | 2008 | 2007 | 2006 | 2005 | ||||||||||||||||
Number of correctional contracts(1) |
62 | 64 | 60 | 92 | 105 | |||||||||||||||
Average number of inmates in all
facilities covered
by correctional contracts(2) |
173,172 | 130,749 | 131,459 | 175,728 | 218,170 |
(1) | Indicates the number of contracts in effect at the end of the period specified. The 2006 and 2005 number of correctional contracts also includes independent pharmacy distribution contracts totaling 16 and 24, respectively, which are not included in the 2007, 2008 and 2009 number of correctional contracts due to the Transaction discussed above. | |
(2) | Based on an average number of inmates during the last month of each period specified. The 2006 and 2005 inmate counts also include inmates under independent pharmacy distribution contracts totaling approximately 11,000 and 32,000, respectively, which are not included in the 2007, 2008 and 2009 inmate counts due to the Transaction discussed above. |
ASG was incorporated in 1990 as a Delaware holding company for PHS. Unless the context
otherwise requires, the terms ASG or the Company refer to ASG and its direct and indirect
subsidiaries. ASGs executive offices are located at 105 Westpark Drive, Suite 200, Brentwood,
Tennessee 37027.
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Audit Committee Investigation
On October 24, 2005, the Company announced that the Audit Committee had initiated an internal
investigation into certain matters related to SPP. As disclosed in further detail in the Companys
Annual Report on Form 10-K for the year ended December 31, 2005, on March 15, 2006 the Company
announced that the Audit Committee had concluded its investigation and reached certain conclusions
with respect to findings of the investigation that resulted in an accrual of $3.7 million of
aggregate refunds due to customers, including PHS, that were not charged by SPP in accordance with
the terms of the respective contracts. In circumstances where SPPs incorrect billings resulted in
PHS billing its clients incorrectly, PHS passed the applicable amount through to its clients. This
amount plus associated interest represented managements best estimate of the amounts due to
affected customers, based on the results of the Audit Committees investigation. As of December
31, 2009, the Company has paid all of these refunds plus associated interest to customers except
for $0.4 million which has been tendered for payment to the appropriate customers. The ultimate
amounts paid could differ from the Companys estimates; however, actual amounts to date have not
differed materially from the estimated amounts. There can be no assurance that the Company, a
customer or a third-party, including a governmental entity, will not assert that additional
amounts, which may include penalties and/or associated interest, are owed to these customers.
During the year ended December 31, 2009, the Company recognized additional expense totaling $8.4
million relative to this matter due to the Company recording a reserve related to the settlement in principle reached on February 19, 2010, regarding the shareholder
litigation filed against the Company and certain individual defendants on April 6, 2006;
an insurance settlement for $8.0 million entered into by the Company and its primary directors and officers liability (D&O)
insurance carrier; and legal expenses.
The settlement regarding the shareholder litigation, which is subject to final documentation
as well as approval by the Court, provides for payment by the Company of $10.5 million and issuance
by the Company of 300,000 shares of common stock and would lead to a dismissal with prejudice of
all claims against all defendants in the litigation (see Note 21 to the Companys consolidated
financial statements and Item 3. Legal Proceedings).
Correctional Healthcare Services
The Company, through PHS and CHS, contracts with state, county and local governmental agencies
to provide and/or administer healthcare services to inmates of prisons and jails. The Companys
revenues from correctional healthcare services are generated primarily by payments from
governmental entities, none of which are dependent on third party payment sources although they are
dependent on appropriate governmental funding. The Company provides and/or administers a wide
range of on-site healthcare programs, and arranges for and oversees off-site hospitalization and
specialty outpatient care. The hospitalization and specialty outpatient care is performed by third
parties through arrangements with independent doctors and local hospitals. For the years ended
December 31, 2009, 2008 and 2007, revenues from correctional healthcare services accounted for
100%, 100% and 99.4%, respectively, of the Companys healthcare revenues from continuing operations
and discontinued operations combined. Required financial information related to this business
segment is set forth in Note 23 to the Companys consolidated financial statements.
The Companys target correctional market consists of state prison systems and county and local
jails. A prison is a facility in which an inmate is incarcerated for an extended period of time
(typically one year or longer). A jail is a facility in which the inmate is held for a shorter
period of time, often while awaiting trial or sentencing. The expected higher inmate turnover in
jails typically requires that healthcare be provided to a much larger number of individual inmates
over time and includes the costs associated with stabilizing and treating whatever health
conditions or injuries are present at the time of initial incarceration. As a result of the higher
number of individual inmate patient encounters and the greater likelihood of previously undiagnosed
acute healthcare needs associated with healthcare in jail settings, the severity and therefore
related costs of treating such patients, particularly with respect to professional liability costs,
are typically greater in jails as opposed to prison systems. Conversely, the costs of chronic
healthcare requirements are generally greater with respect to state prison contracts. State prison
contracts often cover a larger number of facilities and often have longer terms than jail
contracts.
Services Provided and/or Administered. Although the precise type of services to be provided
and/or administered by the Company vary depending on the specific terms of a contract, generally,
the Companys obligation to provide and/or administer medical services to a particular inmate
begins upon the inmates booking into the correctional facility and ends upon the inmates release.
In order to reduce costs and provide better care, emphasis is placed upon early identification of
serious injuries or illnesses so that prompt and clinically-effective treatment is commenced.
Medical services provided and/or administered on-site may include physical and mental health
screening upon intake. Screening includes the compilation of the inmates health history and the
identification of any current, chronic or acute healthcare needs. After initial screening,
services provided and/or administered may include regular physical and dental screening and care,
psychiatric care, OB-GYN screening and care and diagnostic testing. Hospitalization is provided
off-site at acute-care hospitals. Sick call is regularly conducted and physicians, nurse
practitioners, physicians assistants and others are also involved in the delivery of care on a
regular basis. Necessary medications are administered by clinical staff.
Medical services provided and/or administered off-site may include specialty outpatient
diagnostic testing and care, emergency room care, surgery and hospitalization. This care is
performed by third parties through arrangements with independent doctors and
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local hospitals. In addition, the Company provides administrative support services on-site,
at regional offices and at the Companys headquarters. Administrative support services may include
program management, maintenance of on-site medical records and employee recruitment, scheduling,
continuing education and quality assurance, medical audits, credentialing, and clinical program
development activities.
Most of the Companys correctional contracts require it to staff the facilities it serves with
nurses 24 hours a day. Doctors at the facilities have regular hours and are generally available on
call. In addition, dentists, psychiatrists and other specialists are available on a routine basis
at facilities where correctional contracts cover such services.
The National Commission on Correctional Health Care (NCCHC) and the American Correctional
Association (ACA) set standards for and offer accreditation to facilities that meet their
respective standards. These standards provide specific guidance related to a service providers
operations including administration, personnel, support services such as hospital care, regular
services such as sick call, records management and medical and legal issues. Accreditation with
NCCHC and ACA standards is voluntary and includes many other aspects of the operation of the
correctional facility other than the healthcare component. As such, not all of the Companys
clients seek this accreditation. For those clients that do request the Company to seek such
accreditation, the Company believes it has a 100% success rate of obtaining and maintaining
accreditation with these organizations.
The NCCHC, an independent not-for-profit organization initially formed by the American Medical
Association, was established to improve the quality of health care in jails, prisons, and juvenile
confinement facilities. NCCHC offers a voluntary health services accreditation program through
external peer review to determine whether correctional institutions meet certain standards in their
provision of health services. NCCHC renders a professional judgment and assists in the improvement
of services provided and/or administered. The ACA, an independent not-for-profit organization, was
established to develop uniformity and industry standards for the operation of correctional
facilities and the provision of inmate healthcare. Accreditation involves an extensive audit and
compliance procedure, and is generally granted for a three-year period.
Contract Provisions. The Companys contracts with correctional institutions typically fall
into one of three general categories: fixed fee, population based, or cost plus a fee. For fixed
fee contracts, the Companys revenues are based on fixed monthly amounts established in the service
contract irrespective of inmate population. The Companys revenues for population-based contracts
are based either on a fixed fee that is subsequently adjusted using a per diem rate for variances
in the inmate population from predetermined population levels or on a per diem rate multiplied by
the average or actual inmate population for the period of service. For cost plus a fee contracts,
the Companys revenues are based on actual expenses incurred during the service period plus a
contractual fee.
Some contracts provide for annual increases in the fixed fee or per diem based upon the
regional medical care component of the Consumer Price Index. In all other contracts that extend
beyond one year, the Company utilizes a projection of the future inflation rate of the Companys
costs of services when bidding and negotiating the fixed fee for future years. The Company often
bears the risk of increased or unexpected costs, which could result in reduced profits or cause it
to sustain losses when costs are higher than projected. Conversely, the Company will derive
increased profits when costs are lower than projected. Certain contracts also contain financial
penalties when performance and/or staffing criteria are not achieved.
Generally, the Companys contracts will also include additional provisions that mitigate a
portion of the Companys risk related to cost increases. Off-site utilization risk is mitigated in
the majority of the Companys contracts through aggregate pools or caps for off-site expenses,
stop-loss provisions, cost plus a fee arrangements or, in some cases, the entire exclusion of
certain or all off-site service costs. Pharmacy expense risk is similarly mitigated in certain of
the Companys contracts. Typically, under the terms of such provisions, the Companys revenue
under the contract increases to offset increases in specified cost categories such as off-site
expenses or pharmaceutical costs. While such provisions serve to mitigate the Companys exposure
to losses resulting from cost fluctuations in the specified cost categories, the Company will still
experience variances in its gross margin percentage on these contracts as the additional revenue
under these contract provisions is typically equal to the additional costs incurred by the Company.
Many contracts contain termination provisions which allow either party to terminate the contract
under agreed-upon notice periods. The ability to terminate a contract serves to mitigate the
Companys risk related to increasing costs of services being provided.
At
December 31, 2009, contracts accounting for approximately 7.8% of the Companys correctional healthcare services
revenues from continuing operations for the year ended December 31, 2009 contain no limits on the
Companys exposure for treatment costs related to off-site expenses, catastrophic illnesses or
injuries to inmates. However, none of these contracts has longer than one year remaining without a
termination provision.
Moreover, when preparing bid proposals, the Company estimates the extent of its exposure to
cost increases, severe individual cases and catastrophic events and attempts to compensate for its
exposure in the pricing of its bids. The Companys management has experience in evaluating these
risks for bidding purposes and maintains an extensive database of historical experience.
Nonetheless, increased or unexpected costs against which the Company is not protected could render
a contract unprofitable. Furthermore, in an
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effort to manage risk under contracts that contain no limits on the Companys exposure for
treatment costs related to off-site expenses, catastrophic illnesses or injuries to inmates, the
Company typically maintains stop loss insurance from an unaffiliated insurer with respect to, among
other things, inpatient and outpatient hospital expenses (as defined in the policy) for amounts in
excess of $375,000 per inmate up to an annual cap of $1.0 million per inmate.
Amounts reimbursable per claim under the policy are further limited to the lesser of 60% of billed
charges, the amount paid or the contracted amounts in situations where the Company has negotiated
rates with the applicable providers.
The average length of a contract for services is generally one to three years, with subsequent
renewal options. In general, contracts may be terminated by the governmental agency, and often by
the Company as well, without cause at any time upon proper notice. The required notice period for
such contracts ranges from one day to six months, but is typically between 60 and 120 days.
Governmental agencies may be subject to political or financial influences that could lead to
termination of a contract through no fault of the Company. As with other governmental contracts,
the Companys contracts are subject to adequate budgeting and appropriation of funds by the
governing legislature or administrative body.
Administrative Systems. The Company has centralized administrative systems in order to
enhance economies of scale and to provide management with accurate, up-to-date field data for
forecasting purposes. These systems also enable the Company to refine its bids and help the
Company reduce the costs associated with the delivery of consistent healthcare.
The Company maintains a utilization review system to monitor the extent and duration of most
healthcare services required by inmates on an inpatient and outpatient basis. The current
automated utilization review program is an integral part of the services provided and/or
administered at each facility. The system is designed to ensure that the medical care rendered is
medically necessary and is provided safely in a clinically appropriate setting while maintaining
traditional standards of quality of care. The system provides for determinations of medical
necessity by medical professionals through a process of pre-authorization and concurrent review of
the appropriateness of any hospital stay. The system seeks to identify the maximum capability of
on-site healthcare units to allow for a more timely discharge from the hospital back to the
correctional facility. The utilization review staff consists of doctors and nurses who are
supported by medical directors at the regional and corporate levels.
The Company has developed a variety of customized databases to facilitate and improve
operational review including (i) a claims management tracking system that monitors current
outpatient charges and inpatient stays, (ii) a comprehensive cost review system that analyzes the
Companys average costs per inmate at each facility, which includes pharmaceutical utilization and
trend analysis available from Maxor, and (iii) a daily operating report to manage off-site
utilization.
Bid Process. Contracts with governmental agencies are obtained primarily through a
competitive bidding process, which is governed by applicable state and local statutes and
ordinances. Although practices vary, typically a formal request for proposal (RFP), or similar
request or invitation, is issued by the governmental agency, stating the scope of work to be
performed, length of contract, performance bonding requirements, minimum qualifications of bidders,
selection criteria and the format to be followed in the bid or proposal. Usually, a committee
appointed by the governmental agency reviews bids and makes an award determination. The committee
may award the contract to a particular bidder or decide not to award the contract. Typically, the
committee considers a number of factors, including the technical quality of the proposal, the bid
price and the reputation of the bidder for providing quality care. The award of a contract may be
subject to formal or informal protest by unsuccessful bidders through a governmental appeals
process. If the committee does not award a contract, the correctional agency may, among various
options, continue to provide healthcare services to its inmates with its own personnel or the
existing provider.
Contractual and Regulatory Compliance. The Companys contracts with governmental agencies
often require it to comply with numerous additional requirements regarding record-keeping and
accounting, non-discrimination in the hiring of personnel, safety, safeguarding confidential
information, management qualifications, professional licensing requirements, emergency healthcare
needs of corrections employees and other matters. If a violation of the terms of an applicable
contractual or statutory provision occurs, a contractor may be debarred or suspended from obtaining
future contracts for specified periods of time in the applicable location. The Company has never
been debarred or suspended from seeking procurements in any jurisdiction.
Marketing. The Company gathers, monitors and analyzes relevant information on potential jail
and prison systems which meet predefined new business criteria. These criteria include facility
size, location, revenue and margin potential and exposure to risk. The Company then devotes the
necessary resources in securing new business.
The Company believes it is one of the largest private providers of healthcare services to
county/municipal jails and detention centers in the United States. The Company will continue to
focus its business development efforts on those facilities where stabilization and treatment of the
population is the primary mission. The Company will also continue to pursue certain opportunities
at state prison systems, where in many cases, services are provided to a larger system with a more
permanent population. Due to the more permanent population at the state prison facilities, the
primary healthcare mission shifts to disease management and treatment.
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The Company maintains a staff of sales and marketing representatives assigned to specific
projects, geographic areas or markets. In addition, the Company uses consultants, from time to
time, to help identify marketing opportunities, to determine the needs of specific potential
customers and to engage customers and others on the Companys behalf. The Company uses paid
advertising and promotion to reach prospective clients as well as to reinforce its image with
existing clients.
Management believes that the constitutional requirement to provide healthcare to inmates, an
increasing inmate population and medical Consumer Price Index, combined with public sector budget
constraints, will continue the trend toward privatization of correctional healthcare and present
opportunities for future revenue growth for the Company.
Pharmaceutical Distribution Services
Prior to May 1, 2007, the Company, through SPP, contracted with federal, state and local
governments and certain private entities (including PHS) to distribute pharmaceuticals and certain
medical supplies to inmates of correctional facilities. However, as discussed above in Item 1.
General Business, SPP sold certain of its assets to Maxor effective April 30, 2007 which ended
the Companys participation in pharmaceutical distribution services as a separate segment.
Required financial information related to this business segment is set forth in Note 23 to the
Companys consolidated financial statements.
Employees and Independent Contractors
The services provided and/or administered by the Company require an experienced staff of
healthcare professionals and facilities administrators. In particular, a nursing staff with
experience in correctional healthcare and specialized skills in all necessary areas contributes
significantly to the Companys ability to provide efficient service. In addition to nurses, the
Companys staff of employees and independent contractors includes physicians, dentists,
psychologists and other healthcare professionals.
As of December 31, 2009, the Company had approximately 3,840 employees, including
approximately 373 doctors and 1,899 nurses. The Company also utilizes approximately 1,063
independent contractors, including physicians, dentists, psychiatrists, psychologists and other
healthcare professionals. Of the Companys employees, approximately 655 are represented by labor
unions. The Company believes that its employee relations are good.
Seasonality
The Companys business of correctional healthcare services is not materially impacted by
seasonality.
Competition
The business of providing correctional healthcare services to governmental entities is highly
fragmented and competitive with few barriers to entry. The Company is in direct competition with
local, regional and national correctional healthcare providers including certain state medical
schools and other state or municipal organizations. The Company estimates that it currently has
approximately 7% of the combined privatized and non-privatized market, based on its estimates of
national aggregate annual expenditures on correctional healthcare services. Its primary
competitors are Correctional Medical Services, which the Company estimates currently has
approximately 7% of the combined privatized and non-privatized market, and Wexford Health Sources,
Inc., which the Company estimates currently has approximately 2% of such market. The market share
estimates shown above for the Company reflect its contracts currently in place. The market share
estimates shown above for Correctional Medical Services and Wexford Health Sources, Inc., reflect
the Companys estimate of contracts currently held by these competitors. As the private market for
providing correctional healthcare matures, the Companys competitors may gain additional experience
in bidding and administering correctional healthcare contracts. In addition, new competitors, some
of whom may have extensive experience in related fields or greater financial resources than the
Company, may enter the market.
Government Regulation
Governmental Regulations and Court Orders. The industry in which the Company operates is
subject to extensive federal, state and local regulations and/or orders of judicial authorities,
including healthcare, pharmaceutical and safety regulations and judicial orders, decrees and
judgments. Some of the regulations and orders are unique to the Companys industry, and the
combination of regulations and orders it faces is unique. Generally, prospective providers of
healthcare services to correctional facilities must be able to comply with a variety of applicable
state and local regulations and judicial orders. The Companys contracts typically include
reporting requirements as well as, supervision and on-site monitoring by representatives of the
contracting governmental agencies or courts. In addition, the Companys doctors, nurses and other
healthcare professionals who provide services on its behalf are in most cases required to obtain
and maintain professional licenses and are subject to state regulation regarding professional
standards of conduct. The Companys services are also subject to operational and financial audits
by the governmental agencies with which the Company has contracts and by the courts of competent
jurisdiction. The Company may not always successfully comply with these
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regulations or court orders and failure to comply can result in material penalties, or
non-renewal or termination of contracts with correctional facilities, or prohibition from proposing
for new business in certain jurisdictions.
Health Insurance Portability and Accountability Act of 1996. The
Administrative Simplification Provisions of the Health Insurance Portability and Accountability Act of
1996 (HIPAA) require the use of uniform electronic data transmission standards for healthcare
claims and payment transactions (standard transactions) submitted or received electronically.
These provisions are intended to encourage electronic commerce in the healthcare industry. Beginning
January 28, 2010, the Company began conducting certain standard transactions electronically. As a result,
the Company became a HIPAA covered entity and is subject to applicable HIPAA regulations.
HIPAA includes
extensive privacy and security regulations governing the use and disclosure of protected health information
by health care providers, health care plans and health care clearinghouses (covered entities)
and requires covered entities to implement administrative, physical and technical safeguards to protect the
security of such information. The American Recovery and Investment Act of 2009 (ARRA) expanded
the scope of the HIPAA privacy and security regulations. ARRA increases civil penalties for violations of
HIPAA and broadens the applicability of criminal penalties to employees of covered entities. ARRA also
strengthens enforcement of HIPAA by requiring the U.S. Department of Health and Human Services to conduct
periodic audits and authorizes state attorney generals to bring civil actions seeking injunctions or damages
in response to violations of HIPAA privacy and security regulations that threaten the privacy of state
residents. In addition to HIPAA, most states have enacted laws governing the use and disclosure of patient
health information These state laws supersede HIPAA to the extent they are more restrictive than the privacy
and security standards in HIPAA. The Company has in place a HIPAA compliance plan which is enforced and
monitored for compliance by our privacy and security officers.
Corporate Practice of Medicine/Fee Splitting. Many of the states in which the Company
operates have laws that prohibit unlicensed persons or business entities, including corporations,
from employing physicians or laws that prohibit certain direct or indirect payments or
fee-splitting arrangements between physicians and unlicensed persons or business entities.
Possible sanctions for violations of these laws include loss of a physicians license, civil and
criminal penalties and rescission of business arrangements that may violate these restrictions.
These statutes vary from state to state, are often vague and seldom have been interpreted by the
courts or regulatory agencies. The Company reviews, on an ongoing basis, the applicable laws in
each state in which the Company operates and reviews its arrangements with its healthcare providers
to ensure that these arrangements comply with all applicable laws. The Company can provide no
assurance that governmental officials responsible for enforcing these laws will not assert that the
Company, or transactions in which it is involved, are in violation of such laws, or that such laws
ultimately will be interpreted by the courts in a manner consistent with the Companys
interpretations.
Major Contracts
Substantially all of the Companys operating revenue is derived from contracts with state,
county and local governmental entities. The Companys Rikers Island, New York contract accounted
for approximately 20.1% of the total healthcare revenues from continuing and discontinued
operations combined for the year ended December 31, 2009. The Companys Commonwealth of
Pennsylvania, Department of Corrections contract accounted for approximately 14.7% of the total
healthcare revenues from continuing and discontinued operations combined for the year ended
December 31, 2009. The Companys contract to provide prisoner health care services to prisoners
under the care of the State of Michigan Department of Corrections, which commenced on April 1,
2009, accounted for approximately 14.0% of the total healthcare revenues from continuing and
discontinued operations combined for the year ended December 31, 2009. No other contract accounted
for 10% or more of such revenues during the years ended December 31, 2009, 2008 or 2007. Summaries
of the Companys three largest contracts based on healthcare revenues from continuing and
discontinued operations combined for the fiscal year ended December 31, 2009 follow below.
Rikers Island Contract. Effective January 1, 2005, the Company, through PHS, entered into a
contract with the New York City Department of Health and Mental Hygiene (NYCDOH) to provide
management and administrative services with respect to the provision of comprehensive medical,
mental health, dental and ancillary services to inmates in the custody of the New York City
Department of Correction. The three-year cost plus fixed fee contract commenced on January 1,
2005 and was renewed, effective as of January 1, 2008 (the Renewal Agreement). Pursuant to the
Renewal Agreement, PHS, through arrangements with professional service corporations, who are also
parties to the Renewal Agreement, will administer the provision of comprehensive medical, mental
health, dental and ancillary services to inmates in the custody of the New York City Department of
Correction. The renewed cost plus fixed fee contract has a term of three years ending on
December 31, 2010. Pursuant to the Renewal Agreement, PHS is subject to mandatory staffing and
other performance requirements. Additionally, NYCDOH is required to indemnify PHS and the
professional service corporations and their respective employees for damages for personal injuries
and/or death alleged to have been sustained by an inmate by reason of malpractice, except where PHS
or the professional service corporations or their respective employees have engaged in intentional
misconduct or a criminal act. The Renewal Agreement may be terminated by NYCDOH without cause at
any time upon 75 days written notice. PHS shall have the right to terminate the Renewal Agreement
upon 90 days written notice in the event its obligations are materially changed by modification to
the Renewal Agreement by NYCDOH. NYCDOH may terminate the Renewal Agreement on ten days notice for
any material breach, subject to certain cure provisions.
Commonwealth of Pennsylvania, Department of Corrections. The Company, through PHS, entered
into a contract with the Commonwealth of Pennsylvania, Department of Corrections (Pennsylvania
DOC) on September 1, 2003, for a period of five years for medical services exclusive of mental
health and pharmacy. On January 31, 2008, PHS and the Pennsylvania DOC entered into Contract
Modification Agreement No. 3 to the current contract, which extended the current contract with
Pennsylvania DOC for a period of five additional years through August 31, 2013. The contract
covers each of the 27 Pennsylvania state prison system facilities. The Pennsylvania DOC pays the
Company a flat rate per month, which is adjusted for changes in inmate population levels. Under
the terms of the contract, the Company is reimbursed for the costs of the medical malpractice
insurance related to this contract and its exposure to off-site medical costs related to this
contract is limited to a specified maximum amount. Pharmacy and mental health services are
provided by separate contractors to the Pennsylvania DOC. The Pennsylvania DOC may terminate the
contract on
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six months notice. The Company may terminate the contract without cause subject to delivery
of nine months notice to the Pennsylvania DOC.
Michigan Department of Corrections. On February 10, 2009, the Company, through PHS, and the
State of Michigan entered into a three-year contract under which PHS will provide prisoner health
care services to prisoners under the care of the State of Michigan Department of Corrections (the
Michigan Contract). PHS began providing prisoner health care services under the Michigan
Contract on April 1, 2009. Compensation payable to PHS under the Michigan Contract is based on a
fixed per prisoner per month rate that will be adjusted for changes in monthly average prisoner
population and annually for inflation. Compensation is also subject to adjustment in accordance
with the risk-sharing terms described in the Michigan Contract. After its initial three-year term,
the Michigan Contract may be renewed for up to four additional one-year periods by mutual, written
agreement of the parties not less than 30 days before the expiration of the then current term.
Under the terms of the Michigan Contract, the State of Michigan may terminate the Michigan Contract
for cause if PHS (i) breaches any of its material duties or obligations under the Michigan
Contract, or (ii) fails to cure a breach within the time period specified in the written notice of
breach provided by the State of Michigan. In addition, the State of Michigan may terminate the
Michigan Contract if it determines that a termination is in its best interest. PHS has also agreed
to indemnify, defend and hold harmless the State of Michigan from liability for injuries or damages
that are attributable to the negligence or tortious acts of PHS, its employees, agents or
subcontractors in its performance of the Michigan Contract.
Other Available Information
The Company files its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current
Reports on Form 8-K, and all amendments to those reports with the SEC. Copies of these documents
may be obtained by visiting the SECs Public Reference Room at 100 F Street, NE, Washington, DC
20549, by calling the SEC at 1-800-SEC-0330 or by accessing the SECs website at
http://www.sec.gov. In addition, as soon as reasonably practicable, after such materials are filed
with or furnished to the SEC, the Company makes copies of these documents available to the public
free of charge through its web site at http://www.asgr.com or by contacting its Corporate Secretary
at its principal offices, which are located at 105 Westpark Drive, Suite 200, Brentwood, Tennessee
37027, telephone number (615) 373-3100.
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PART I
Item 1A. Risk Factors
If any of the events discussed in the following risks were to occur, the Companys business,
financial condition, results of operations, cash flows or prospects could be materially and
adversely affected. Additional risks and uncertainties not presently known, or currently deemed
immaterial by the Company, may also constrain its business and operations. In either case, the
trading price of the Companys common stock could decline and stockholders could lose all or part
of their investment.
The Company has paid refunds to customers and may be required to pay, or incur expenses
investigating claims of, additional refunds. As a result of the internal investigation described
in Item 1. Business Audit Committee Investigation, the Audit Committee determined that, in
certain instances, SPP did not charge its customers in accordance with applicable contracts. As a
result, the Company recorded accruals to provide aggregate refunds to customers of approximately
$3.7 million, covering all periods since the Companys acquisition of SPP in September 2000, plus
interest at the applicable federal rate (which ranged from 4% to 9%) during the period covered by
the investigation. These amounts represented managements best estimate of the amounts due to
affected customers based on the Audit Committees investigation. However, the Company can provide
no assurance that a customer or a third-party, including a governmental entity, will not assert
that additional amounts, which may include penalties, are owed to these customers and, that as a
result of such assertions, the Company will not incur additional investigation and related expenses
or be required to make additional refunds.
The
Company is the subject of a certain government inquiry and we could become the subject of
additional government investigations, enforcement actions or penalties in the future, any of which
could adversely affect the Company. The Company could be the subject of future government
investigations, enforcement actions or penalties. As previously and currently disclosed, the
Company was the subject of an informal inquiry by the SEC as it related to the Audit Committee investigation. However, in November 2009, the SEC
confirmed that its informal inquiry has been formally closed without any enforcement action. The
SEC further confirmed it never issued a formal order of investigation or a Wells Notice relating to
this matter.
The Company was also the subject of an informal inquiry by the U.S. Attorney for the
Middle District of Tennessee (the U.S. Attorney) with respect to those matters that were the subject of the Audit
Committees internal investigation. The Company was recently
informed that the U.S. Attorney has no active investigation against
the Company.
In addition, the Company has received notice from the Delaware
Department of Justice, Office of Attorney General that it is conducting an inquiry into the indirect payment of claims by the
Delaware Department of Correction to SPP for pharmaceutical services (see Note 21 to the Companys
consolidated financial statements and Item 3. Legal Proceedings). Both the Audit Committee and
the Company have cooperated and intend to continue to cooperate fully
with the Delaware Attorney General regarding its inquiry. However, there can be no assurance that
the Delaware Attorney General or any other governmental authority (including, without limitation,
the governmental entities with which the Company entered into contractual relationships) will not
take any action that would adversely affect the Company as a result of the matters investigated by
the Audit Committee. Such actions could result in criminal, civil or other penalties, including
the imposition of fines, the termination of existing contracts, the debarment from pursuing future
business in certain jurisdictions or additional restatements of the Companys financial statements.
Management of the Company is unable to predict the effect that any such actions may have on its
business, financial condition, results of operations, cash flows or stock price.
The Company is a defendant in a shareholder class action lawsuit and may be required to pay
damages in excess of the coverage of its directors and officers liability insurance. The Company
and certain of its executive officers have been named defendants in a shareholder class action
lawsuit (see Note 21 to the Companys consolidated financial statements and Item 3. Legal
Proceedings). Additionally, the Company and its current or former directors or officers could be
named defendants in future shareholder class actions.
On July 22, 2009, the Court administratively closed the shareholder litigation case, while the
parties pursued mediation of this matter. On February 19, 2010, the parties agreed to the terms of
a mediators proposal to settle all of the claims in this lawsuit. The settlement, which is
subject to final documentation as well as approval by the Court, provides for payment by the
Company of $10.5 million and issuance by the Company of 300,000 shares of common stock and would
lead to a dismissal with prejudice of all claims against all defendants in the litigation. The
preliminary total value of the settlement, based upon the Companys closing share price for its
common stock of $15.42 per share on February 19, 2010, is approximately $15.1 million. As such,
the Company has recorded a reserve of $15.1 million, which has been included in accrued expenses in
the Companys consolidated balance sheet as of December 31, 2009.
The final value of the settlement will be determined based upon the Companys closing share price at the time of final approval of the settlement by the Court. The settlement
provides for price protection to the plaintiffs in the event the closing share price is below $14.65 per share at the time of final approval of the settlement by the Court.
In such event, the Company would pay in cash the difference between the share value at the time of final approval and $14.65 per share.
The parties are formalizing the
terms of the settlement through a written agreement which will be executed by the parties and
presented to the Court for final approval. Upon final approval of the Court and payment of the
settlement amount, the Company will consider this matter closed.
In September 2009, the Company and its primary D&O
carrier reached an agreement under which the Company and the primary D&O carrier mutually released
each other from future claims related to this matter and the primary D&O carrier remitted insurance
proceeds to the Company totaling $8.0 million, less approximately $0.4 million in legal fees
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paid by the primary D&O carrier as of the settlement date. The Company has paid and/or
accrued additional legal fees incurred through December 31, 2009, of $0.8 million related to this
matter.
In addition to its primary D&O carrier, the Company also maintains D&O insurance with an
excess D&O carrier that provides for additional insurance coverage of up to $5.0 million for losses
in excess of $10.0 million. As of the date of this Annual Report on Form 10K, the excess D&O
carrier has denied coverage of this matter.
There is a risk that the excess D&O carrier will continue to deny coverage of this matter, or
that, even if covered, the Companys ultimate liability will exceed its recorded reserve and the
available limits of insurance. Accordingly, the ultimate resolution of these matters could have a
material adverse impact on the Companys business, financial condition, liquidity, results of
operations and/or stock price.
The Companys revenue depends on client contracts that are generally terminable without cause
and termination of contracts accounting for a significant portion of its revenue could adversely
affect its financial condition, results of operations and cash flows. The Companys operating
revenue is derived almost exclusively from contracts with state, county and local governmental
agencies. Generally, contracts may be terminated by the governmental agency without cause upon
proper notice (typically between 60 and 120 days). Governmental agencies may be subject to
political or financial influences, including governmental budgetary concerns, that could lead to
termination of a contract or failure to renew or extend a contract through no fault of the Company.
Although the Company generally attempts to renew or renegotiate contracts at or prior to their
termination, contracts that are put out for bid are subject to intense competition. As a result,
the Companys portfolio of contracts is subject to change. The changes in the Companys portfolio
of contracts are largely unpredictable, which creates uncertainties about the amount of its total
revenues from period to period. The Company must engage in competitive bidding for new business to
replace contracts that expire or are terminated. The Company, therefore, can provide no assurance
that it will be able to replace contracts that expire or are terminated or are not renewed on
favorable terms or otherwise. The non-renewal or termination, or renewal on unfavorable terms, of
any of the Companys contracts with governmental agencies could have a material adverse affect on
its financial condition, results of operations and cash flows.
