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EX-32.1 - EX-32.1 - AMERICA SERVICE GROUP INC /DE | g27053exv32w1.htm |
EX-31.2 - EX-31.2 - AMERICA SERVICE GROUP INC /DE | g27053exv31w2.htm |
EX-32.2 - EX-32.2 - AMERICA SERVICE GROUP INC /DE | g27053exv32w2.htm |
EX-31.1 - EX-31.1 - AMERICA SERVICE GROUP INC /DE | g27053exv31w1.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2011
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 | 51-0332317 | |
(State or other jurisdiction of | (I.R.S. Employer | |
incorporation or organization) | Identification No.) | |
105 Westpark Drive, Suite 200 | ||
Brentwood, Tennessee | 37027 | |
(Address of principal executive offices) | (Zip Code) |
(615) 373-3100
(Registrants telephone number, including area code)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be
filed under Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12
months (or for such shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes 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 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
There were 9,297,566 shares of common stock, par value $0.01 per share, outstanding as of
April 26, 2011.
AMERICA SERVICE GROUP INC.
QUARTERLY REPORT ON FORM 10-Q
INDEX
INDEX
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PART I:
FINANCIAL INFORMATION
ITEM 1. | FINANCIAL STATEMENTS |
AMERICA SERVICE GROUP INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(shown in 000s except share and per share amounts)
(UNAUDITED)
(UNAUDITED)
March 31, | December 31, | |||||||
2011 | 2010 | |||||||
ASSETS |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 41,606 | $ | 39,584 | ||||
Accounts receivable, net of allowance for doubtful accounts of $430 and $411, respectively |
54,054 | 52,481 | ||||||
Inventories |
2,870 | 2,868 | ||||||
Prepaid expenses and other current assets |
14,048 | 13,750 | ||||||
Current deferred tax assets |
| 3,359 | ||||||
Total current assets |
112,578 | 112,042 | ||||||
Property and equipment, net |
11,163 | 11,040 | ||||||
Goodwill |
40,772 | 40,772 | ||||||
Contracts, net |
1,588 | 1,658 | ||||||
Other assets |
11,776 | 11,852 | ||||||
Noncurrent deferred tax assets |
244 | | ||||||
Total assets |
$ | 178,121 | $ | 177,364 | ||||
LIABILITIES AND EQUITY |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 23,051 | $ | 23,691 | ||||
Accrued medical claims liability |
20,310 | 23,750 | ||||||
Accrued expenses |
42,561 | 38,810 | ||||||
Deferred revenue |
12,377 | 10,053 | ||||||
Current deferred tax liabilities |
1,576 | | ||||||
Total current liabilities |
99,875 | 96,304 | ||||||
Noncurrent portion of accrued expenses |
20,744 | 20,460 | ||||||
Noncurrent deferred tax liabilities |
| 4,836 | ||||||
Total liabilities |
120,619 | 121,600 | ||||||
Commitments and contingencies (Note 19) |
||||||||
Stockholders equity: |
||||||||
Preferred stock, $0.01 par value, 2,000,000 shares authorized at March 31, 2011 and
December 31, 2010; no shares issued or outstanding |
| | ||||||
Common stock, $0.01 par value, 20,000,000 shares authorized at March 31, 2011 and
December 31, 2010; 9,297,566 and 9,280,382 shares issued and outstanding at March 31,
2011 and December 31, 2010, respectively |
93 | 93 | ||||||
Additional paid-in capital |
40,553 | 40,015 | ||||||
Retained earnings |
16,856 | 15,656 | ||||||
Total stockholders equity |
57,502 | 55,764 | ||||||
Total liabilities and equity |
$ | 178,121 | $ | 177,364 | ||||
The accompanying notes to condensed consolidated financial statements are an integral part
of these condensed consolidated balance sheets. The condensed consolidated balance sheet at
December 31, 2010 is taken from the audited financial statements at that date.
of these condensed consolidated balance sheets. The condensed consolidated balance sheet at
December 31, 2010 is taken from the audited financial statements at that date.
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AMERICA SERVICE GROUP INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(shown in 000s except share and per share amounts)
(UNAUDITED)
(UNAUDITED)
Quarter ended | ||||||||
March 31, | ||||||||
2011 | 2010 | |||||||
Healthcare revenues |
$ | 153,865 | $ | 159,960 | ||||
Healthcare expenses |
139,761 | 144,628 | ||||||
Gross margin |
14,104 | 15,332 | ||||||
Selling, general and administrative expenses |
8,682 | 8,852 | ||||||
Merger expenses |
1,339 | | ||||||
Audit Committee investigation and related expenses |
43 | 153 | ||||||
Depreciation and amortization |
927 | 769 | ||||||
Income from operations |
3,113 | 5,558 | ||||||
Interest income |
5 | 20 | ||||||
Income from continuing operations before income tax provision |
3,118 | 5,578 | ||||||
Income tax provision |
1,365 | 2,328 | ||||||
Income from continuing operations |
1,753 | 3,250 | ||||||
Income (loss) from discontinued operations, net of taxes |
5 | (53 | ) | |||||
Net income |
$ | 1,758 | $ | 3,197 | ||||
Net income available to common shareholders (Note 20) |
$ | 1,741 | $ | 3,091 | ||||
Net income (loss) available to common shareholders per common share basic: |
||||||||
Continuing operations |
$ | 0.19 | $ | 0.36 | ||||
Discontinued operations, net of taxes |
| | ||||||
Net income available to common shareholders per common share (Note 20) |
$ | 0.19 | $ | 0.36 | ||||
Net income (loss) available to common shareholders per common share diluted: |
||||||||
Continuing operations |
$ | 0.19 | $ | 0.36 | ||||
Discontinued operations, net of taxes |
| (0.01 | ) | |||||
Net income available to common shareholders per common share (Note 20) |
$ | 0.19 | $ | 0.35 | ||||
Weighted average common shares outstanding: |
||||||||
Basic |
9,194,683 | 8,659,803 | ||||||
Diluted |
9,323,272 | 8,743,774 | ||||||
Dividends declared per share |
$ | 0.06 | $ | 0.06 | ||||
The accompanying notes to condensed consolidated financial statements are an
integral part of these condensed consolidated statements.
integral part of these condensed consolidated statements.
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AMERICA SERVICE GROUP INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(shown in 000s)
(UNAUDITED)
(UNAUDITED)
Quarter ended | ||||||||
March 31, | ||||||||
2011 | 2010 | |||||||
Cash flows from operating activities: |
||||||||
Net income |
$ | 1,758 | $ | 3,197 | ||||
Adjustments to reconcile net income to net cash provided by
operating activities: |
||||||||
Depreciation and amortization |
928 | 771 | ||||||
Loss on retirement of fixed assets |
| 1 | ||||||
Finance cost amortization |
8 | 8 | ||||||
Deferred income taxes |
(145 | ) | 2,243 | |||||
Share-based compensation expense |
338 | 432 | ||||||
Changes in operating assets and liabilities: |
||||||||
Accounts receivable, net |
(1,573 | ) | (6,023 | ) | ||||
Inventories |
(2 | ) | 141 | |||||
Prepaid expenses and other current assets |
(298 | ) | 474 | |||||
Other assets |
69 | 1,355 | ||||||
Accounts payable |
(640 | ) | 6,019 | |||||
Accrued medical claims liability |
(3,440 | ) | 1,542 | |||||
Accrued expenses |
3,477 | (4,560 | ) | |||||
Deferred revenue |
2,324 | (665 | ) | |||||
Net cash provided by operating activities |
2,804 | 4,935 | ||||||
Cash flows from investing activities: |
||||||||
Capital expenditures |
(982 | ) | (1,319 | ) | ||||
Net cash
used in investing activities |
(982 | ) | (1,319 | ) | ||||
Cash flows from financing activities: |
||||||||
Share repurchases |
| (544 | ) | |||||
Issuance of common stock |
200 | 186 | ||||||
Exercise of stock options |
| 591 | ||||||
Net cash provided by financing activities |
200 | 233 | ||||||
Net increase in cash and cash equivalents |
2,022 | 3,849 | ||||||
Cash and cash equivalents at beginning of period |
39,584 | 37,655 | ||||||
Cash and cash equivalents at end of period |
$ | 41,606 | $ | 41,504 | ||||
The accompanying notes to condensed consolidated financial statements are an
integral part of these condensed consolidated statements.
integral part of these condensed consolidated statements.
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AMERICA SERVICE GROUP INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2011
(unaudited)
(unaudited)
1. Basis of Presentation
The interim condensed consolidated financial statements of America Service Group Inc. and its
consolidated subsidiaries (collectively, the Company) as of March 31, 2011 and for the quarters
ended March 31, 2011 and 2010 are unaudited, but in the opinion of management, have been prepared
in conformity with United States generally accepted accounting principles (U.S. GAAP) applied on
a basis consistent with those of the Companys annual audited consolidated financial statements.
Such interim condensed consolidated financial statements reflect all adjustments (consisting of
normal recurring accruals) necessary for a fair presentation of the financial position and the
results of operations for the periods presented. The results of operations presented for the
quarter ended March 31, 2011 are not necessarily indicative of the results to be expected for the
year ending December 31, 2011. The interim condensed consolidated financial statements should be
read in conjunction with the audited consolidated financial statements and the related notes
thereto included in the Companys Annual Report on Form 10-K for the year ended December 31, 2010
filed with the Securities and Exchange Commission (SEC).
The preparation of the condensed consolidated financial statements in conformity with U. S.
GAAP requires management to make estimates and assumptions that affect the amounts reported in the
condensed consolidated financial statements and accompanying notes. Actual results could differ
from those estimates. Some of the more significant areas requiring estimates in the 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.
2. Description of Business
The Company provides and/or administers managed healthcare services to correctional facilities
under contracts with state and local governments. The health status of inmates impacts the results
of operations under such contractual arrangements. The condensed 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). The
Company has one reportable segment: correctional healthcare services.
3. Pending Merger
On March 2, 2011, the Company entered into an Agreement and Plan of Merger (the Merger
Agreement) with Valitás Health Services, Inc., a Delaware corporation (Valitás), and Whiskey
Acquisition Corp., a Delaware corporation and a wholly owned subsidiary of Valitás (Merger Sub),
providing for the acquisition of the Company by Valitás. Subject to the terms and conditions of
the Merger Agreement, the Merger Sub will be merged with and into the Company (the Merger), with
the Company surviving the Merger as a wholly owned subsidiary of Valitás.
At the effective time of the Merger (the Effective Time), each share of common stock of the
Company that is issued and outstanding as of immediately prior to the Effective Time (other than
shares held by the Company, Valitás or any of their respective
direct or indirect subsidiaries or shares held by
stockholders who have properly exercised and perfected appraisal
rights in accordance with Delaware law) will be
automatically cancelled and converted into the right to receive $26.00 in cash, without interest
and less any applicable withholding taxes
(such per share
amount, the Merger Consideration).
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Prior to the Effective Time, each outstanding option to purchase shares of the
Companys common stock
will vest and become exercisable in full. Each option to purchase shares of the Companys common stock
outstanding at the Effective Time will be canceled and converted into the right to receive, as soon as reasonably
practicable after the Effective Time, an amount in cash equal to: (i) the number of shares subject to such option
multiplied by (ii) the excess (if any) of the Merger Consideration over the exercise price per share of such option. As
of the date of this Quarterly Report on Form 10-Q, the Company has no outstanding stock options with an exercise
price per share in excess of the Merger Consideration. As of the Effective Time, the vesting restrictions on each
outstanding share of restricted stock will be accelerated and will lapse and each such share of restricted stock will be
automatically canceled and converted into the right to receive the Merger Consideration.
The Merger Agreement also contains certain termination rights in favor of each party,
including rights allowing the Company to terminate the Merger Agreement in order to accept a
Superior Proposal. Upon termination of the Merger Agreement under certain specified circumstances,
the Company will be required to pay to Valitás a specified fee and to reimburse Valitás for up to
$2.0 million in documented transaction expenses.
While the Merger Agreement provided for a reduced fee of $4.5 million in connection with terminations based on
the Companys acceptance of a Superior Proposal made by an Excluded Party, because the No-Shop Period Start
Date has passed and no third party qualifies as an Excluded Party,
the Company will be required to pay to Valitás a
fee in the amount of $8.0 million, plus documented transaction expenses, in connection with any termination that
requires payment of a termination fee.
Completion of the Merger requires the fulfillment or waiver of a number of conditions, including: (i) the
adoption of the Merger Agreement by the affirmative vote of the holders of a majority of the outstanding shares of
the Companys common stock entitled to vote thereon at the special meeting of the stockholders of the Company
(or any adjournment or postponement thereof); (ii) the expiration or termination of the applicable waiting period
under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended; (iii) the absence of any law or
governmental order prohibiting or making illegal the completion of the Merger; and (iv) subject to certain
qualifications based on materiality thresholds, the accuracy of the parties representations and warranties and the
parties compliance with the covenants and agreements set forth in the Merger Agreement.
The Companys Board of Directors, unanimously approved the Merger Agreement
and the Merger and determined that the Merger Agreement and the Merger are advisable, fair and in the
best interest of the Company and its stockholders. The Merger is expected to be completed in the second
quarter of 2011.
4. 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 March 31,
2011, 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 Delaware Department of Corrections, which
was serviced by a customer of SPP (see Note 19). 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 quarter ended March
31, 2011, the Company recognized additional expense totaling $43,000 relative to this matter which
is primarily due to related litigation filed by the Company against one of its insurance carriers
(see Note 19).
5. Restructuring Charge
On June 16, 2010, the former Senior Vice President, Chief Administrative Officer and Chief
Compliance Officer of the Company, resigned his position, effective July 16, 2010. In connection
with his resignation and this restructuring, his duties and responsibilities were reassigned to
various members of management. The Company incurred a one-time termination charge related to the
restructuring of approximately $0.3 million, comprised of $0.2
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million in accrued compensation and benefits and a $0.1 million non-cash charge related to the
accelerated vesting of remaining unvested restricted shares. The accrued compensation and
benefits, which will be fully paid by July 16, 2011, are included in accrued expenses in the
Companys condensed consolidated balance sheet. The non-cash charge related to the stock based
compensation is included in additional paid in capital in the Companys condensed consolidated
balance sheet.
A reconciliation of the related restructuring liability at March 31, 2011 is as follows (in
thousands):
One-time | ||||
Termination | ||||
Benefits | ||||
Balance at December 31, 2010 |
$ | 144 | ||
Plus: Costs incurred |
| |||
Less: Amounts paid |
(65 | ) | ||
Balance at March 31, 2011 |
$ | 79 | ||
6. 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 quarters ended March 31, 2011 and 2010, the Company recognized total share-based
compensation costs of $0.3 million and $0.4 million, respectively.
No options were issued during the quarters ended March 31, 2011 and 2010. A summary of option
activity and changes during the quarter ended March 31, 2011 is presented below:
Weighted | Weighted Average | Aggregate Intrinsic | ||||||||||||||
Average | Remaining | Value (in | ||||||||||||||
Options | Exercise Price | Contractual Term | thousands) (1) | |||||||||||||
Outstanding, December 31, 2010 |
897,172 | $ | 17.12 | |||||||||||||
Granted |
| | ||||||||||||||
Exercised |
(4,500 | ) | 16.42 | |||||||||||||
Canceled |
| | ||||||||||||||
Outstanding, March 31, 2011 |
892,672 | $ | 17.13 | 5.65 | $ | 7,599 | ||||||||||
Exercisable, March 31, 2011 |
638,672 | $ | 18.05 | 4.19 | $ | 4,847 | ||||||||||
Expected to vest, March 31, 2011 (2) |
244,793 | $ | 14.79 | 9.31 | $ | 2,656 | ||||||||||
(1) | Based upon the difference between the closing market price of the Companys common stock on the last trading day of the quarter and the exercise price of in-the-money options. | |
(2) | Amount represents options expected to vest, net of estimated forfeitures. |
A summary of the nonvested shares of restricted stock and activity during the quarter
ended March 31, 2011 is presented below:
Weighted | ||||||||
Restricted | Average Grant- | |||||||
Shares | Date Fair Value | |||||||
Nonvested, December 31, 2010 |
91,065 | $ | 13.53 | |||||
Granted |
| | ||||||
Vested |
(4,665 | ) | 10.63 | |||||
Forfeited |
| | ||||||
Nonvested, March 31, 2011 |
86,400 | $ | 13.69 | |||||
7. 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, the contracts operations generally will be
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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 condensed consolidated statements of
income have been reclassified.