Additionally, the Company relies on a small number of client contracts for a significant
portion of its revenues. The combined revenues of the Companys Rikers Island, New York,
Commonwealth of Pennsylvania, Department of Corrections and State of Michigan contracts accounted
for approximately 48.7% of the total healthcare revenues from continuing and discontinued
operations combined for the year ended December 31, 2009. The loss of any of these contracts could
have a material adverse effect on the Companys financial condition, results of operations and cash
flows. For more information on the Companys significant contracts, see Item 1. Business Major
Contracts.
The Companys cash flow depends on timely payment and any delay or failure of its clients to
make payments could adversely affect its results of operations or cash flows. The Companys cash
flow is subject to the receipt of sufficient funding of, and timely payment by, the governmental
entities with which it contracts. Economic circumstances at the national, state or local level
could affect governmental entity budgets, which could result in insufficient funding, increased
pricing pressure or termination of contracts. In addition, federal, state and local governments
are constantly under pressure to control additional spending or reduce current levels of spending.
Accordingly, if a governmental entity does not receive sufficient or timely funding to cover its
obligations under a healthcare services contract, the contract may be terminated and payment for
the Companys services could be delayed or not occur. The termination of contracts, a significant
delay in payment or non-payment could adversely affect the Companys financial condition, results
of operations or cash flows.
The Companys future growth depends, in part, on further privatization of correctional
healthcare services and it can provide no assurances that such further privatization will occur.
The Companys future revenue growth depends, in part, on continued privatization by state, county
and local governmental agencies of healthcare services for correctional facilities. The Company
believes, based on marketplace information and internal estimates
that no significant annualized correctional
healthcare contract revenues were newly privatized in 2009 by governmental agencies either for the
first time or as a result of the expansion of existing contracted services to encompass additional
or expanded services. There can be no assurance that this market will continue to grow, or that existing contracts will continue to be made available to the
private sector. Revenue growth could also be adversely affected by material decreases in the
inmate population of correctional facilities. Any of these results could cause the Companys
revenue to decline and harm its business and operating results.
Negative publicity concerning the Company or its business could adversely affect the Companys
business, results of operations and ability to obtain future business. Negative publicity
regarding the provision of correctional healthcare services by for-profit companies, including the
Company, or specific alleged actions or inactions of the Company could adversely affect the
Companys results of operations or business. Privatization of healthcare services for correctional
facilities may encounter resistance from groups or constituencies that believe that healthcare
services to correctional facilities should only be provided by governmental agencies.
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Negative publicity regarding the privatization of correctional healthcare services or specific
alleged actions or inactions of the Company or other industry participants may result in increased
regulation and legislative review of industry practices that further increase the Companys costs
of doing business and adversely affect its results of operations by:
| requiring the Company to change its services; | ||
| placing pressure on certain of the Companys clients either to force such clients to change the way they do business with the Company or sever their relationship with the Company altogether; | ||
| increasing the Companys exposure to litigation; | ||
| increasing the regulatory burdens under which it operates; or | ||
| adversely affecting its ability to market its services. |
Moreover, negative publicity relating to the Company in particular also may adversely affect
its ability to renew or maintain existing contracts or to obtain new contracts, which could have a
material adverse effect on its business.
The Company is subject to extensive government regulations and its failure to comply with such
regulations could adversely affect its business or results of operations. Failure to comply with
governmental regulations and/or orders of judicial authorities could result in material penalties
or non-renewal or termination of the Companys contracts to manage correctional and detention
facilities. The industry in which the Company operates is subject to extensive federal, state and
local regulations, including educational, healthcare, pharmacy and safety regulations and judicial
orders, decrees and judgments. Some of the regulations are unique to the Companys industry, and
the combination of regulations it faces is unique. Generally, providers of healthcare services to
correctional facilities must be able to comply with a variety of applicable state and local
regulations and court orders. The Companys contracts typically include reporting requirements,
supervision and on-site monitoring by representatives of the contracting governmental agencies or
courts. The Company may not always successfully comply with these regulations or court orders, and
failure to comply can result in material penalties, sanctions or non-renewal or termination of
contracts, which could have a materially adverse affect on the Companys business and results of
operation. For a discussion of certain specific governmental regulations, see Item 1. Business
Government Regulations.
The Company is subject to audits and investigations of governmental agencies, which could
result in reduced reimbursements from its clients, refunds to its clients or civil or criminal
penalties. Certain of the governmental agencies with which the Company contracts have the
authority to audit and investigate its contracts with them. As part of that process, governmental
agencies may review the Companys performance of the contract, its pricing practices, its cost
structure and its compliance with applicable laws, regulations and standards. For contracts that
actually or effectively provide for certain reimbursement of expenses, if an agency determines that
the Company has improperly allocated costs to a specific contract, it may not be reimbursed for
those costs, and it could be required to refund the amount of any such costs that have been
reimbursed. If a government audit asserts improper or illegal activities by the Company, it may be
subject to civil and criminal penalties and administrative sanctions, including termination of
contracts, forfeitures of profits, suspension of payments, fines and suspension or disqualification
from doing business with certain governmental entities. Any adverse determination could adversely
impact the Companys ability to bid in response to RFPs in one or more jurisdictions and could have
a materially adverse affect on the Companys business and results of operation. Additionally, as a
result of any governmental agency investigations and/or audits, the Companys collections of
balances due from its customers could be substantially delayed. See risk factors below for more
information on the Companys risk of accounts receivable collection.
The Companys business is highly competitive and increased competition could harm its business
and operating results. The business of providing correctional healthcare services to governmental
agencies is highly competitive with few barriers to entry. The Company is in direct competition
with local, regional and national correctional healthcare providers, including certain state
medical schools and other state or municipal organizations. The Company estimates that it
currently has approximately 7% of the combined privatized and non-privatized market, based on its
estimates of national aggregate annual expenditures on correctional healthcare services. Its
primary competitors are Correctional Medical Services, which the Company estimates currently has
approximately 7% of the combined privatized and non-privatized market, and Wexford Health Sources,
Inc., which the Company estimates currently has approximately 2% of such market. The market share
estimates shown above for the Company reflect its contracts currently in place. The market share
estimates shown above for Correctional Medical Services and Wexford Health Sources, Inc., reflect
the Companys estimate of contracts currently held by these competitors. As the private market for
providing correctional healthcare matures, the Companys competitors may gain additional experience
in bidding and administering correctional healthcare contracts. In addition, new competitors, some
of whom may have extensive experience in related fields or greater financial resources than the
Company, may enter the market. Increased competition could result in a loss of contracts and
market share, or less favorable contract terms, and could seriously harm the Companys business and
operating results.
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The Companys growth strategy in part depends on its ability to identify, fund and integrate
any future acquisitions and no assurances can be made that it will do so successfully. The
Companys expansion strategy involves both internal growth and, as opportunities become available,
acquisitions. The inability to identify, fund and successfully integrate future acquisitions may
seriously reduce the Companys potential growth.
Certain of the Companys contracts expose it to costs related to catastrophic events, and
therefore any such event could adversely affect the Companys financial condition or results of
operations. At December 31, 2009, contracts accounting for approximately 7.8% of the Companys correctional healthcare
services revenues from continuing operations for the year ended December 31, 2009 contain no limits
on the Companys exposure for treatment costs related to catastrophic illnesses or injuries to
inmates. Although the Company attempts to compensate for the increased financial risk when pricing
contracts that do not contain catastrophic limits, there can be no assurance
that the Company will not experience a catastrophic illness or injury of a patient that exceeds its
coverage in the future. The occurrence of severe individual cases outside of the catastrophic
limits contained in the Companys insurance coverage could render contracts unprofitable and could
have a material adverse effect on the Companys financial condition and results of operations.
The Company depends on key personnel, the loss of whom could adversely affect its business and
operating results. The success of the Company depends in large part on the ability and experience
of its senior management. The loss of services of one or more key employees could adversely affect
the Companys business and operating results. The Company has employment contracts with Richard
Hallworth, President and Chief Executive Officer; Michael W. Taylor, Executive Vice President and
Chief Financial Officer and Jonathan B. Walker, Senior Vice President and Chief Development
Officer, as well as certain other key personnel. The Company does not maintain key man life
insurance on any member of its senior management.
The Company faces significant competition for qualified healthcare professionals and its
failure to attract such professionals could adversely affect its operating results. The Company
faces stiff competition for staffing, which may increase its labor, professional liability and
other costs (including contractually mandated penalties) and reduce profitability. The Company
competes with other healthcare and service providers in recruiting qualified management and staff
personnel for the day-to-day operations of its business, including nurses and other healthcare
professionals. In some markets, the scarcity of physicians, nurses and other medical support
personnel is a significant operating issue to healthcare businesses. This scarcity may require the
Company to enhance wages and benefits to recruit and retain qualified nurses and other healthcare
professionals. Because a significant percentage of the Companys existing contracts are structured
as fixed fee and/or population based contracts, the Companys ability to pass along increased labor
costs is limited. If the Company is not successful in attracting and retaining a sufficient number
of qualified healthcare personnel in the future, it may not be able to perform under its contracts,
which could lead to the loss of existing contracts or its ability to obtain new contracts.
Moreover, lack of success in this area could further result in the provision of negligent
healthcare services or in the provision of untimely healthcare services, or in the allegation of
such negligent or untimely services (whether valid or invalid), any or all of which could increase
the Companys exposure to professional, medical, pharmaceutical or other liability expenses.
Additionally, approximately 48% of the Companys contracts contain financial penalties that apply
when performance or staffing criteria are not achieved. For the year ended December 31, 2009, the
Company incurred revenue deductions related to these criteria totaling approximately $0.2 million,
or less than 1% of the Companys total healthcare revenues from continuing operations and
discontinued operations combined. Failure to attract qualified management and staff personnel for
the day-to-day operations of the Companys business could materially adversely affect the Companys
business and operating results.
As a result of its business, the Company is exposed to professional liability claims and can
provide no assurances that adequate levels of liability insurance will continue to be available or
that it will not be exposed to claims in excess of its insurance coverage. The Companys business
ordinarily results in the Company becoming involved in actions for medical malpractice and other
claims related to the provision of healthcare services with the attendant risk of substantial
damage awards, or court endorsed non-monetary relief such as changes in operating practices or
procedures, which may lead to the potential for substantial increases in the Companys operating
expenses. The most significant source of potential liability in this regard is the risk of suits
brought by inmates (or their successors) alleging negligent healthcare services or the lack of
timely adequate healthcare services. The Company may also be liable, as employer, for the
negligence of healthcare professionals it employs or healthcare professionals or entities with whom
it contracts. All but one of the Companys contracts generally provides for the Company to
indemnify the governmental agency for losses incurred related to healthcare provided by the Company
and its agents. The Company maintains professional and general liability insurance; however, due
to the use of adjustable premium policies in 2002 through 2006 and 2008 through 2009, with respect
to a majority of its patients, the Company is effectively self-insured for professional liability
claims incurred under its primary program. For 2007, the Company is insured through a claims made
policy subject to per event and aggregate coverage limits. Any amounts ultimately incurred above
the coverage limits contained in the Companys professional and general liability insurance
policies would be the responsibility of the Company. In addition to its primary program, the
Company also has traditional risk transfer insurance policies that relate to certain specific
healthcare services contracts. Many of the Companys independent contractors maintain professional
liability insurance in amounts deemed appropriate by management based upon the Companys claims
history and the nature and risks of its business. The Company indemnifies and pays for such
coverage for some of its independent contractors. Management establishes reserves for the
estimated losses that will be incurred under these insurance policies
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after taking into consideration the Companys professional liability claims department and
external counsel evaluations of the merits of the individual claims, analysis of claim history,
actuarial analysis and coverage limits where applicable. However, there can be no assurance that a
future claim or claims will not exceed managements loss estimates or the limits of available
insurance coverage, the result of which could have a material adverse impact on the Companys
financial condition, results of operations or cash flows.
If the Company is unable to obtain adequate levels of insurance at reasonable costs its
business and results of operations may be adversely affected. Adequate levels of malpractice and
other liability insurance may not continue to be available to the Company at a reasonable price or
at all. The Company is dependent on the financial health of the insurance carriers with whom it
has insurance policies. Substantially all of the Companys contracts require the Company to be
insured at certain levels. Failure to obtain sufficient levels of professional liability insurance
at a reasonable price or at all or deterioration in an insurance carriers financial health, may
expose the Company to significant financial or contractual losses, which could have a material
adverse impact on the Companys financial condition, results of operations or cash flows.
The Companys business depends on the operation of its information technology systems and the
failure or disruption of these systems could adversely affect its results of operations. The
Company depends on its information technology systems for timely and accurate information. Failure
to maintain effective and efficient information technology systems or disruptions in the Companys
information technology systems could cause disruptions in its business operations, loss of existing
customers, difficulty in attracting new customers, disputes with customers and providers, potential
regulatory problems, increases in administrative expenses and other adverse consequences.
The Companys failure to maintain effective internal control over financial reporting could
adversely affect its business and operating results. Under rules of the SEC, promulgated under
Section 404 of the Sarbanes-Oxley Act of 2002, the Company is required to furnish in its Annual
Report on Form 10-K for each fiscal year a report by management on its internal control over
financial reporting. The Companys report must contain, among other matters, an assessment of the
effectiveness of its internal control over financial reporting as of December 31 of the applicable
fiscal year, including a statement as to whether or not its internal control over financial
reporting is effective. In the course of the Companys assessment of the effectiveness of its
internal control over financial reporting as of December 31, 2009, the Company has not identified
any material weaknesses in its internal control over financial reporting. However, the Company
cannot assure you that deficiencies or weaknesses in its controls and procedures will not be
identified in the future. Any weaknesses or deficiencies that might be identified in the future,
could harm the Companys business and operating results, and could result in adverse publicity and
a loss in investor confidence in the accuracy and completeness of its financial reports.
The Company may be dependent on its credit facility for its capital requirements and it can
make no assurances that it will be able to obtain alternative financing. The Companys debt
consists of a credit facility dated July 28, 2009, which was
subsequently amended on March 2, 2010, with CapitalSource Bank. The Company may be
dependent on the availability of borrowings pursuant to this credit facility to meet its working
capital needs, capital expenditure requirements and other cash flow requirements.
Recent market and economic conditions have been unprecedented and challenging, with
significantly tighter credit markets. As a
result of these conditions, the cost and availability of credit has been and may continue to be
adversely affected in the United States. Concern about the stability of the markets, generally,
and the strength of numerous financial institutions, specifically, has led many lenders to reduce,
and in some cases, cease, to provide funding to borrowers. If these market and economic conditions
continue, they may limit the Companys ability to borrow money from CapitalSource Bank or other
lenders. If the Company is unable to borrow sufficient amounts of money to fund its capital
requirements, its financial condition, business and cash flows may be materially adversely
affected.
In addition, the Companys access to funds under its credit facility depends on the ability of
CapitalSource Bank to meet its funding commitment to the Company. The Company can provide no
assurance that continuing long-term disruptions in the global economy and the continuation of
tighter credit conditions among, and potential failures of, third party financial institutions as a
result of such disruptions, will not have an adverse effect on CapitalSource Bank and its lenders.
If the Companys lenders are not able to meet their funding commitments, the Companys business,
results of operation, cash flows and financial condition could be adversely affected.
The credit facility requires the Company to meet certain financial covenants related to
minimum levels of earnings. The financial covenants contained in the credit facility are described
in Managements Discussion and Analysis of Financial Condition and Results of Operations
Liquidity and Capital Resources contained in this Annual Report on Form 10-K. At December 31,
2009, the Company was not in compliance with one of the financial
covenant requirements due to the accrual of expense associated with
settlement of the shareholder litigation.
For further information regarding the shareholder litigation, see Item 3. Legal Proceedings.
The Company has obtained a
waiver of the debt covenant violation and an amendment to the
calculation of the covenant to exclude a portion of the expense
associated with the shareholder litigation. Should the Company fail to meet its projected results, fail to remain
in compliance with the terms of the credit facility or fail to obtain a waiver, amendment or other
curative document, in the event of default, it may be forced to seek alternative sources of
financing. No assurances can be made that the Company can obtain alternative financing
arrangements on terms acceptable to it, or at all.
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A prolonged economic slowdown or recession could adversely affect the Companys business and
operating results. The Company may be exposed to risks related to the overall macro-economic
environment, including deflationary pressures on pricing and governmental budgetary shortfalls that
could result in inadequate payments under its healthcare services contracts. Unfavorable economic
conditions also could increase the Companys funding and working capital costs, limit its access to
the capital markets or result in a decision by lenders not to extend credit to the Company, any of
which would adversely affect the Companys business, financial condition, operating results or cash
flows.
An increase in inflation could adversely affect the Companys operating results. Some of the
Companys contracts provide for annual increases in the fixed base fee based upon changes in the
regional medical care component of the Consumer Price Index. In all other contracts that extend
beyond one year, the Company utilizes a projection of the future inflation rate of its cost of
services when bidding and negotiating the fixed fee for future years. If inflation exceeds
projected levels, depending on the contract structure, the Companys profitability could be
adversely affected.
The Company is required to maintain performance bonds and if it is unable to obtain or renew
such bonds its financial condition and results of operations could be adversely affected. The
Company is required under certain contracts to provide a performance
bond and may also be required to post performance bonds for other
business reasons. At December 31, 2009,
the Company had outstanding performance bonds totaling $16.0 million. The performance bonds are
renewed on an annual basis. The Company has letters of credit in the amount of $1.6 million at
December 31, 2009 that collateralize these performance bonds, reduce availability under the
Companys credit facility and limit funds available for working capital. The
Company is also dependant on the financial health of the surety companies that it relies on to
issue its performance bonds. An inability to obtain new or renew existing performance bonds could
result in limitations on the Companys ability to bid for new or renew existing contracts which
could have a negative effect on the Companys ability to retain existing contracts or be awarded
new contracts.
A change in the Companys estimate of collectibility, or a delay in collection, of its
accounts receivable, could adversely affect its results of operations. The Companys accounts
receivable are stated at estimated net realizable value. The Company recognizes allowances for
doubtful accounts based on a variety of factors, including the length of time receivables are past
due, significant one-time events, contractual rights, client funding and/or political pressures,
discussions with clients and historical experience. If circumstances change, estimates of the
recoverability of receivables would be further adjusted and such adjustments could have a material
adverse effect on the Companys results of operations in the period in which they are recorded.
Additionally, the timing of the collection of accounts receivable, if delayed, could have a
material adverse effect on the Companys cash flows from operations, days sales outstanding in
accounts receivable, cash balances and debt levels outstanding.
The Companys stock repurchase program could affect its stock price and add volatility. There
can be no assurance that the repurchases will be made or will be made at the best possible price.
The existence of a stock repurchase program could also cause the Companys stock price to be higher
than it would be in the absence of such a program and could potentially reduce the market liquidity
for its stock. Additionally, the Company is permitted to and could discontinue its stock repurchase
program at any time and any such discontinuation could cause the market price of its stock to
decline.
The failure of a third party insurance carrier with whom the Company contracts could result in
the Company losing insurance coverage or access to loss funding which has been prepaid to the
insurance carrier. The Company contracts with third party insurance carriers to provide insurance
related to workers compensation and professional liability claims for years 2002 to 2006 and 2008
through 2009. The Companys insurance coverage under these policies is essentially self-insurance
in the form of retro-premium adjustments based on actual claims experience. Under the terms of its
insurance coverage for these policy periods, the Company was required to prepay insurance premiums
to its third party insurance carrier, which are held by the third party insurance carrier to pay
valid claims made under the policies in the same or subsequent years. For the 2007 professional
liability claims policy, the Company has maintained an insurance policy that provides for per event
and aggregate coverage limits on a claims made basis based on a fixed paid premium. If the
financial position and/or liquidity of one of these third party insurance carriers were to become
impaired such that the third party insurer was unable to pay claims or meet its contractual
obligations to the Company, the Company could lose all or a portion of its prepaid premiums to such
carrier and/or lose the benefit of the coverage it has paid for, the occurrence of which could have
a material adverse effect on the Companys financial position and its results of operations.
The Company regularly maintains cash balances at a commercial bank in excess of the Federal
Deposit Insurance Corporation insurance limit and the failure of such commercial bank could result
in the loss of a portion of such cash deposits. The Company regularly maintains cash balances at a
commercial bank in excess of the Federal Deposit Insurance Corporation insurance limit. If the
commercial bank were to fail or be seized by federal regulators, the Company could lose a portion
of its cash deposits at such bank, the result of which could have a material adverse effect on the
Companys financial position and results of operations.
The Company has not established a minimum dividend payment level for its common stockholders
and there are no assurances of the Companys ability to pay dividends to common stockholders in the
future. In July 2009, the Companys Board of Directors adopted a quarterly dividend program for
the purpose of returning capital to the Companys stockholders. However, the Company has
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not established a minimum dividend payment level for its common stockholders and its ability
to pay dividends may be harmed by the risks and uncertainties described in this Annual Report on
Form 10-K and in the other documents it files from time to time with the SEC. Future dividends, if
any, will be authorized by the Companys Board of Directors and declared by the Company based upon
a variety of factors deemed relevant by the Companys directors, including, among other things, the
Companys financial condition, liquidity, earnings projections and business prospects. In
addition, financial covenants in the Companys credit facility may restrict the Companys ability
to pay future quarterly dividends. The Company can provide no assurance of its ability to pay
dividends in the future.
A decline in the fair value of the Companys business could cause the Company to impair its
goodwill resulting in a material non-cash charge to earnings. At December 31, 2009, the Company
had approximately $41.0 million of goodwill recorded on its books. The Company expects to recover
the carrying value of this goodwill through its future cash flows. On an ongoing basis, the
Company evaluates, based on the fair value of its business, whether the carrying value of its
goodwill is impaired. If the carrying value of the Companys goodwill is impaired, it may incur a
material non-cash charge to earnings. The current turmoil in the financial markets and weakness in
macroeconomic conditions globally continue to be challenging and the Company cannot be certain of
the duration of these conditions and their potential impact on its stock price performance. If a
material decline in the Companys market capitalization and other factors resulted in the decline
in its fair value, it is reasonably likely that a goodwill impairment assessment prior to the next
annual review, at December 31, 2010, would be necessary. If such an assessment is required, an
impairment of goodwill may be recognized. A non-cash goodwill impairment charge would have the
effect of decreasing the Companys earnings or increasing its losses in the period the impairment
is recognized. The amount of such effect on earnings and losses is dependent on the size of the
impairment charge.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
The Company occupies approximately 51,490 square feet of leased office space in Brentwood,
Tennessee, where it maintains its corporate headquarters. The Companys lease on its current
headquarters expires in April 2014. The Company leases additional office facilities in Alameda,
California; Lansing, Michigan; Verona, New Jersey; Astoria, New York; Camp Hill, Pennsylvania and
Richmond, Virginia. While the Company may open additional offices to meet the local needs of
future contracts awarded in new areas, management believes that its current facilities are adequate
for its existing contracts for the foreseeable future.
Item 3. Legal Proceedings
Litigation and Claims
Lysager Professional Liability Suit. On November 22, 2008, PHS received an adverse jury
verdict in the Sixth Judicial District in and for the County of Bannock, Idaho relating to a
complaint filed on December 30, 2004 by Jamie Justice Amos Lysager and Taylor Lysager regarding
medical care provided to the plaintiff while plaintiff was incarcerated at the Pocatello Womens
Correctional Center in Bannock County, Idaho in February 2004. The complaint alleged negligence,
deliberate indifference and intentional infliction of emotional distress by PHS in providing
medical care to plaintiff, then almost 33 weeks pregnant, associated with the premature delivery of
plaintiffs son and sought general and special damages and reimbursement for costs and attorneys
fees incurred by plaintiff in connection with the litigation. The complaint also sought punitive
damages alleging that the actions of PHS named defendant employees met the minimum statutory
standard for jury consideration of the imposition of punitive damages against PHS, their employer.
A jury trial commenced October 28, 2008 and ended, November 21, 2008. The verdict was received on
November 22, 2008 and consisted of compensatory damages of $0.1 million and punitive damages of
$0.2 million awarded to plaintiff, and compensatory damages of $1.3 million and punitive damages of
$2.0 million awarded to plaintiffs son, resulting in an aggregate award of $3.6 million.
Post-trial motions were heard on January 29, 2009, whereby PHS challenged the appropriateness and
amounts of the verdict awarded to the plaintiffs and vigorously opposed plaintiffs request for
attorney fees on grounds of lack of entitlement and method of calculation. However, on March 10,
2009, by Memorandum Decision and Order, the plaintiff was granted an award for court costs and
attorney fees totaling $0.2 million and the plaintiffs son was granted an award for court costs
and attorney fees totaling $1.6 million, resulting in an aggregate award of $1.8 million for court
costs and attorney fees. PHS filed an appeal to the Idaho Supreme Court seeking a reversal of the
adverse verdict and judgment described above, as it believed there were several reversible errors
made by the trial court. In relation to this appeal, the Company posted an appeal bond totaling
$7.4 million. On January 29, 2010, through a formal mediation session, the parties agreed to
settle all of the claims arising out of and related to this lawsuit for $3.5 million. As a result
of this settlement, in the fourth quarter of 2009, the Company reduced its recorded reserves for
this matter from $5.4 million, which represented the initial jury verdict award plus the award for
court costs and attorney fees discussed above, to the $3.5 million settlement amount. The parties
are in the process of formalizing the terms of their settlement through a written settlement
agreement and mutual release (the Settlement Agreement). Upon execution of the Settlement
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Agreement, payment of the settlement amount and dismissal of this lawsuit with prejudice by
the court, the Company will consider this matter closed.
Andrew Berkowitz, M.D., Individually and on behalf of all others similarly situated v. Prison
Health Services, Inc. and City of Philadelphia. On or about August 2, 2006, plaintiff, an
individual physician independent contractor in Philadelphia, Pennsylvania, filed a putative class
action suit against PHS and the City of Philadelphia (the City) in the Court of Common Pleas of
Philadelphia County, Trial Division, seeking unspecified damages for the class, but damages in the
amount of approximately $10,000 individually. Plaintiff alleges that he provided services to
inmates in the Philadelphia Prison System at the request of the defendants and that the defendants
breached the alleged contractual duties owed to him by paying an amount alleged to be less than the
full amount plaintiff billed for his medical services. On September 22, 2006, the City filed a New
Matter Crossclaim against PHS alleging breach of contract, negligence and seeking indemnification.
On September 29, 2006, PHS filed its Answer to plaintiffs complaint, which Answer included a
crossclaim against the City for contribution and indemnification. The plaintiff filed his motion
for class certification on October 1, 2007; and PHS and the City responded to this motion. On
January 16, 2009, the court denied the plaintiffs motion for class certification. The plaintiff
has appealed the trial courts ruling. While PHS believes that the trial courts ruling denying
class certification is sound and will be upheld on appeal, in the event the appellate court
overturns the trial courts ruling and PHS is not successful at trial, an adverse judgment could
have a material adverse affect on the Companys financial position and its results of operations.
As of December 31, 2009, the Company has no reserves associated with this proceeding.
Saint Josephs Regional Medical Center v. Correctional Health Services, et al. On or about
February 8, 2007, the Companys subsidiary, CHS, was served with a lawsuit by plaintiff, Saint
Josephs Regional Medical Center (St. Josephs). Plaintiff filed suit in the Superior Court of
New Jersey, Law Division: Passaic County, against CHS, Barnert Hospital, County of Bergen, Bergen
County Jail, County of Essex, Essex County Jail, County of Hudson, Hudson County Jail, County of
Passaic and Passaic County Jail, John Does #1-30, ABC Corporations #1-30, XYZ Jails, Prisons
and/or Detention Centers seeking damages from CHS totaling approximately $2.5 million. Plaintiff
claims that CHS failed to administer various contracts with respect to medical claims for the
treatment of certain patients and the payment of such claims between each of the respective
counties and jails named in the complaint and Barnert Hospital, to which St. Josephs claims it was
an intended third-party beneficiary. On August 15, 2007, Barnert Hospital filed for Chapter 11
bankruptcy protection. As a result, the court has stayed the proceedings in the lawsuit pending
resolution of the bankruptcy. CHS intends to defend itself vigorously, and maintains that it is
not responsible for any payments that may be due and owing to the plaintiff. However, a judgment
adverse to CHS could have a material adverse effect on the Companys financial position and its
results of operations. As of December 31, 2009, the Company has no reserves associated with this
proceeding.
Matters involving PHS and Baltimore County, Maryland. PHS is currently involved in a
lawsuit with its former client, Baltimore County, Maryland (the County) in the Circuit Court for
Baltimore County, Maryland seeking collection of outstanding receivable balances, damages for
breach of contract, quantum meruit, and unjust enrichment as well as prejudgment interest (the
Collection Matter). The outstanding receivable balances total approximately $1.7 million at
December 31, 2009 and are primarily related to services performed by PHS between April 1, 2006 and
September 14, 2006 while PHS and the County were jointly seeking a judicial interpretation of a
contract dispute regarding whether the County had timely exercised its renewal options under its
contract with PHS.
PHS contended that the original term of its contract with the County expired on June 30, 2005,
without the County exercising the first of three, two-year renewal options. On July 1, 2005, PHS
sent a letter to the County stating its position that PHS contract to provide services expired on
June 30, 2005 due to the Countys failure to provide such extension notice. The County disputed
PHS contention asserting that it properly exercised the first renewal option and that the term of
the contract therefore was through June 30, 2007, with extension options through June 30, 2011. In
July 2005, the County and PHS agreed to have a judicial authority interpret the contract through
formal judicial proceedings (the Contract Matter). At the written request of the County, PHS
continued to provide healthcare services to the County from July 1, 2005 to September 14, 2006,
under the terms and conditions of the contested contract, pending the judicial resolution of the
Contract Matter, while reserving all of its rights. Finally, during September 2006, amid
reciprocal claims of default, both PHS and the County took individual steps to terminate the
relationship between the parties. PHS contends that it terminated the relationship effective
September 14, 2006, due to various breaches by the County, including failure to remit payment of
approximately $1.7 million primarily related to services rendered between April 1, 2006 and
September 14, 2006. On October 27, 2006 PHS initiated the Collection Matter lawsuit against the
County.
The Collection Matter, although filed, was initially dormant, pending the resolution of the
Contract Matter. As discussed in more detail below, the Contract Matter was resolved in favor of
PHS on August 26, 2008, when the Maryland Court of Appeals (the States highest appellate court)
denied the Countys request for a review of a Maryland Court of Special Appeals decision in favor
of PHS. After the resolution of the Contract Matter, the parties, during 2009, commenced the
discovery process on the Collection Matter. PHS believes, in the case of the Collection Matter,
that it has a valid and meritorious cause of action and, as a result, has concluded that the
outstanding receivables, which represent services performed under the relationship between the
parties, are probable of collection. However, although PHS believes it has valid contractual and
legal arguments, an adverse result in the Collection Matter could have a negative impact on PHS
ability to collect the outstanding receivable amount and result in losses in future periods.
During 2009, the Contract Matter, mentioned above, was resolved in the following manner. In
November 2005, the Circuit Court for Baltimore County, Maryland ruled in favor of the County, with
respect to the Contract Matter, ruling that the County properly exercised its first, two-year
renewal option by sending a faxed written renewal amendment to PHS on July 1, 2005. PHS appealed
this ruling. On December 6, 2006, the Maryland Court of Special Appeals (i) reversed this
judgment; (ii) ruled that the County did not timely exercise its renewal option by its actions of
July 1, 2005; and (iii) remanded the case to the Circuit Court to determine whether the County
properly exercised the option by its conduct prior to June 30, 2005 an issue not originally
decided by the Circuit Court. On May 15, 2007, the Circuit Court, upon remand, held a hearing on
the parties pending cross motions for summary judgment. The Court issued an oral opinion at the
end of the hearing indicating its intention to rule in favor of the Countys motion for summary
judgment and against PHS motion for summary judgment. On June 6, 2007, the Court filed its order
memorializing the aforementioned ruling. In its order, the Court ruled that, by its actions, the
County properly and timely exercised the first two-year renewal option. The Company filed a Notice
of Appeal and on May 14, 2008, the Maryland Court of Special Appeals issued its ruling that the
actions the County claimed constituted an exercise of renewal were ineffective. Accordingly, the
Court of Special Appeals reversed the Circuit Courts ruling and directed it to grant the Companys
motion for summary judgment in the lawsuit. On June 27, 2008, the County petitioned the Maryland
Court of Appeals (the States highest appellate court) to review the May 14, 2008 Court of Special
Appeals decision. By order dated August 26, 2008, the Court of Appeals denied the Countys request
to review the decision, resulting in the ruling of the Court of Special Appeals in favor of the
Company becoming final, thereby bringing closure to the Contract Matter.
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Matters Related to the Audit Committee Investigation and Shareholder Litigation
As disclosed in further detail in the Companys Annual Report on Form 10-K for the year ended
December 31, 2005, on March 15, 2006 the Company announced that its Audit Committee had concluded
its investigation and reached certain conclusions with respect to findings of the investigation
that resulted in the recording of amounts due to SPPs customers that were not charged in
accordance with the terms of their respective contracts.
SEC and United States Attorney Informal Inquiries. As previously reported, the Company
contacted the SEC to inform it of the existence of the internal investigation conducted by the
Audit Committee and the issues being investigated. Since that time, the Company has cooperated with
the SEC in the informal inquiry that it conducted. In November 2009, the SEC confirmed that its
informal inquiry has been formally closed without any enforcement action. The SEC further
confirmed it never issued a formal order of investigation or a Wells Notice relating to this
matter. As a result of receiving this confirmation from the SEC, the Company considers this matter
closed.