The components of income (loss) from discontinued operations, net of taxes, are as follows (in
thousands):
Quarter ended | ||||||||
March 31, | ||||||||
2011 | 2010 | |||||||
Healthcare revenues |
$ | (139 | ) | $ | 4,121 | |||
Healthcare expenses |
(149 | ) | 4,209 | |||||
Gross margin |
10 | (88 | ) | |||||
Depreciation and amortization |
1 | 2 | ||||||
Income (loss) from discontinued operations before taxes |
9 | (90 | ) | |||||
Income tax provision (benefit) |
4 | (37 | ) | |||||
Income (loss) from discontinued operations, net of taxes |
$ | 5 | $ | (53 | ) | |||
8. Fair Value of Financial Instruments
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).
The Company has available-for-sale securities and money market accounts totaling $13.4 million
and $4.0 million at March 31, 2011 and December 31, 2010, respectively, that are classified as cash
equivalents on the accompanying condensed consolidated balance sheet. 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.
9. Accounts Receivable
Accounts receivable consist of the following (in thousands):
March 31, | December 31, | |||||||
2011 | 2010 | |||||||
Billed accounts receivable |
$ | 19,598 | $ | 23,894 | ||||
Unbilled accounts receivable |
34,122 | 28,262 | ||||||
Other accounts receivable |
1,006 | 943 | ||||||
54,726 | 53,099 | |||||||
Less: Allowances |
(430 | ) | (411 | ) | ||||
54,296 | 52,688 | |||||||
Less: Receivables reclassified as noncurrent |
(242 | ) | (207 | ) | ||||
$ | 54,054 | $ | 52,481 | |||||
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 19, 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
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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. During February 2011, the parties agreed to resolve this matter through
binding arbitration which is expected to occur during the third quarter of 2011. At March 31,
2011, the Company has classified these receivables as current assets in its condensed consolidated
balance sheet.
As discussed more fully in Note 19, 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.
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 19, 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.
10. Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets are stated at amortized cost and comprised of the
following (in thousands):
March 31, | December 31, | |||||||
2011 | 2010 | |||||||
Prepaid insurance |
$ | 6,990 | $ | 6,303 | ||||
Prepaid cash deposits for professional liability claims losses |
4,974 | 5,524 | ||||||
Prepaid other |
2,084 | 1,923 | ||||||
$ | 14,048 | $ | 13,750 | |||||
11. Property and Equipment
Property and equipment are stated at cost and comprised of the following (in thousands):
March 31, | December 31, | Estimated | ||||||||||
2011 | 2010 | Useful Lives | ||||||||||
Leasehold improvements |
$ | 1,029 | $ | 1,004 | 7 years | |||||||
Equipment and furniture |
11,089 | 10,635 | 5 years | |||||||||
Computer software |
10,004 | 9,227 | 3-5 years | |||||||||
Medical equipment |
1,009 | 980 | 5 years | |||||||||
Automobiles |
44 | 44 | 5 years | |||||||||
Management information systems under development |
505 | 689 | | |||||||||
23,680 | 22,579 | |||||||||||
Less: Accumulated depreciation |
(12,517 | ) | (11,539 | ) | ||||||||
$ | 11,163 | $ | 11,040 | |||||||||
Depreciation expense for the quarters ended March 31, 2011 and 2010 was approximately
$0.9 million and $0.7 million, respectively.
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. In addition, the Company capitalizes costs
associated with upgrades or enhancements to its internally developed software systems which result
in additional functionality.
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12. Other Assets
Other assets are stated at amortized cost or net realizable value and are comprised of the
following (in thousands):
March 31, | December 31, | |||||||
2011 | 2010 | |||||||
Deferred financing costs |
$ | 68 | $ | 68 | ||||
Less: Accumulated amortization |
(49 | ) | (42 | ) | ||||
19 | 26 | |||||||
Prepaid cash deposits for professional
liability claims losses |
7,405 | 7,509 | ||||||
Prepaid insurance deposits |
3,996 | 3,996 | ||||||
Noncurrent receivables |
242 | 207 | ||||||
Other refundable deposits |
114 | 114 | ||||||
$ | 11,776 | $ | 11,852 | |||||
13. Contract Intangibles
The gross and net values of contract intangibles consist of the following (in thousands):
March 31, | December 31, | |||||||
2011 | 2010 | |||||||
Gross contracts value |
$ | 4,000 | $ | 4,000 | ||||
Less: Accumulated amortization |
(2,412 | ) | (2,342 | ) | ||||
$ | 1,588 | $ | 1,658 | |||||
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.
Estimated aggregate amortization expense related to the above contract intangibles for the
remainder of 2011 is $0.2 million and for each of the next four years is $0.3 million.
14. Accrued Expenses
Accrued expenses consist of the following (in thousands):
March 31, | December 31, | |||||||
2011 | 2010 | |||||||
Salaries and employee benefits |
$ | 21,429 | $ | 22,230 | ||||
Professional liability claims |
24,287 | 22,646 | ||||||
Accrued workers compensation claims |
7,284 | 6,469 | ||||||
Other |
10,305 | 7,925 | ||||||
63,305 | 59,270 | |||||||
Less: Noncurrent portion of deferred lease liability |
(814 | ) | (844 | ) | ||||
Less: Noncurrent portion of professional liability
and workers compensation claims |
(19,930 | ) | (19,616 | ) | ||||
$ | 42,561 | $ | 38,810 | |||||
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15. 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.
There are no loss contracts identified as of March 31, 2011.
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.
16. 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 March 31, 2011 and
December 31, 2010, the Company had no borrowings outstanding under the Credit Agreement. At March
31, 2011, the Company had $14.9 million available for borrowing, based on the current facility cap
and the Companys collateral base on that date and no standby letters of credit.
Borrowings under the Credit Agreement are limited to the lesser of (1) 85% of eligible
receivables or (2) $20.0 million (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.
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 $0.4 million.
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 cash
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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,
net of insurance recoveries, 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 March 31, 2011.
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 March 31, 2011, the Company was
in compliance with both the pre-distribution fixed charge coverage ratio and the post-distribution
fixed charge coverage ratio. The Company is prohibited under the terms of the Merger Agreement
from paying any additional dividends until the Merger closes or the Merger Agreement is terminated.
17. 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 March 31, 2011, the Companys valuation allowance of
approximately $0.2 million represents managements estimate of state net operating loss
carryforwards which will expire unused.
The Companys estimated effective tax rate is based on expected pre-tax income, expected
permanent book/tax differences, statutory tax rates and tax planning opportunities available in the
various jurisdictions in which it operates. On an interim basis, management estimates the annual
tax rate based on projected taxable income for the full year and records a quarterly income tax
provision in accordance with the anticipated annual rate. As the year progresses, management
refines the estimate of the years taxable income as new information becomes available, including
year-to-date financial results. This continual estimation process often results in a change to the
Companys expected effective tax rate for the year. When this occurs, management adjusts the income
tax provision during the quarter in which the change in estimate occurs so that the year-to-date
provision reflects the expected annual tax rate. The Companys effective income tax rate on income
from continuing operations before taxes for the quarter ended March 31, 2011 is 43.7%.
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
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.
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It is the Companys policy to recognize accrued interest and penalties related to its tax
contingencies as income tax expense. The Company has no tax contingencies at March 31, 2011, and
there is no accrued interest and penalties included in income tax expense for the quarters ended
March 31, 2011 and 2010.
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 2007 through 2010. The Company is currently under audit for the 2008 tax year.
Additionally, open tax years related to state jurisdictions remain subject to examination.
18. Professional and General Liability Self-Insurance Retention
The Company maintains a primary professional liability insurance program, principally on a
claims-made basis. For 2002 through 2006 and 2008 through 2011 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 2011, 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 2011 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. In addition to the coverage
described above, for 2010 and 2011, the Company has purchased excess liability policies which
provide coverage on a claims made basis for indemnity losses in excess of $4.0 million up to a
maximum coverage of $10.0 million per loss and in the aggregate. Any amounts ultimately incurred
above these coverage limits would be the responsibility of the Company.
The Company records a liability for reported as well as unreported professional and general
liability claims made against it, its directors and employees, and others who are indemnified by
the Company. Amounts accrued were $24.3 million and $22.6 million at March 31, 2011 and December
31, 2010, respectively, and are included in accrued expenses and the non-current portion of
accrued expenses in the condensed consolidated balance sheets. Changes in estimates of losses
resulting from the continuous review process and differences between estimates and loss payments
are recognized in the period in which the estimates are changed or payments are made. For the
quarter ended March 31, 2011 and 2010, the Company recorded increases of approximately $1.5
million and $0.6 million, respectively, related to its prior years known claims reserves as a
result of adverse developments 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 20), the Companys net income available to common shareholders and basic
and diluted earnings per common share were negatively impacted as a result of this adverse
development by amounts totaling $0.9 million, or $0.10 per basic and diluted common share, for the
quarter ended March 31, 2011 and $0.3 million, or $0.04 per basic common share and $0.03 per
diluted common share, for the quarter ended March 31, 2010. Reserves for professional and general
liability exposures are subject to fluctuations in frequency and severity and can fluctuate as a
result of court decisions or as new facts become available. Given the inherent degree of
variability in any such estimates, the reserves reported at March 31, 2011 represent managements
best estimate of the amounts necessary to discharge the Companys self-insured professional and
general liabilities. Any adverse developments on individual claims or matters in the future could
have a material adverse effect on the Companys financial position and its results of operations
in the period in which the reserve for any adverse development is recorded.
19. Commitments and Contingencies
The Company is a party to various legal proceedings incidental to its business. With respect
to all litigation matters, the Company considers the likelihood of a negative outcome typically in
consultation with outside counsel handling the Companys defense in these matters and estimates of
the probable costs for resolution of these matters are based upon an estimated range of potential
results, assuming a combination of litigation and settlement strategies. If the Company determines
the likelihood of a negative outcome is probable and the amount of the loss can be reasonably
estimated, the Company records an estimated loss for the expected outcome of the litigation.
However, it is difficult to predict the outcome or estimate a possible loss or range of loss in
some instances because litigation is subject to significant uncertainties. 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 litigation.
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A discussion is provided below of significant outstanding matters for which there have been
updates during 2011. For a discussion of all other significant outstanding matters, please refer
to Note 21 of the Companys 2010 Annual Report on Form 10-K filed on March 3, 2011.
Litigation and Claims
DeSantis Professional Liability Suit. On August 26, 2010, Theresa DeSantis and Julie
Giangiolini, as guardians of the estate of Anthony DeSantis, Jr., filed a complaint in the Court of
the Sixteenth Judicial Circuit in Kane County, Illinois alleging that PHS, by and through the
actions of its medical staff committed medical negligence which caused Anthony DeSantis Jr. to
suffer from significant injuries. Plaintiffs seek damages to recoup compensation for past and
future pain and suffering, loss of income, medical bills incurred and for the cost of future
medical treatment. This matter is currently in the discovery phase; however, the Company believes
that a negative outcome is probable and has recorded significant reserves related to this matter.
Such reserves are included in the Companys reserves for professional liability claims which total
$24.3 million at March 31, 2011. Should the ultimate resolution of this matter exceed the
Companys recorded reserves and available insurance coverage, such resolution could have a material
adverse effect on the Companys results of operations, financial position or cash flows in future
periods.
Dawkins Professional Liability Suit. On September 18, 2009, Johnathan Dawkins, Sara H.
Humphrey, guardian ad litem of Johnathan Dawkins, a mentally incapacitated person and Sara H.
Humphrey, individually, filed a complaint in the U.S. District Court of New Jersey, against CHS,
the New Jersey Counties of Essex and Union and a broad number of correctional personnel. The
complaint alleges that in 2007 Johnathan Dawkins suffered permanent injuries while incarcerated at
the Union County Jail as a result of actions of the defendants. This matter is currently in the
discovery stage. Management currently believes this matter is covered under the policy limits of
its 2007 professional liability insurance policy, however, should the ultimate resolution of this
matter exceed such policy limits, such resolution could have a material adverse effect on the
Companys results of operations, financial position or cash flows in future periods.
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
March 31, 2011 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 first renewal option 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. On March 30, 2010, the court held a scheduling
conference in which the judge set February 8, 2011 as the trial date for the Collection Matter.
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Prior to the trial date, preliminary settlement discussions were conducted without resolution.
Subsequently, the parties agreed to forego the trial and resolve the Collection Matter through
binding arbitration which is expected to occur during the third quarter of 2011. 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, continues to be 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 2008, 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.
Litigation Related to the Merger
On March 4, 2011, a purported class action lawsuit was filed on behalf of the Companys
stockholders in the Chancery Court for Davidson County, Tennessee, docketed as Colleen Witmer,
individually and on behalf of all others similarly situated, v. America Service Group Inc., Valitás
Health Services, Inc., Whiskey Acquisition Corp., Burton C. Einspruch, William M. Fenimore, Jr.,
John W. Gildea, Richard Hallworth, John C. McCauley, Michael W. Taylor, and Richard D. Wright, Case
No. 11-0300-IV. The lawsuit alleges, among other things, that the Companys Board of Directors
(the Board) breached fiduciary duties owed to the Companys stockholders by failing to take steps
to maximize stockholder value or to engage in a fair sale process when approving the Merger. The
complaint also alleges that the Company, Valitás and Merger Sub aided and abetted the members of
the Board in the alleged breach of their fiduciary duties. The complaint seeks an order enjoining
or rescinding the Merger, together with other relief.
Pursuant to the terms of the Merger Agreement, it is a condition to the completion of the
Merger that there does not exist any law or governmental order prohibiting or making illegal the
completion of the Merger. However, the Company believes the lawsuit is wholly without merit.
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.
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 were substantially
identical and generally alleged 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
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Companys business, forecasts and financial performance. The
complaints sought 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 alleged 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 sought 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 remained. 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. At a hearing on October 15,
2010, the Court approved the settlement, entering a final judgment and dismissing with prejudice
all claims against all defendant in the litigation. The settlement provided for payment by the
Company of $10.5 million and issuance by the Company of 300,000 shares of common stock. The total
value of the settlement, based upon the Companys closing share price for its common stock of
$15.12 per share on October 15, 2010, was approximately $15.0 million. The Company considers 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.
In addition to its primary D&O carrier, with which the Company has settled all claims, 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. The excess D&O
carrier has denied coverage of this matter. After failing to reach agreement with the excess D&O
carrier concerning the amount of their contribution to the settlement, the Company filed suit
against the excess D&O carrier in the second quarter of 2010. This suit is currently in the
discovery phase.
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. During the second quarter of 2010, the Company received a written offer
from the Delaware Department of Justice to settle the inquiry in exchange for a cash payment. The
Company has reserves totaling $0.4 million related to this matter which is the Companys estimate
of refund and associated interest due to the Delaware Department of Corrections, which was serviced
by a customer of SPP (see Note 4). This amount is recorded in accrued expenses in the Companys
consolidated balance sheet. The Company is continuing to cooperate with the Delaware Department of
Justice during its inquiry.
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Other Matters
The Companys business results from time to time 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 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 March 31, 2011, the Company had
outstanding performance bonds totaling $6.6 million. The performance bonds are renewed on an
annual basis. The Company has no letters of credit at March 31, 2011 collateralizing these
performance bonds. The Company is dependent 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.
20. Net Income (Loss) Per Common Share
Net income (loss) per common 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. Unvested
restricted shares of common stock are not considered outstanding common shares for purposes of
calculating earnings per share available to common shareholders.
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.
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The following table presents information necessary to calculate basic and diluted earnings per
common share (in thousands except for share and per share data):
Quarter ended | ||||||||
March 31, | ||||||||
2011 | 2010 | |||||||
Numerator: |
||||||||
Income from continuing operations |
$ | 1,753 | $ | 3,250 | ||||
Income (loss) from discontinued operations, net of taxes |
5 | (53 | ) | |||||
Net income |
1,758 | 3,197 | ||||||
Less: Income allocated to participating securities (unvested restricted shares) |
(17 | ) | (106 | ) | ||||
Net income allocated to common shareholders |
$ | 1,741 | $ | 3,091 | ||||
Components of income allocated to participating securities (unvested restricted shares): |
||||||||
Income from continuing operations |
$ | 17 | $ | 107 | ||||
Income (loss) from discontinued operations, net of taxes |
| (1 | ) | |||||
Income allocated to participating securities |
$ | 17 | $ | 106 | ||||
Components of net income allocated to common shareholders numerator for calculating
net income (loss) available to common shareholders per common share: |
||||||||
Income from continuing operations |
$ | 1,736 | $ | 3,143 | ||||
Income (loss) from discontinued operations, net of taxes |
5 | (52 | ) | |||||
Net income allocated to common shareholders |
$ | 1,741 | $ | 3,091 | ||||
Denominator: |
||||||||
Denominator for basic net income loss) available to common shareholders per common
share weighted average shares |
9,194,683 | 8,659,803 | ||||||
Effect of dilutive non-participating securities: |
||||||||
Employee stock options |
128,589 | 83,971 | ||||||
Denominator for diluted net income (loss) available to common shareholders per common
share adjusted weighted average shares and assumed conversions |
9,323,272 | 8,743,774 | ||||||
Net income (loss) available to common shareholders per common share basic: |
||||||||
Continuing operations |
$ | 0.19 | $ | 0.36 | ||||
Discontinued operations, net of taxes |
| | ||||||
Net income available to common shareholders per common share |
$ | 0.19 | $ | 0.36 | ||||
Net income (loss) available to common shareholders per common share diluted: |
||||||||
Continuing operations |
$ | 0.19 | $ | 0.36 | ||||
Discontinued operations, net of taxes |
| (0.01 | ) | |||||
Net income available to common shareholders per common share |
$ | 0.19 | $ | 0.35 | ||||
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 average market price of
the common shares for the periods shown and, therefore, the effect would be anti-dilutive.