The Company has also cooperated with the Office of the U. S. Attorney for the Middle District
of Tennessee (the U.S. Attorney) in an informal inquiry
it conducted. The Company has recently been informed that the U.S.
Attorney has no active investigation against the Company.
As a result of receiving this confirmation from the U.S. Attorney,
the Company considers this matter closed.
Shareholder Litigation. On April 6, 2006, plaintiffs filed the first of four similar
securities class action lawsuits in the United States District Court for the Middle District of
Tennessee against the Company and the Companys Chief Executive Officer, at that time, and Chief
Financial Officer. Plaintiffs allegations in these class action lawsuits are substantially
identical and generally allege on behalf of a putative class of individuals who purchased the
Companys common stock between September 24, 2003 and March 16, 2006 that, prior to the Companys
announcement of the Audit Committee investigation, the Company and/or the Companys Chief Executive
Officer, at that time, and Chief Financial Officer violated Sections 10(b) and 20(a) of the
Securities and Exchange Act of 1934 and SEC Rule 10b-5 by making false and misleading statements,
or concealing information about the Companys business, forecasts and financial performance. The
complaints seek certification as a class action, unspecified compensatory damages, attorneys fees
and costs, and other relief. By order dated August 3, 2006, the district court consolidated the
lawsuits into one consolidated action and on October 31, 2006, plaintiff filed an amended complaint
adding SPP, Enoch E. Hartman III and Grant J. Bryson as defendants. Enoch E. Hartman III is a
former employee of the Company and SPP and Grant J. Bryson is a former employee of SPP. The
amended complaint also generally alleges that defendants made false and misleading statements
concerning the Companys business which caused the Companys securities to trade at inflated prices
during the class period. Plaintiff seeks an unspecified amount of damages in the form of (i)
restitution; (ii) compensatory damages, including interest; and (iii) reasonable costs and
expenses. Defendants moved to dismiss the amended complaint on January 19, 2007, and the parties
completed the briefs on the motion in May 2007. On March 31, 2009, the Court ruled on the
defendants motion to dismiss, granting it in part and denying it in part. While the Courts
ruling dismissed significant portions of plaintiffs amended complaint and, as a result, narrowed
the scope of plaintiffs claims, none of the defendants were dismissed from the case and several of
plaintiffs claims under Sections 10(b) and 20(a) of the Securities and Exchange Act of 1934 and
SEC Rule 10b-5 remain. The parties were not in agreement as to the scope of the Courts order and
defendants filed a motion to confirm which claims the Court dismissed in its March 31, 2009 ruling.
The Court granted defendants motion to confirm the scope of the dismissal order on July 20, 2009,
ruling that certain of Plaintiffs claims had been in fact dismissed. The Court also confirmed,
however, that certain other claims remained viable.
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On July 22, 2009, the Court administratively closed the shareholder litigation case, while the
parties pursued mediation of this matter. On February 19, 2010, the parties agreed to the terms of
a mediators proposal to settle all of the claims in this lawsuit. The settlement, which is
subject to final documentation as well as approval by the Court, provides for payment by the
Company of $10.5 million and issuance by the Company of 300,000 shares of common stock and would
lead to a dismissal with prejudice of all claims against all defendants in the litigation. The
preliminary total value of the settlement, based upon the Companys closing share price for its
common stock of $15.42 per share on February 19, 2010, is approximately $15.1 million. As such,
the Company has recorded a reserve of $15.1 million, which has been included in accrued expenses in
the Companys consolidated balance sheet as of December 31, 2009.
The final value of the settlement will be determined based upon the Companys closing share price at the time of final approval of the settlement by the Court. The settlement
provides for price protection to the plaintiffs in the event the closing share price is below $14.65 per share at the time of final approval of the settlement by the Court.
In such event, the Company would pay in cash the difference between the share value at the time of final approval and $14.65 per share.
The parties are formalizing the
terms of the settlement through a written agreement which will be executed by the parties and
presented to the Court for final approval. Upon final approval of the Court and payment of the
settlement amount, the Company will consider this matter closed.
In September 2009, the Company and its primary directors and officers liability (D&O)
carrier reached an agreement under which the Company and the primary D&O carrier mutually released
each other from future claims related to this matter and the primary D&O carrier remitted insurance
proceeds to the Company totaling $8.0 million, less approximately $0.4 million in legal fees paid
by the primary D&O carrier as of the settlement date. The Company has paid and/or accrued
additional legal fees incurred through December 31, 2009, of $0.8 million related to this matter.
In addition to its primary D&O carrier, the Company also maintains D&O insurance with an
excess D&O carrier that provides for additional insurance coverage of up to $5.0 million for losses
in excess of $10.0 million. As of the date of this Annual Report on Form 10K, the excess D&O
carrier has denied coverage of this matter.
Delaware Department of Justice Inquiry. On April 4, 2006, the Company received a letter
notifying it that the Office of the Attorney General, Delaware Department of Justice is conducting
an inquiry into the indirect payment of claims by the Delaware Department of Correction to SPP
beginning in July 2002 and ending in the spring of 2005 for pharmaceutical services. There can be
no assurance that the Delaware Department of Justice inquiry will not result in the Company
incurring additional investigation and related expenses; being required to make additional refunds;
incurring criminal, or civil penalties, including the imposition of fines; or being debarred from
pursuing future business in certain jurisdictions. Management of the Company is unable to predict
the effect that any such actions may have on its business, financial condition, results of
operations or stock price. The Company has cooperated and intends to continue to cooperate with
the Delaware Department of Justice during its inquiry.
Other Matters
In January 2010, the Company entered into a $4.3 million settlement for a matter in which a
law firm representing a former inmate, for whom the Company provided healthcare services, had sent
notice asserting that the Company was responsible for permanent injuries to the inmate. As a
result of this settlement agreement, in the fourth quarter of 2009, the Company recorded additional
expense totaling $0.7 million to increase its reserves related to this matter to $4.3 million as of
December 31, 2009. The Company now considers this matter closed.
The Companys business ordinarily results in labor and employment related claims and matters,
actions for professional liability and related allegations of deliberate indifference in the
provision of healthcare and other causes of action related to its provision of healthcare services.
Therefore, in addition to the matters discussed above, the Company is a party to a multitude of
filed or pending legal and other proceedings incidental to its business. An estimate of the amounts
payable on existing claims for which the liability of the Company is probable and estimable is
included in accrued expenses. The Company is not aware of any unasserted claims that would have a
material adverse effect on its consolidated financial position, results of operations or cash
flows.
Item 4.
Reserved
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PART II
Item 5. Market For Registrants Common Stock, Related Stockholder Matters and Issuer Purchases of
Equity Securities
The Companys common stock is traded on The Nasdaq Global Select Markets National Market
System under the symbol ASGR. As of March 1, 2010, there
were approximately 74 registered holders
of record of the Companys common stock. The high and low sales prices of the Companys common
stock as reported on The Nasdaq Global Select Market during each quarter from January 1, 2008
through December 31, 2009 are shown below as well as the dividends per share declared on shares of
the Companys common stock by its Board of Directors for each quarter:
Quarter Ended | High | Low | Dividends | |||||||||
March 31, 2008 |
$ | 8.62 | $ | 6.00 | $ | | ||||||
June 30, 2008 |
$ | 9.54 | $ | 5.10 | $ | | ||||||
September 30, 2008 |
$ | 11.69 | $ | 8.69 | $ | | ||||||
December 31, 2008 |
$ | 10.99 | $ | 7.31 | $ | | ||||||
March 31, 2009 |
$ | 13.76 | $ | 8.98 | $ | | ||||||
June 30, 2009 |
$ | 17.22 | $ | 12.28 | $ | | ||||||
September 30, 2009 |
$ | 19.00 | $ | 15.37 | $ | 0.05 | ||||||
December 31, 2009 |
$ | 16.80 | $ | 12.34 | $ | 0.05 |
The Company did not pay cash dividends on its common stock during the year ended December 31,
2008, quarter ended March 31, 2009 and quarter ended June 30, 2009. The Company paid a $0.05 per
share on the Companys common stock for each of the quarters ended September 30, 2009 and December
31, 2009.
On
March 1, 2010, the Companys Board of Directors declared a quarterly cash dividend of
$0.06 per share on the Companys common stock for the quarter
ended March 31, 2010. The dividend will be
paid on April 13, 2010 to stockholders of record on
March 23, 2010.
The Board of Directors recent
adoption of a dividend program reflects the Companys intent to return capital to stockholders.
The Company expects that any future quarterly cash dividends will be paid from cash generated by
the Companys business in excess of its operating needs, interest and principal payments on
indebtedness, dividends on any future senior classes of the Companys capital stock, if any,
capital expenditures, taxes and future reserves, if any. Any future dividends will be authorized
by the Board of Directors and declared by the Company based upon a variety of factors deemed
relevant by directors of the Company. In addition, financial covenants in the Credit Agreement may
restrict the Companys ability to pay future quarterly dividends. The Board of Directors will
continue to evaluate the Companys dividend program each quarter and will make adjustments as
necessary, based on a variety of factors, including, among other things, the Companys financial
condition, liquidity, earnings projections and business prospects, and no assurance can be given
that this dividend program will not change in the future.
The following table shows the Companys repurchase activity for the fourth quarter of 2009
(shown in 000s except share and per share amounts):
(d) | ||||||||||||||||
Maximum Number | ||||||||||||||||
(c) | (or Approximate | |||||||||||||||
(a) | Total Number of | Dollar Value) | ||||||||||||||
Total of | Shares Purchased as | of shares that May | ||||||||||||||
Number of | (b) | Part of Publicly | Yet Be Purchased | |||||||||||||
Shares | Average Price | Announced Plans or | Under the Plans or | |||||||||||||
Period | Purchased | Paid per Share | Programs | Programs (1) | ||||||||||||
October 2009 (10/1/09 to 10/31/09) |
| $ | | | $ | | ||||||||||
November 2009 (11/1/09 to 11/30/09) |
350,000 | $ | 13.40 | 350,000 | $ | 4,356 | ||||||||||
December 2009 (12/1/09 to 12/31/09) |
| $ | | | $ | |
(1) | On February 27, 2008, the Companys Board of Directors approved a stock repurchase program to repurchase up to $15 million of the Companys common stock through the end of 2009. On July 28, 2009, the Companys Board of Directors authorized the extension of this program by two years through the end of 2011, while maintaining the total $15 million limit. See Note 18 of the Companys consolidated financial statements included in this Annual Report for further information. As of December 31, 2009, the Company has repurchased and retired a total of 858,350 common shares under the stock repurchase program at an aggregate cost of approximately $10.6 million. |
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The information required by Item 201(e) of Regulation S-K, Performance Graph, may be found
under the heading Performance Graph in the Companys Annual Report to Stockholders for fiscal
year 2009, which is incorporated herein by reference.
Item 6. Selected Financial Data
The following financial information should be read in conjunction with Managements
Discussion and Analysis of Financial Condition and Results of Operations, and the consolidated
financial statements and related notes included elsewhere in this Annual Report on Form 10-K.
Year Ended December 31, | ||||||||||||||||||||
2009 | 2008 | 2007 | 2006 | 2005 | ||||||||||||||||
(In thousands, except per share data) | ||||||||||||||||||||
Statement of Operations Data: |
||||||||||||||||||||
Healthcare revenues |
$ | 606,176 | $ | 485,022 | $ | 452,346 | $ | 440,822 | $ | 409,196 | ||||||||||
Income (loss) from continuing operations before income taxes |
6,614 | 5,825 | (6,100 | ) | (12,475 | ) | (7,481 | ) | ||||||||||||
Income (loss) from continuing operations |
3,491 | 3,193 | (3,807 | ) | (8,097 | ) | (4,807 | ) | ||||||||||||
Income (loss) from discontinued operations, net of taxes |
(209 | ) | 641 | 6,622 | 4,717 | 9,172 | ||||||||||||||
Net income (loss) |
$ | 3,282 | $ | 3,834 | $ | 2,815 | $ | (3,380 | ) | $ | 4,365 | |||||||||
Net income (loss) available to common shareholders |
$ | 3,176 | $ | 3,759 | $ | 2,815 | $ | (3,380 | ) | $ | 4,365 | |||||||||
Net income (loss) available to common shareholders per common share basic: |
||||||||||||||||||||
Continuing operations |
$ | 0.38 | $ | 0.34 | $ | (0.41 | ) | $ | (0.77 | ) | $ | (0.44 | ) | |||||||
Discontinued operations, net of taxes |
(0.02 | ) | 0.07 | 0.71 | 0.45 | 0.84 | ||||||||||||||
Net income (loss) available to common shareholders per common share |
$ | 0.36 | $ | 0.41 | $ | 0.30 | $ | (0.32 | ) | $ | 0.40 | |||||||||
Net income (loss) available to common shareholders per common share diluted: |
||||||||||||||||||||
Continuing operations |
$ | 0.38 | $ | 0.34 | $ | (0.41 | ) | $ | (0.77 | ) | $ | (0.44 | ) | |||||||
Discontinued operations, net of taxes |
(0.03 | ) | 0.07 | 0.71 | 0.45 | 0.84 | ||||||||||||||
Net income (loss) available to common shareholders per common share |
$ | 0.35 | $ | 0.41 | $ | 0.30 | $ | (0.32 | ) | $ | 0.40 | |||||||||
Weighted average common shares outstanding basic |
8,917 | 9,144 | 9,395 | 10,511 | 10,824 | |||||||||||||||
Weighted average common shares outstanding diluted |
8,959 | 9,153 | 9,395 | 10,511 | 10,824 | |||||||||||||||
Cash dividends per share |
$ | 0.10 | $ | | $ | | $ | | $ | |
See Managements Discussion and Analysis of Financial Condition and Results of
Operations and Note 6 to the Companys consolidated financial statements included in this Annual
Report for a description of the reclassification from continuing operations to discontinued
operations of expired contracts. During 2006, the Company recorded a non-cash impairment charge
for goodwill of $3.0 million related to the Companys pharmaceutical distribution services segment.
During 2009, 2008, 2007, 2006 and 2005, the Company recorded increases of approximately $3.2
million, $6.3 million, $10.5 million, $4.2 million and $4.3 million, respectively, to healthcare
expenses as a result of adverse development related to professional liability claims. During 2009,
2008, 2007, 2006 and 2005, the Company incurred Audit Committee investigation and related expenses
totaling $8.4 million, $0.2 million, $0.1 million, $5.3 million and $3.7 million, respectively,
related to an internal investigation into matters at SPP and costs
related to shareholder litigation.
The Audit Committee investigation and related expenses incurred in
the year ended December 31, 2009 are primarily due to the
Company recording a reserve related to the settlement in principle reached on February 19, 2010, regarding the shareholder litigation; an insurance settlement for $8.0 million entered into by the Company and its primary D&O
insurance carrier; and legal expenses.
For further information regarding the shareholder litigation, see Item 3. Legal Proceedings.
During 2009, 2008, 2007 and 2006, the
Company recognized share-based compensation expenses of $1.8 million, $2.1 million, $3.2 million and
$4.2 million, respectively, as a result of accounting for share-based compensation in accordance
with United States generally accepted accounting principles (U.S. GAAP). See Item 1A. Risk
Factors for a discussion of material risks that could affect the Companys results of operations
in the future.
As of December 31, | ||||||||||||||||||||
2009 | 2008 | 2007 | 2006 | 2005 | ||||||||||||||||
(In thousands) | ||||||||||||||||||||
Balance Sheet Data: |
||||||||||||||||||||
Working capital (deficit) |
$ | (2,812 | ) | $ | 8,284 | $ | (5,004 | ) | $ | 4,796 | $ | 4,353 | ||||||||
Total assets |
175,212 | 141,883 | 150,920 | 184,183 | 205,237 | |||||||||||||||
Long-term debt, including current portion |
| | 7,500 | 10,000 | 12,500 | |||||||||||||||
Stockholders equity |
41,973 | 44,046 | 39,650 | 46,454 | 56,004 |
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The working capital amounts as of December 31, 2007, 2006 and 2005 include $7.5 million, $10.0
million and $12.5 million, respectively, of borrowings outstanding under the Companys revolving
credit facilities in place on those dates which were classified as current liabilities based on the
maturity date of the credit facility or in accordance with the U.S. GAAP as discussed below.
Borrowings outstanding at December 31, 2007 were current due to the fact that the credit facility
was scheduled to mature within a year from the balance sheet date. Borrowings outstanding at
December 31, 2006 and 2005 were scheduled to mature at a date in excess of a year from the
respective balance sheet dates; however, due to the presence of a typical material adverse effect
clause in the loan agreement combined with the existence of a mandatory lock-box agreement,
borrowings outstanding under the revolving credit facilities have been classified as current
liabilities in accordance with the U.S. GAAP. For further discussion, see Managements Discussion
and Analysis of Financial Condition and Results of Operations Liquidity and Capital Resources or
Note 14 to the Companys consolidated financial statements included in this Annual Report.
Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the Companys consolidated
financial statements and related notes thereto provided under Part II, Item 8 of this Annual Report
on Form 10-K. This discussion contains forward-looking statements that involve risks and
uncertainties. Our actual results may differ materially from those anticipated in these
forward-looking statements as a result of certain factors, including, but not limited to, those
described under Risk Factors and included in other portions of this report.
Critical Accounting Policies And Estimates
General
This Managements Discussion and Analysis of Financial Condition and Results of Operations
is based upon the Companys consolidated financial statements, which have been prepared in
accordance with U.S. GAAP. The preparation of these financial statements requires the Company to
make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and
expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the
Company evaluates its estimates, including, but not limited to, those related to:
| revenue (net of contractual allowances) and cost recognition (including the estimated cost of off-site medical claims); | ||
| allowance for doubtful accounts; | ||
| loss contracts; | ||
| professional and general liability self-insurance retention; | ||
| other self-funded insurance reserves; | ||
| legal contingencies; | ||
| impairment of intangible assets and goodwill; | ||
| amortizable life of contract intangibles; | ||
| income taxes; and | ||
| share-based compensation. |
The Company bases its estimates on historical experience and on various other assumptions that
are believed to be reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are not readily apparent
from other sources. Actual results may differ from these estimates under different assumptions or
conditions.
The Company believes the following critical accounting policies are affected by its more
significant judgments and estimates used in the preparation of its consolidated financial
statements.
Revenue and Cost Recognition
The Companys contracts to provide healthcare services to correctional institutions are
principally fixed price contracts with revenue adjustments for census fluctuations and risk sharing
arrangements, such as stop-loss provisions and aggregate limits for off-site or pharmaceutical
costs. Such contracts typically have a term of one to three years with subsequent renewal options
and generally may be terminated by either party without cause upon proper notice. Revenues earned
under contracts with correctional institutions are recognized in the period that services are
rendered. Cash received in advance for future services is recorded as deferred revenue and
recognized as income when the service is performed.
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Revenues are calculated based on the specific contract terms and fall into one of three
general categories: fixed fee, population based, or cost plus a fee.
For fixed fee contracts, revenues are recorded based on fixed monthly amounts established in
the service contract irrespective of inmate population. Revenues for population-based contracts
are calculated either on a fixed fee that is subsequently adjusted using a per diem rate for
variances in the inmate population from predetermined population levels or by a per diem rate
multiplied by the average inmate population for the period of service. For cost plus a fee
contracts, revenues are calculated based on actual expenses incurred during the service period plus
a contractual fee.
Generally, the Companys contracts will also include additional provisions which mitigate a
portion of the Companys risk related to cost increases. Off-site utilization risk is mitigated in
the majority of the Companys contracts through aggregate pools or caps for off-site expenses,
stop-loss provisions, cost plus a fee arrangements or, in some cases, the entire exclusion of
certain or all off-site service costs. Pharmacy expense risk is similarly mitigated in certain of
the Companys contracts. Typically, under the terms of such provisions, the Companys revenue
under the contract increases to offset increases in specified cost categories such as off-site
expenses or pharmaceutical costs. For contracts that include such provisions, the Company
recognizes the additional revenues due from clients based on its estimates of applicable contract
to date costs incurred as compared to the corresponding pro rata contractual limit for such costs.
Because such provisions typically specify how often such additional revenue may be invoiced and
require all such additional revenue to be ultimately settled based on actual expenses, the
additional revenues are initially recorded as unbilled receivables until the time period for
billing has been met and actual costs are known. Any differences between the Companys estimates
of incurred costs and the actual costs are recorded in the period in which such differences become
known along with the corresponding adjustment to the amount of recorded additional revenues.
Under all contracts, the Company records revenues net of any estimated contractual allowances
for potential adjustments resulting from a failure to meet performance or staffing related
criteria. If necessary, the Company revises its estimates for such adjustments in future periods
when the actual amount of the adjustment is determined.
The table below illustrates these revenue categories as a percentage of total revenues from
continuing operations for the years ended December 31, 2009, 2008 and 2007.
Percentage of Revenue from Continuing Operations | ||||||||||||
For the Year Ended | For the Year Ended | For the Year Ended | ||||||||||
Contract Category | December 31, 2009 | December 31, 2008 | December 31, 2007 | |||||||||
Fixed Fee |
12.8 | % | 15.2 | % | 14.9 | % | ||||||
Population Based. |
63.7 | % | 58.0 | % | 57.6 | % | ||||||
Cost Plus a Fee |
23.5 | % | 26.8 | % | 26.8 | % | ||||||
Pharmacy Revenue* |
| | 0.7 | % |
* | Pharmacy revenue is revenue recognized by SPP. Effective April 30, 2007, SPP sold certain of its assets to Maxor. For more information, see Item 1. General Business. |
Contracts under the population based and fixed fee categories generally have similar
margins which are higher than margins for contracts under the cost plus a fee category. Cost plus
a fee contracts generally have lower margins but with much less potential for variability due to
the limited risk involved. The Companys profitability under each of the three general contract
categories discussed above varies based on the level of risk assumed under the contract terms with
the most potential for variability being in contracts under the population based or fixed fee
categories which do not contain the risk mitigating provisions related to off-site utilization
described above. For the year ended December 31, 2009, contracts accounting for approximately 7.8%
of the Companys correctional healthcare services revenues from continuing operations do not
contain such risk mitigating provisions.
Healthcare expenses include the compensation of physicians, nurses and other healthcare
professionals and related benefits and all other direct costs of providing and/or administering
the managed care, including the costs associated with services provided and/or administered by
off-site medical providers, the costs of professional and general liability insurance and other
self-funded insurance reserves discussed more fully below. Many of the Companys contracts require
the Companys customers to reimburse the Company for all treatment costs or, in some cases, only
treatment costs related to certain catastrophic events, and/or for specific disease diagnoses
illnesses. Certain of the Companys contracts do not contain such limits. The Company attempts to
compensate for the increased financial risk when pricing contracts that do not contain individual,
catastrophic or specific disease diagnosis-related limits. However, the occurrence of severe
individual cases, specific disease diagnoses illnesses or a catastrophic event in a facility
governed by a contract without such limitations could render the contract unprofitable and could
have a material adverse effect on the Companys operations. For certain of its contracts that do
not contain catastrophic protection, the Company maintains stop loss insurance from an
unaffiliated insurer with respect to, among other things, inpatient and outpatient hospital
expenses (as defined in the policy) for amounts in excess of $375,000 per inmate up to an annual
cap of $1.0 million per inmate. Amounts reimbursable per
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claim under the policy are further limited to the lessor of 60% of billed charges, the amount
paid or the contracted amounts in situations where the Company has negotiated rates with the
applicable providers.
The cost of healthcare services provided, administered or contracted for are recognized in the
period in which they are provided and/or administered based in part on estimates, including an
accrual for estimated unbilled medical services rendered through the balance sheet date. The
Company estimates the accrual for unbilled medical services using actual utilization data including
hospitalization, one-day surgeries, physician visits and emergency room and ambulance visits and
their corresponding costs, which are estimated using the average historical cost of such services.
Additionally, the Companys utilization management personnel perform a monthly review of inpatient
hospital stays in order to identify any stays which would have a cost in excess of the historical
average rates. Once identified, reserves for such stays are determined which take into
consideration the specific facts of the stay. An actuarial analysis is also prepared at least
quarterly as an additional tool to be considered by management in evaluating the adequacy of the
Companys total accrual related to contracts which have sufficient claims payment history. The
analysis takes into account historical claims experience (including the average historical costs
and billing lag time for such services) and other actuarial data.
Actual payments and future reserve requirements will differ from the Companys current
estimates. The differences could be material if significant fluctuations occur in the healthcare
cost structure or the Companys future claims experience. Changes in estimates of claims resulting
from such fluctuations and differences between actuarial estimates and actual claims payments are
recognized in the period in which the estimates are changed or the payments are made. In 2009,
2008 and 2007, the Company recorded decreases of approximately $0.4 million, $0.7 million and $6.1
million, respectively, to its prior year claims liabilities as a result of revisions to its
estimated claims expense. The impact to net income of these reductions to the Companys claims
reserves and associated expense is dependent upon whether any of the associated customer contracts
contained provisions limiting risk of off-site costs. For 2007, the overall decrease in claims
liabilities is net of an increase to the claims liabilities associated with two former full risk
contracts resulting in a negative impact to the Companys net income of $0.7 million. The
reductions to claims reserves in 2008 and 2009 did not result in a significant impact to the
Companys net income as the changes occurred primarily in connection with contracts which contained
provisions limiting risk of off-site costs and, as a result, these changes were off-set by
corresponding reductions to revenue.
Allowance for Doubtful Accounts
Accounts receivable are stated at estimated net realizable value. The Company recognizes
allowances for doubtful accounts based on a variety of factors, including the length of time
receivables are past due, significant one-time events, contractual rights, client funding and/or
political pressures, discussions with clients and historical experience. If circumstances change,
estimates of the recoverability of receivables would be further adjusted and such adjustments could
have a material adverse effect on the Companys results of operations in the period in which they
are recorded.
Unbilled accounts receivable generally represent additional revenue earned under shared-risk
contracting models that remain unbilled at each balance sheet date, due to provisions within the
contracts governing the timing for billing such amounts.
The Company and its clients will, from time to time, have disputes over amounts billed under
the Companys contracts. The Company records a reserve for
contractual allowances in
circumstances where it concludes that a loss from such disputes is probable.
As discussed more fully
in Part I Item 3. Legal Proceedings, PHS
is currently involved in a
lawsuit with its former client, Baltimore County, Maryland (the County)
involving the Countys lack of payment for services rendered. PHS has approximately $1.7
million of receivables due from the County, primarily related to services rendered between April 1,
2006 and September 14, 2006, the date the Companys relationship with the County was terminated.
The County has refused to pay PHS for these amounts and therefore, on October 27, 2006, PHS filed
suit against the County in the Circuit Court for Baltimore County, Maryland seeking collection of
the outstanding receivables balance, damages for breach of contract, quantum meruit, and unjust
enrichment as well as prejudgment interest. As discussed more fully
in Part I Item 3. Legal Proceedings, PHS believes, in the case of this lawsuit, that it has
a valid and meritorious cause of action and, as a result, has concluded that the outstanding
receivables, which represent services performed under the contractual relationship between the
parties, are probable of collection. Although PHS believes it has valid contractual and legal
arguments, an adverse result in this lawsuit could have a negative impact on the results of this
matter and/or PHS ability to collect the outstanding receivables amount. These receivables are
classified as other noncurrent assets in the Companys consolidated balance sheet.
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As stated above, the Company believes the recorded amount represents valid receivables which
are contractually due from the County and expects full
collection. However, due to the factors discussed above and more fully in Part I Item 3. Legal
Proceedings, there is a heightened risk of uncollectibility of these receivables which may result
in future losses. Nevertheless, the Company intends to take all
necessary and available measures in order to collect these receivables.
Changes in circumstances related to the matter discussed above involving the County, or any
other receivables, could result in a change in the allowance for doubtful accounts or the estimate
of contractual adjustments in future periods. Such change, if it were to occur, could have a
material adverse affect on the Companys results of operations and financial position in the period
in which the change occurs.
Loss Contracts
On a quarterly basis, the Company performs a review of its portfolio of contracts for the
purpose of identifying potential loss contracts and developing a loss contract reserve for
succeeding periods if any loss contracts are identified. The Company accrues losses under its
fixed price contracts when it is probable that a loss has been incurred and the amount of the loss
can be reasonably estimated. The Company performs this loss accrual analysis on a specific
contract basis taking into consideration such factors as the Companys ability to terminate the
contract, future contractual revenue, projected future healthcare and maintenance costs, projected
future stop-loss insurance recoveries and the contracts specific terms related to future revenue
increases as compared to increased healthcare costs. The projected future healthcare and
maintenance costs are estimated based on historical trends and managements estimate of future cost
increases. These estimates are subject to the same adverse fluctuations and future claims
experience as previously noted.
In the course of performing its reviews in future periods, the Company might identify
contracts which have become loss contracts due to a change in circumstances. Circumstances that
might change and result in the identification of a contract as a loss contract in a future period
include interpretations regarding contract termination or expiration provisions, unanticipated
adverse changes in the healthcare cost structure, inmate population or the utilization of outside
medical services in a contract, where such changes are not offset by increased healthcare revenues.
Should a contract be identified as a loss contract in a future period, the Company would record,
in the period in which such identification is made, a reserve for the estimated future losses that
would be incurred under the contract. The identification of a loss contract in the future could
have a material adverse effect on the Companys results of operations in the period in which the
reserve is recorded.
There are no loss contracts identified as of December 31, 2009 and 2008.
Professional and General Liability Self-Insurance Retention
As a healthcare provider, the Companys business occasionally results in actions for
negligence and other causes of action related to its provision of healthcare services with the
attendant risk of substantial damage awards, or court ordered non-monetary relief such as, changes
in operating practices or procedures, which may lead to the potential for substantial increases in
the Companys operating expenses. The most significant source of potential liability in this regard
is the risk of suits brought by inmates alleging negligent healthcare services, deliberate
indifference to their medical needs or the lack of timely or adequate healthcare services. The
Company may also be liable, as employer, for the negligence of healthcare professionals it employs
or healthcare professionals with whom it contracts. The Companys contracts generally provide for
the Company to indemnify the governmental agency for losses incurred related to healthcare provided
by the Company and its agents.
To mitigate a portion of this risk, the Company maintains a primary professional liability
insurance program, principally on a claims-made basis. For 2002 through 2006 and 2008 through 2009
with respect to the majority of its patients, the Company purchased commercial insurance coverage,
but is effectively self-insured due to the terms of the coverage which include adjustable premiums.
For 2002 through 2006 and 2008 through 2009, the Company is covered by separate policies, each of
which contains a premium that is retroactively adjusted, with adjustment based on actual losses.
The Companys ultimate premium for its 2002 through 2006 and 2008 through 2009 policies will depend
on the final incurred losses related to each of these separate policy periods. For 2007, the
Company is insured through claims made policies subject to per event and aggregate coverage limits.
Any amounts ultimately incurred above these coverage limits would be the responsibility of the
Company. Management establishes reserves for the estimated losses that will be incurred under
these insurance policies after taking into consideration the Companys professional liability
claims department and external counsel evaluations of the merits of the individual claims, analysis
of claim history, actuarial analysis and coverage limits where applicable. Any adjustments
resulting from the review are reflected in current earnings.
Given the fact that many claims are not brought during the year of occurrence, in addition to
its reserves for known claims, the Company maintains a reserve for incurred but not reported
claims. The reserve for incurred but not reported claims is recorded on an
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undiscounted basis. The Companys estimates of this reserve are supported by various
analyses, including an actuarial analysis, which is performed on a quarterly basis.
At December 31, 2009, the Companys reserves for both known and incurred but not reported
claims totaled $25.2 million. Reserves for medical malpractice claims fluctuate because the number
of claims and the severity of the underlying incidents change from one period to the next.
Reserves for medical malpractice claims can also fluctuate as a result of court decisions or as new
facts become available. Furthermore, payments with respect to previously estimated liabilities
frequently differ from the estimated liability. Changes in estimates of losses resulting from such
fluctuations and differences between managements established reserves and actual loss payments are
recognized by an adjustment to the reserve for medical malpractice claims in the period in which
the estimates are changed or payments are made. In 2009, 2008 and 2007, the Company recorded
increases of approximately $3.2 million, $6.3 million and $10.5 million, respectively, to its prior
year claims reserves as a result of adverse development on individual claims or matters. The
reserves can also be affected by changes in the financial health of the third-party insurance
carriers used by the Company. If a third party insurance carrier fails to meet its contractual
obligations under the agreement with the Company, the Company would then be responsible for such
obligations. Such changes could have a material adverse effect on the Companys financial position
and its results of operations in the period in which the changes occur.
Other Self-Funded Insurance Reserves
At December 31, 2009, the Company has approximately $8.6 million in accrued liabilities for
employee health and workers compensation claims. Approximately $7.1 million of this amount is
related to workers compensation claims, of which approximately $4.5 million is included within the
noncurrent portion of accrued expenses as it is not expected to be paid within a year. The Company
is essentially self-insured for employee health and workers compensation claims subject to certain
individual case stop loss levels. As such, its insurance expense is largely dependent on claims
experience and the ability to control claims. The Company accrues the estimated liability for
employee health insurance based on its history of claims experience and estimated time lag between
the incident date and the date of actual claim payment. The Company accrues the estimated
liability for workers compensation claims based on evaluations of the merits of the individual
claims and analysis of claims history. These estimated liabilities are recorded on an undiscounted
basis. An actuarial analysis is prepared at least annually as an additional tool to be considered
by management in evaluating the adequacy of the Companys reserve for workers compensation claims.
These estimates of self-funded insurance reserves could change in the future based on changes in
the factors discussed above. Any adjustments resulting from such changes in estimates are
reflected in current earnings. In 2009, 2008 and 2007, the Company recorded a decrease of
approximately $0.2 million, a decrease of approximately $0.9 million, and an increase of
approximately $1.0 million, respectively, related to its prior year other self-insurance reserves
as a result of revisions to its estimated claims experience.
Legal Contingencies
In addition to professional and general liability claims, the Company is also subject to other
legal proceedings in the ordinary course of business. Such proceedings generally relate to labor,
employment or contract matters. When estimable, the Company accrues an estimate of the probable
costs for the resolution of these claims. Such estimates are developed in consultation with outside
counsel handling the Companys defense in these matters and are based upon an estimated range of
potential results, assuming a combination of litigation and settlement strategies. The Company
does not believe any of these current proceedings will have a material adverse effect on its
consolidated financial position. However, it is possible that future results of operations for
any particular quarterly or annual period could be materially affected by changes in assumptions,
new developments or changes in approach, such as a change in settlement strategy in dealing with
such litigation. See discussion of certain outstanding legal matters in Part I Item 3. Legal
Proceedings.
In addition to professional and general liability claims and other legal proceedings in the
ordinary course of business, the Company is involved in other legal matters related to an Audit
Committee investigation, which was announced by the Company on October 24, 2005. See Part 1 Item
1. Business Audit Committee Investigation and Part I Item 3. Legal Proceedings for further
information regarding the Audit Committee investigation and related legal matters.
Intangible Assets and Goodwill
Goodwill acquired is not amortized but is reviewed for impairment on an annual basis or more
frequently whenever events or circumstances indicate that the carrying value may not be
recoverable. U.S. GAAP requires that goodwill be tested at the reporting unit level, defined as an
operating segment or one level below an operating segment (referred to as a component), with the
fair value of the reporting unit being compared to its carrying amount, including goodwill. If the
fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is not
considered to be impaired. The Company has determined that it has one operating, as well as one
reportable, segment. The Companys policy is to perform its annual goodwill impairment test as of
the last day of each fiscal year, i.e. December 31.
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In
performing its annual goodwill impairment test, the Company uses a two-step process. The
first step is a screen for potential impairment, while the second step measures the amount of the
impairment, if any. The first step of the goodwill impairment test compares the fair value of a
reporting unit with its carrying amount, including goodwill. The Company determined the fair value
of its reporting unit to equal the market capitalization of its common stock as of the testing
date. As of December 31, 2009, the indicated fair value of the Companys reporting unit exceeded
the carrying value of its reporting unit by 338%, and, as such, the Company concluded that there
was no indication of goodwill impairment.
Future events could cause the Company to conclude that impairment indicators exist and that
the Companys goodwill is impaired. Any resulting impairment loss could have a material adverse
impact on the Companys financial condition and results of operations.
Important factors taken into consideration when evaluating the need for an impairment review,
other than the annual impairment test, include the following:
| significant underperformance or loss of key contracts relative to expected historical or projected future operating results; | ||
| significant changes in the manner of use of the Companys assets or in the Companys overall business strategy; | ||
| significant negative industry or economic trends; and | ||
| an adverse change in the Companys market capitalization. |
If the Company determines that the carrying value of goodwill may be impaired based upon the
existence of one or more of the above or other indicators of impairment or as a result of its
annual impairment review, the impairment will be measured using a fair-value-based goodwill
impairment test. Fair value is the amount at which the asset could be bought or sold in a current
transaction between willing parties and may be estimated using a number of techniques, including
quoted market prices or valuations by third parties, present value techniques based on estimates of
cash flows, or multiples of earnings or revenues. The fair value of the asset could be different
using different estimates and assumptions in these valuation techniques.
The Companys other identifiable intangible assets, such as customer contracts acquired in
acquisitions are amortized on the straight-line method over their estimated useful lives. The
Company also assesses the potential impairment of its other identifiable intangibles whenever
events or changes in circumstances indicate that the carrying value may not be recoverable.
When the Company determines that the carrying value of other intangible assets may not be
recoverable based upon the existence of one or more of the above indicators of impairment, such
impairment will be measured using an estimate of the assets fair value based on the projected net
cash flows expected to result from that asset, including eventual disposition.
Amortizable Life of Contract Intangibles
The Company amortizes its contract intangibles on a straight-line basis over their estimated
useful life. The Company evaluates the estimated remaining useful life of its contract intangibles
on at least a quarterly basis, taking into account new facts and circumstances, including its
retention rate for acquired contracts. If such facts and circumstances indicate the current
estimated useful life is no longer reasonable, the Company adjusts the estimated useful life on a
prospective basis.
Income Taxes
The Company accounts for income taxes under the provisions of U.S. GAAP related to income
taxes. Under the asset and liability method of U.S. GAAP related to income taxes, deferred tax
assets and liabilities are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and liabilities and their
respective tax bases.
The Company regularly reviews its deferred tax assets for recoverability taking into
consideration such factors as historical losses, projected future taxable income and the expected
timing of the reversals of existing temporary differences. U.S. GAAP requires the Company to
record a valuation allowance when it is more likely than not that some portion or all of the
deferred tax assets will not be realized. At December 31, 2009, the Companys valuation allowance
of approximately $0.2 million represents managements estimate of state net operating loss
carryforwards which will expire unused.
The Company accounts for tax contingency accruals under the provisions of U.S. GAAP related to
accounting for uncertainty in income taxes. The Companys tax contingency accruals are reviewed
quarterly and can be adjusted in light of changing facts and circumstances, such as the progress of
tax audits, case law and emerging legislation. Adjustments to the tax contingency accruals are
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recorded in the period in which the new facts or circumstances become known, therefore the
accruals are subject to change in future periods and such change, if it were to occur, could have a
material adverse effect on the Companys results of operations.
It is the Companys policy to recognize accrued interest and penalties related to its tax
contingencies as income tax expense. As the Company has no tax contingencies at December 31, 2009,
there is no accrued interest and penalties included in income tax expense for the year ended
December 31, 2009.
The Company files income tax returns in the U.S. federal jurisdiction and various state
jurisdictions. The Company may be subject to examination by the Internal Revenue Service (IRS)
for calendar years 2006 through 2009. Additionally, open tax years related to certain state and
local jurisdictions remain subject to examination.
Share-Based Compensation
The Company measures and recognizes compensation expense for all share-based payment awards
based on estimated fair values at the date of grant. Determining the fair value of share-based
awards at the grant date requires judgment in developing assumptions, which involve a number of
variables. These variables include, but are not limited to, the expected stock price volatility
over the term of the awards and expected stock option exercise behavior. In addition, the Company
also uses judgment in estimating the number of share-based awards that are expected to be
forfeited.
Results of Operations
The following table sets forth, for the years indicated, the percentage relationship to
healthcare revenues of certain items in the consolidated statements of operations.
Year Ended December 31, | ||||||||||||
2009 | 2008 | 2007 | ||||||||||
Healthcare revenues |
100.0 | % | 100.0 | % | 100.0 | % | ||||||
Healthcare expenses |
92.1 | 91.8 | 94.2 | |||||||||
Gross margin |
7.9 | 8.2 | 5.8 | |||||||||
Selling, general and administrative expenses |
4.9 | 5.6 | 5.8 | |||||||||
Corporate restructuring expenses |
| 0.5 | 0.1 | |||||||||
Audit Committee investigation and related expenses |
1.4 | | | |||||||||
Depreciation and amortization |
0.5 | 0.8 | 0.9 | |||||||||
Income (loss) from operations |
1.1 | 1.3 | (1.0 | ) | ||||||||
Interest expense, net |
| 0.1 | 0.3 | |||||||||
Income (loss) from continuing operations before income tax provision (benefit) |
1.1 | 1.2 | (1.3 | ) | ||||||||
Income tax provision (benefit) |
0.5 | 0.5 | (0.5 | ) | ||||||||
Income (loss) from continuing operations |
0.6 | 0.7 | (0.8 | ) | ||||||||
Income (loss) from discontinued operations, net of taxes |
(0.1 | ) | 0.1 | 1.4 | ||||||||
Net income |
0.5 | 0.8 | 0.6 | |||||||||
As discussed in Note 6 to the Companys consolidated financial statements, the Company is
applying the discontinued operations provisions of U.S. GAAP to all correctional healthcare service
contracts upon expiration of the contracts. In accordance with U.S. GAAP, the results of
operations of contracts that expire, less applicable income taxes, are classified on the Companys
consolidated statements of operations separately from continuing operations. The presentation
prescribed for discontinued operations requires the collapsing of healthcare revenues and expenses,
as well as other specifically identifiable costs, into the income or loss from discontinued
operations, net of taxes. Items such as indirect selling, general and administrative expenses or
interest expense cannot be allocated to expired contracts. The U.S. GAAP accounting presentation
as it relates to discontinued operations and the Companys expired contracts has no impact on net
income, earnings per share, total cash flows or stockholders equity. As a result of the
application of U.S. GAAP related to discontinued operations, healthcare revenues and healthcare
expenses on the Companys consolidated statements of operations for any period presented will only
include revenues and expenses from continuing contracts.
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Year Ended December 31, 2009 Compared to Year Ended December 31, 2008
Healthcare revenues. Healthcare revenues for the year ended December 31, 2009 increased
$121.2 million, or 25.0%, from $485.0 million in 2008 to $606.2 million in 2009. Healthcare
revenues in 2009 included $88.3 million of revenue growth resulting from new correctional
healthcare services contracts added subsequent to January 1, 2008 through marketing activities.
The primary correctional healthcare services contract added during this time period was the
Companys new contract to provide healthcare services to the State of Michigan Department of
Corrections, which commenced on April 1, 2009. Correctional healthcare services contracts in place
at January 1, 2008 and continuing beyond December 31, 2009, experienced revenue growth of 6.8%
consisting of an increase in revenue of $32.9 million during 2009 as the result of contract
renegotiations and automatic price adjustments. As discussed in the discontinued operations
section below, all healthcare services contracts that have expired or otherwise been terminated
have been classified as discontinued operations.
Healthcare expenses. Healthcare expenses for the year ended December 31, 2009 increased
$113.0 million, or 25.4%, from $445.2 million, or 91.8% of revenues, in 2008 to $558.2 million, or
92.1% of revenues, in 2009. Included in healthcare expenses for each of the years ended December
31, 2009 and 2008 is approximately $0.1 million related to share-based compensation expense.
Expenses related to new correctional healthcare services contracts added subsequent to January 1,
2008 through marketing activities accounted for $87.4 million of the increase. The primary
correctional healthcare services contract added during this time period was the Companys contract
to provide healthcare services to the State of Michigan Department of Corrections, which commenced
on April 1, 2009. Correctional healthcare services contracts in place at January 1, 2008
and continuing beyond December 31, 2009, accounted for $25.1 million of the increase as a result of
increases in the levels of staff and staff compensation, increases in the off-site medical services
and pharmacy costs associated with providing healthcare to inmates at existing contracts. Included
in this increase for continuing contracts is insurance expense of approximately $3.2 million and
$6.3 million for the years ended December 31, 2009 and 2008, respectively, as a result of adverse
development related to professional liability claims. Also included in healthcare expenses for the
years ended December 31, 2009 and 2008 is approximately $0.9 million and $0.4 million of accrued
bonus expenses related to the Companys 2009 incentive compensation plan and 2008 incentive
compensation plan, respectively.
Selling, general and administrative expenses. Selling, general and administrative expenses
were $30.0 million, or 4.9% of revenues, and $27.0 million, or 5.6% of revenues, for the years
ended December 31, 2009 and 2008, respectively. Included in the selling, general and
administrative expenses for the years ended December 31, 2009 and 2008 is approximately $1.8
million and $2.0 million, respectively, related to share-based compensation expense. Also included
in selling, general and administrative expenses for the year ended December 31, 2009 is
approximately $2.7 million of accrued bonus expense related to the Companys 2009 incentive
compensation plan. Included in selling, general and administrative expenses for the year ended
December 31, 2008 is approximately $1.6 million of accrued bonus expense related to the Companys
2008 incentive compensation plan.
Corporate restructuring expenses. Corporate restructuring expenses were $2.3 million for the
year ended December 31, 2008, which related to the Company
entering into a seperation agreement and general release with its
former Chief Executive Officer on September 15, 2008. There were no corporate restructuring expenses incurred for the year
ended December 31, 2009.
Audit Committee investigation and related expenses. Audit Committee investigation and related
expenses were $8.4 million for the year ended December 31, 2009 as compared to $0.2 million for the
year ended December 31, 2008. The Audit Committee investigation and related expenses incurred in
the year ended December 31, 2009 are primarily due to the Company recording
a reserve related to the settlement in principle reached on February 19, 2010, regarding the shareholder
litigation filed against the Company and certain individual defendants on April 6, 2006; an insurance
settlement for $8.0 million entered into by the Company and its primary D&O
insurance carrier; and legal expenses.
The settlement regarding the shareholder litigation, which is subject to final documentation as well as
approval by the Court, provides for payment by the Company of $10.5 million and issuance by the
Company of 300,000 shares of common stock and would lead to a dismissal with prejudice of all
claims against all defendants in the litigation. The Audit Committee investigation and related
expenses incurred in the year ended December 31, 2008, primarily related to the legal costs of
inquiry responses and lawsuit defenses as a result of an internal investigation conducted by the
Audit Committee. See Item 3. Legal Proceedings for further discussion of the Audit committee
investigation and related legal matters.
Depreciation and amortization. Depreciation and amortization expense was $2.8 million and
$3.8 million for the years ended December 31, 2009 and 2008, respectively. The reduction in
depreciation and amortization expense is due to a reduction in contract amortization.
Interest expense, net. Net interest expense decreased to $0.1 million in 2009, from $0.7
million in 2008. This decrease is the result of a decrease in the average borrowings outstanding.
Income tax provision. The income tax provision for the year ended December 31, 2009 was $3.1
million as compared to $2.6 million in 2008. See Note 15 to the Companys consolidated financial
statements for more information on the Companys income tax provision.
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Income from continuing operations. Income from continuing operations for the year ended
December 31, 2009 was $3.5 million, or 0.6% of revenues, as compared with $3.2 million, or 0.7% of
revenues, in 2008.
Income (loss) from discontinued operations, net of taxes. The loss from discontinued
operations, net of taxes for the year ended December 31, 2009 was $0.2 million as compared with
income from discontinued operations, net of taxes of $0.6 million in 2008. Income (loss) from
discontinued operations, net of taxes represents the operating results of the Companys
correctional healthcare services contracts that have expired. The
classification of these expired contracts is the result of the Companys application of U.S. GAAP
related to discontinued operations. See Note 6 to the Companys consolidated financial statements
for further discussion of discontinued operations.
Net income. Net income for the year ended December 31, 2009 was $3.3 million, or 0.5% of
revenues, as compared with $3.8 million, or 0.8% of revenues, in
2008. The decrease is due to the
factors discussed above.
Year Ended December 31, 2008 Compared to Year Ended December 31, 2007
Healthcare revenues. Healthcare revenues for the year ended December 31, 2008 increased $32.7
million, or 7.2%, from $452.3 million in 2007 to $485.0 million in 2008. Healthcare revenues in
2008 included $7.1 million of revenue growth resulting from new correctional healthcare services
contracts added subsequent to January 1, 2007 through marketing activities. Correctional
healthcare services contracts in place at January 1, 2007 and continuing beyond December 31, 2009,
experienced revenue growth of 6.5% consisting of an increase in revenue of $29.1 million during
2008 as the result of contract renegotiations and automatic price adjustments. Offsetting these
revenue increases, SPP pharmaceutical distribution revenue decreased $3.5 million as a result of
the sale of SPP assets to Maxor effective April 30, 2007, as discussed in Item 1. Business
General. As discussed in the discontinued operations section below, the Companys correctional
healthcare services contracts that have expired or otherwise been terminated have been classified
as discontinued operations.
Healthcare expenses. Healthcare expenses for the year ended December 31, 2008 increased $18.9
million, or 4.4%, from $426.3 million, or 94.2% of revenues, in 2007 to $445.2 million, or 91.8% of
revenues, in 2008. Included in healthcare expenses for the year ended December 31, 2008 and 2007
is approximately $0.1 million and $0.3 million, respectively, related to share-based compensation
expense. Expenses related to new correctional healthcare services contracts added subsequent to
January 1, 2007 through marketing activities accounted for $6.6 million of the increase.
Correctional healthcare services contracts in place at January 1, 2007 and continuing beyond
December 31, 2009 accounted for $15.9 million of the increase as a result of increases in the
levels of staff and staff compensation and increases in the outpatient services and pharmacy costs
associated with providing healthcare to inmates at existing contracts. Included in this increase
for continuing contracts is insurance expense of approximately $6.3 million and $10.5 million for
the years ended December 31, 2008 and 2007, respectively, as a result of adverse development
related to professional liability claims. Also included in healthcare expenses for the year ended
December 31, 2008 is approximately $0.4 million of accrued bonus expenses related to the Companys
2008 incentive compensation plan. There was no accrued bonus expense in healthcare expenses for
the year ended December 31, 2007 related to the Companys 2007 incentive compensation plan.
Offsetting these healthcare expense increases, SPP pharmaceutical distribution expense decreased
$3.8 million primarily as a result of the sale of SPP assets to Maxor effective April 30, 2007, as
discussed in Item 1. Business General.
Selling, general and administrative expenses. Selling, general and administrative
expenses for the year ending December 31, 2008 increased $0.7 million from $26.3 million, or 5.8%
of revenues, in 2007 to $27.0 million, or 5.6% of revenues, in 2008. Included in the selling,
general and administrative expenses for the years ended December 31, 2008 and 2007 is approximately
$2.0 million and $2.9 million, respectively, related to share-based compensation expense. Also
included in selling, general and administrative expenses for the year ended December 31, 2008 is
approximately $1.6 million of accrued bonus expense related to the Companys 2008 incentive
compensation plan. There was no accrued bonus expense in selling, general and administrative
expenses for the year ended December 31, 2007 related to the Companys 2007 incentive compensation
plan.
Corporate restructuring expenses. Corporate restructuring expenses were $2.3 million for the
year ended December 31, 2008, which related to the Company
entering into a seperation agreement and general release with its
former Chief Executive Officer on September 15, 2008. Corporate restructuring expenses were $0.4 million for the year
ended December 31, 2007, which related to the elimination of certain administrative and operational
positions as part of a Company-wide cost reduction process implemented in the third and fourth
quarters of 2007.
Audit Committee investigation and related expenses. Audit Committee investigation and related
expenses were $0.2 million for the year ended December 31, 2008 as compared to $0.1 million for the
year ended December 31, 2007. The Audit Committee investigation and related expenses incurred in
the years ended December 31, 2008 and 2007 related to the legal costs of inquiry responses and
lawsuit defenses as a result of an internal investigation conducted by the Audit Committee. See
Item 3. Legal Proceedings for further discussion of the Audit committee investigation and related
legal matters.
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Depreciation and amortization. Depreciation and amortization expense for each of the years
ended December 31, 2008 and 2007 was $3.8 million.
Interest expense, net. Net interest expense decreased to $0.7 million in 2008, from $1.6
million in 2007. This decrease is the result of a decrease in the average borrowings outstanding
combined with a reduction in interest rates on such borrowings.
Income tax provision (benefit). The income tax provision for the year ended December 31, 2008
was $2.6 million as compared to and income tax benefit of $2.3 million in 2007. See Note 15 to the
Companys consolidated financial statements for more information on the Companys income tax
provision (benefit).
Income (loss) from continuing operations. Income from continuing operations for the year
ended December 31, 2008 was $3.2 million, or 0.7% of revenues, as compared with a loss from
continuing operations of $3.8 million, or 0.8% of revenues, in 2007.
Income from discontinued operations, net of taxes. Income from discontinued operations, net
of taxes for the year ended December 31, 2008 was $0.6 million as compared with $6.6 million in
2007. Income from discontinued operations, net of taxes represents the operating results of the
Companys correctional healthcare services contracts that have expired or otherwise been
terminated. The classification of these expired contracts is the result of the Companys
application of U.S. GAAP related to discontinued operations. See Note 6 to the Companys
consolidated financial statements for further discussion of discontinued operations.
Net income. Net income for the year ended December 31, 2008 was $3.8 million or 0.8% of
revenues, as compared with $2.8 million, or 0.6% of revenues, in 2007. The increase is due to the
factors discussed above.
Liquidity and Capital Resources
Overview
The Company had negative working capital of $2.8 million at December 31, 2009 compared to
working capital of $8.3 million at December 31, 2008. At December 31, 2009, days sales outstanding
in accounts receivable were 25, accounts payable days outstanding were 19 and medical claims
liability days outstanding were 46. Each of these metrics have been favorably impacted by the
Companys new contract with the State of Michigan Department of Corrections, which commenced on
April 1, 2009. At December 31, 2008, days sales outstanding in accounts receivable were 31,
accounts payable days outstanding were 41 and medical claims liability days outstanding were 81.
The Company had net income of $3.3 million for the year ended December 31, 2009 compared to
$3.8 million for the year ended December 31, 2008. The Company had stockholders equity of $42.0
million at December 31, 2009 as compared to $44.0 million at December 31, 2008. The Companys cash
and cash equivalents increased to $37.7 million at December 31, 2009 from $24.9 million at December
31, 2008. The increase in cash and cash equivalents was primarily due
to cash flows from operating activities less capital expenditures,
stock repurchases and dividend payments. The Company had no outstanding balance on its credit facility at December 31, 2009 or
2008.
Cash flows from operating activities represent net income plus depreciation and amortization,
changes in various components of working capital and adjustments for various non-cash charges, such
as share-based compensation expense and deferred income taxes. Cash flows provided by operating
activities were $24.5 million for the year ended December 31, 2009 as compared with $28.8 million
for the year ended December 31, 2008. The decrease was primarily due to a combined net increase of
$16.1 million in accounts receivable, deferred taxes, prepaid expenses and
other current assets and other assets in the year ended December 31, 2009 as compared with a
combined reduction of $26.0 million in these operating assets in the year ended December 31, 2008.
This was partially offset by a combined net increase of
$32.6 million in accounts payable, accrued expenses, accrued medical claims liability and deferred
revenue in the year ended December 31, 2009 as compared with a combined reduction of $7.8 million
in these operating liabilities in the year ended December 31, 2008.
Cash flows used in investing activities were $4.5 million and $3.4 million, respectively, for
the years ended December 31, 2009 and 2008 which represented purchases of property and equipment
and management systems under development, which were financed through cash flows from operating
activities.
Cash flows used in financing activities during the year ended December 31, 2009 were $7.2
million which represented share repurchases of $8.3 million, restricted stock repurchased from
employees for employees tax liability of $0.2 million and dividends on common stock of $0.9
million, partially offset by the issuance of common stock under the Companys employee stock
purchase plan of $0.3 million, excess tax benefits from share-based compensation arrangements of
$0.1 million and cash receipts resulting from option exercises of $1.7 million. Cash flows used in
financing activities during the year ended December 31, 2008
were $9.6 million which were primarily due to
share repurchases of $2.4 million and $7.5 million in net
payments on the line of credit.
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Share Repurchases
On February 27, 2008, the Companys Board of Directors approved a stock repurchase program to
repurchase up to $15 million of the Companys common stock through the end of 2009. On July 28,
2009, the Companys Board of Directors authorized the extension of this program by two years
through the end of 2011, while maintaining the total $15 million limit. As of December 31, 2009,
the Company has repurchased and retired a total of 858,350 shares of common stock under the stock
repurchase program at an aggregate cost of approximately $10.6 million.
The stock repurchase program is intended to be implemented through purchases made from time to
time in either the open market or through private transactions, in accordance with SEC
requirements. The Company may elect to terminate or modify the program at any time. Under the
stock repurchase program, no shares will be purchased directly from officers or directors of the
Company. The timing, prices and sizes of purchases will depend upon prevailing stock prices,
general economic and market conditions and other considerations. Funds for the repurchase of
shares are expected to come primarily from cash provided by operating activities and also from
funds on hand, including amounts available under the Companys credit facility.
See Note 18 of the Companys consolidated financial statements included in this annual report
for further information.
Dividends
The
Company paid a $0.05 cash dividend per share on the Companys common stock for each of the quarters
ended September 30, 2009 and December 31, 2009. On March 1, 2010, the Companys Board of
Directors declared a quarterly cash dividend of $0.06 per share on
the Companys common stock for the quarter ended March 31, 2010.The dividend will be paid on April 13, 2010 to stockholders of record on
March 23, 2010.
The Board of Directors recent adoption of a dividend program reflects the Companys intent to
return capital to stockholders. The Company expects that any future quarterly cash dividends will
be paid from cash generated by the Companys business in excess of its operating needs, interest
and principal payments on indebtedness, dividends on any future senior classes of the Companys
capital stock, if any, capital expenditures, taxes and future reserves, if any. Any future
dividends will be authorized by the Board of Directors and declared by the Company based upon a
variety of factors deemed relevant by directors of the Company. In addition, financial covenants
in the Credit Agreement may restrict the Companys ability to pay future quarterly dividends. The
Board of Directors will continue to evaluate the Companys dividend program each quarter and will
make adjustments as necessary, based on a variety of factors, including, among other things, the
Companys financial condition, liquidity, earnings projections and business prospects, and no
assurance can be given that this dividend program will not change in the future.
Credit Facility
On July 28, 2009, the Company entered into a Revolving Credit and Security Agreement which was
subsequently amended on March 2, 2010 (the Credit Agreement) with CapitalSource Bank
(CapitalSource). The Credit Agreement is set to mature on October 31, 2011 and includes a $40.0
million revolving credit facility, with a current facility cap of $20.0 million, under which the Company has
available standby letters of credit up to $15.0 million.
The Company may request an increase in the current facility cap of up
to an additional $20.0 million subject to lender approval.
The amount available to the Company for
borrowings under the Credit Agreement is based on the Companys collateral base, as determined
under the Credit Agreement, and is reduced by the amount of each outstanding standby letter of
credit. The Credit Agreement is secured by substantially all assets of the Company and its
operating subsidiaries. At December 31, 2009, the Company had no borrowings outstanding under the
Credit Agreement and $16.6 million available for borrowing,
based on the current facility cap and the Companys
collateral base on that date less outstanding standby letters of credit totaling $3.4 million.
Borrowings under the Credit Agreement are limited to the lesser of (1) 85% of eligible
receivables or (2) the current facility cap (the Borrowing Capacity). Interest under the Credit Agreement
is payable monthly at an annual rate of one-month LIBOR plus 2%, subject to a minimum LIBOR rate of
3.14%. The Company is also required to pay a monthly collateral management fee equal to 0.042% on
average borrowings outstanding under the Credit Agreement.
Under the terms of the Credit Agreement, the Company is required to pay a monthly unused line
fee equal to 0.0375% on the Borrowing Capacity less the actual average borrowings outstanding under
the Credit Agreement for the month and the balance of any outstanding letters of credit.
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All amounts outstanding under the Credit Agreement will be due and payable on October 31,
2011. If the Credit Agreement is extinguished prior to July 31, 2011, the Company will be required
to pay an early termination fee equal to between $0.4 million and $0.8 million of the Borrowing
Capacity depending on the date extinguished.
The Credit Agreement requires the Company to maintain a minimum level of EBITDA of $8.0
million on a trailing twelve-month basis to be measured at the end of each calendar quarter. The
Credit Agreement defines EBITDA as net income plus interest expense, income taxes, depreciation
expense, amortization expense, any other non-cash non-recurring expense, loss from asset sales
outside of the normal course of business and charges and expenses arising out of the Audit
Committee investigation into matters at SPP including any expenses or charges incurred in the
associated shareholder securities suit provided such amounts do not exceed $4.5 million in the
aggregate, minus gains on asset sales outside the normal course of business or other non-recurring
gains. The Company was in compliance with the minimum level of EBITDA covenant requirement at
December 31, 2009.
The Credit Agreement permits the Company to declare and pay cash dividends, but requires the
Company to maintain both a pre-distribution fixed charge coverage ratio and a post-distribution
fixed charge coverage ratio both calculated on a trailing twelve-month basis to be measured at the
end of each calendar quarter. The Credit Agreement defines the pre-distribution fixed charge
coverage ratio as EBITDA, as defined above, divided by the sum of principal payments on outstanding
debt, cash interest expense on outstanding debt, capital expenditures and cash income taxes paid or
accrued. The Credit Agreement requires that the Company maintain a minimum pre-distribution fixed
charge coverage ratio of 1.75. The Credit Agreement defines the post-distribution fixed charge
coverage ratio as EBITDA, as defined above, divided by the sum of principal payments on outstanding
debt, cash interest expense on outstanding debt, capital expenditures, cash income taxes paid or
accrued, and cash dividends paid or accrued or declared. The Credit Agreement requires a minimum
post-distribution fixed charge coverage ratio of 1.25 if the Companys average net cash (cash less
outstanding debt) plus the average amount available for borrowing under the Credit Agreement is
greater than or equal to $20.0 million for the most recent calendar quarter; or, a minimum
post-distribution fixed charge coverage ratio of 1.50 if the Companys average net cash (cash less
outstanding debt) plus the average amount available for borrowing under the Credit Agreement is
less than $20.0 million for the most recent calendar quarter. At December 31, 2009, the Company
was not in compliance with the pre-distribution fixed charge coverage
ratio, as defined prior to the March 2, 2010 amendment, principally due to expenses in the fourth quarter of 2009
related to settlement of the shareholder litigation and has obtained a
waiver of the debt covenant violation from CapitalSource. For further information regarding the shareholder litigation, see Item 3. Legal Proceedings.
Liquidity and Capital Resources Outlook
The Company currently believes that cash flows from operating activities, its available cash,
and its expected available credit under the Amended Credit Agreement will continue to enable it to
meet its contractual obligations and capital expenditure requirements for the foreseeable future.
The Company may, from time to time, consider acquisitions involving other companies or assets.
Such acquisitions or other opportunities may require the Company to raise additional capital by
expanding its existing credit facility and /or issuing debt or equity, as market conditions permit.
If the Company is unable to obtain such additional capital on a timely basis, on favorable terms
or at all, it could have inadequate capital to operate its business, meet its contractual
obligations and capital expenditure requirements or fund potential acquisitions. Current market
and economic conditions, including turmoil and uncertainty in the financial services industry and
credit markets, have caused credit
markets to tighten and led many lenders and institutional investors to reduce, and in some cases,
cease to provide, funding to borrowers. Should the credit markets not improve, the Company can
make no assurances that it would be able to secure additional financing if needed and, if such
funds were available, whether the terms or conditions would be acceptable.
A
portion of the Companys cash resources will need to be used to
fund the settlement of the shareholder litigation
against the Company and certain executive officers. On
February 19, 2010 the Company agreed to the terms of a
mediators proposed settlement, subject to final documentation
as well as approval by the Court. As part of the settlement, the
Company will pay $10.5 million in cash and issue 300,000 shares
of common stock. If the closing share price is below $14.65 per share
at the time of final approval of the settlement by the Court, the
Company will pay the difference in cash.
Contractual Obligations And Commercial Commitments
The Company has certain contractual obligations as of December 31, 2009, summarized by the
period in which payment is due, as follows (dollar amounts in thousands):
Current | 2-3 years | 4-5 years | After 5 years | |||||||||||||
Operating leases |
$ | 1,535 | $ | 2,632 | $ | 2,496 | $ | 2,186 | ||||||||
Workers compensation claims |
2,590 | 2,829 | 1,046 | 665 | ||||||||||||
Professional and general liability claims |
15,253 | 8,660 | 1,238 | 85 | ||||||||||||
Total |
$ | 19,378 | $ | 14,121 | $ | 4,780 | $ | 2,936 | ||||||||
The amounts included in the table above do not include future cash payments for interest. At
December 31, 2009, the Company has no debt outstanding.
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Other Financing Transactions
At December 31, 2009, the Company had standby letters of credit outstanding totaling $3.4
million which were collateralized by a reduction of available borrowing under the Credit Agreement.
At December 31, 2009, the Company was contingently liable for $16.0 million of performance
and litigation bonds. The bonds are collateralized by outstanding standby letters of credit totaling
$3.4 million discussed above.
Off-Balance Sheet Transactions
As
of December 31, 2009, the Company did not have any off-balance sheet financing transactions
or arrangements except the standby letters of credit discussed above and operating leases.
Inflation
Some of the Companys contracts provide for annual increases in the base fixed fee based upon
changes in the regional medical care component of the Consumer Price Index. In all other contracts
that extend beyond one year, the Company utilizes a projection of the future inflation rate of its
cost of services when bidding and negotiating the fixed fee for future years. If the rate of
inflation exceeds the levels projected, the excess costs will be absorbed by the Company with the
financial impact dependent upon contract structure. Conversely, the Company may benefit should the
actual rate of inflation fall below the estimate used in the bidding and negotiation process.