Quarter ended | ||||||||
March 31, | ||||||||
2011 | 2010 | |||||||
Options excluded from computation of diluted net
income per common share as effect would be
anti-dilutive |
372,917 | 396,000 | ||||||
Weighted average exercise price of excluded options |
$ | 20.07 | $ | 21.82 | ||||
21. Comprehensive Income
For the quarters ended March 31, 2011 and 2010, the Companys comprehensive income was equal
to net income.
22. 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
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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. There were no shares repurchased during the quarter ended March 31,
2011. As of March 31, 2011, the Company has repurchased and retired a total of 891,850 shares of
common stock under the stock repurchase program at an aggregate cost of approximately $11.2
million. Under the terms of the Merger Agreement discussed in Note 3, the Company is prohibited from making
any additional repurchases of its common stock until the Merger is
completed, the Merger Agreement is terminated or the Company obtains
prior written consent from Valitás.
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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
General
America Service Group Inc. (ASG or the Company) is a leading non-governmental provider
and/or administrator of managed correctional healthcare services in the United States. The Company
is a provider and/or administrator of managed healthcare services to county/municipal jails and
detention centers and state correctional facilities. As of April 1, 2011, the Company provided
and/or administered managed healthcare services under 57 contracts to approximately 161,000 inmates
at over 140 sites in 19 states.
The Company operates through its subsidiaries, Prison Health Services, Inc. (PHS),
Correctional Health Services, LLC (CHS) and Secure Pharmacy Plus, LLC (SPP). ASG was
incorporated in 1990 as a 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. Its
telephone number is (615) 373-3100.
The following discussion should be read in conjunction with the unaudited condensed
consolidated financial statements and accompanying notes included herein.
Pending Merger
On March 2, 2011, the Company entered into an Agreement and Plan of Merger (the Merger
Agreement) with Valitás Health Services, Inc., a Delaware corporation (Valitás), and Whiskey
Acquisition Corp., a Delaware corporation and a wholly owned subsidiary of Valitás (Merger Sub),
providing for the acquisition of the Company by Valitás. Subject to the terms and conditions of
the Merger Agreement, the Merger Sub will be merged with and into the Company (the Merger), with
the Company surviving the Merger as a wholly owned subsidiary of Valitás.
At the effective time of the Merger (the Effective Time), each share of common stock of the
Company that is issued and outstanding as of immediately prior to the Effective Time (other than
shares held by the Company, Valitás or any of their respective
direct or indirect subsidiaries or shares held by
stockholders who have properly exercised and perfected appraisal
rights in accordance with Delaware law) will be
automatically cancelled and converted into the right to receive $26.00 in cash,
without interest and less any applicable withholding taxes (such per share
amount, the Merger Consideration).
Prior to the Effective Time, each outstanding option to purchase shares of the Companys
common stock will vest and become exercisable in full. Each option to purchase shares of the
Companys common stock outstanding at the Effective Time will be canceled and converted into the
right to receive, as soon as reasonably practicable after the Effective Time, an amount in cash
equal to: (i) the number of shares subject to such option multiplied by (ii) the excess (if any) of
the Merger Consideration over the exercise price per share of such option. As of the date of this
Quarterly Report on Form 10-Q, the Company has no outstanding stock options with an exercise price
per share in excess of the Merger Consideration. As of the Effective Time, the vesting
restrictions on each outstanding share of restricted stock will be accelerated and will lapse and
each such share of restricted stock will be automatically canceled and converted into the right to
receive the Merger Consideration.
The Companys Board of Directors (the Board of Directors), unanimously approved the Merger Agreement and
the Merger and determined that the Merger Agreement and the Merger
are advisable, fair to and in the best interests of the Company and
its stockholders. In connection with such approval,
Oppenheimer & Co. Inc. rendered its opinion to the Board of Directors that, as of the date of the
opinion and subject to the various assumptions limitations and qualifications set forth therein, the Merger
Consideration to be received by the Companys stockholders is fair, from a financial point of view,
to such stockholders.
Completion of the Merger requires the fulfillment or waiver of a number of conditions,
including: (i) the adoption of the Merger Agreement by the affirmative vote of the holders of a
majority of the outstanding shares of the Companys common stock entitled to vote thereon at the
special meeting of the stockholders of the Company (or any adjournment or postponement thereof);
(ii) the expiration or termination of the applicable waiting period under the Hart-Scott-Rodino
Antitrust Improvements Act of 1976, as amended; (iii) the absence of any law or governmental order
prohibiting or making illegal the completion of the Merger; and (iv) subject to certain
qualifications based on materiality thresholds, the accuracy of the parties representations and
warranties and the parties compliance with the covenants and agreements set forth in the Merger
Agreement.
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The Merger Agreement contains customary representations and warranties of the parties. The
Merger Agreement also contains customary covenants, including covenants requiring: (i) each of the
parties to use reasonable best efforts to cause the Merger to be consummated; and (ii) the Company
to call and hold a special meeting of the Companys stockholders at which the Board of Directors will recommend, subject to
certain exceptions based on its fiduciary duties, that the stockholders approve the Merger
Agreement and the transactions contemplated thereby, including the Merger. The Merger Agreement
also requires the Company to conduct its operations in the ordinary course of business consistent
with past practice during the period between the execution of the Merger Agreement and the
Effective Time or the earlier termination of the Merger Agreement.
The Merger Agreement generally provided
that until 11:59 p.m. (Eastern time) on April 16, 2011 (the Go-Shop Period) the Company was permitted to solicit, initiate and
encourage other acquisition proposals and provide non-public information to third parties pursuant to confidentiality agreements
not materially more favorable to such third parties than the
Companys confidentiality agreement with Valitás. After
12:00 a.m.
(Eastern time) on April 17, 2011 (the No-Shop Period Start Date) and until the earlier of the Effective Time or the termination
of the Merger Agreement, the Company became prohibited from soliciting, initiating or encouraging other acquisition proposals or
providing non-public information to third parties that could reasonably be expected to lead to any acquisition proposal.
Notwithstanding these restrictions, and subject to certain requirements set forth in the Merger Agreement, after the Go-Shop Period,
the Company: (i) was entitled to provide confidential information,
until 12:00 a.m. (Eastern time) on May 1, 2011, to any party
(an Excluded Party) (A) who made a written acquisition proposal prior to the No-Shop Period Start Date (and did not withdraw,
terminate or let such acquisition proposal expire) that the Board of Directors or a properly constituted committee thereof
determined in good faith, after consultation with its independent financial advisor, is or would reasonably be expected to
result in a Superior Proposal (as such term is defined in the Merger
Agreement), (B) whom the Company identified to Valitás
within 24 hours after the No-Shop Period Start Date to be an Excluded
Party and (C) who continued to satisfy the criteria for
remaining an Excluded Party as set forth in the Merger Agreement; and
(ii) is entitled to provide confidential information to
a third party in response to an unsolicited acquisition proposal, following which the Company is permitted to engage in
discussions and negotiations with such third party if: (X) the Board of Directors or a properly constituted committee
thereof determines in good faith, after consultation with outside legal counsel, that the failure to take such action would
be inconsistent with its fiduciary duties; (Y) the Board of Directors or a properly constituted committee thereof determines
in good faith, after consultation with its independent financial advisor, that the acquisition proposal is, or would reasonably
be expected to result in, a Superior Proposal; and (Z) prior to
taking such action, the Company gives Valitás four business
days notice of the Companys intent to do so, the identity of the third party and the terms of the acquisition proposal
and the Company executes a confidentiality agreement with such third party with terms no less favorable than those contained in
the Companys confidentiality agreement with Valitás and containing customary standstill provisions. Following the expiration
of the Go-Shop Period, there were no third parties that qualified as Excluded Parties, and as of the date of this Quarterly
Report on Form 10-Q the Company has not received any alternative acquisition proposals.
The Merger
Agreement also contains certain termination rights in favor of each party,
including rights allowing the Company to terminate the Merger Agreement in order to accept a
Superior Proposal. Upon termination of the Merger Agreement under certain specified circumstances,
the Company will be required to pay to Valitás a specified fee and to reimburse Valitás for up to
$2.0 million in documented transaction expenses.
While the Merger Agreement provided for a reduced fee of $4.5 million in connection with terminations based on
the Companys acceptance of a Superior Proposal made by an Excluded Party, because the No-Shop Period Start Date
has passed and no third party qualifies as an Excluded Party, the
Company will be required to pay to Valitás a
fee in the amount of $8.0 million, plus documented transaction expenses, in connection with any termination that
requires payment of a termination fee.
Barclays Bank PLC and Bank of America, N.A. (collectively, the Senior Lenders) have provided
customary senior debt commitments letters letter dated March 2, 2011, to provide Valitás with
$360.0 million in senior secured credit facilities, comprised of: (i) a term loan facility of
$285.0 million; and (ii) a revolving credit facility of
$75.0 million (which Valitás will draw upon only in the
event that the combined cash on hand of the Company and Valitás
upon the completion of the Merger is less than approximately $73.0
million). In addition, funds managed
by GSO Capital Partners LP and its affiliates (collectively with the
Senior Lenders, the Lenders) have provided customary mezzanine financing commitment letters dated
March 2, 2011, to provide Valitás with $100.0 million in gross proceeds from the issuance and sale
by Valitás of unsecured senior subordinated notes pursuant to a private placement. The obligations
of the Lenders to provide the debt financing under the respective debt commitment letters are
subject to a number of conditions which the Company believes are customary for financings of this
type or are otherwise similar to certain conditions in the Merger Agreement. The final termination
date for the commitments under each debt commitment letter is August 31, 2011.
Valitás, obligation to complete the Merger is not subject to any
financing condition.
The Merger is expected to be completed in the second quarter of 2011.
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements made pursuant to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking
statements represent managements current expectations regarding future events. All statements
other than statements of current or historical fact contained in this quarterly 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. Forward-looking statements typically are identified by use of terms such as may,
will, should, plan, expect, anticipate, estimate, believe, continue, intend,
project and similar words, although some forward-looking statements are expressed differently.
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 or financial position to differ materially from those expressed or implied by the
forward-looking statements include, among other things:
| the Companys ability to obtain shareholder approval, regulatory approval and close the transaction discussed in the section titled Pending Merger above; | ||
| 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; |
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| 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 inmate medical costs, catastrophic illnesses, injuries and medical malpractice claims in excess of amounts covered under contracts or insurance coverage; | ||
| 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; and | ||
| the Companys ability to expand its business beyond its traditional correctional health client base. |
In addition to the factors referenced above and the other cautionary statements discussed in
this report, you should also consider the risks included in Item 1A, Risk Factors contained in
this Form 10-Q and Item 1A, Risk Factors contained in the Companys Annual Report on Form 10-K
for the year ended December 31, 2010 and in other documents that the Company files from time to
time with the Securities and Exchange Commission. Because these risk factors could cause actual
results or outcomes to differ materially from those expressed or implied in any forward-looking
statements made by the Company or on the Companys behalf, stockholders should not place undue
reliance on any forward-looking statements. Further, any forward-looking statement speaks only as
of the date on which it is made, and the Company undertakes no obligation to update any
forward-looking statement to reflect events or circumstances after the date on which the statement
is made or to reflect the occurrence of unanticipated events. New factors emerge from time to
time, and it is not possible for the Company to predict which factors will arise. In addition, the
Company cannot assess the impact of each factor on its business or the extent to which any factor,
or combination of factors, may cause actual results to differ materially from those contained in or
implied by any forward-looking statements.
Critical Accounting Policies And Estimates
General
The Companys discussion and analysis of its financial condition and results of operations are
based upon its condensed consolidated financial statements, which have been prepared in accordance
with United States generally
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accepted accounting principles. 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 condensed 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.
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.
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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 quarter ended March 31, 2011 and 2010.
Percentage of Revenue from | ||||||||
Continuing Operations | ||||||||
Quarter Ended | Quarter Ended | |||||||
Contract Category | March 31, 2011 | March 31, 2010 | ||||||
Fixed Fee |
12.9 | % | 12.0 | % | ||||
Population Based |
67.3 | % | 68.2 | % | ||||
Cost Plus a Fee |
19.8 | % | 19.8 | % |
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 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 and $3.0 million in total. Amounts reimbursable per claim under
the policy are further limited to the lessor 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
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actuarial estimates and actual claims payments are recognized in the period in which the
estimates are changed or the payments are made.
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 II Item 1. 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. During February 2011, the parties agreed to resolve this matter through
binding arbitration which is expected to occur during the third quarter of 2011. At March 31,
2011, the Company has classified these receivables as current assets in its consolidated balance
sheet.
As discussed more fully in Part II Item 1. 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, continues to be 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.
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 II Item 1. 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 effect 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
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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.
There are no loss contracts identified as of March 31, 2011 and 2010.
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.
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 2011
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 2011, 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 2011 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.
In addition to the coverage described above, for 2010 and 2011, the
Company has purchased
excess liability policies which provide coverage on a claims made basis for indemnity losses in
excess of $4.0 million up to a maximum coverage of $10.0 million per loss and in the aggregate.
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.
At March 31, 2011, the Companys reserves for both known as well as incurred but not reported
claims totaled $24.3 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. For the quarter ended March 31, 2011 and 2010, the
Company recorded increases of approximately $1.5 million and $0.6 million, respectively, related to
its prior year known
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claims reserves as a result of adverse developments. 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 March 31, 2011, the Company has approximately $8.8 million in accrued liabilities for
employee health and workers compensation claims. Approximately $7.3 million of this amount is
related to workers compensation claims, of which approximately $4.0 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.
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. 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 II Item 1. 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 II
Item 1. Legal Proceedings for further information regarding the Audit Committee investigation and
related legal matters.
Impairment of 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.
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, 2010, the indicated fair value of the Companys reporting unit exceeded
the carrying value of its reporting unit by a substantial amount, and, as such, the Company
concluded that there was no indication of goodwill impairment.
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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 represent customer contracts acquired in
acquisitions and 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 March 31, 2011, the Companys valuation allowance of
approximately $0.2 million represents managements estimate of state net operating loss
carryforwards which will expire unused.
The Companys estimated effective tax rate is based on expected pre-tax income, expected
permanent book/tax differences, statutory tax rates and tax planning opportunities available in the
various jurisdictions in which it operates. On an interim basis, management estimates the annual
tax rate based on projected taxable income for the full year and records a quarterly income tax
provision in accordance with the anticipated annual rate. As the year
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progresses, management refines the estimate of the years taxable income as new information
becomes available, including year-to-date financial results. This continual estimation process
often results in a change to the Companys expected effective tax rate for the year. When this
occurs, management adjusts the income tax provision during the quarter in which the change in
estimate occurs so that the year-to-date provision reflects the expected annual tax rate. The
Companys effective income tax rate on income from continuing operations before taxes for the
quarter ended March 31, 2011 is 43.7%.
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
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. The Company has no tax contingencies at March 31, 2011 and
there is no accrued interest and penalties included in income tax expense for the quarters ended
March 31, 2011 and 2010.
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 2007 through 2010. The Company is currently under audit for the 2008 tax year.
Additionally, open tax years related to state 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.
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Results of Operations
The following table sets forth, for the periods indicated, the percentage relationship to
healthcare revenues of certain items in the condensed consolidated statements of income.