Recent Accounting Pronouncements
Business Combinations. In December 2007, the FASB issued an accounting pronouncement related
to business combinations. This pronouncement addresses the recognition and accounting for
identifiable assets acquired, liabilities assumed, and noncontrolling interests in business
combinations. This pronouncement requires more assets and liabilities to be recorded at fair value
and requires expense recognition (rather than capitalization) of certain pre-acquisition costs. It
also requires any adjustments to acquired deferred tax assets and liabilities occurring after the
related allocation period to be made through earnings. Furthermore, this pronouncement requires
this treatment of acquired deferred tax assets and liabilities be applied to acquisitions occurring
prior to the effective date of this pronouncement. This pronouncement is effective for fiscal
years beginning after December 15, 2008 and is required to be adopted prospectively. The Company
adopted this pronouncement on January 1, 2009 and the adoption had no impact on its financial
position or results of operations.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market risk represents the risk of loss that may impact the consolidated financial statements
of the Company due to adverse changes in financial market prices and rates. The Companys
exposure to market risk is primarily related to changes in the variable interest rate under the
Companys Credit Agreement. The Credit Agreement contains an interest rate based on the one-month
LIBOR rate, subject to a minimum LIBOR rate of 3.14%; therefore the Companys cash flow may be
affected by changes in the one-month LIBOR rate. A hypothetical 10% change in the underlying
interest rate would have would have had no material effect on interest expense paid under the
Credit Agreement. Interest expense represents less than 0.1% and 0.1% of the Companys revenues
for the years ended December 31, 2009 and 2008, respectively. The Company has no debt outstanding
at December 31, 2009.
Item 8. Financial Statements and Supplementary Data
The Companys consolidated financial statements, together with the reports thereon of Deloitte
& Touche LLP, dated March 5, 2010 and Ernst & Young
LLP, dated March 3, 2009, except for Note 6 and Note 17, as
to which the date is March 5, 2010, begin on page F-1 of this Annual Report on Form 10-K and are
incorporated herein by reference.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Changes in Independent Registered Public Accounting Firm
As previously disclosed by the Company, in its Current Report on Form 8-K filed June 12, 2009,
the Companys Audit Committee of the Board of Directors (the Audit Committee) conducted a
competitive process to select a firm to serve as the Companys independent registered public
accounting firm for the fiscal year ending December 31, 2009. As a result of this process and
following careful deliberation, on June 10, 2009, the Audit Committee engaged Deloitte & Touche LLP
(Deloitte) as the
34
Table of Contents
Companys independent registered public accounting firm for the fiscal year ending December
31, 2009, and dismissed Ernst & Young LLP (E&Y) from that role on June 10, 2009.
E&Ys audit reports on the Companys consolidated financial statements as of and for the
fiscal years ended December 31, 2008 and 2007 did not contain an adverse opinion or a disclaimer of
opinion and were not qualified or modified as to uncertainty, audit scope or accounting principles.
During the fiscal years ended December 31, 2008 and 2007 and in the subsequent interim period
through June 10, 2009, neither the Company, nor anyone acting on its behalf, consulted with
Deloitte on any matters or events set forth in Item 304(a)(2) of Regulation S-K.
Disagreements with Accountants on Accounting and Financial Disclosure
There are no disagreements with accountants on accounting and financial disclosure required to
be reported in this annual report pursuant to Item 304 of Regulation S-K.
Item 9A. Controls and Procedures
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
Disclosure controls and procedures are the Companys controls and other procedures that are
designed to ensure that information required to be disclosed in the reports that the Company files
or submits under the Securities Exchange Act of 1934, as amended, (the Exchange Act) is recorded,
processed, summarized and reported in a complete, accurate and appropriate manner, within the time
periods specified in the SECs rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information required to be
disclosed in the reports that the Company files under the Exchange Act is accumulated and
communicated to management, including the Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required disclosure.
As of December 31, 2009, the Company evaluated under the supervision and with the
participation of management, including the Chief Executive Officer and Chief Financial Officer, the
effectiveness of the design and operation of the Companys disclosure controls and procedures,
pursuant to Exchange Act Rule 13a-15 and Rule 15d-15. Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that the Companys disclosure controls and
procedures are effective to ensure that information required to be disclosed in the reports that
the Company files under the Exchange Act is accumulated and communicated to management, including
the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions
regarding required disclosure.
Managements Annual Report on Internal Control Over Financial Reporting
The Companys management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rules 13a 15(f).
Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies and procedures may deteriorate. Under the supervision
and with the participation of management, including the Chief Executive Officer and Chief Financial
Officer, management conducted an evaluation of the effectiveness of internal control over financial
reporting based on the framework in Internal Control Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO). Based on managements assessment
under such framework, management concluded that the Companys internal control over financial
reporting was effective as of December 31, 2009.
Deloitte & Touche LLP, the independent registered public accounting firm that audited the
Companys consolidated financial statements for the year ended December 31, 2009, has issued an
attestation report on the Companys internal control over financial reporting which is included on
page 37.
35
Table of Contents
Changes in Internal Controls
There have been no changes in the Companys internal control over financial reporting during
the Companys fourth fiscal quarter that materially affect, or are reasonably likely to materially
affect, the Companys internal control over financial reporting.
36
Table of Contents
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of
America Service Group Inc.
Brentwood, Tennessee
America Service Group Inc.
Brentwood, Tennessee
We have audited the internal control over financial reporting of America Service Group Inc. and
subsidiaries (the Company) as of December 31, 2009 based on criteria established in Internal
Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. The Companys management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal control over financial
reporting, included in the accompanying Managements Annual Report on Internal Control Over
Financial Reporting. Our responsibility is to express an opinion on the Companys internal control
over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, assessing the risk that a material weakness exists, testing and
evaluating the design and operating effectiveness of internal control based on the assessed risk,
and performing such other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A companys internal control over financial reporting is a process designed by, or under the
supervision of, the companys principal executive and principal financial officers, or persons
performing similar functions, and effected by the companys board of directors, management, and
other personnel to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A companys internal control over financial reporting includes
those policies and procedures that (1) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the
possibility of collusion or improper management override of controls, material misstatements due to
error or fraud may not be prevented or detected on a timely basis. Also, projections of any
evaluation of the effectiveness of the internal control over financial reporting to future periods
are subject to the risk that the controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2009, based on the criteria established in Internal Control
Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the consolidated financial statements and financial statement schedule as of
and for the year ended December 31, 2009 of the Company and our report dated March 5, 2010
expressed an unqualified opinion on those consolidated financial statements and financial statement
schedule.
/s/ DELOITTE & TOUCHE LLP
Nashville, Tennessee
March 5, 2010
March 5, 2010
Item 8B. Other Information
None.
37
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PART III
Item 10. Directors, Executive Officers and Corporate Governance
For information regarding the Directors and Executive Officers of the Company, Audit
Committee and Audit Committee Financial Experts of the Company, the heading Corporate Governance,
Information as to Directors, Nominees and Executive Officers and the subsection Section 16(a)
Beneficial Reporting Compliance under the heading Additional Information in the Companys Proxy
Statement for its 2010 Annual Meeting of Stockholders to be held on June 8, 2010 (the Companys
2010 Proxy Statement) and the accompanying text are incorporated herein by reference.
America Service Group Code Of Conduct & Ethics
America Service Group has a Code of Conduct & Ethics that applies to all its employees,
including senior executives and its Board of Directors. This ethics policy may be viewed on the
Companys web site at www.asgr.com. The Company intends to satisfy the disclosure requirement
under Item 5.05 of Form 8-K relating to amendments to or waivers from any provision of the Code of
Conduct & Ethics applicable to the Companys Chief Executive Officer and Chief Financial Officer by
posting such information on its website.
Item 11. Executive Compensation
The heading Director and Executive Officer Compensation in the Companys 2010 Proxy
Statement and the accompanying text are incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
The headings Security Ownership of Directors and Officers, Principal Stockholders and the
subsection Equity Compensation Plan Information under the heading Director and Executive Officer
Compensation in the Companys 2010 Proxy Statement and the accompanying text are incorporated
herein by reference.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The heading Certain Related Person Transactions and the subsection Director Independence
under the heading Information as to Directors, Nominees and Executive Officers in the Companys
2010 Proxy Statement and the accompanying text is incorporated herein by reference.
Item 14. Principal Accountant Fees and Services
The heading Proposal Two: Ratification of Appointment of Independent Registered Public
Accounting Firm in the Companys 2010 Proxy Statement and the accompanying text is incorporated
herein by reference.
38
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PART IV
Item 15. Exhibits and Financial Statement Schedule
(a) (1) Financial Statements
Listed on the Index to the Consolidated Financial Statements and Schedule on page F-1 of this
Report.
(2) Financial Statement Schedule
Listed on the Index to the Consolidated Financial Statements and Schedule on page F-1 of this
Report.
(3) Exhibits
Exhibit | Description | |||
3.1 | Amended and Restated Certificate of Incorporation of America Service Group Inc. (incorporated
herein by reference to Exhibit 3.1 to the Companys Quarterly Report on Form 10-Q for the
three-month period ended June 30, 2002). |
|||
3.2 | Certificate of Amendment of Amended and Restated Certificate of Incorporation of America Service
Group Inc. (incorporated herein by reference to Exhibit 3.4 to the Companys Quarterly Report on
Form 10-Q for the three month period ended June 30, 2004). |
|||
3.3 | Amended and Restated By-Laws of America Service Group Inc. (incorporated herein by reference to
Exhibit 3.1 to the Companys Current Report on Form 8-K filed on March 3, 2009). |
|||
4.1 | Specimen Common Stock Certificate (incorporated herein by reference to Exhibit 4.1 to the Companys
Quarterly Report on Form 10-Q for the three-month period ended June 30, 2002). |
|||
4.2 | Certificate of Designation of the Series A Convertible Preferred Stock (incorporated herein by
reference to Exhibit 99.3 to the Companys Current Report on Form 8-K filed on February 10, 1999). |
|||
10.1 | Registration Rights Agreement, dated as of January 26, 1999, among America Service Group Inc.,
Health Care Capital Partners L.P. and Health Care Executive Partners L.P. (incorporated herein by
reference to Exhibit 99.9 to the Companys Current Report on Form 8-K filed on February 10,
1999). |
|||
10.2 | Amended and Restated Employment Agreement, dated as of September 15, 2008, between America Service
Group Inc. and Richard Hallworth (incorporated herein by reference to Exhibit 10.2 to the Companys
Current Report on Form 8-K filed on September 19, 2008).* |
|||
10.3 | Separation Agreement and General Release, dated as of September 15, 2008, between America Service
Group Inc. and Michael Catalano (incorporated herein by reference to Exhibit 10.1 to the Companys
Current Report on Form 8-K filed on September 19, 2008).* |
|||
10.4 | Letter Agreement, dated as of November 7, 2008, between America Service Group Inc. and Michael
Catalano (incorporated herein by reference to Exhibit 10.1 to the Companys Current Report on Form
8-K filed on November 10, 2008).* |
|||
10.5 | Amended and Restated Employment Agreement, dated as of September 15, 2008, between America Service
Group Inc. and Michael W. Taylor (incorporated herein by reference to Exhibit 10.3 to the Companys
Current Report on Form 8-K filed on September 19, 2008).* |
|||
10.6 | Employment Agreement, dated March 24, 1998, between Lawrence H. Pomeroy and America Service Group
Inc. (incorporated herein by reference to Exhibit 10.2 to the Companys Quarterly Report on Form
10-Q for the three month period ended March 31, 2004).* |
|||
10.7 | Employment Agreement, dated as of January 26, 2009, between America Service Group Inc. and Jonathan
Walker (incorporated herein by reference to Exhibit 10.1 to the Companys Current Report on Form
8-K filed on March 13, 2009).* |
|||
10.8 | America Service Group Inc. Amended and Restated Incentive Stock Plan (incorporated herein by
reference to Exhibit 10.12 to the Companys Annual Report on Form 10-K for the year ended December
31, 2002).* |
39
Table of Contents
Exhibit | Description | |||
10.9 | America Service Group Inc. Amended and Restated 1999 Incentive Stock Plan (incorporated herein by
reference to Appendix B to the Companys Definitive Proxy Statement for its Annual Meeting of
Stockholders held on June 16, 2004, which Definitive Proxy Statement was filed on April 29, 2004).* |
|||
10.10 | America Service Group Inc. 2009 Equity Incentive Plan (incorporated by reference to Annex A of the
Companys Definitive Proxy Statement on Schedule 14A filed April 30, 2009).* |
|||
10.11 | Amended and Restated Employee Stock Purchase Plan of America Service Group Inc. (incorporated
herein by reference to Exhibit 10.16 to the Companys Annual Report on Form 10-K for the year ended
December 31, 2004).* |
|||
10.12 | 2009 Incentive Compensation Plan of America Service Group Inc. (incorporated herein by reference to
Exhibit 10.3 to the Companys Quarterly Report on Form 10-Q/A for the quarterly period ended March
31, 2009).* |
|||
10.13 | 2010 Incentive Compensation Plan of America Service Group Inc. (incorporated herein by reference to
Exhibit 10.2 to the Companys Current Report on
Form 8-K filed on March 2, 2010).* |
|||
10.14 | Summary of 2010 Director and Executive Officer Compensation.* |
|||
10.15 | Contract between Prison Health Services, Inc, and the New York City Department of Health and Mental
Hygiene (incorporated herein by reference to Exhibit 10.12 to the Companys Annual Report on Form
10-K filed on March 31, 2006). |
|||
10.16 | Renewal, effective as of January 1, 2008, to an Agreement dated January 1, 2005, as amended,
effective July 1, 2005 (incorporated herein by reference to Exhibit 99.1 to the Companys Current
Report on Form 8-K filed on January 4, 2008). |
|||
10.17 | Form of New Director Stock Grant Certificate under the America Service Group Inc. Amended and
Restated 1999 Incentive Stock Plan (incorporated herein by reference to Exhibit 10.1 to the
Companys Current Report on Form 8-K filed on June 14, 2006).* |
|||
10.18 | Form of Director Non-Qualified Stock Option Agreement under the America Service Group Inc. Amended
and Restated Incentive Stock Plan (incorporated herein by reference to Exhibit 10.19 to the
Companys Annual Report on Form 10-K for the year ended December 31, 2004).* |
|||
10.19 | Form of Employee Non-Qualified Stock Option Agreement under the America Service Group Inc. Amended
and Restated Incentive Stock Plan (incorporated herein by reference to Exhibit 10.20 to the
Companys Annual Report on Form 10-K for the year ended December 31, 2004).* |
|||
10.20 | Form of Director Non-Incentive Stock Option Agreement under the America Service Group Inc. Amended
and Restated 1999 Incentive Stock Plan (incorporated herein by reference to Exhibit 10.21 to the
Companys Annual Report on Form 10-K for the year ended December 31, 2004).* |
|||
10.21 | Form of Employee Non-Incentive Stock Option Agreement under the America Service Group Inc. Amended
and Restated 1999 Incentive Stock Plan (incorporated herein by reference to Exhibit 10.22 to the
Companys Annual Report on Form 10-K for the year ended December 31, 2004).* |
|||
10.22 | Form of Employee Incentive Stock Option Agreement under the America Service Group Inc. Amended and
Restated 1999 Incentive Stock Plan (incorporated herein by reference to Exhibit 10.23 to the
Companys Annual Report on Form 10-K for the year ended December 31, 2004).* |
|||
10.23 | Form of Stock Grant Certificate under the America Service Group Inc. Amended and Restated 1999
Incentive Stock Plan (incorporated herein by reference to Exhibit 10.2 to the Companys Quarterly
Report on Form 10-Q filed on August 8, 2007) (supersedes previous form filed as Exhibit 10.24 to
the Companys Annual Report on Form 10-K for the year ended December 31, 2004 (Commission File No.
000-19673) filed with the Commission on March 14, 2005).* |
|||
10.24 | Form of Employee Stock Grant Certificate under the America Service Group Inc. Amended and Restated
1999 Incentive Stock Plan (incorporated herein by reference to Exhibit 10.3 to the Companys
Quarterly Report on Form 10-Q filed on August 8, 2007).* |
|||
10.25 | Form of 2008 Employee Stock Grant Certificate under the America Service Group Inc. Amended and
Restated 1999 Incentive Stock Plan (incorporated herein by reference to Exhibit 10.1 to the
Companys Current Report on Form 8-K filed on August 7, 2008).* |
|||
10.26 | Form of 2008 Non-employee Director Stock Grant Certificate under the America Service Group Inc.
Amended and Restated 1999 Incentive Stock Plan (incorporated herein by reference to Exhibit 10.1 to
the Companys Current Report on Form 8-K filed on August 7, 2008).* |
40
Table of Contents
Exhibit | Description | |||
10.27 | Form of March 2009 Employee Stock Grant Certificate under the America Service Group Inc. Amended
and Restated 1999 Incentive Stock Plan (incorporated herein by reference to Exhibit 10.2 to the
Companys Current Report on Form 8-K filed on March 13, 2009).* |
|||
10.28 | Form of August 2009 Employee Stock Grant Certification under the America Service Group Inc. 2009
Equity Incentive Plan (incorporated by reference to Exhibit 10.1 to the Companys Current Report on
Form 8-K filed on August 11, 2009).* |
|||
10.29 | Contract between Prison Health Services, Inc. and the Commonwealth of Pennsylvania Department of
Corrections (incorporated herein by reference to Exhibit 10.1 to the Companys Current Report on
Form 8-K filed on August 28, 2003). |
|||
10.30 | Contract Modification Agreement No. 1 to Medical Services Agreement between Commonwealth of
Pennsylvania Department of Corrections and Prison Health Services, Inc. (incorporated herein by
reference to Exhibit 10.28 to the Companys Annual Report on Form 10-K filed on March 31, 2006). |
|||
10.31 | Contract Modification Agreement No. 2 to Medical Services Agreement between Commonwealth of
Pennsylvania Department of Corrections and Prison Health Services, Inc. (incorporated herein by
reference to Exhibit 10.29 to the Companys Annual Report on Form 10-K filed on March 31, 2006). |
|||
10.32 | Contract Modification Agreement No. 3 to Medical Services Agreement between Commonwealth of
Pennsylvania Department of Corrections and Prison Health Services, Inc. (incorporated herein by
reference to Exhibit 99.1 to the Companys Current Report on Form 8-K filed on February 6, 2008). |
|||
10.33 | Pharmacy Service Agreement, dated as of May 1, 2007, by and among Prison Health Service, Inc.,
Correctional Health Services, LLC and Maxor National Pharmacy Services Corporation (incorporated
herein by reference to Exhibit 10.1 to the Companys Quarterly Report on Form 10-Q filed on August
8, 2007).+ |
|||
10.34 | Revolving Credit and Security Agreement dated July 28, 2009 between America Service Group Inc., a
Delaware corporation, Prison Health Services, Inc., a Delaware corporation, Prison Health Services
of Indiana, LLC, an Indiana limited liability company, Secure Pharmacy Plus, LLC, a Tennessee
limited liability company, Correctional Health Services, LLC, a New Jersey limited liability
company, and CapitalSource Bank, a California industrial bank, as lender and collateral and
administrative agent (incorporated herein by reference to Exhibit 10.1 to the Companys Current
Report on Form 8-K filed on July 29, 2009). |
|||
10.35 | Amendment
No.1 and Waiver to the Revolving Credit and Security Agreement, dated
March 2, 2010
between America Service Group Inc., a Delaware corporation, Prison Health Services, Inc., a
Delaware corporation, Prison Health Services of Indiana, LLC, an Indiana limited liability company,
Secure Pharmacy Plus, LLC, a Tennessee limited liability company, Correctional Health Services,
LLC, a New Jersey limited liability company, and CapitalSource Bank, a California industrial bank,
as lender and collateral and administrative agent (incorporated herein by reference to
Exhibit 10.1 to the Companys Current Report on
Form 8-K filed on March 2, 2010). |
|||
10.36 | Contract between Prison Health Services, Inc. and the State of Michigan, dated February 10, 2009
(incorporated herein by reference to Exhibit 10.1 to the Companys Current Report on Form 8-K filed
on February 13, 2009). |
|||
11.0 | Computation of Per Share Earnings.** |
|||
21.1 | Subsidiaries of the Company. |
|||
23.1 | Consent of Deloitte & Touche LLP. |
|||
23.2 | Consent of Ernst & Young LLP. |
|||
31.1 | Certification of the Chief Executive Officer Pursuant to Rule 13a-14(a), as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002. |
|||
31.2 | Certification of the Chief Financial Officer Pursuant to Rule 13a-14(a), as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002. |
|||
32.1 | Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002. |
|||
32.2 | Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002. |
* | Management contract, compensatory plan or arrangement. |
41
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** | Data required by U.S. GAAP related to earnings per share is provided in Note 17 to the consolidated financial statements in this report. | |
+ | Indicates that portions of this agreement have been omitted and filed separately with the SEC in a confidential treatment request pursuant to Rule 24b-2 of the Exchange Act. |
42
Table of Contents
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized, on March 8, 2010.
AMERICA SERVICE GROUP INC. | ||||
By: | /s/ RICHARD HALLWORTH | |||
Richard Hallworth | ||||
President and Chief Executive Officer | ||||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the capacities indicated
on March 8, 2010.
Signatures | Title | |
/s/ RICHARD HALLWORTH | Director, President and Chief Executive Officer |
|
Richard Hallworth | (Principal Executive Officer) |
|
Director, Executive Vice President,
|
||
/s/ MICHAEL W. TAYLOR |
Chief Financial Officer and Treasurer |
|
Michael W. Taylor | (Principal Financial and Accounting Officer) |
|
/s/ RICHARD D. WRIGHT | Director, Chairman |
|
Richard D. Wright | ||
/s/ BURTON C. EINSPRUCH | Director |
|
Burton C. Einspruch | ||
/s/ WILLIAM M. FENIMORE, JR. | Director |
|
William M. Fenimore, Jr. | ||
/s/ JOHN W. GILDEA | Director |
|
John W. Gildea | ||
/s/ JOHN C. MCCAULEY | Director |
|
John C. McCauley |
43
Table of Contents
AMERICA SERVICE GROUP INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
Page | ||||
Consolidated Financial Statements |
||||
F-2 | ||||
F-4 | ||||
F-5 | ||||
F-6 | ||||
F-7 | ||||
F-8 | ||||
F-35 | ||||
Valuation and Qualifying Accounts and Reserves (Schedule II) for the years ended December 31, 2009, 2008 and 2007 |
All other schedules are omitted as the required information is inapplicable or is presented in
the Companys Consolidated Financial Statements or the Notes thereto.
F-1
Table of Contents
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of
America Service Group Inc.
Brentwood, Tennessee
America Service Group Inc.
Brentwood, Tennessee
We have audited the accompanying consolidated balance sheet of America Service Group Inc. and
subsidiaries (the Company) as of December 31, 2009, and the related consolidated statements of
operations, stockholders equity, and cash flows for the year then ended. Our audit also included
the financial statement schedule listed in the index at Item 15 (a). These consolidated financial
statements and financial statement schedule are the responsibility of the Companys management. Our
responsibility is to express an opinion on these consolidated financial statements and financial
statement schedule based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such 2009 consolidated financial statements present fairly, in all material
respects, the financial position of America Service Group Inc. and subsidiaries at December 31,
2009, and the results of their operations and their cash flows for the year then ended in
conformity with accounting principles generally accepted in the United States of America. Also, in
our opinion, such financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the Companys internal control over financial reporting as of December 31,
2009, based on the criteria established in Internal ControlIntegrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 5, 2010
expressed an unqualified opinion on the Companys internal control over financial reporting.
/s/ DELOITTE & TOUCHE LLP
Nashville, Tennessee
March 5, 2010
March 5, 2010
F-2
Table of Contents
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of America Service Group Inc.
We have audited the accompanying consolidated balance sheet of America Service Group Inc. (the
Company) as of December 31, 2008, and the related consolidated statements of operations, changes
in stockholders equity and cash flows for each of the two years in the period ended December 31,
2008. Our audits also included the financial statement schedule referenced at Item 15(a) for the
years ended December 31, 2008 and 2007. These financial statements and schedule are the
responsibility of the Companys management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material
respects, the consolidated financial position of America Service Group Inc. at December 31, 2008,
and the consolidated results of its operations and its cash flows for each of the two years in the
period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles.
Also, in our opinion, the related financial statement schedule for the years ended December 31,
2008 and 2007, when considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
As discussed in Note 2 to the consolidated financial statements, on January 1, 2007, the Company
changed its method of accounting for income tax contingencies in accordance with the guidance
originally issued in Financial Accounting Standards Board Interpretation No. 48 (codified in FASB
ASC Topic 740, Income Taxes).
/s/ ERNST & YOUNG LLP
Nashville, Tennessee
March 3, 2009, except for Note 6 and Note 17, as to which the date is March 5, 2010
March 3, 2009, except for Note 6 and Note 17, as to which the date is March 5, 2010
F-3
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AMERICA SERVICE GROUP INC.
CONSOLIDATED BALANCE SHEETS
(shown in 000s except share and per share amounts)
(shown in 000s except share and per share amounts)
December 31, | ||||||||
2009 | 2008 | |||||||
ASSETS |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 37,655 | $ | 24,855 | ||||
Accounts receivable: healthcare and other, less allowances of $358 and $417, respectively |
44,629 | 41,007 | ||||||
Inventories |
2,929 | 2,933 | ||||||
Prepaid expenses and other current assets |
16,754 | 12,987 | ||||||
Current deferred tax assets |
9,252 | 5,333 | ||||||
Total current assets |
111,219 | 87,115 | ||||||
Property and equipment, net |
9,447 | 6,442 | ||||||
Goodwill |
40,772 | 40,772 | ||||||
Contracts, net |
1,937 | 2,217 | ||||||
Other intangibles, net |
| 154 | ||||||
Other assets |
11,837 | 5,183 | ||||||
Total assets |
$ | 175,212 | $ | 141,883 | ||||
LIABILITIES AND EQUITY |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 15,393 | $ | 19,570 | ||||
Accrued medical claims liability |
22,358 | 14,743 | ||||||
Accrued expenses |
62,895 | 36,466 | ||||||
Deferred revenue |
13,385 | 8,052 | ||||||
Total current liabilities |
114,031 | 78,831 | ||||||
Noncurrent portion of accrued expenses |
15,481 | 17,146 | ||||||
Noncurrent deferred tax liabilities |
3,727 | 1,860 | ||||||
Total liabilities |
133,239 | 97,837 | ||||||
Commitments and contingencies (Note 21) |
||||||||
Stockholders equity: |
||||||||
Preferred stock, $0.01 par value, 2,000,000 shares authorized at December 31, 2009 and
2008; no shares issued or outstanding |
| | ||||||
Common stock, $0.01 par value, 20,000,000 shares authorized at December 31, 2009 and
2008; 8,947,370 and 9,260,708 shares issued and outstanding at December 31, 2009 and
2008, respectively |
89 | 93 | ||||||
Additional paid-in capital |
33,608 | 38,047 | ||||||
Retained earnings |
8,276 | 5,906 | ||||||
Total stockholders equity |
41,973 | 44,046 | ||||||
Total
liabilities and equity |
$ | 175,212 | $ | 141,883 | ||||
The accompanying notes to consolidated financial statements are an integral part of these
consolidated balance sheets.
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AMERICA SERVICE GROUP INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(shown in 000s except share and per share amounts)
(shown in 000s except share and per share amounts)
Year Ended December 31, | ||||||||||||
2009 | 2008 | 2007 | ||||||||||
Healthcare revenues |
$ | 606,176 | $ | 485,022 | $ | 452,346 | ||||||
Healthcare expenses |
558,228 | 445,152 | 426,269 | |||||||||
Gross margin |
47,948 | 39,870 | 26,077 | |||||||||
Selling, general, and administrative expenses |
29,972 | 27,045 | 26,271 | |||||||||
Corporate restructuring expenses |
| 2,255 | 440 | |||||||||
Audit Committee investigation and related expenses |
8,413 | 226 | 108 | |||||||||
Depreciation and amortization |
2,832 | 3,797 | 3,771 | |||||||||
Income (loss) from operations |
6,731 | 6,547 | (4,513 | ) | ||||||||
Interest expense, net |
117 | 722 | 1,587 | |||||||||
Income (loss) from continuing operations before income tax provision
(benefit) |
6,614 | 5,825 | (6,100 | ) | ||||||||
Income tax provision (benefit) |
3,123 | 2,632 | (2,293 | ) | ||||||||
Income (loss) from continuing operations |
3,491 | 3,193 | (3,807 | ) | ||||||||
Income (loss) from discontinued operations, net of taxes |
(209 | ) | 641 | 6,622 | ||||||||
Net income |
$ | 3,282 | $ | 3,834 | $ | 2,815 | ||||||
Net income available to common shareholders (Note 17) |
$ | 3,176 | $ | 3,759 | $ | 2,815 | ||||||
Net income (loss) available to common shareholders per common share basic: |
||||||||||||
Continuing operations |
$ | 0.38 | $ | 0.34 | $ | (0.41 | ) | |||||
Discontinued operations, net of taxes |
(0.02 | ) | 0.07 | 0.71 | ||||||||
Net income available to common shareholders per common share (Note 17) |
$ | 0.36 | $ | 0.41 | $ | 0.30 | ||||||
Net income (loss) available to common shareholders per common share
diluted: |
||||||||||||
Continuing operations |
$ | 0.38 | $ | 0.34 | $ | (0.41 | ) | |||||
Discontinued operations, net of taxes |
(0.03 | ) | 0.07 | 0.71 | ||||||||
Net income available to common shareholders per common share (Note 17) |
$ | 0.35 | $ | 0.41 | $ | 0.30 | ||||||
Weighted average common shares outstanding: |
||||||||||||
Basic |
8,916,737 | 9,144,102 | 9,394,729 | |||||||||
Diluted |
8,959,087 | 9,152,712 | 9,394,729 | |||||||||
Dividends declared and paid per share |
$ | 0.10 | $ | | $ | | ||||||
The accompanying notes to consolidated financial statements are an integral part of these
consolidated statements.
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AMERICA SERVICE GROUP INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
(shown in 000s except share amounts)
(shown in 000s except share amounts)
Retained | ||||||||||||||||||||
Additional | Earnings | |||||||||||||||||||
Common Stock | Paid-In | (Accumulated | ||||||||||||||||||
Shares | Amount | Capital | Deficit) | Total | ||||||||||||||||
Balance at December 31, 2006 |
10,049,587 | $ | 100 | $ | 47,597 | $ | (1,243 | ) | $ | 46,454 | ||||||||||
Impact of adoption of income tax contingency accrual guidance |
| | | 500 | 500 | |||||||||||||||
Opening balance at January 1, 2007 as adjusted |
10,049,587 | 100 | 47,597 | (743 | ) | 46,954 | ||||||||||||||
Net income |
| | | 2,815 | 2,815 | |||||||||||||||
Total comprehensive income |
2,815 | |||||||||||||||||||
Issuance of common stock under employee stock plan |
28,897 | | 377 | | 377 | |||||||||||||||
Issuance of restricted shares |
109,570 | 1 | (1 | ) | | | ||||||||||||||
Forfeiture of restricted shares |
(6,840 | ) | | | | | ||||||||||||||
Share-based employee compensation expense |
| | 3,158 | | 3,158 | |||||||||||||||
Repurchase and retirement of common stock |
(865,200 | ) | (8 | ) | (13,646 | ) | | (13,654 | ) | |||||||||||
Balance at December 31, 2007 |
9,316,014 | 93 | 37,485 | 2,072 | 39,650 | |||||||||||||||
Net income |
| | | 3,834 | 3,834 | |||||||||||||||
Total comprehensive income |
3,834 | |||||||||||||||||||
Issuance of common stock under employee stock plan |
37,294 | 1 | 234 | | 235 | |||||||||||||||
Exercise of options and related tax benefits |
15,300 | | 84 | | 84 | |||||||||||||||
Issuance of restricted shares |
148,000 | 1 | (1 | ) | | | ||||||||||||||
Income tax deficiency from share-based employee compensation |
| | (145 | ) | | (145 | ) | |||||||||||||
Forfeiture of restricted shares |
(9,000 | ) | | | | | ||||||||||||||
Share-based employee compensation expense |
| | 2,762 | | 2,762 | |||||||||||||||
Repurchase and retirement of common stock |
(246,900 | ) | (2 | ) | (2,372 | ) | | (2,374 | ) | |||||||||||
Balance at December 31, 2008 |
9,260,708 | 93 | 38,047 | 5,906 | 44,046 | |||||||||||||||
Net income |
| | | 3,282 | 3,282 | |||||||||||||||
Total comprehensive income |
3,282 | |||||||||||||||||||
Dividends on common stock ($0.10 per common share) |
| | | (912 | ) | (912 | ) | |||||||||||||
Issuance of common stock under employee stock plan |
37,608 | | 319 | | 319 | |||||||||||||||
Exercise of options and related tax benefits |
149,088 | 1 | 1,862 | | 1,863 | |||||||||||||||
Issuance of restricted shares |
132,700 | 1 | (1 | ) | | | ||||||||||||||
Restricted stock repurchased from employees for employees tax liability |
(10,284 | ) | | (177 | ) | | (177 | ) | ||||||||||||
Forfeiture of restricted shares |
(11,000 | ) | | | | | ||||||||||||||
Share-based employee compensation expense |
| | 1,822 | | 1,822 | |||||||||||||||
Repurchase and retirement of common stock |
(611,450 | ) | (6 | ) | (8,264 | ) | | (8,270 | ) | |||||||||||
Balance at December 31, 2009 |
8,947,370 | $ | 89 | $ | 33,608 | $ | 8,276 | $ | 41,973 | |||||||||||
The accompanying notes to consolidated financial statements are an integral part of these consolidated statements.