Quarter ended | ||||||||
March 31, | ||||||||
Percentage of Healthcare Revenues | 2011 | 2010 | ||||||
Healthcare revenues |
100.0 | % | 100.0 | % | ||||
Healthcare expenses |
90.8 | 90.4 | ||||||
Gross margin |
9.2 | 9.6 | ||||||
Selling, general and administrative expenses |
5.7 | 5.5 | ||||||
Merger expenses |
0.9 | | ||||||
Audit Committee investigation and related expenses |
| 0.1 | ||||||
Depreciation and amortization |
0.6 | 0.5 | ||||||
Income from operations |
2.0 | 3.5 | ||||||
Interest income |
| | ||||||
Income from continuing operations before income tax provision |
2.0 | 3.5 | ||||||
Income tax provision |
0.9 | 1.5 | ||||||
Income from continuing operations |
1.1 | 2.0 | ||||||
Income (loss) from discontinued operations, net of taxes |
| | ||||||
Net income |
1.1 | % | 2.0 | % | ||||
Quarter Ended March 31, 2011 Compared to Quarter Ended March 31, 2010
Healthcare revenues. Healthcare revenues for the quarter ended March 31, 2011 decreased $6.1
million, or 3.8%, from $160.0 million for the quarter ended March 31, 2010 to $153.9 million for
the quarter ended March 31, 2011. Correctional healthcare services contracts in place at January
1, 2010 and continuing beyond March 31, 2011 experienced
negative revenue growth of 3.8% resulting
in a reduction to revenue of $6.1 million during the first quarter of 2011. This revenue reduction
is primarily the result of a reduction in risk sharing revenue on two large customers due to a
reduction in off-site expenses combined with cost reductions on one large cost-plus contract
resulting in revenue reductions. Additionally, the Companys revenue related to contract base fees
experienced slight negative growth due to customer budgetary pressures and contract renegotiations.
There were no new correctional healthcare services contracts added subsequent to January 1, 2010.
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 quarter ended March 31, 2011 decreased $4.9
million, or 3.4%, from $144.6 million, or 90.4% of revenues, for the quarter ended March 31, 2010
to $139.8 million, or 90.8% of revenues, for the quarter ended March 31, 2011. Correctional
healthcare services contracts in place at January 1, 2010 and continuing beyond March 31, 2011
experienced a reduction in healthcare expenses of $4.6 million during the first quarter of 2011
primarily as a result of reductions in the off-site medical services associated with providing
healthcare to inmates at existing contracts. Within this reduction is an offsetting increase in
insurance expense of approximately $0.9 million during the first quarter of 2011 as a result of
adverse development related to professional liability claims. There were no new correctional
healthcare services contracts added subsequent to January 1, 2010. Also included in healthcare
expenses for the quarter ended March 31, 2011 and 2010 is approximately $0.2 million and $0.5
million of accrued bonus expenses related to the Companys 2011 incentive compensation plan and
2010 incentive compensation plan, respectively.
Selling, general and administrative expenses. Selling, general and administrative expenses
were $8.7 million, or 5.7% of revenues, for the quarter ended March 31, 2011 as compared to $8.9
million, or 5.5% of revenues, for the quarter ended March 31, 2010. Included in selling, general
and administrative expenses for the quarters ended March 31, 2011 and 2010 is approximately $0.3
million and $0.4 million, respectively, related to share-based compensation expense. Also included
in selling, general and administrative expenses for the quarter ended March 31, 2011 is
approximately $0.5 million of accrued bonus expense related to the Companys 2011 incentive
compensation plan. Included in selling, general and administrative expenses for the quarter ended
March 31, 2010 is approximately $1.5 million of accrued bonus expense related to the Companys 2010
incentive compensation plan.
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Merger expenses. During the quarter ended March 31, 2011, the Company incurred $1.3 million
of expenses related to the Merger discussed in Part I Item 2. Pending Merger. There were no
merger expenses incurred for the quarter ended March 31, 2010.
Audit Committee investigation and related expenses. Audit Committee investigation and related
expenses were $43,000 for the quarter ended March 31, 2011 as compared to $0.2 million for the
quarter ended March 31, 2010. The Audit Committee investigation and related expenses incurred in
the quarter ended March 31, 2011, primarily related to legal expenses incurred due to litigation
filed by the Company against one of its insurance carriers. The Audit Committee investigation and
related expenses incurred in the quarter ended March 31, 2010, are primarily due to legal expenses.
See Part II Item 1. Legal Proceedings for further discussion of the Audit committee
investigation and related legal matters.
Depreciation and amortization. Depreciation and amortization expense was $0.9 million and
$0.8 million, respectively, for the quarters ended March 31, 2011 and 2010, respectively. The
increase in depreciation and amortization is primarily due to an increase in capital expenditures.
Interest income. Interest income was $5,000 for the quarter ended March 31, 2011 compared to
$20,000 for the quarter ended March 31, 2010. During the quarters ended March 31, 2011 and 2010,
the Company had no borrowings outstanding on its Credit Agreement resulting in a reduction in
interest expense. This reduction, combined with earnings on cash balances, resulted in net
interest income for each period.
Income tax provision. The income tax provision for the quarter ended March 31, 2011 was $1.4
million as compared with $2.3 million for the quarter ended March 31, 2010. This decrease was the
result of a decrease in income from continuing operations before income tax provision from $5.6
million for the quarter ended March 31, 2010 to $3.1 million for the quarter ended March 31, 2011.
Income from continuing operations. Income from continuing operations for the quarter ended
March 31, 2011 was $1.8 million, as compared with $3.3 million for the quarter ended March 31, 2010
as the result of the factors discussed above.
Income (loss) from discontinued operations, net of taxes. Income from discontinued
operations, net of taxes, for the quarter ended March 31, 2011 was $5,000 as compared with a loss
of $53,000 for the quarter ended March 31, 2010. Income (loss) 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 7 of the Companys condensed consolidated financial statements for further
discussion of this application of U.S. GAAP.
Net income. Net income for the quarter ended March 31, 2011 was $1.8 million, or 1.1% of
revenues, as compared with $3.2 million, or 2.0% of revenues, for the quarter ended March 31, 2010.
This change in net income resulted from the factors discussed above.
Liquidity and Capital Resources
Overview
The Company had working capital of $12.7 million at March 31, 2011 compared to $15.7 million
at December 31, 2010. At March 31, 2011, days sales outstanding in accounts receivable were 32,
accounts payable days outstanding were 30 and accrued medical claims liability days outstanding
were 45. At December 31, 2010, days sales outstanding in accounts receivable were 30, accounts
payable days outstanding were 30 and accrued medical claims liability days outstanding were 48.
The Company had stockholders equity of $57.5 million at March 31, 2011 compared to $55.8
million at December 31, 2010. The Company had cash and cash equivalents of $41.6 million at March
31, 2011 compared to $39.6 million at December 31, 2010. The increase in cash and cash equivalents
was primarily due to cash flows from operating activities less capital expenditures. The Company
had no outstanding balance on its credit facility at March 31, 2011 or December 31, 2010.
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Cash flows from operating activities represent the year to date net income plus adjustments
for various non-cash charges, such as depreciation and amortization expense and share-based
compensation expense, and changes in various components of working
capital. Cash flows provided by
operating activities during the quarter ended March 31, 2011 were $2.8 million, a decrease of $2.1
million from cash flows provided by operations during the quarter ended March 31, 2010 of $4.9
million.
Cash flows used in investing activities were $1.0 million and $1.3 million for the quarters
ended March 31, 2011 and 2010, respectively, which represented capital expenditures, which were
financed through working capital.
Cash flows provided by financing activities during the quarter ended March 31, 2011 were $0.2
million, which resulted from the issuance of common stock under the Companys employee stock
purchase plan. Cash flows provided by financing activities during the quarter ended March 31,
2010 were $0.2 million, which resulted from the issuance of common stock under the Companys
employee stock purchase plan of $0.2 million and cash receipts resulting from option exercises of
$0.6 million, partially offset by dividends on common stock of $0.5 million.
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 March 31, 2011, the
Company has repurchased and retired a total of 891,850 shares of common stock under the stock
repurchase program at an aggregate cost of approximately $11.2 million. The Company is prohibited
under the terms of the Merger Agreement from making any additional repurchases of its common stock
until the Merger closes or the Merger Agreement is terminated. See Part I Item 2. Pending
Merger.
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.
Dividends
On April 12, 2011, the Company paid a $0.06 cash dividend per share on the Companys common
stock for the quarter ended March 31, 2011.
The Board of Directors 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 Company is
prohibited under the terms of the Merger Agreement from paying any additional dividends until the
Merger closes or the Merger Agreement is terminated. See Part I Item 2. Pending Merger.
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
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$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
March 31, 2011 and December 31, 2010, the Company had no borrowings outstanding under the Credit
Agreement. At March 31, 2011, the Company had $14.9 million available for borrowing, based on the
current facility cap and the Companys collateral base on that date and no standby letters of
credit.