F -6
Table of Contents
AMERICA SERVICE GROUP INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(shown in 000s)
(shown in 000s)
Year Ended December 31, | ||||||||||||
2009 | 2008 | 2007 | ||||||||||
Cash flows from operating activities |
||||||||||||
Net income |
$ | 3,282 | $ | 3,834 | $ | 2,815 | ||||||
Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||||||
Depreciation and amortization |
2,842 | 3,841 | 3,875 | |||||||||
Loss on retirement of fixed assets |
32 | 81 | 58 | |||||||||
Finance cost amortization |
114 | 40 | 116 | |||||||||
Deferred income taxes |
(1,908 | ) | 2,640 | 2,058 | ||||||||
Share-based compensation expense |
1,822 | 2,813 | 3,158 | |||||||||
Excess tax benefits from share-based compensation expense |
(144 | ) | (51 | ) | | |||||||
Changes in operating assets and liabilities, net of effect of sale of SPP assets: |
||||||||||||
Accounts receivable, net |
(3,622 | ) | 21,656 | 15,687 | ||||||||
Inventories |
4 | 66 | 2,180 | |||||||||
Prepaid expenses and other current assets |
(3,767 | ) | (2,260 | ) | 2,088 | |||||||
Other assets |
(6,767 | ) | 3,958 | 785 | ||||||||
Accounts payable |
(4,177 | ) | (694 | ) | (6,545 | ) | ||||||
Accrued medical claims liability |
7,615 | (7,441 | ) | (8,821 | ) | |||||||
Accrued expenses |
23,865 | 4,286 | (8,202 | ) | ||||||||
Deferred revenue |
5,333 | (3,944 | ) | 256 | ||||||||
Net cash provided by operating activities |
24,524 | 28,825 | 9,508 | |||||||||
Cash flows from investing activities |
||||||||||||
Proceeds from sale of SPP assets |
| | 3,811 | |||||||||
Capital expenditures |
(4,547 | ) | (3,384 | ) | (2,309 | ) | ||||||
Net cash provided by (used in) investing activities |
(4,547 | ) | (3,384 | ) | 1,502 | |||||||
Cash flows from financing activities |
||||||||||||
Net payments on line of credit facility |
| (7,500 | ) | (2,500 | ) | |||||||
Dividends on common stock |
(912 | ) | | | ||||||||
Restricted stock repurchased from employees for employees tax liability |
(177 | ) | | | ||||||||
Excess tax benefits from share-based compensation expense |
144 | 51 | | |||||||||
Share repurchases |
(8,270 | ) | (2,374 | ) | (13,654 | ) | ||||||
Issuance of common stock |
319 | 235 | 377 | |||||||||
Exercise of stock options |
1,719 | 33 | | |||||||||
Net cash used in financing activities |
(7,177 | ) | (9,555 | ) | (15,777 | ) | ||||||
Net increase (decrease) in cash and cash equivalents |
12,800 | 15,886 | (4,767 | ) | ||||||||
Cash and cash equivalents at beginning of year |
24,855 | 8,969 | 13,736 | |||||||||
Cash and cash equivalents at end of year |
$ | 37,655 | $ | 24,855 | $ | 8,969 | ||||||
Supplemental cash flow information |
||||||||||||
Cash paid for interest |
$ | 208 | $ | 929 | $ | 1,771 | ||||||
Cash paid for income taxes |
$ | 1,668 | $ | 342 | $ | 157 | ||||||
Supplemental schedule of non-cash operating and investing activities |
||||||||||||
Capital expenditures funded by tenant improvement allowance |
$ | 899 | $ | | $ | | ||||||
The accompanying notes to consolidated financial statements are an integral part of these consolidated statements.
F -7
Table of Contents
AMERICA SERVICE GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009
December 31, 2009
1. Description of Business
America Service Group Inc. (ASG or the Company) and its consolidated subsidiaries provide
managed healthcare services to correctional facilities under contracts with state and local
governments and certain private entities. The health status of inmates impacts the results of
operations under such contractual arrangements. The consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries, Prison Health Services, Inc. (PHS),
Correctional Health Services, LLC (CHS) and Secure Pharmacy Plus, LLC (SPP).
On April 12, 2007, SPP and PHS, as guarantor, entered into an asset purchase agreement with
Maxor National Pharmacy Services Corporation (Maxor) whereby SPP agreed to sell certain of its
assets at net book value (the Transaction). The closing of the Transaction occurred on May 3,
2007, with an effective date as of April 30, 2007. The net book value of the assets included in
the Transaction was approximately $3.8 million as of April 30, 2007, which consisted of
approximately $1.9 million in inventory and approximately $2.0 million in fixed assets, offset by
approximately $0.1 million of liabilities for accrued vacation assumed by Maxor. Additionally, as
a condition to the closing of the Transaction, Maxor and PHS entered into a long-term pharmacy
services agreement (the Services Agreement) pursuant to which Maxor became the provider of
pharmaceuticals and medical supplies to PHS. The Services Agreement commenced effective May 1,
2007 and will remain in effect until October 31, 2014 (unless terminated earlier in accordance with
the terms of the Services Agreement). During the term of the Services Agreement, PHS will utilize
Maxor on an exclusive basis to provide pharmaceuticals and medical and surgical supplies to PHS,
except in certain specified situations, including when a PHS client elects or requires PHS to
utilize another pharmacy services provider.
2. Summary of Significant Accounting Policies
Principles of Consolidation
All intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of the consolidated financial statements in conformity with United States
Generally Accepted Accounting Principles (U. S. GAAP) requires management to make estimates and
assumptions that affect the amounts reported in the consolidated financial statements and
accompanying notes. Actual results could differ from those estimates. Some of the more
significant areas requiring estimates in the consolidated financial statements include the
Companys accruals for unbilled medical services calculated based upon a claims payment lag
methodology, realization of goodwill, estimated amortizable life of contract intangibles,
reductions in revenue for contractual allowances, allowance for doubtful accounts, legal
contingencies and share-based compensation as well as accruals associated with employee health,
workers compensation and professional and general liability claims, for which the Company is
substantially self-insured. Estimates change as new events occur, more experience is acquired, or
additional information is obtained. A change in an estimate is accounted for in the period of
change.
Fair Value of Financial Instruments
The Companys financial instruments reported in the consolidated balance sheets consist of
cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities. Due to
the short term nature of these instruments and the variable interest rate nature of the cash
equivalents, the carrying amounts approximate fair value.
Revenue and Cost Recognition
The Companys contracts to provide healthcare services to correctional institutions are
principally fixed price contracts with revenue adjustments for census fluctuations and risk sharing
arrangements, such as stop-loss provisions and aggregate limits for off-site or pharmaceutical
costs. Such contracts typically have a term of one to three years with subsequent renewal options
and generally may be terminated by either party without cause upon proper notice. Revenues earned
under contracts with correctional institutions
F -8
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are recognized in the period that services are rendered. Cash received in advance for future
services is recorded as deferred revenue and recognized as income when the service is performed.
Revenues are calculated based on the specific contract terms and fall into one of three
general categories: fixed fee, population based, or cost plus a fee.
For fixed fee contracts, revenues are recorded based on fixed monthly amounts established in
the service contract irrespective of inmate population. Revenues for population-based contracts
are calculated either on a fixed fee that is subsequently adjusted using a per diem rate for
variances in the inmate population from predetermined population levels or by a per diem rate
multiplied by the average inmate population for the period of service. For cost plus a fee
contracts, revenues are calculated based on actual expenses incurred during the service period plus
a contractual fee.
Generally, the Companys contracts will also include additional provisions which mitigate a
portion of the Companys risk related to cost increases. Off-site utilization risk is mitigated in
the majority of the Companys contracts through aggregate pools or caps for off-site expenses,
stop-loss provisions, cost plus a fee arrangements or, in some cases, the entire exclusion of
certain or all off-site service costs. Pharmacy expense risk is similarly mitigated in certain of
the Companys contracts. Typically, under the terms of such provisions, the Companys revenue
under the contract increases to offset increases in specified cost categories such as off-site
expenses or pharmaceutical costs. For contracts that include such provisions, the Company
recognizes the additional revenues due from clients based on its estimates of applicable contract
to date costs incurred as compared to the corresponding pro rata contractual limit for such costs.
Because such provisions typically specify how often such additional revenue may be invoiced and
require all such additional revenue to be ultimately settled based on actual expenses, the
additional revenues are initially recorded as unbilled receivables until the time period for
billing has been met and actual costs are known. Any differences between the Companys estimates
of incurred costs and the actual costs are recorded in the period in which such differences become
known along with the corresponding adjustment to the amount of recorded additional revenues.
Under all contracts, the Company records revenues net of any estimated contractual allowances
for potential adjustments resulting from a failure to meet performance or staffing related
criteria. If necessary, the Company revises its estimates for such adjustments in future periods
when the actual amount of the adjustment is determined.
The table below illustrates these revenue categories as a percentage of total revenues from
continuing operations for the years ended December 31, 2009, 2008 and 2007.
Percentage of Revenue from Continuing Operations | ||||||||||||
For the Year Ended | For the Year Ended | For the Year Ended | ||||||||||
Contract Category | December 31, 2009 | December 31, 2008 | December 31, 2007 | |||||||||
Fixed Fee |
12.8 | % | 15.2 | % | 14.9 | % | ||||||
Population Based |
63.7 | % | 58.0 | % | 57.6 | % | ||||||
Cost Plus a Fee |
23.5 | % | 26.8 | % | 26.8 | % | ||||||
Pharmacy Revenue* |
| | 0.7 | % |
* | Pharmacy revenue is revenue recognized by SPP. Effective April 30, 2007, SPP sold certain of its assets to Maxor. For more information, see Note 1. |
Contracts under the population based and fixed fee categories generally have similar
margins which are higher than margins for contracts under the cost plus a fee category. Cost plus
a fee contracts generally have lower margins but with much less potential for variability due to
the limited risk involved. The Companys profitability under each of the three general contract
categories discussed above varies based on the level of risk assumed under the contract terms with
the most potential for variability being in contracts under the population based or fixed fee
categories which do not contain the risk mitigating provisions related to off-site utilization
described above.
Healthcare expenses include the compensation of physicians, nurses and other healthcare
professionals and related benefits and all other direct costs of providing and/or administering
the managed care, including the costs associated with services provided and/or administered by
off-site medical providers, the costs of professional and general liability insurance and other
self-funded insurance reserves discussed more fully below. Many of the Companys contracts require
the Companys customers to reimburse the Company for all treatment costs or, in some cases, only
treatment costs related to certain catastrophic events, and/or for specific disease diagnoses
illnesses. Certain of the Companys contracts do not contain such limits. The Company attempts to
compensate for the
F -9
Table of Contents
increased financial risk when pricing contracts that do not contain individual, catastrophic
or specific disease diagnosis-related limits. However, the occurrence of severe individual cases,
specific disease diagnoses illnesses or a catastrophic event in a facility governed by a contract
without such limitations could render the contract unprofitable and could have a material adverse
effect on the Companys operations. For certain of its contracts that do not contain catastrophic
protection, the Company maintains stop loss insurance from an unaffiliated insurer with respect
to, among other things, inpatient and outpatient hospital expenses (as defined in the policy) for
amounts in excess of $375,000 per inmate up to an annual cap of $1.0 million per inmate. Amounts
reimbursable per claim under the policy are further limited to the lessor of 60% of billed
charges, the amount paid or the contracted amounts in situations where the Company has negotiated
rates with the applicable providers.
The cost of healthcare services provided, administered or contracted for are recognized in the
period in which they are provided and/or administered based in part on estimates, including an
accrual for estimated unbilled medical services rendered through the balance sheet date. The
Company estimates the accrual for unbilled medical services using actual utilization data including
hospitalization, one-day surgeries, physician visits and emergency room and ambulance visits and
their corresponding costs, which are estimated using the average historical cost of such services.
Additionally, the Companys utilization management personnel perform a monthly review of inpatient
hospital stays in order to identify any stays which would have a cost in excess of the historical
average rates. Once identified, reserves for such stays are determined which take into
consideration the specific facts of the stay. An actuarial analysis is also prepared at least
quarterly as an additional tool to be considered by management in evaluating the adequacy of the
Companys total accrual related to contracts which have sufficient claims payment history. The
analysis takes into account historical claims experience (including the average historical costs
and billing lag time for such services) and other actuarial data.
Actual payments and future reserve requirements will differ from the Companys current
estimates. The differences could be material if significant fluctuations occur in the healthcare
cost structure or the Companys future claims experience. Changes in estimates of claims resulting
from such fluctuations and differences between actuarial estimates and actual claims payments are
recognized in the period in which the estimates are changed or the payments are made. In 2009,
2008 and 2007, the Company recorded decreases of approximately $0.4 million, $0.7 million and $6.1
million, respectively, to its prior year claims liabilities as a result of revisions to its
estimated claims expense. The impact to net income of these reductions to the Companys claims
reserves and associated expense is dependent upon whether any of the associated customer contracts
contained provisions limiting risk of off-site costs. For 2007, the overall decrease in claims
liabilities is net of an increase to the claims liabilities associated with two former full risk
contracts resulting in a negative impact to the Companys net income of $0.7 million. The
reductions to claims reserves in 2008 and 2009 did not result in a significant impact to the
Companys net income as the changes occurred primarily in connection with contracts which contained
provisions limiting risk of off-site costs and, as a result, these changes were off-set by
corresponding reductions to revenue.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, demand deposits, money market funds and
investments which can be liquidated within three months or less when purchased. Due to the short
term nature of these instruments, the carrying amounts approximate fair value.
Accounts Receivable
Accounts receivable represent amounts due from state and local governments for healthcare
services provided and/or administered by the Company. Included in unbilled accounts receivable is
the Companys estimate of revenue earned under risk sharing provisions.
Accounts receivable are stated at estimated net realizable value. The Company recognizes
allowances for doubtful accounts based on a variety of factors, including the length of time
receivables are past due, significant one-time events, contractual rights, client funding and/or
political pressures, discussions with clients and historical experience. If circumstances change,
estimates of the recoverability of receivables would be further adjusted and such adjustments could
have a material adverse effect on the Companys results of operations in the period in which they
are recorded.
Inventories
Pharmacy and medical supplies inventories are stated at the lower of cost (first-in, first-out method) or market.
F -10
Table of Contents
Property and Equipment
Property and equipment are recorded at cost and depreciated on a straight-line basis over the
estimated useful lives of the assets. Expenditures for maintenance and repairs are charged to
expense as incurred, whereas expenditures for improvements and replacements are capitalized. The
cost and accumulated depreciation of assets sold or otherwise disposed of are removed from the
accounts and the resulting gain or loss is reflected in the consolidated statements of operations.
Software Costs
The Company capitalizes costs associated with internally developed software systems that have
reached the application development stage. Capitalized costs include external direct costs of
materials and services utilized in developing or obtaining internal-use software and payroll and
payroll-related expenses for employees who are directly associated with and devote time to the
internal-use software project. Capitalization of such costs begins when the preliminary project
stage is complete and ceases no later than the point at which the project is substantially
complete and ready for its intended purpose.
Goodwill
Goodwill acquired is not amortized but is reviewed for impairment on an annual basis or more
frequently whenever events or circumstances indicate that the carrying value may not be
recoverable. U.S. GAAP requires that goodwill be tested at the reporting unit level, defined as an
operating segment or one level below an operating segment (referred to as a component), with the
fair value of the reporting unit being compared to its carrying amount, including goodwill. If the
fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is not
considered to be impaired. The Company has determined that it has one operating, as well as one
reportable, segment. The Companys policy is to perform its annual goodwill impairment test as of
the last day of each fiscal year, i.e. December 31.
In
performing its annual goodwill impairment test, the Company uses a two-step process. The
first step is a screen for potential impairment, while the second step measures the amount of the
impairment, if any. The first step of the goodwill impairment test compares the fair value of a
reporting unit with its carrying amount, including goodwill. The Company determined the fair value
of its reporting unit to equal the market capitalization of its common stock as of the testing
date. As of December 31, 2009, the indicated fair value of the Companys reporting unit exceeded
the carrying value of its reporting unit by 338%, and, as such, the Company concluded that there
was no indication of goodwill impairment.
Future events could cause the Company to conclude that impairment indicators exist and that
the Companys goodwill is impaired. Any resulting impairment loss could have a material adverse
impact on the Companys financial condition and results of operations.
Important factors taken into consideration when evaluating the need for an impairment review,
other than the annual impairment test, include the following:
| significant underperformance or loss of key contracts relative to expected historical or projected future operating results; | ||
| significant changes in the manner of use of the Companys assets or in the Companys overall business strategy; | ||
| significant negative industry or economic trends; and | ||
| an adverse change in the Companys market capitalization. |
If the Company determines that the carrying value of goodwill may be impaired based upon the
existence of one or more of the above or other indicators of impairment or as a result of its
annual impairment review, any impairment is measured using a fair-value-based goodwill impairment
test. Fair value is the amount at which the asset could be bought or sold in a current
transaction between willing parties and may be estimated using a number of techniques, including
quoted market prices or valuations by third parties, present value techniques based on estimates
of cash flows, or multiples of earnings or revenues. The fair value of the asset could be
different using different estimates and assumptions in these valuation techniques.
Contracts and Other Intangibles
The Companys other identifiable intangible assets, such as customer contracts acquired in
acquisitions are amortized on the straight-line method over their estimated useful lives. The
Company also assesses the potential impairment of its other identifiable intangibles whenever
events or changes in circumstances indicate that the carrying value may not be recoverable.
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When the Company determines that the carrying value of other intangible assets may not be
recoverable based upon the existence of one or more of the above indicators of impairment, such
impairment will be measured using an estimate of the assets fair value based on the projected net
cash flows expected to result from that asset, including eventual disposition.
The Company amortizes its contract intangibles on a straight-line basis over their estimated
useful life. The Company evaluates the estimated remaining useful life of its contract intangibles
on at least a quarterly basis, taking into account new facts and circumstances, including its
retention rate for acquired contracts. If such facts and circumstances indicate the current
estimated useful life is no longer reasonable, the Company adjusts the estimated useful life on a
prospective basis. Contract amortization expense totaled approximately $0.3 million, $1.7 million
and $1.6 million for the years ended December 31, 2009, 2008 and 2007, respectively.
Other intangibles are comprised primarily of non-compete agreements. Amortization of
non-compete agreements is calculated over the term of the related agreements (2 to 10 years) and
approximates $0.2 million for each of the three years ended December 31, 2009, 2008 and 2007.
Other Assets
Other assets at December 31, 2009 and 2008 include cash deposits totaling approximately $9.8
million and $3.3 million, respectively, which are held by the Companys professional liability
insurer and workers compensation insurer and are not expected to be utilized within the next year.
In addition to cash deposits recorded within other assets, the Company has recorded cash
deposits for professional liability claims losses totaling $8.5 million and $6.1 million at
December 31, 2009 and 2008, respectively, within prepaid expenses and other current assets, which
are expected to be utilized within a year. Under the terms of the Companys professional
liability insurance policies for 2002 through 2006 and 2008 through 2009, this cash will be used
by the insurer to pay any professional liability claims made against the Company during those
years. Based on evaluation of outstanding claims, management estimates the amount of cash
deposits that will be utilized by the insurer to pay losses within a year.
Also included in other assets at December 31, 2009 and 2008 are deferred financing costs
associated with the Companys credit facility (see Note 14). Such costs are being amortized over
the life of the credit facility and such amortization is included in interest expense on the
accompanying consolidated statements of operations. Amortization expense associated with deferred
financing costs was approximately $0.1 million, $40,000 and $0.1 million for the years ended
December 31, 2009, 2008 and 2007, respectively.
Long-Lived Assets
The Company considers whether indicators of impairment of long-lived assets held for use
(including the Companys property and equipment, contracts and other intangibles) are present. If
such indicators are present, the Company determines whether the sum of the estimated undiscounted
future cash flows attributable to such assets is less than their carrying amount, and if so,
recognizes an impairment loss based on the excess of the carrying amount of the assets over their
fair value. Accordingly, management periodically evaluates the ongoing value of property and
equipment and intangible assets and considers events, circumstances and operating results,
including consideration of contract performance at the fixed price contract level, to determine if
impairment exists. If long-lived assets are deemed impaired, management adjusts the asset value
to fair value.
Income Taxes
The Company accounts for income taxes under the provisions of U.S. GAAP related to income
taxes. Under the asset and liability method of U.S. GAAP related to income taxes, deferred tax
assets and liabilities are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and liabilities and their
respective tax bases.
The Company regularly reviews its deferred tax assets for recoverability taking into
consideration such factors as historical losses, projected future taxable income and the expected
timing of the reversals of existing temporary differences. U.S. GAAP requires the Company to
record a valuation allowance when it is more likely than not that some portion or all of the
deferred tax assets will not be realized. At December 31, 2009, the Companys valuation allowance
of approximately $0.2 million represents managements estimate of state net operating loss
carryforwards which will expire unused.
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The Company accounts for tax contingency accruals under the provisions of U.S. GAAP related to
accounting for uncertainty in income taxes, as adopted on January 1, 2007. The Companys tax
contingency accruals are reviewed quarterly and can be adjusted in light of changing facts and
circumstances, such as the progress of tax audits, case law and emerging legislation. Adjustments
to the tax contingency accruals are recorded in the period in which the new facts or circumstances
become known, therefore the accruals are subject to change in future periods and such change, if it
were to occur, could have a material adverse effect on the Companys results of operations.
It is the Companys policy to recognize accrued interest and penalties related to its tax
contingencies as income tax expense. As the Company has no tax contingencies at December 31, 2009,
there is no accrued interest and penalties included in income tax expense for the year ended
December 31, 2009.
The Company files income tax returns in the U.S. federal jurisdiction and various state
jurisdictions. The Company may be subject to examination by the Internal Revenue Service (IRS)
for calendar years 2006 through 2009. Additionally, open tax years related to certain state and
local jurisdictions remain subject to examination.
Professional and General Liability Self-Insurance Retention
As a healthcare provider, the Companys business occasionally results in actions for
negligence and other causes of action related to its provision of healthcare services with the
attendant risk of substantial damage awards, or court ordered non-monetary relief such as, changes
in operating practices or procedures, which may lead to the potential for substantial increases in
the Companys operating expenses. The most significant source of potential liability in this regard
is the risk of suits brought by inmates alleging negligent healthcare services, deliberate
indifference to their medical needs or the lack of timely or adequate healthcare services. The
Company may also be liable, as employer, for the negligence of healthcare professionals it employs
or healthcare professionals with whom it contracts. The Companys contracts generally provide for
the Company to indemnify the governmental agency for losses incurred related to healthcare provided
by the Company and its agents.
To mitigate a portion of this risk, the Company maintains a primary professional liability
insurance program, principally on a claims-made basis. For 2002 through 2006 and 2008 through 2009
with respect to the majority of its patients, the Company purchased commercial insurance coverage,
but is effectively self-insured due to the terms of the coverage which include adjustable premiums.
For 2002 through 2006 and 2008 through 2009, the Company is covered by separate policies, each of
which contains a premium that is retroactively adjusted, with adjustment based on actual losses.
The Companys ultimate premium for its 2002 through 2006 and 2008 through 2009 policies will depend
on the final incurred losses related to each of these separate policy periods. For 2007, the
Company is insured through claims made policies subject to per event and aggregate coverage limits.
Any amounts ultimately incurred above these coverage limits would be the responsibility of the
Company. Management establishes reserves for the estimated losses that will be incurred under
these insurance policies after taking into consideration the Companys professional liability
claims department and external counsel evaluations of the merits of the individual claims, analysis
of claim history, actuarial analysis and coverage limits where applicable. Any adjustments
resulting from the review are reflected in current earnings.
Given the fact that many claims are not brought during the year of occurrence, in addition to
its reserves for known claims, the Company maintains a reserve for incurred but not reported
claims. The reserve for incurred but not reported claims is recorded on an undiscounted basis.
The Companys estimates of this reserve are supported by various analyses, including an actuarial
analysis, which is performed on a quarterly basis.
Other Self-funded Insurance Reserves
As of December 31, 2009, the Company has approximately $8.6 million in accrued liabilities for
employee health and workers compensation claims. Approximately $7.1 million of this amount is
related to workers compensation claims, of which approximately $4.5 million is included within the
noncurrent portion of accrued expenses as it is not expected to be paid within a year. The Company
is essentially self-insured for employee health and workers compensation claims subject to certain
individual case stop-loss levels. As such, its insurance expense is largely dependent on claims
experience and the ability to control claims. The Company accrues the estimated liability for
employee health insurance based on its history of claims experience and estimated time lag between
the incident date and the date of actual claim payment. The Company accrues the estimated
liability for workers compensation claims based on evaluations of the merits of the individual
claims and analysis of claims history. An actuarial analysis is prepared at least annually as an
additional tool to be considered by management in evaluating the adequacy of the Companys reserve
for workers compensation claims. These estimates of self-funded insurance reserves could change
in the future based on changes in the factors discussed above. Any adjustments resulting from such
changes in estimates are reflected in current earnings. In 2009, 2008 and 2007,
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the Company recorded a decrease of approximately $0.2 million, a decrease of approximately
$0.9 million, and an increase of approximately $1.0 million, respectively, related to its prior
year other self-insurance reserves as a result of revisions to its estimated claims experience.
After considering the impact of earnings that would have been
allocated to participating securities in calculating net
income per common share (see Note 17), the Companys net income
available to common shareholders and basic and diluted net income per common share were positively impacted
as a result of revisions to its estimated experience by amounts totaling $0.1 million and $0.01 per
common share, for the year ended December 31, 2009 and
$0.5 million and $0.05 per common share, for
the year ended December 31, 2008. The Companys net income (loss) and basic and diluted net income
(loss) per common share were negatively impacted as a result of revisions to its estimated
experience by amounts totaling $0.6 million and $0.06 per common share, respectively, for the year
ended December 31, 2007.
Comprehensive Income (Loss)
Comprehensive income (loss) encompasses all changes in stockholders equity (except those
arising from transactions with owners) and includes net income (loss), unrealized gains or losses
on derivatives that qualify as hedges, net unrealized capital gains or losses on available for
sale securities and foreign currency translation adjustments. The Companys comprehensive income
(loss) is presented in the accompanying consolidated statements of changes in stockholders
equity. The Company had no elements of comprehensive income (loss) apart from net income (loss)
during any of the years presented.
Share-Based Compensation
The Company measures and recognizes compensation expense for all share-based payment awards
based on estimated fair values at the date of grant. Determining the fair value of share-based
awards at the grant date requires judgment in developing assumptions, which involve a number of
variables. These variables include, but are not limited to, the expected stock price volatility
over the term of the awards and expected stock option exercise behavior. In addition, the Company
also uses judgment in estimating the number of share-based awards that are expected to be
forfeited.
See Note 16 for further information on share-based compensation.
Operating Leases
The Company leases office space and equipment under certain noncancelable operating leases.
In accordance with the provisions of lease accounting, rent expense under these operating leases
with scheduled rent increases is accounted for on a straight-line basis over the lease term,
beginning on the effective date of the lease agreement. Where operating leases contain rent
holidays and tenant build-out incentives or allowances, the Company applies them in the
determination of straight-line rent expense over the lease term. The amount of the excess of
straight-line rent expense over scheduled payments is recorded as a deferred liability on the
accompanying consolidated balance sheets.
Credit and Other Concentration Risks
The Companys credit risks relate primarily to cash and cash equivalents, accounts receivable
and deposits on professional liability and other insurance programs. Cash and cash equivalents are
primarily held in bank accounts and overnight investments. The Companys accounts receivable
represent amounts due primarily from governmental agencies. Accounts receivable due from the
Virginia Department of Corrections and the Commonwealth of Pennsylvania, Department of Corrections
each represent approximately 22% of accounts receivable, less allowances, at December 31, 2009.
Deposits on professional liability and other insurance programs represent amounts paid by the
Company that are subject to future refund from the insurance company which provides the coverage.
Currently, these balances are carried by American International Group for workers compensation and
various regulated subsidiaries of professional liability. The Companys financial instruments are
subject to the possibility of loss in carrying value as a result of either the failure of other
parties to perform according to their contractual obligations or changes in market prices that make
the instruments less valuable. Additionally, if the financial position and/or liquidity of one of
these third party insurance carriers were to become impaired such that the third party insurer was
unable to pay claims or meet its contractual obligations to the Company, the Company could lose all
or a portion of its prepaid premiums to such carrier and/or lose the benefit of the coverage the
Company has paid for, the occurrence of which could have a material adverse effect on the Companys
financial position, results of operations or cash flows.
Substantially all of the Companys revenue for the year ended December 31, 2009 relates to
amounts earned under contracts with state and local governments.
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Approximately 17% of the Companys workforce is represented by labor unions.
Recent Accounting Pronouncements
Business Combinations. In December 2007, the FASB issued an accounting pronouncement related
to business combinations. This pronouncement addresses the recognition and accounting for
identifiable assets acquired, liabilities assumed, and noncontrolling interests in business
combinations. This pronouncement requires more assets and liabilities to be recorded at fair value
and requires expense recognition (rather than capitalization) of certain pre-acquisition costs. It
also requires any adjustments to acquired deferred tax assets and liabilities occurring after the
related allocation period to be made through earnings. Furthermore, this pronouncement requires
this treatment of acquired deferred tax assets and liabilities be applied to acquisitions occurring
prior to the effective date of this pronouncement. This pronouncement is effective for fiscal
years beginning after December 15, 2008 and is required to be adopted prospectively. The Company
adopted this pronouncement on January 1, 2009 and the adoption had no impact on its financial
position, results of operations or cash flows.
3. Audit Committee Investigation
On October 24, 2005, the Company announced that the Audit Committee had initiated an internal
investigation into certain matters related to SPP. As disclosed in further detail in the Companys
Annual Report on Form 10-K for the year ended December 31, 2005, on March 15, 2006 the Company
announced that the Audit Committee had concluded its investigation and reached certain conclusions
with respect to findings of the investigation that resulted in an accrual of $3.7 million of
aggregate refunds due to customers, including PHS, that were not charged by SPP in accordance with
the terms of the respective contracts. In circumstances where SPPs incorrect billings resulted in
PHS billing its clients incorrectly, PHS passed the applicable amount through to its clients. This
amount plus associated interest represented managements best estimate of the amounts due to
affected customers, based on the results of the Audit Committees investigation. As of December
31, 2009, the Company has paid all of these refunds plus associated interest to customers except
for $0.4 million which has been tendered for payment to the appropriate customers. The ultimate
amounts paid could differ from the Companys estimates; however, actual amounts to date have not
differed materially from the estimated amounts. There can be no assurance that the Company, a
customer or a third-party, including a governmental entity, will not assert that additional
amounts, which may include penalties and/or associated interest, are owed to these customers.
During the year ended December 31, 2009, the Company recognized additional expenses totaling $8.4
million relative to this matter, due to the Company recording a reserve related to the settlement in principle reached
on February 19, 2010, regarding the shareholder
litigation filed against the Company and certain individual defendants on April 6, 2006; an insurance
settlement for $8.0 million entered into by the Company and its primary directors and officers liability (D&O)
insurance carrier; and legal expenses.
The settlement regarding the shareholder litigation, which is subject to final documentation
as well as approval by the Court, provides for payment by the Company of $10.5 million and issuance
by the Company of 300,000 shares of common stock and would lead to a dismissal with prejudice of
all claims against all defendants in the litigation (see Note 21).
4. Restructuring Charge
On September 15, 2008, the Company entered into a separation agreement and general release
with Michael Catalano, which was subsequently modified on November 7, 2008 (the Separation
Agreement). Under the terms of the Separation Agreement, Mr. Catalano resigned his position as
Chief Executive Officer of the Company effective December 30, 2008. The Separation Agreement also
provided for Mr. Catalanos resignation from the Company and from its Board of Directors effective
January 1, 2009, the termination of Mr. Catalanos previously existing employment agreement and the
release of claims by each of Mr. Catalano and the Company against each other. Additionally, in
connection with the restructuring, the Company elected to its Board of Directors and amended the
employment agreements of Richard Hallworth, its current President and Chief Executive Officer, and
Michael W. Taylor, its current Executive Vice President, Chief Financial Officer and Treasurer.
The Company incurred a charge related to the Separation Agreement of approximately $2.3 million,
comprised of $1.5 million in compensation and benefits, a $0.7 million non-cash charge related to
the accelerated vesting of remaining unvested stock options and restricted shares and the
modification of the time period in which to exercise stock options and $0.1 million in legal and
consulting fees. The non-cash charge related to the stock based compensation is included in
additional paid in capital in the Companys consolidated balance sheet.
Corporate restructuring expenses were $0.4 million for the year ended December 31, 2007, which
related to the elimination of certain administrative and operational positions as part of a
Company-wide cost reduction process implemented in the third and fourth quarters of 2007.
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5. Reserve for Loss Contracts
On a quarterly basis, the Company performs a review of its portfolio of contracts for the
purpose of identifying potential loss contracts and developing a loss contract reserve for
succeeding periods if any loss contracts are identified. The Company accrues losses under its
fixed price contracts when it is probable that a loss has been incurred and the amount of the loss
can be reasonably estimated. The Company performs this loss accrual analysis on a specific
contract basis taking into consideration such factors as the Companys ability to terminate the
contracts, future contractual revenue, projected future healthcare and maintenance costs, projected
future stop-loss insurance recoveries and each contracts specific terms related to future revenue
increases as compared to increased healthcare costs. The projected future healthcare and
maintenance costs are estimated based on historical trends and managements estimate of future cost
increases. These estimates are subject to the same adverse fluctuations and future claims
experience as previously noted.