Borrowings under the Credit Agreement are limited to the lesser of (1) 85% of eligible
receivables or (2) $20.0 million (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.
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 $0.4 million.
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 cash 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, net of insurance recoveries, 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 March 31, 2011.
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 March 31, 2011, the Company was
in compliance with both the pre-distribution fixed charge coverage ratio and the post-distribution
fixed charge coverage ratio. The Company is prohibited under the terms of the Merger Agreement
from paying any additional dividends until the Merger closes or the Merger Agreement is terminated.
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
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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.
Other Financing Transactions
At March 31, 2011, the Company was contingently liable for $6.6 million of performance bonds.
Off-Balance Sheet Transactions
As of March 31, 2011, the Company did not have any off-balance sheet financing transactions or
arrangements except for operating leases.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss that may impact the condensed 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 for the quarter ended March 31, 2011 would have had no material effect on
interest expense paid under the Credit Agreement. Net interest income represents less than 1% of
the Companys revenues for each of the quarters ended March 31, 2011 and 2010. The Company has no
debt outstanding at March 31, 2011.
ITEM 4. 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, within the time periods specified in the Securities and
Exchange Commission (SEC) 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 or furnishes 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 the end of the period covered by this report, 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 the Exchange Act. 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 or furnishes 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.
There were no changes in the Companys internal control over financial reporting during the
period covered by this report that have materially affected, or are reasonably likely to materially
affect, the Companys internal control over financial reporting.
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PART II:
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is subject to legal proceedings in the ordinary course of business. A discussion
is provided below of significant outstanding matters for which there have been updates during
2011. For a discussion of all other significant outstanding matters, please refer to Note 21 of
the Companys 2010 Annual Report on Form 10-K filed on March 3, 2011.
The Company is a party to various legal proceedings incidental to its business. With respect
to all litigation matters, the Company considers the likelihood of a negative outcome typically in
consultation with outside counsel handling the Companys defense in these matters and estimates of
the probable costs for resolution of these matters are based upon an estimated range of potential
results, assuming a combination of litigation and settlement strategies. If the Company
determines the likelihood of a negative outcome is probable and the amount of the loss can be
reasonably estimated, the Company records an estimated loss for the expected outcome of the
litigation. However, it is difficult to predict the outcome or estimate a possible loss or range
of loss in some instances because litigation is subject to significant uncertainties. 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 litigation.
DeSantis Professional Liability Suit. On August 26, 2010, Theresa DeSantis and Julie
Giangiolini, as guardians of the estate of Anthony DeSantis, Jr., filed a complaint in the Court of
the Sixteenth Judicial Circuit in Kane County, Illinois alleging that PHS, by and through the
actions of its medical staff committed medical negligence which caused Anthony DeSantis Jr. to
suffer from significant injuries. Plaintiffs seek damages to recoup compensation for past and
future pain and suffering, loss of income, medical bills incurred and for the cost of future
medical treatment. This matter is currently in the discovery phase; however, the Company believes
that a negative outcome is probable and has recorded significant reserves related to this matter.
Such reserves are included in the Companys reserves for professional liability claims which total
$24.3 million at March 31, 2011. Should the ultimate resolution of this matter exceed the
Companys recorded reserves and available insurance coverage, such resolution could have a material
adverse effect on the Companys results of operations, financial position or cash flows in future
periods.
Dawkins Professional Liability Suit. On September 18, 2009, Johnathan Dawkins, Sara H.
Humphrey, guardian ad litem of Johnathan Dawkins, a mentally incapacitated person and Sara H.
Humphrey, individually, filed a complaint in the U.S. District Court of New Jersey, against CHS,
the New Jersey Counties of Essex and Union and a broad number of correctional personnel. The
complaint alleges that in 2007 Johnathan Dawkins suffered permanent injuries while incarcerated at
the Union County Jail as a result of actions of the defendants. This matter is currently in the
discovery stage. Management currently believes this matter is covered under the policy limits of
its 2007 professional liability insurance policy, however, should the ultimate resolution of this
matter exceed such policy limits, such resolution could have a material adverse effect on the
Companys results of operations, financial position or cash flows in future periods.
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
March 31, 2011 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 first renewal option 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
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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. On March 30, 2010, the court held a scheduling
conference in which the judge set February 8, 2011 as the trial date for the Collection Matter.
Prior to the trial date, preliminary settlement discussions were conducted without resolution.
Subsequently, the parties agreed to forego the trial and resolve the Collection Matter through
binding arbitration which is expected to occur during the third quarter of 2011. 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, continues to be 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 2008, 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.
Litigation Related to the Merger
On March 4, 2011, a purported class action lawsuit was filed on behalf of the Companys
stockholders in the Chancery Court for Davidson County, Tennessee, docketed as Colleen Witmer,
individually and on behalf of all others similarly situated, v. America Service Group Inc., Valitás
Health Services, Inc., Whiskey Acquisition Corp., Burton C. Einspruch, William M. Fenimore, Jr.,
John W. Gildea, Richard Hallworth, John C. McCauley, Michael W. Taylor, and Richard D. Wright, Case
No. 11-0300-IV. The lawsuit alleges, among other things, that the Companys Board of Directors
(the Board) breached fiduciary duties owed to the Companys stockholders by failing to take steps
to maximize stockholder value or to engage in a fair sale process when approving the Merger. The
complaint also alleges that the Company, Valitás and Merger Sub aided and abetted the members of
the Board in the alleged breach of their fiduciary duties. The complaint seeks an order enjoining
or rescinding the Merger, together with other relief.
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Pursuant to the terms of the Merger Agreement, it is a condition to the completion of the
Merger that there does not exist any law or governmental order prohibiting or making illegal the
completion of the Merger. However, the Company believes the lawsuit is wholly without merit.
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.
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 were substantially
identical and generally alleged 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 sought 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 alleged 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 sought 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 remained. 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. At a hearing on October 15,
2010, the Court approved the settlement, entering a final judgment and dismissing with prejudice
all claims against all defendant in the litigation. The settlement provided for payment by the
Company of $10.5 million and issuance by the Company of 300,000 shares of common stock. The total
value of the settlement, based upon the Companys closing share price for its common stock of
$15.12 per share on October 15, 2010, was approximately $15.0 million. The Company considers 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.
In addition to its primary D&O carrier, with which the Company has settled all claims, 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. The excess D&O
carrier has denied coverage of this matter. After failing to reach agreement with the excess D&O
carrier concerning the amount of their contribution to the settlement, the Company filed suit
against the excess D&O carrier in the second quarter of 2010. This suit is currently in the
discovery phase.
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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. During the second quarter of 2010, the Company received a written offer
from the Delaware Department of Justice to settle the inquiry in exchange for a cash payment. The
Company has reserves totaling $0.4 million related to this matter which is the Companys estimate
of refund and associated interest due to the Delaware Department of Corrections, which was serviced
by a customer of SPP (see Note 4). This amount is recorded in accrued expenses in the Companys
consolidated balance sheet. The Company is continuing to cooperate with the Delaware Department of
Justice during its inquiry.
Other Matters
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 1A. RISK FACTORS
The Company previously disclosed risk factors under Item 1A. Risk Factors in its Annual
Report on Form 10-K for the year ended December 31, 2010. The risks discussed in the Companys
Annual Report on Form 10-K for the year ended December 31, 2010 are not the only risks facing the
Company. Additional risks and uncertainties not currently known to the Company or that the Company
deems immaterial may materially adversely affect our business, financial condition and/or results
of operations.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. RESERVED
ITEM 5. OTHER INFORMATION
Not applicable.
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ITEM 6. EXHIBITS
2.1
|
| Agreement and Plan of Merger, dated March 2, 2011 by and among Valitás Health Services, Inc., Whiskey Acquisition Corp. and America Service Group Inc. (incorporated herein by reference to Exhibit 2.1 to the Companys Current Report on Form 8-K filed on March 3, 2011). | ||
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). | ||
11
|
| Computation of Per Share Earnings.* | ||
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. |
* | Data required by U.S. GAAP related to earnings per share is provided in Note 20 to the condensed consolidated financial statements in this report. |
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SIGNATURES
Pursuant to the requirements 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.
AMERICA SERVICE GROUP INC. | ||
/s/ RICHARD HALLWORTH
|
||
President & Chief Executive Officer | ||
(Duly Authorized Officer) |
/s/ MICHAEL W. TAYLOR
|
||
Executive Vice President & Chief Financial Officer | ||
(Principal Financial Officer) | ||
Dated: May 2, 2011 |
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