In the course of performing its reviews in future periods, the Company might identify
contracts which have become loss contracts due to a change in circumstances. Circumstances that
might change and result in the identification of a contract as a loss contract in a future period
include interpretations regarding contract termination or expiration provisions, unanticipated
adverse changes in the healthcare cost structure, inmate population or the utilization of outside
medical services in a contract, where such changes are not offset by increased healthcare revenues.
Should a contract be identified as a loss contract in a future period, the Company would record,
in the period in which such identification is made, a reserve for the estimated future losses that
would be incurred under the contract. The identification of a loss contract in the future could
have a material adverse effect on the Companys results of operations in the period in which the
reserve is recorded.
There are no loss contracts identified as of December 31, 2009 and 2008.
6. Discontinued Operations
Pursuant
to U.S. GAAP related to discontinued operations, each of the Companys correctional
healthcare services contracts is a component of an entity whose operations can be distinguished
from the rest of the Company. Therefore, when a correctional healthcare services contract
terminates, by expiration or otherwise, the contracts operations generally will be eliminated from
the ongoing operations of the Company and classified as discontinued operations. Accordingly, the
operations of such contracts, net of applicable income taxes, have been presented as discontinued
operations and prior period consolidated statements of operations have been reclassified.
The components of income (loss) from discontinued operations, net of taxes, are as follows (in
thousands):
Year Ended December 31, | ||||||||||||
2009 | 2008 | 2007 | ||||||||||
Healthcare revenues |
$ | 4,288 | $ | 20,067 | $ | 104,059 | ||||||
Healthcare expenses |
4,631 | 18,941 | 92,777 | |||||||||
Gross margin |
(343 | ) | 1,126 | 11,282 | ||||||||
Depreciation and amortization |
9 | 44 | 104 | |||||||||
Income (loss) from discontinued operations before
income tax provision (benefit) |
(352 | ) | 1,082 | 11,178 | ||||||||
Income tax provision (benefit) |
(143 | ) | 441 | 4,556 | ||||||||
Income (loss) from discontinued operations, net of taxes |
$ | (209 | ) | $ | 641 | $ | 6,622 | |||||
7. Fair Value
Fair value is a market-based measurement, not an entity-specific measurement. Therefore, a
fair value measurement should be determined based on the assumptions that market participants would
use in pricing the asset or liability. As a basis for considering market participant assumptions
in fair value measurements, the Company utilizes the U.S. GAAP fair value hierarchy that
distinguishes between market participant assumptions based on market data obtained from sources
independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of
the hierarchy) and the reporting entitys own assumption about market participant assumptions
(unobservable inputs classified within Level 3 of the hierarchy).
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The Company has available-for-sale securities and money market accounts totaling $15.0
million at December 31, 2009, that are classified as cash equivalents on the accompanying
consolidated balance sheet. The Company had no securities at December 31, 2008. These financial
assets are recorded at fair value in accordance with the U.S. GAAP fair value hierarchy, classified
as a Level 1 measurement. Inputs used to measure fair value in accordance with Level 1 are quoted
market prices in active markets for identical assets or liabilities.
8. Accounts Receivable
Accounts receivable consist of the following (in thousands):
December 31, | ||||||||
2009 | 2008 | |||||||
Billed accounts receivable |
$ | 20,762 | $ | 16,064 | ||||
Unbilled accounts receivable |
25,485 | 24,126 | ||||||
Other accounts receivable |
648 | 2,923 | ||||||
46,895 | 43,113 | |||||||
Less: Allowances |
(358 | ) | (417 | ) | ||||
46,537 | 42,696 | |||||||
Less: Receivables reclassified as noncurrent |
(1,908 | ) | (1,689 | ) | ||||
$ | 44,629 | $ | 41,007 | |||||
Unbilled accounts receivable generally represent additional revenue earned under shared-risk
contracting models that remain unbilled at each balance sheet date, due to provisions within the
contracts governing the timing for billing such amounts.
The Company and its clients will, from time to time, have disputes over amounts billed under
the Companys contracts. The Company records a reserve for contractual allowances in
circumstances where it concludes that a loss from such disputes is probable.
As
discussed more fully in Note 21, PHS is currently involved in a lawsuit with its former
client, Baltimore County, Maryland (the County) involving the Countys
lack of payment for services rendered. PHS has approximately $1.7 million of receivables due from
the County, primarily related to services rendered between April 1, 2006 and September 14, 2006,
the date the Companys relationship with the County was terminated. The County has refused to pay
PHS for these amounts and therefore, on October 27, 2006, PHS filed suit against the County in the
Circuit Court for Baltimore County, Maryland seeking collection of the outstanding receivables
balance, damages for breach of contract, quantum meruit, and unjust enrichment as well as
prejudgment interest. As discussed more fully in Note 21, PHS believes, in the case of this lawsuit, that it has a valid and
meritorious cause of action and, as a result, has concluded that the outstanding receivables, which
represent services performed under the contractual relationship between the parties, are probable
of collection. Although PHS believes it has valid contractual and legal arguments, an adverse
result in this lawsuit could have a negative impact on the results of this matter and/or PHS
ability to collect the outstanding receivables amount. These receivables are classified as other
noncurrent assets in the Companys consolidated balance sheet (see Note 11).
As stated above, the Company believes the recorded amount represents valid receivables which
are contractually due from the County and expects full
collection. However, due to the factors discussed above and more fully in Note 21, there is a
heightened risk of uncollectibility of these receivables which may result in future losses. Nevertheless, the Company intends to take all necessary and available
measures in order to collect these receivables.
Changes in circumstances related to the matter discussed above, or any other receivables,
could result in a change in the allowance for doubtful accounts or the estimate of contractual
adjustments in future periods. Such change, if it were to occur, could have a material adverse
affect on the Companys results of operations and financial position in the period in which the
change occurs.
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9. Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets are stated at amortized cost and comprised of the
following (in thousands):
December 31, | ||||||||
2009 | 2008 | |||||||
Prepaid insurance |
$ | 6,824 | $ | 6,079 | ||||
Prepaid cash deposits for professional liability claims losses |
8,501 | 6,130 | ||||||
Prepaid performance bonds |
80 | 110 | ||||||
Prepaid other |
1,349 | 668 | ||||||
$ | 16,754 | $ | 12,987 | |||||
10. Property and Equipment
Property and equipment are stated at cost and comprised of the following (in thousands):
December 31, | Estimated | |||||||||||
2009 | 2008 | Useful Lives | ||||||||||
Leasehold improvements |
$ | 1,006 | $ | 91 | 7 years | |||||||
Equipment and furniture |
9,843 | 8,342 | 5 years | |||||||||
Computer software |
7,095 | 3,805 | 3-5 years | |||||||||
Medical equipment |
1,180 | 1,101 | 5 years | |||||||||
Automobiles |
62 | 66 | 5 years | |||||||||
Management information systems under development |
176 | 712 | | |||||||||
19,362 | 14,117 | |||||||||||
Less: Accumulated depreciation |
(9,915 | ) | (7,675 | ) | ||||||||
$ | 9,447 | $ | 6,442 | |||||||||
At December 31, 2009 and 2008, the net book value of computer software, exclusive of
management systems under development at each date, was $4.6 million and $2.2 million,
respectively. Depreciation expense for the years ended December 31, 2009, 2008 and 2007 was
approximately $2.4 million, $1.9 million and $2.0 million, respectively.
11. Other Assets
Other assets are stated at amortized cost and comprised of the following (in thousands):
December 31, | ||||||||
2009 | 2008 | |||||||
Deferred financing costs |
$ | 68 | $ | 384 | ||||
Less: Accumulated amortization |
(10 | ) | (281 | ) | ||||
58 | 103 | |||||||
Excess deposits for professional liability claims |
5,217 | | ||||||
Prepaid insurance |
4,540 | 3,277 | ||||||
Long-term receivables |
1,908 | 1,689 | ||||||
Other refundable deposits |
114 | 114 | ||||||
$ | 11,837 | $ | 5,183 | |||||
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12. Contracts and Other Intangible Assets
The gross and net values of contracts and other intangible assets consist of the following
(in thousands):
December 31, | ||||||||
2009 | 2008 | |||||||
Contracts: |
||||||||
Gross value |
$ | 4,000 | $ | 4,670 | ||||
Less: Accumulated amortization |
(2,063 | ) | (2,453 | ) | ||||
$ | 1,937 | $ | 2,217 | |||||
Non-compete agreements: |
||||||||
Gross value |
$ | | $ | 2,400 | ||||
Less: Accumulated amortization |
| (2,246 | ) | |||||
$ | | $ | 154 | |||||
Estimated aggregate amortization expense related to the above intangibles for each of the
next five years is $0.3 million.
13. Accrued Expenses
Accrued expenses consist of the following (in thousands):
December 31, | ||||||||
2009 | 2008 | |||||||
Salaries and employee benefits |
$ | 21,528 | $ | 20,013 | ||||
Professional liability claims |
25,236 | 22,033 | ||||||
Accrued workers compensation claims |
7,130 | 6,263 | ||||||
Accrued loss contingency related to shareholder litigation (see Note 21) |
15,126 | | ||||||
Other |
9,356 | 5,303 | ||||||
78,376 | 53,612 | |||||||
Less: Noncurrent portion of deferred lease liability |
(958 | ) | | |||||
Less: Noncurrent portion of professional liability and workers compensation claims |
(14,523 | ) | (17,146 | ) | ||||
$ | 62,895 | $ | 36,466 | |||||
14. Banking Arrangements
On July 28, 2009, the Company entered into a Revolving Credit and Security Agreement which was
subsequently amended on March 2, 2010 (the Credit Agreement) with CapitalSource Bank
(CapitalSource). The Credit Agreement is set to mature on October 31, 2011 and includes a $40.0
million revolving credit facility, with a current facility cap of $20.0 million, under which the Company has
available standby letters of credit up to $15.0 million.
The Company may request an increase in the current facility cap of up
to an additional $20.0 million subject to lender approval.
The amount available to the Company for
borrowings under the Credit Agreement is based on the Companys collateral base, as determined
under the Credit Agreement, and is reduced by the amount of each outstanding standby letter of
credit. The Credit Agreement is secured by substantially all assets of the Company and its
operating subsidiaries. At December 31, 2009, the Company had no borrowings outstanding under the
Credit Agreement and $16.6 million available for borrowing, based on the current facility cap and the Companys
collateral base on that date less outstanding standby letters of credit totaling $3.4 million.
Borrowings under the Credit Agreement are limited to the lesser of (1) 85% of eligible
receivables or (2) the current facility cap (the Borrowing Capacity). Interest under the Credit Agreement
is payable monthly at an annual rate of one-month LIBOR plus 2%, subject to a minimum LIBOR rate of
3.14%. The Company is also required to pay a monthly collateral management fee equal to 0.042% on
average borrowings outstanding under the Credit Agreement.
Under the terms of the Credit Agreement, the Company is required to pay a monthly unused line
fee equal to 0.0375% on the Borrowing Capacity less the actual average borrowings outstanding under
the Credit Agreement for the month and the balance of any outstanding letters of credit.
F-19
Table of Contents
All amounts outstanding under the Credit Agreement will be due and payable on October 31,
2011. If the Credit Agreement is extinguished prior to July 31, 2011, the Company will be required
to pay an early termination fee equal to between $0.4 million
and $0.8 million depending on the
date extinguished.
The Credit Agreement requires the Company to maintain a minimum level of EBITDA of $8.0
million on a trailing twelve-month basis to be measured at the end of each calendar quarter. The
Credit Agreement defines EBITDA as net income plus interest expense, income taxes, depreciation
expense, amortization expense, any other non-cash non-recurring expense, loss from asset sales
outside of the normal course of business and charges and expenses arising out of the Audit
Committee investigation into matters at SPP including any expenses or charges incurred in the
associated shareholder securities suit provided such amounts do not exceed $4.5 million in the
aggregate, minus gains on asset sales outside the normal course of business or other non-recurring
gains. The Company was in compliance with the minimum level of EBITDA covenant requirement at
December 31, 2009.
The Credit Agreement permits the Company to declare and pay cash dividends, but requires the
Company to maintain both a pre-distribution fixed charge coverage ratio and a post-distribution
fixed charge coverage ratio both calculated on a trailing twelve-month basis to be measured at the
end of each calendar quarter. The Credit Agreement defines the pre-distribution fixed charge
coverage ratio as EBITDA, as defined above, divided by the sum of principal payments on outstanding
debt, cash interest expense on outstanding debt, capital expenditures and cash income taxes paid or
accrued. The Credit Agreement requires that the Company maintain a minimum pre-distribution fixed
charge coverage ratio of 1.75. The Credit Agreement defines the post-distribution fixed charge
coverage ratio as EBITDA, as defined above, divided by the sum of principal payments on outstanding
debt, cash interest expense on outstanding debt, capital expenditures, cash income taxes paid or
accrued, and cash dividends paid or accrued or declared. The Credit Agreement requires a minimum
post-distribution fixed charge coverage ratio of 1.25 if the Companys average net cash (cash less
outstanding debt) plus the average amount available for borrowing under the Credit Agreement is
greater than or equal to $20.0 million for the most recent calendar quarter; or, a minimum
post-distribution fixed charge coverage ratio of 1.50 if the Companys average net cash (cash less
outstanding debt) plus the average amount available for borrowing under the Credit Agreement is
less than $20.0 million for the most recent calendar quarter. At December 31, 2009, the Company
was not in compliance with the pre-distribution fixed charge coverage
ratio, as defined prior to the March 2, 2010 amendment,
principally due to expenses in the fourth quarter of 2009 related to
settlement of the shareholder litigation
and has obtained a
waiver of the debt covenant violation from CapitalSource. For further information regarding the shareholder litigation see Note 21.
15. Income Taxes
Significant components of the income tax expense (benefit), related to continuing operations,
included in the accompanying consolidated statements of operations are as follows (in thousands):
Year Ended December 31, | ||||||||||||
2009 | 2008 | 2007 | ||||||||||
Current income taxes: |
||||||||||||
Federal |
$ | 4,662 | $ | 118 | $ | 130 | ||||||
State |
513 | 102 | 51 | |||||||||
5,175 | 220 | 181 | ||||||||||
Deferred income taxes: |
||||||||||||
Federal |
(2,070 | ) | 2,086 | (2,110 | ) | |||||||
State |
18 | 326 | (364 | ) | ||||||||
(2,052 | ) | 2,412 | (2,474 | ) | ||||||||
Income tax expense (benefit) |
$ | 3,123 | $ | 2,632 | $ | (2,293 | ) | |||||
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Table of Contents
Deferred income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and the amounts used
for income tax purposes. Significant components of the Companys deferred tax assets
(liabilities) are as follows (in thousands):
December 31, | ||||||||
2009 | 2008 | |||||||
Deferred tax assets/(liabilities): |
||||||||
Accrued vacation |
$ | 1,027 | $ | 883 | ||||
Bad debt allowance |
146 | 170 | ||||||
Prepaid insurance |
(1,432 | ) | (993 | ) | ||||
Self insurance reserves |
2,892 | 1,961 | ||||||
Accrued liabilities |
6,383 | 280 | ||||||
Net operating loss carryforwards |
576 | 2,656 | ||||||
Other |
(340 | ) | 376 | |||||
Net current deferred tax asset |
9,252 | 5,333 | ||||||
Self insurance reserves |
2,789 | 2,435 | ||||||
Depreciation |
(2,345 | ) | (1,209 | ) | ||||
Amortization |
(8,003 | ) | (6,867 | ) | ||||
Share-based compensation |
3,783 | 3,419 | ||||||
Net operating loss carryforwards |
279 | 576 | ||||||
Net noncurrent deferred tax liability before valuation allowance |
(3,497 | ) | (1,646 | ) | ||||
Valuation allowance |
(230 | ) | (214 | ) | ||||
Net noncurrent deferred tax liability |
(3,727 | ) | (1,860 | ) | ||||
Net deferred tax asset |
$ | 5,525 | $ | 3,473 | ||||
The Company regularly reviews its deferred tax assets for recoverability taking into
consideration such factors as historical financial results, projected future taxable income and the
expected timing of the reversals of existing temporary differences. U.S. GAAP requires the
Company to record a valuation allowance when it is more likely than not that some portion or all
of the deferred tax assets will not be realized. At each of the years ended December 31, 2009,
2008 and 2007, the Companys valuation allowance of approximately $0.2 million, represents
managements estimate of state net operating loss carryforwards which will expire unused.
At December 31, 2009, the Company has a state net operating loss carryforward of $14.8
million, which expires at various dates through 2023.
A reconciliation of the federal statutory tax rate to the effective tax rate, related to
income from continuing operations, is as follows:
Year Ended December 31, | ||||||||||||
2009 | 2008 | 2007 | ||||||||||
Federal tax |
35.0 | % | 35.0 | % | (35.0 | )% | ||||||
State income taxes |
5.8 | 5.8 | (5.8 | ) | ||||||||
Permanent differences |
4.2 | 4.4 | 3.9 | |||||||||
Revision of prior year tax estimates |
1.9 | 0.1 | (1.4 | ) | ||||||||
Other |
| 0.2 | (0.2 | ) | ||||||||
Change in valuation allowance |
0.3 | (0.3 | ) | 0.9 | ||||||||
Effective rate |
47.2 | % | 45.2 | % | (37.6 | )% | ||||||
The Company has no material unrecognized tax benefits or any known material tax contingencies
at December 31, 2009, 2008 or 2007. Tax returns filed with the IRS for years 2006 through 2009
along with tax returns filed with numerous state and local governmental entities remain subject to
examination.
F-21
Table of Contents
16. Share-Based Compensation
The Company has issued equity incentive awards to eligible employees and outside directors
under the Amended and Restated Incentive Stock Plan, the Amended and Restated 1999 Incentive Stock
Plan and the 2009 Equity Incentive Plan (2009 Equity Plan). The Company currently has two types of share-based awards
outstanding under these plans: stock options and restricted stock. Additionally, the Company
instituted an Employee Stock Purchase Plan during 1996. The Company accounts for share-based
compensation in accordance with U.S. GAAP related to share-based payments.
For the year ended December 31, 2009, the Company recognized total share-based compensation
costs of $1.8 million, which consisted of $0.1 million classified in healthcare expenses and $1.7
million classified in selling, general and administrative expenses in the accompanying consolidated
statements of operations. In addition to the $0.7 million of stock based compensation expense
incurred in September 2008 and discussed above in Note 4, for the year ended December 31, 2008, the
Company recognized total share-based compensation cost of $2.1 million, which consisted of $0.1
million classified in healthcare expenses and $2.0 million classified in selling, general and
administrative expenses in the accompanying consolidated statements of operations. For the year
ended December 31, 2007, the Company recognized total share-based compensation cost of $3.2
million, which consisted of $0.3 million classified in healthcare expenses and $2.9 million
classified in selling, general and administrative expenses in the accompanying consolidated
statements of operations. For the years ended December 31, 2009, 2008 and 2007, the Company also
recognized a total income tax benefit in the consolidated statements of operations for share-based
compensation arrangements of $0.7 million, $0.8 million and $1.2 million, respectively. The
Company did not capitalize any share-based compensation cost during the years ended December 31,
2009, 2008 and 2007.
Stock Options
The Company maintains the 2009 Equity
Plan to assist the
Company in attracting, retaining and motivating valued directors, officers, employees, consultants
and other service providers, and to further align their interests with the interests of the
Companys stockholders, by providing for or increasing their ownership interests in the Company.
The 2009 Equity Plan generally provides for the issuance of (i) incentive stock options; (ii)
nonqualified stock options; (iii) stock appreciation rights (SARs); (iv) restricted stock
awards; (v) restricted stock units; and (vi) other stock-based awards to any director, officer,
employee or service provider of the Company and its affiliates. Subject to certain adjustments,
the maximum number of shares of common stock that may be issued under the 2009 Equity Plan in
connection with awards is 500,000 shares. In addition, in any calendar year, no single
participant may receive any award that relates to more than 100,000 shares in the case of options
and SARs, or 50,000 shares in the case of restricted stock, restricted stock units or incentive
awards (as such terms is defined in the 2009 Equity Plan). Additionally, incentive award cash
payments and other stock based award cash payments to any one participant are each limited to
$500,000 in any calendar year. Awards and vesting periods under the 2009 Equity Plan are
discretionary and are administered by the Incentive Stock and Compensation Committee of the Board
of Directors (the Compensation Committee). The exercise price of any options granted under the
2009 Equity Plan shall not be less than the fair market value of the Companys common stock at the
date of grant. Options expire at such times as the Compensation Committee determines at the time
of grant, but no later than ten years from the grant date.
Prior to June 9, 2009, the effective date of the 2009 Equity Plan, the Company had an
Incentive Stock Plan (Incentive Plan) which provided for the granting of options, stock awards
and stock appreciation rights to officers, key employees and non-employee directors for up to
2,224,500 shares of the Companys common stock. Awards and vesting periods under the Incentive
Plan were discretionary and were administered by the Compensation Committee. The exercise price
of any options granted under the Incentive Plan shall not be less than the fair market value of
the Companys common stock at the date of grant. Options and other benefits expire at such times
as the Compensation Committee determines at the time of grant, but no later than ten years from
the grant date.
In addition to the Incentive Plan and prior to June 9, 2009, the effective date of the 2009
Equity Plan, the Company maintained the America Service Group Inc. Amended and Restated 1999
Incentive Stock Plan (the Amended Plan) to attract and retain eligible employees and outside
directors of the Company, to provide an incentive to eligible employees and outside directors to
work to increase the value of the Companys common stock and to provide eligible employees and
outside directors with a stake in the future of the Company which corresponds to the stake of each
stockholder. There were 2,439,000 shares of the Companys common stock authorized under the
Amended Plan. The exercise price of any options granted under the Amended Plan shall not be less
than the fair market value of the Companys common stock at the date of grant. Options and other
benefits expire at such times as the Committee determines at the time of grant, but no later than
10 years from the grant date.
At December 31, 2009, there were 468,000 shares available for future grants under the 2009
Equity Incentive Plan
and none available under the Incentive Plan and Amended and Restated
1999 Incentive Stock Plan.
F-22
Table of Contents
As of December 31, 2009, there were $0.2 million of total unrecognized compensation costs
related to nonvested stock options granted under the stock incentive plans discussed above. That
cost is expected to be recognized over a weighted average period of 1.72 years.
For the year ended December 31, 2008, the Company estimated the fair value of each option
award on the date of grant using a Black-Scholes option pricing model. The Company based expected
volatility on historical volatility of the Companys stock. The Company estimated the expected
term of stock options using historical exercise and employee termination experience. There were no
options granted during the years ended December 31, 2009 and 2007. The following table shows the
weighted average assumptions used to develop the fair value estimates
for options granted during the year ended December 31, 2008:
Year Ended December 31, | ||||
2008 | ||||
Weighted average grant date fair value of options |
$ | 4.45 | ||
Assumptions: |
||||
Volatility |
0.52 | |||
Interest rate |
2.92 | % | ||
Expected life (years) |
4.18 | |||
Dividend yields |
0.00 | % |
A summary of option activity and changes during the year ended December 31, 2009 is
presented below:
Weighted Average | Aggregate | |||||||||||||||
Weighted Average | Remaining | Intrinsic Value | ||||||||||||||
Options | Exercise Price | Contractual Term | (in thousands) (1) | |||||||||||||
Outstanding, December 31, 2008 |
1,177,011 | $ | 17.26 | |||||||||||||
Granted |
| | ||||||||||||||
Exercised |
(149,088 | ) | 11.54 | |||||||||||||
Canceled |
(205,250 | ) | 21.78 | |||||||||||||
Outstanding, December 31, 2009 |
822,673 | $ | 17.16 | 4.96 | $ | 1,291 | ||||||||||
Exercisable, December 31, 2009 |
772,673 | $ | 17.63 | 4.72 | $ | 998 | ||||||||||
Expected to vest, December 31, 2009 |
48,742 | $ | 10.01 | 8.72 | $ | 286 | ||||||||||
(1) | Based upon the difference between the closing market price of the Companys common stock on the last trading day of the year and the grant price of in-the-money options. |
The total intrinsic value, which represents the difference between the underlying stocks
market price and the options exercise price, of options
exercised during each of the years ended December
31, 2009 and 2008 was $0.1 million. There were no options exercised
during the year ended December 31, 2007.
Cash received from option exercises under all share-based payment arrangements for the year
ended December 31, 2009 was $1.7 million. The actual tax benefit realized for the tax deductions
from option exercises of the share-based payment arrangements totaled $0.1 million for the year
ended December 31, 2009.
For the year ended December 31, 2009, the Company recognized share-based compensation cost
related to stock options of $0.4 million, which was classified in selling, general and
administrative expenses in the accompanying consolidated statements of operations. For the year
ended December 31, 2008, the Company recognized share-based compensation cost related to stock
options of $1.1 million which consisted of $0.1 million classified in healthcare expenses and $1.0
million classified in selling, general and administrative expenses in the accompanying consolidated
statements of operations. For the year ended December 31, 2007, the Company recognized share-based
compensation cost related to stock options $2.6 million which consisted of $0.3 million classified
in healthcare expenses and $2.3 million classified in selling, general and administrative
expenses in the accompanying consolidated statements of operations.
F-23
Table of Contents
Restricted Stock
As part of the approved Board of Directors compensation program, each new
non-employee Director (as
defined by the 2009 Equity Plan) upon election to the Board of Directors, receives 10,000
restricted shares of the Companys common stock issued pursuant to the 2009 Equity Plan.
Additionally, each non-employee director receives 3,000 restricted shares of the Companys common
stock on an annual basis. Effective March 9, 2009 and August 5, 2009, each non-employee director
received 2,200 and 800 restricted shares of the Companys common stock, respectively, which was an
aggregate grant to all non-employee directors of 15,000 shares. Each new Director and each
non-employee director shall have the right, among other rights, to receive cash dividends on all
of these shares and to vote such shares unless the directors right to such shares is forfeited.
The shares granted to each new Director upon election to the Board of Directors become
nonforfeitable in equal annual installments over four years beginning on the first anniversary of
the date of grant. The shares granted annually to each non-employee director become
nonforfeitable in equal annual installments over three years beginning on the first anniversary of
the date of grant. The restricted shares are valued at the market value of the Companys common
stock on the date of grant and are recognized as compensation expense over the restricted stocks
vesting period.
On January 27, 2009, the Board of Directors unanimously elected Richard D. Wright as its
Non-Executive Chairman of the Board. In connection with Mr. Wrights service to the Company as
Non-Executive Chairman of the Board, Mr. Wright is being paid a monthly fee of $12,000, effective
February 1, 2009. Mr. Wright will receive no additional cash compensation from the Company for his
service on any committees of the Board or his attendance at any meetings of the Board and any
committees thereof. In addition, the Board and the Compensation Committee approved a grant of
3,000 shares of restricted common stock of the Company to Mr. Wright (the Stock Award) pursuant
to the Amended Plan. The Stock Award has a grant date of January 27, 2009 and will vest one third
on each of the first, second and third anniversaries of the grant date.
Effective March 9, 2009, the Compensation Committee, approved to award eligible employees
restricted shares of the Companys common stock issued pursuant to the Amended Plan totaling
86,700 shares. Each employee shall have the right, among other rights, to receive cash dividends
on all of these shares and to vote such shares unless the employees right to such shares is
forfeited.
Effective August 5, 2009, the Compensation Committee, approved to award eligible employees
restricted shares of the Companys common stock issued pursuant to the 2009 Equity Plan totaling
28,000 shares. Each employee shall have the right, among other rights, to receive cash dividends
on all of these shares and to vote such shares unless the employees right to such shares is
forfeited.
As of December 31, 2009, there were $2.2 million of total unrecognized compensation costs
related to nonvested restricted stock that is expected to be recognized over a weighted average
period of 1.74 years.
A summary of the nonvested shares of restricted stock and activity during the years ended
December 31, 2009 is presented below:
Weighted Average | ||||||||
Grant Date | ||||||||
Restricted Shares | Fair Value | |||||||
Nonvested, December 31, 2008 |
231,390 | $ | 12.68 | |||||
Granted |
132,700 | 12.56 | ||||||
Vested |
(55,020 | ) | 11.41 | |||||
Forfeited |
(11,000 | ) | 13.42 | |||||
Nonvested, December 31, 2009 |
298,070 | $ | 12.83 | |||||
For the years ended December 31, 2009, 2008 and 2007, the Company recognized share-based
compensation cost related to restricted stock of $1.3 million, $0.9 million and $0.5 million,
respectively, which was classified in selling, general and administrative expenses in the
accompanying consolidated statements of operations.
Employee Stock Purchase Plan
The Company instituted an Employee Stock Purchase Plan during 1996 pursuant to which an
aggregate of 750,000 shares of the Companys common stock may be sold. The Employee Stock Purchase
Plan allows eligible employees to elect to purchase shares of
F-24
Table of Contents
common stock through voluntary automatic payroll deductions of up to 10% of the employees annual salary. Purchases of stock
under the plan are made at the end of two six-month offering periods each year, one beginning on
January 1 and one beginning on July 1. At the end of each six-month period, the employees
contributions during that six-month period are used to purchase shares of common stock from the
Company at 85% of the fair market value of the common stock on the first or last day of that
six-month period, whichever is lower. The employee may elect to discontinue participation in the
plan at any time.
At December 31, 2009, there were 282,518 shares available for future employee purchases under
the above plan.
The Company records compensation expense for the Employee Stock Purchase Plan based on the
fair value of the employees purchase rights, which is estimated using a Black-Scholes option
pricing model. The following table shows the weighted average assumptions used to develop the fair
value estimates for the years ended December 31, 2009 and 2008:
Year ended December 31, | ||||||||
2009 | 2008 | |||||||
Weighted average grant date fair value |
$ | 4.06 | $ | 3.01 | ||||
Assumptions: |
||||||||
Volatility |
0.39 | 0.64 | ||||||
Interest rate |
0.30 | % | 2.05 | % | ||||
Expected life (years) |
0.50 | 0.50 | ||||||
Dividend yields |
0.71 | % | 0.00 | % |
Employees purchased 37,608 shares and 37,294 shares in 2009 and 2008, respectively. For each
of the years ended December 31, 2009, 2008 and 2007, the Company recognized share-based
compensation cost related to the Employee Stock Purchase Plan in selling, general and
administrative expenses totaling approximately $0.1 million.
17. Net Income (Loss) Per Share
Net income (loss) per share is measured at two levels: basic income (loss) per common share
and diluted income (loss) per common share. Basic income (loss) per common share is computed by
dividing net income (loss) available to common shareholders by the weighted average number of
common shares outstanding during the period. Diluted income (loss) per common share is computed by
dividing net income (loss) available to common shareholders by the weighted average number of
common shares outstanding after considering the additional dilution related to other dilutive
non-participating securities. The Companys other dilutive non-participating securities
outstanding consist of options to purchase shares of the Companys common stock.
In June 2008, the FASB issued guidance which clarifies that unvested share-based payment
awards that contain nonforfeitable rights to dividends or dividend equivalents, whether paid or
unpaid, are participating securities and should be included in the computation of earnings per
share under the two class method. In periods where the
Company has income from continuing operations, the two class method allocates undistributed earnings between
common shares and participating securities. In periods in which the
Company has incurred a loss from continuing operations, the two-class method does
not result in an allocation of such loss between the Companys common shares and participating securities.
Based on this clarification, the Company has
determined that its unvested restricted stock awards are considered participating securities. The
modified guidance became effective for the Company on January 1, 2009 and the Company is required
to retrospectively apply the modified guidance to any prior periods presented.
The Company has prepared its current period earnings per share calculations and
retrospectively revised its prior period calculations to exclude net income allocated to these
unvested restricted stock awards. Basic and diluted income from continuing operations per share
decreased by $0.01 for the year ended December 31, 2008. Earnings per share for the year ended
December 31, 2007 was not impacted as the Company had a loss from continuing operations.
The following table presents information necessary to calculate basic and diluted earnings per
common share (in thousands except for share and per share data):
F-25
Table of Contents
Year Ended December 31, | ||||||||||||
2009 | 2008 | 2007 | ||||||||||
Numerator: |
||||||||||||
Income (loss) from continuing operations |
$ | 3,491 | $ | 3,193 | $ | (3,807 | ) | |||||
Income (loss) from discontinued operations, net of taxes |
(209 | ) | 641 | 6,622 | ||||||||
Net income |
3,282 | 3,834 | 2,815 | |||||||||
Income allocated to participating securities (unvested restricted shares) |
(106 | ) | (75 | ) | | |||||||
Net income allocated to common shareholders |
$ | 3,176 | $ | 3,759 | $ | 2,815 | ||||||
Components of income allocated to participating securities (unvested
restricted shares): |
||||||||||||
Income from continuing operations |
$ | 113 | $ | 63 | $ | | ||||||
Income (loss) from discontinued operations, net of taxes |
(7 | ) | 12 | | ||||||||
Income allocated to participating securities |
$ | 106 | $ | 75 | $ | | ||||||
Components of net income available to common shareholders numerator
for calculating earnings per common share: |
||||||||||||
Income (loss) from continuing operations |
$ | 3,378 | $ | 3,130 | $ | (3,807 | ) | |||||
Income (loss) from discontinued operations, net of taxes |
(202 | ) | 629 | 6,622 | ||||||||
Net income available to common shareholders |
$ | 3,176 | $ | 3,759 | $ | 2,815 | ||||||
Year Ended December 31, | ||||||||||||
2009 | 2008 | 2007 | ||||||||||
Denominator: |
||||||||||||
Denominator for basic net income (loss) per common share weighted
average shares |
8,916,737 | 9,144,102 | 9,394,729 | |||||||||
Effect of dilutive non-participating securities: |
||||||||||||
Employee stock options |
42,350 | 8,610 | | |||||||||
Denominator for diluted net income (loss) per common share adjusted
weighted average shares and assumed conversions |
8,959,087 | 9,152,712 | 9,394,729 | |||||||||
Net income (loss) available to common shareholders per common share basic: |
||||||||||||
Continuing operations |
$ | 0.38 | $ | 0.34 | $ | (0.41 | ) | |||||
Discontinued operations, net of taxes |
(0.02 | ) | 0.07 | 0.71 | ||||||||
Net income available to common shareholders per common share |
$ | 0.36 | $ | 0.41 | $ | 0.30 | ||||||
Net income (loss) available to common shareholders per common share
diluted: |
||||||||||||
Continuing operations |
$ | 0.38 | $ | 0.34 | $ | (0.41 | ) | |||||
Discontinued operations, net of taxes |
(0.03 | ) | 0.07 | 0.71 | ||||||||
Net income available to common shareholders per common share |
$ | 0.35 | $ | 0.41 | $ | 0.30 | ||||||
The table below sets forth information regarding options that have been excluded from the
computation of diluted net income (loss) per common share because the Company generated a net loss
from continuing operations for the period or the options exercise price was greater than the
average market price of the common shares for the periods shown and, therefore, the effect would
be anti-dilutive.
Year Ended December 31, | ||||||||||||
2009 | 2008 | 2007 | ||||||||||
Options excluded from computation of diluted net
income (loss) per common share as effect would be
anti-dilutive |
629,997 | 1,114,348 | 1,193,951 | |||||||||
Weighted average exercise price of excluded options |
$ | 19.17 | $ | 17.72 | $ | 17.19 | ||||||
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Table of Contents
18. Share Repurchases
On February 27, 2008, the Companys Board of Directors approved a stock repurchase program to
repurchase up to $15 million of the Companys common stock through the end of 2009. On July 28,
2009, the Companys Board of Directors authorized the extension of this program by two years
through the end of 2011, while maintaining the total $15 million limit. This program is intended
to be implemented through purchases made from time to time in either the open market or through
private transactions, in accordance with SEC requirements. The Company may elect to terminate or
modify the program at any time. Under the stock repurchase program, no shares will be purchased
directly from officers or directors of the Company. The timing, prices and sizes of purchases will
depend upon prevailing stock prices, general economic and market conditions and other
considerations. Funds for the repurchase of shares are expected to come primarily from cash
provided by operating activities and also from funds on hand, including amounts available under the
Companys credit facility. During the year ended December 31, 2009, the Company repurchased and
retired a total of 611,450 common shares at an aggregate cost of approximately $8.3 million. As of
December 31, 2009, the Company has repurchased and retired a total of 858,350 shares of common
stock under the stock repurchase program at an aggregate cost of approximately $10.6 million.
19. Other Employee Benefit Plan
The Company has a 401(k) Retirement Savings Plan (the Plan) covering substantially all
employees who have completed 60 days of service. The Plan permits eligible employees to defer and
contribute to the Plan a portion of their compensation. The Company may, at the Boards
discretion, match such employee contributions to the Plan ranging from 1% to 3% of eligible
compensation, depending on the employees years of participation. The Company made no matching
contributions in 2009, 2008 or 2007.
20. Professional and General Liability Self-insurance Retention
At
December 31, 2009, the Companys reserves for both known as
well as incurred but not reported
professional and general liability claims totaled $25.2 million. Reserves for professional and
general liability claims fluctuate because the number of claims and the severity of the underlying
incidents change from one period to the next. Furthermore, payments with respect to previously
estimated liabilities frequently differ from the estimated liability. Changes in estimates of
losses resulting from such fluctuations and differences between managements established reserves
and actual loss payments are recognized by an adjustment to the reserve for professional and
general liability claims in the period in which the estimates are changed or payments are made. In
2009, 2008 and 2007, the Company recorded increases of approximately $3.2 million, $6.3 million and
$10.5 million, respectively, to its prior year claims reserves as a result of adverse development
on individual claims or matters. After considering the impact of earnings that would have been
allocated to participating securities in calculating net income per
common share (see Note 17), the
Companys net income available to common shareholders and basic and diluted net income per
common share were negatively impacted as a result of this adverse development by amounts totaling
$1.9 million and $0.20 per basic common share and $0.21 per diluted common share, respectively, for
the year ended December 31, 2009, $3.7 million and $0.40 per basic and diluted common share,
respectively, for the year ended December 31, 2008 and $6.2 million and $0.66 per basic and diluted
common share, respectively, for the year ended December 31, 2007. The reserves can also be
affected by changes in the financial health of the third-party insurance carriers used by the
Company. If a third party insurance carrier fails to meet its contractual obligations under the
agreement with the Company, the Company would then be responsible for such obligations. Such
changes could have a material adverse effect on the Companys results of operations in the period
in which the changes occur.
21. Commitments and Contingencies
Operating Leases
Future minimum annual lease payments at December 31, 2009 are as follows (in thousands):
Year Ending December 31: |
||||
2010 |
$ | 1,535 | ||
2011 |
1,346 | |||
2012 |
1,286 | |||
2013 |
1,241 | |||
2014 |
1,255 | |||
Thereafter |
2,186 | |||
$ | 8,849 | |||
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Rental expense under operating leases was $2.7 million, $2.3 million and $2.6 million for the
years ended December 31 2009, 2008 and 2007, respectively, which consisted of $1.6 million, $1.4
million and $1.6 million classified in healthcare expenses, respectively, and $1.1 million, $0.9
million and $1.0 million classified in selling, general and administrative expenses, respectively.
Catastrophic Limits
Many of the Companys contracts require the Companys customers to reimburse the Company for
all treatment costs or, in some cases, only treatment costs related to certain catastrophic
events, and/or for specific disease diagnoses illnesses. Certain of the Companys contracts do not
contain such limits. The Company attempts to compensate for the increased financial risk when
pricing contracts that do not contain individual, catastrophic or specific disease
diagnosis-related limits. However, the occurrence of severe individual cases, specific disease
diagnoses illnesses or a catastrophic event in a facility governed by a contract without such
limitations could render the contract unprofitable and could have a material adverse effect on the
Companys operations. For certain of its contracts that do not contain catastrophic protection,
the Company maintains stop loss insurance from an unaffiliated insurer with respect to, among
other things, inpatient and outpatient hospital expenses (as defined in the policy) for amounts in
excess of $375,000 per inmate up to an annual cap of $1.0 million per inmate.
Amounts reimbursable per claim under the policy are further limited to the lessor of 60% of billed
charges, the amount paid or the contracted amounts in situations where the Company has negotiated
rates with the applicable providers.
Litigation and Claims
Lysager Professional Liability Suit. On November 22, 2008, PHS received an adverse jury
verdict in the Sixth Judicial District in and for the County of Bannock, Idaho relating to a
complaint filed on December 30, 2004 by Jamie Justice Amos Lysager and Taylor Lysager regarding
medical care provided to the plaintiff while plaintiff was incarcerated at the Pocatello Womens
Correctional Center in Bannock County, Idaho in February 2004. The complaint alleged negligence,
deliberate indifference and intentional infliction of emotional distress by PHS in providing
medical care to plaintiff, then almost 33 weeks pregnant, associated with the premature delivery of
plaintiffs son and sought general and special damages and reimbursement for costs and attorneys
fees incurred by plaintiff in connection with the litigation. The complaint also sought punitive
damages alleging that the actions of PHS named defendant employees met the minimum statutory
standard for jury consideration of the imposition of punitive damages against PHS, their employer.
A jury trial commenced October 28, 2008 and ended, November 21, 2008. The verdict was received on
November 22, 2008 and consisted of compensatory damages of $0.1 million and punitive damages of
$0.2 million awarded to plaintiff, and compensatory damages of $1.3 million and punitive damages of
$2.0 million awarded to plaintiffs son, resulting in an aggregate award of $3.6 million.
Post-trial motions were heard on January 29, 2009, whereby PHS challenged the appropriateness and
amounts of the verdict awarded to the plaintiffs and vigorously opposed plaintiffs request for
attorney fees on grounds of lack of entitlement and method of calculation. However, on March 10,
2009, by Memorandum Decision and Order, the plaintiff was granted an award for court costs and
attorney fees totaling $0.2 million and the plaintiffs son was granted an award for court costs
and attorney fees totaling $1.6 million, resulting in an aggregate award of $1.8 million for court
costs and attorney fees. PHS filed an appeal to the Idaho Supreme Court seeking a reversal of the
adverse verdict and judgment described above, as it believed there were several reversible errors
made by the trial court. In relation to this appeal, the Company posted an appeal bond totaling
$7.4 million. On January 29, 2010, through a formal mediation session, the parties agreed to
settle all of the claims arising out of and related to this lawsuit for $3.5 million. As a result
of this settlement, in the fourth quarter of 2009, the Company reduced its recorded reserves for
this matter from $5.4 million, which represented the initial jury verdict award plus the award for
court costs and attorney fees discussed above, to the $3.5 million settlement amount. The parties
are in the process of formalizing the terms of their settlement through a written settlement
agreement and mutual release (the Settlement Agreement). Upon execution of the Settlement
Agreement, payment of the settlement amount and dismissal of this lawsuit with prejudice by the
court, the Company will consider this matter closed.
Andrew Berkowitz, M.D., Individually and on behalf of all others similarly situated v. Prison
Health Services, Inc. and City of Philadelphia. On or about August 2, 2006, plaintiff, an
individual physician independent contractor in Philadelphia, Pennsylvania, filed a putative class
action suit against PHS and the City of Philadelphia (the City) in the Court of Common Pleas of
Philadelphia County, Trial Division, seeking unspecified damages for the class, but damages in the
amount of approximately $10,000 individually. Plaintiff alleges that he provided services to
inmates in the Philadelphia Prison System at the request of the defendants and that the defendants
breached the alleged contractual duties owed to him by paying an amount alleged to be less than the
full amount plaintiff billed for his medical services. On September 22, 2006, the City filed a New
Matter Crossclaim against PHS alleging breach of contract, negligence and seeking indemnification.
On September 29, 2006, PHS filed its Answer to plaintiffs complaint, which Answer included a
crossclaim against the City for contribution and indemnification. The plaintiff filed his motion
for class certification on October 1, 2007; and PHS and the City responded to this motion. On
January 16, 2009, the court denied the plaintiffs
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motion for class certification. The plaintiff has appealed the trial courts ruling. While
PHS believes that the trial courts ruling denying class certification is sound and will be upheld
on appeal, in the event the appellate court overturns the trial courts ruling and PHS is not
successful at trial, an adverse judgment could have a material adverse affect on the Companys
financial position and its results of operations. As of December 31, 2009, the Company has no
reserves associated with this proceeding.
Saint Josephs Regional Medical Center v. Correctional Health Services, et al. On or about
February 8, 2007, the Companys subsidiary, CHS, was served with a lawsuit by plaintiff, Saint
Josephs Regional Medical Center (St. Josephs). Plaintiff filed suit in the Superior Court of
New Jersey, Law Division: Passaic County, against CHS, Barnert Hospital, County of Bergen, Bergen
County Jail, County of Essex, Essex County Jail, County of Hudson, Hudson County Jail, County of
Passaic and Passaic County Jail, John Does #1-30, ABC Corporations #1-30, XYZ Jails, Prisons
and/or Detention Centers seeking damages from CHS totaling approximately $2.5 million. Plaintiff
claims that CHS failed to administer various contracts with respect to medical claims for the
treatment of certain patients and the payment of such claims between each of the respective
counties and jails named in the complaint and Barnert Hospital, to which St. Josephs claims it was
an intended third-party beneficiary. On August 15, 2007, Barnert Hospital filed for Chapter 11
bankruptcy protection. As a result, the court has stayed the proceedings in the lawsuit pending
resolution of the bankruptcy. CHS intends to defend itself vigorously, and maintains that it is
not responsible for any payments that may be due and owing to the plaintiff. However, a judgment
adverse to CHS could have a material adverse effect on the Companys financial position and its
results of operations. As of December 31, 2009, the Company has no reserves associated with this
proceeding.
Matters involving PHS and Baltimore County, Maryland. PHS is currently involved in a
lawsuit with its former client, Baltimore County, Maryland (the County) in the Circuit Court for
Baltimore County, Maryland seeking collection of outstanding receivable balances, damages for
breach of contract, quantum meruit, and unjust enrichment as well as prejudgment interest (the
Collection Matter). The outstanding receivable balances total approximately $1.7 million at
December 31, 2009 and are primarily related to services performed by PHS between April 1, 2006 and
September 14, 2006 while PHS and the County were jointly seeking a judicial interpretation of a
contract dispute regarding whether the County had timely exercised its renewal options under its
contract with PHS.
PHS contended that the original term of its contract with the County expired on June 30, 2005,
without the County exercising the first of three, two-year renewal options. On July 1, 2005, PHS
sent a letter to the County stating its position that PHS contract to provide services expired on
June 30, 2005 due to the Countys failure to provide such extension notice. The County disputed
PHS contention asserting that it properly exercised the first renewal option and that the term of
the contract therefore was through June 30, 2007, with extension options through June 30, 2011. In
July 2005, the County and PHS agreed to have a judicial authority interpret the contract through
formal judicial proceedings (the Contract Matter). At the written request of the County, PHS
continued to provide healthcare services to the County from July 1, 2005 to September 14, 2006,
under the terms and conditions of the contested contract, pending the judicial resolution of the
Contract Matter, while reserving all of its rights. Finally, during September 2006, amid
reciprocal claims of default, both PHS and the County took individual steps to terminate the
relationship between the parties. PHS contends that it terminated the relationship effective
September 14, 2006, due to various breaches by the County, including failure to remit payment of
approximately $1.7 million primarily related to services rendered between April 1, 2006 and
September 14, 2006. On October 27, 2006 PHS initiated the Collection Matter lawsuit against the
County.
The Collection Matter, although filed, was initially dormant, pending the resolution of the
Contract Matter. As discussed in more detail below, the Contract Matter was resolved in favor of
PHS on August 26, 2008, when the Maryland Court of Appeals (the States highest appellate court)
denied the Countys request for a review of a Maryland Court of Special Appeals decision in favor
of PHS. After the resolution of the Contract Matter, the parties, during 2009, commenced the
discovery process on the Collection Matter. PHS believes, in the case of the Collection Matter,
that it has a valid and meritorious cause of action and, as a result, has concluded that the
outstanding receivables, which represent services performed under the relationship between the
parties, are probable of collection. However, although PHS believes it has valid contractual and
legal arguments, an adverse result in the Collection Matter could have a negative impact on PHS
ability to collect the outstanding receivable amount and result in losses in future periods.
During 2009, the Contract Matter, mentioned above, was resolved in the following manner. In
November 2005, the Circuit Court for Baltimore County, Maryland ruled in favor of the County, with
respect to the Contract Matter, ruling that the County properly exercised its first, two-year
renewal option by sending a faxed written renewal amendment to PHS on July 1, 2005. PHS appealed
this ruling. On December 6, 2006, the Maryland Court of Special Appeals (i) reversed this
judgment; (ii) ruled that the County did not timely exercise its renewal option by its actions of
July 1, 2005; and (iii) remanded the case to the Circuit Court to determine whether the County
properly exercised the option by its conduct prior to June 30, 2005 an issue not originally
decided by the Circuit Court. On May 15, 2007, the Circuit Court, upon remand, held a hearing on
the parties pending cross motions for summary judgment. The Court issued an oral opinion at the
end of the hearing indicating its intention to rule in favor of the Countys motion for summary
judgment and against PHS motion for summary judgment. On June 6, 2007, the Court filed its order
memorializing the aforementioned ruling. In its order, the Court ruled that, by its actions, the
County properly and timely exercised the first two-year renewal option. The Company filed a Notice
of Appeal and on May 14, 2008, the Maryland Court of Special Appeals issued its ruling that the
actions the County claimed constituted an exercise of renewal were ineffective. Accordingly, the
Court of Special Appeals reversed the Circuit Courts ruling and directed it to grant the Companys
motion for summary judgment in the lawsuit. On June 27, 2008, the County petitioned the Maryland
Court of Appeals (the States highest appellate court) to review the May 14, 2008 Court of Special
Appeals decision. By order dated August 26, 2008, the Court of Appeals denied the Countys request
to review the decision, resulting in the ruling of the Court of Special Appeals in favor of the
Company becoming final, thereby bringing closure to the Contract Matter.
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Matters Related to the Audit Committee Investigation and Shareholder Litigation
On March 15, 2006 the Company announced that its Audit Committee had concluded its
investigation and reached certain conclusions with respect to findings of the investigation that
resulted in the recording of amounts due to SPPs customers that were not charged in accordance
with the terms of their respective contracts.
SEC and United States Attorney Informal Inquiries. As previously reported, the Company
contacted the SEC to inform it of the existence of the internal investigation conducted by the
Audit Committee and the issues being investigated. Since that time, the Company has cooperated with
the SEC in the informal inquiry that it conducted. In November 2009, the SEC confirmed that its
informal inquiry has been formally closed without any enforcement action. The SEC further
confirmed it never issued a formal order of investigation or a Wells Notice relating to this
matter. As a result of receiving this confirmation from the SEC, the Company considers this matter
closed.
The Company has also cooperated with the Office of the U. S. Attorney for the Middle District
of Tennessee (the U.S. Attorney) in an informal inquiry
it conducted. The Company has recently been informed that the U.S.
Attorney has no active investigation against the Company.
As a result of receiving this confirmation from the U.S. Attorney, the Company
considers this matter closed.
Shareholder Litigation. On April 6, 2006, plaintiffs filed the first of four similar
securities class action lawsuits in the United States District Court for the Middle District of
Tennessee against the Company and the Companys Chief Executive Officer, at that time, and Chief
Financial Officer. Plaintiffs allegations in these class action lawsuits are substantially
identical and generally allege on behalf of a putative class of individuals who purchased the
Companys common stock between September 24, 2003 and March 16, 2006 that, prior to the Companys
announcement of the Audit Committee investigation, the Company and/or the Companys Chief Executive
Officer, at that time, and Chief Financial Officer violated Sections 10(b) and 20(a) of the
Securities and Exchange Act of 1934 and SEC Rule 10b-5 by making false and misleading statements,
or concealing information about the Companys business, forecasts and financial performance. The
complaints seek certification as a class action, unspecified compensatory damages, attorneys fees
and costs, and other relief. By order dated August 3, 2006, the district court consolidated the
lawsuits into one consolidated action and on October 31, 2006, plaintiff filed an amended complaint
adding SPP, Enoch E. Hartman III and Grant J. Bryson as defendants. Enoch E. Hartman III is a
former employee of the Company and SPP and Grant J. Bryson is a former employee of SPP. The
amended complaint also generally alleges that defendants made false and misleading statements
concerning the Companys business which caused the Companys securities to trade at inflated prices
during the class period. Plaintiff seeks an unspecified amount of damages in the form of (i)
restitution; (ii) compensatory damages, including interest; and (iii) reasonable costs and
expenses. Defendants moved to dismiss the amended complaint on January 19, 2007, and the parties
completed the briefs on the motion in May 2007. On March 31, 2009, the Court ruled on the
defendants motion to dismiss, granting it in part and denying it in part. While the Courts
ruling dismissed significant portions of plaintiffs amended complaint and, as a result, narrowed
the scope of plaintiffs claims, none of the defendants were dismissed from the case and several of
plaintiffs claims under Sections 10(b) and 20(a) of the Securities and Exchange Act of 1934 and
SEC Rule 10b-5 remain. The parties were not in agreement as to the scope of the Courts order and
defendants filed a motion to confirm which claims the Court dismissed in its March 31, 2009 ruling.
The Court granted defendants motion to confirm the scope of the dismissal order on July 20, 2009,
ruling that certain of Plaintiffs claims had been in fact dismissed. The Court also confirmed,
however, that certain other claims remained viable.
On July 22, 2009, the Court administratively closed the shareholder litigation case, while the
parties pursued mediation of this matter. On February 19, 2010, the parties agreed to the terms of
a mediators proposal to settle all of the claims in this lawsuit. The settlement, which is
subject to final documentation as well as approval by the Court, provides for payment by the
Company of $10.5 million and issuance by the Company of 300,000 shares of common stock and would
lead to a dismissal with prejudice of all claims against all defendants in the litigation. The
preliminary total value of the settlement, based upon the Companys closing share price for its
common stock of $15.42 per share on February 19, 2010, is approximately $15.1 million. As such,
the Company has recorded a
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reserve of $15.1 million, which has been included in accrued expenses in the Companys
consolidated balance sheet as of December 31, 2009.
The final value of the settlement will be determined based upon the Companys closing share price at the time of final approval of the settlement by the Court. The settlement
provides for price protection to the plaintiffs in the event the closing share price is below $14.65 per
share at the time of final approval of the settlement by the Court.
In such event, the Company would pay in cash the difference between the share
value at the time of final approval and $14.65 per share.
The parties are formalizing the terms of the
settlement through a written agreement which will be executed by the parties and presented to the
Court for final approval. Upon final approval of the Court and payment of the settlement amount,
the Company will consider this matter closed.
In September 2009, the Company and its primary D&O
carrier reached an agreement under which the Company and the primary D&O carrier mutually released
each other from future claims related to this matter and the primary D&O carrier remitted insurance
proceeds to the Company totaling $8.0 million, less approximately $0.4 million in legal fees paid
by the primary D&O carrier as of the settlement date. The Company has paid and/or accrued
additional legal fees incurred through December 31, 2009, of $0.8 million related to this matter.
In addition to its primary D&O carrier, the Company also maintains D&O insurance with an
excess D&O carrier that provides for additional insurance coverage of up to $5.0 million for losses
in excess of $10.0 million. As of the date of this Annual Report on Form 10K, the excess D&O
carrier has denied coverage of this matter.
Delaware Department of Justice Inquiry. On April 4, 2006, the Company received a letter
notifying it that the Office of the Attorney General, Delaware Department of Justice is conducting
an inquiry into the indirect payment of claims by the Delaware Department of Correction to SPP
beginning in July 2002 and ending in the spring of 2005 for pharmaceutical services. There can be
no assurance that the Delaware Department of Justice inquiry will not result in the Company
incurring additional investigation and related expenses; being required to make additional refunds;
incurring criminal, or civil penalties, including the imposition of fines; or being debarred from
pursuing future business in certain jurisdictions. Management of the Company is unable to predict
the effect that any such actions may have on its business, financial condition, results of
operations or stock price. The Company has cooperated and intends to continue to cooperate with
the Delaware Department of Justice during its inquiry.
Other Matters
In January 2010, the Company entered into a $4.3 million settlement for a matter in which a
law firm representing a former inmate, for whom the Company provided healthcare services, had sent
notice asserting that the Company was responsible for permanent injuries to the inmate. As a
result of this settlement agreement, in the fourth quarter of 2009, the Company recorded additional
expense totaling $0.7 million to increase its reserves related to this matter to $4.3 million as of
December 31, 2009. The Company now considers this matter closed.
The Companys business ordinarily results in labor and employment related claims and matters,
actions for professional liability and related allegations of deliberate indifference in the
provision of healthcare and other causes of action related to its provision of healthcare services.
Therefore, in addition to the matters discussed above, the Company is a party to a multitude of
filed or pending legal and other proceedings incidental to its business. An estimate of the amounts
payable on existing claims for which the liability of the Company is probable and estimable is
included in accrued expenses. The Company is not aware of any unasserted claims that would have a
material adverse effect on its consolidated financial position, results of operations or cash
flows.
Performance Bonds
The Company is required under certain contracts to provide a performance bond and may also be
required to post performance bonds for other business reasons. At December
31, 2009, the Company had outstanding performance bonds totaling $16.0 million. The performance
bonds are renewed on an annual basis. The Company has letters of credit in the amount of $1.6
million at December 31, 2009 that collateralize these performance bonds, reduce availability under
the Companys credit facility and limit funds available for debt service and working capital. The
Company is also dependant on the financial health of the surety companies that it relies on to
issue its performance bonds. An inability to obtain new or renew existing performance bonds could
result in limitations on the Companys ability to bid for new or renew existing contracts which
could have a material adverse effect on the Companys financial condition and results of
operations.
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Table of Contents
22. Major Customers
The following is a summary of revenues from major customers, as compared to total revenues
from both continuing and discontinued operations combined (in thousands):
Year Ended December 31, | ||||||||||||||||||||||||
2009 | 2008 | 2007 | ||||||||||||||||||||||
Revenue | Percent | Revenue | Percent | Revenue | Percent | |||||||||||||||||||
New York City
Department of
Health and Mental
Hygiene |
$ | 122,625 | 20.1 | % | $ | 116,777 | 23.1 | % | $ | 109,268 | 19.6 | % | ||||||||||||
Commonwealth of
Pennsylvania,
Department of
Corrections |
89,419 | 14.7 | 78,069 | 15.5 | 74,819 | 13.4 | ||||||||||||||||||
State of Michigan* |
85,269 | 14.0 | | | | |
* | The Companys contract to provide prisoner health care services to prisoners under the care of the State of Michigan Department of Corrections commenced on April 1, 2009. |
23. Segment Data
On May 3, 2007, SPP, closed on the sale, at net book value, of certain of its assets, to
Maxor, effective April 30, 2007. For more information on the sale of SPP assets, see Note 1.
As of May 1, 2007, the Company has one reportable segment: correctional healthcare services.
Prior to the sale of SPP assets described above, the Company also had a reportable segment for
pharmaceutical distribution services. The correctional healthcare services segment contracts with
state, county and local governmental agencies to provide and/or administer healthcare services to
inmates of prisons and jails. The pharmaceutical distribution services segment, prior to May 1,
2007, contracted with federal, state and local governments and certain private entities to
distribute pharmaceuticals and certain medical supplies to inmates of correctional facilities. The
accounting policies of the segments were the same as those described in Note 2. The Company
evaluated segment performance based on each segments gross margin without allocation of corporate
selling, general and administrative expenses, interest expense or income tax provision (benefit).
The following table presents the summary financial information related to each segment for the
year ended December 31, 2007 that was used by the Companys chief operating decision maker (in
thousands):
Correctional | Pharmaceutical | Elimination of | ||||||||||||||
Healthcare | Distribution | Intersegment | ||||||||||||||
Services | Services | Sales | Consolidated | |||||||||||||
Year ended December 31, 2007: |
||||||||||||||||
Healthcare revenues |
$ | 448,936 | $ | 18,979 | $ | (15,569 | ) | $ | 452,346 | |||||||
Healthcare expenses |
422,502 | 19,336 | (15,569 | ) | 426,269 | |||||||||||
Gross margin |
$ | 26,434 | $ | (357 | ) | $ | | $ | 26,077 | |||||||
Depreciation and amortization expense |
$ | 3,527 | $ | 244 | $ | | $ | 3,771 | ||||||||
24. Quarterly Financial Data (Unaudited)
As discussed further in Note 6, the Company follows U.S. GAAP, which requires that terminated
or expired correctional healthcare service contracts be eliminated from the ongoing operations of
the Company and classified as discontinued operations. Accordingly, the operations of such
contracts, net of applicable income taxes, have been presented as discontinued operations and prior
period quarterly financial data has been reclassified.
As discussed further in Note 17, the FASB issued authoritative guidance that requires
share-based compensation awards that qualify as participating securities to be included in basic
earnings per share using the two class method. Under this guidance, all outstanding unvested
share-based payment awards that contain rights to nonforfeitable dividends or dividend equivalents
are considered participating securities. This guidance became effective for the Company on January
1, 2009 and is being applied retrospectively to all prior-period earnings per share computations.
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Table of Contents
The following table is a summary of the Companys unaudited quarterly statements of
operations data for 2009 and 2008 (in thousands except per share data). Earnings per share for
each quarter are computed independently of earnings per share for the year. The sum of the
quarterly earnings per share may not equal the earnings per share for the year because of: (i)
transactions affecting the weighted average number of common shares outstanding in each quarter;
and (ii) the uneven distribution of earnings during the year. Net income (loss) available to common shareholders for each quarter is computed independently of
net income (loss) available to common shareholders for the year. The sum of the quarterly net
income (loss) available to common shareholders may not equal the net income (loss) available to
common shareholders for the year because of: (i) transactions affecting the weighted average number
of unvested restricted shares outstanding during each quarter; and (ii) in periods (quarterly or
annual) in which the Company has incurred losses from continuing operations, no amounts are
allocated to unvested restricted shares for purposes of calculating net income (loss) available to
common shareholders per common share.
2009 | ||||||||||||||||
First | Second | Third | Fourth | |||||||||||||
Quarter | Quarter | Quarter | Quarter | |||||||||||||
Healthcare revenues |
$ | 128,667 | $ | 157,339 | $ | 159,328 | $ | 160,842 | ||||||||
Gross margin |
9,460 | 11,821 | 9,618 | 17,049 | ||||||||||||
Income (loss) from continuing operations |
857 | 2,041 | 768 | (175 | ) | |||||||||||
Income (loss) from discontinued operations, net of taxes |
(158 | ) | 62 | (52 | ) | (61 | ) | |||||||||
Net income (loss) |
699 | 2,103 | 716 | (236 | ) | |||||||||||
Net income (loss) available to common shareholders |
674 | 2,032 | 695 | (236 | ) | |||||||||||
Net income (loss) available to common shareholders
per common share basic: |
||||||||||||||||
Income (loss) from continuing operations |
0.09 | 0.22 | 0.08 | (0.02 | ) | |||||||||||
Income (loss) from discontinued operations, net of taxes |
(0.01 | ) | 0.01 | | (0.01 | ) | ||||||||||
Net income (loss) available to common shareholders per
common share |
0.08 | 0.23 | 0.08 | (0.03 | ) | |||||||||||
Net income (loss) available to common shareholders
per common share diluted: |
||||||||||||||||
Income (loss) from continuing operations |
0.09 | 0.22 | 0.08 | (0.02 | ) | |||||||||||
Income (loss) from discontinued operations, net of taxes |
(0.01 | ) | | | (0.01 | ) | ||||||||||
Net income (loss) available to common shareholders per
common share |
0.08 | 0.22 | 0.08 | (0.03 | ) |
2008 | ||||||||||||||||
First | Second | Third | Fourth | |||||||||||||
Quarter | Quarter | Quarter | Quarter | |||||||||||||
Healthcare revenues |
$ | 121,555 | $ | 121,187 | $ | 124,659 | $ | 117,621 | ||||||||
Gross margin |
8,989 | 9,835 | 11,442 | 9,604 | ||||||||||||
Income from continuing operations |
707 | 1,135 | 197 | 1,154 | ||||||||||||
Income from discontinued operations, net of taxes |
275 | 216 | 151 | (1 | ) | |||||||||||
Net income |
982 | 1,351 | 348 | 1,153 | ||||||||||||
Net income available to common shareholders |
967 | 1,332 | 339 | 1,124 | ||||||||||||
Net income available to common shareholders
per common share basic: |
||||||||||||||||
Income from continuing operations |
0.08 | 0.12 | 0.02 | 0.12 | ||||||||||||
Income from discontinued operations, net of taxes |
0.03 | 0.02 | 0.02 | | ||||||||||||
Net income available to common shareholders per
common share |
0.11 | 0.14 | 0.04 | 0.12 | ||||||||||||
Net income available to common shareholders
per common share diluted: |
||||||||||||||||
Income from continuing operations |
0.08 | 0.12 | 0.02 | 0.12 | ||||||||||||
Income from discontinued operations, net of taxes |
0.03 | 0.02 | 0.02 | | ||||||||||||
Net income available to common shareholders per common
share |
0.11 | 0.14 | 0.04 | 0.12 |
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25. Subsequent Event
On
March 1, 2010, the Companys Board of Directors declared a quarterly cash dividend of
$0.06 per share on the Companys common stock for the quarter ended March 31, 2010. The dividend will be
paid on April 13, 2010, to shareholders of record on March 23, 2010.
In accordance with U.S. GAAP related to subsequent events, the Company evaluated all material
events occurring subsequent to the balance sheet date of December 31, 2009, through the date the
consolidated financial statements were issued, for events requiring disclosure or recognition in
the consolidated financial statements.
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SCHEDULE II
AMERICA SERVICE GROUP INC.
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(in thousands)
(in thousands)
Additions | ||||||||||||||||
Balance at | Charged to | Balance at | ||||||||||||||
Beginning of | Costs and | End of | ||||||||||||||
Period | Expenses | Deductions | Period | |||||||||||||
December 31, 2009 | ||||||||||||||||
Allowance for doubtful accounts |
$ | 417 | $ | 755 | $ | (814 | ) | $ | 358 | |||||||
December 31, 2008 | ||||||||||||||||
Allowance for doubtful accounts |
689 | 491 | (763 | ) | 417 | |||||||||||
December 31, 2007 | ||||||||||||||||
Allowance for doubtful accounts |
524 | 1,081 | (916 | ) | 689 |
F-35