ITEM 1. BUSINESS
This Form 10-K contains statements which may constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Those statements include statements regarding the intent, belief or current expectations of America Service Group Inc. and members of its management team. Prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve a number of risks and uncertainties, and that actual results may differ materially from those contemplated by such forward-looking statements. Important factors currently known to management that could cause actual results to differ materially from those in forward-looking statements are set forth below under the caption "Cautionary Statements." America Service Group Inc. undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time.
GENERAL
America Service Group Inc. ("ASG" or the "Company"), through its subsidiaries Prison Health Services, Inc. ("PHS"), EMSA Correctional Care, Inc. ("EMSA Correctional") and EMSA Military Services, Inc. ("EMSA Military"), contracts to provide managed healthcare services to correctional facilities and military installations throughout the United States. ASG was incorporated in 1990 as a holding company for PHS. Unless the context otherwise requires, the term "Company" refers to ASG and its direct and indirect subsidiaries. ASG's executive offices are located at 105 Westpark Drive, Suite 300 Brentwood, Tennessee 37027. Its telephone number is (615) 373-3100.
RECENT DEVELOPMENTS
On March 29, 2000, the Company, through PHS, purchased two contracts from Correctional Physician Services, Inc. ("CPS"). The contracts with the Commonwealth of Pennsylvania, Department of Corrections for the Eastern Region and the State of New York, Department of Correctional Services in 1999 covered approximately 21,000 inmates with annual revenue of approximately $41 million.
The purchase price of $14 million includes a $1.8 million escrow for certain contingencies. The Company will account for the acquisition using the purchase method of accounting.
In connection with the CPS acquisition, the Company obtained consent from Bank of America, as required under its Credit Facility dated January 26, 1999 and received a separate $10 million working capital line of credit.
CORRECTIONAL HEALTHCARE SERVICES
Generally. ASG, through PHS and EMSA Correctional, contracts with state, county and local governmental agencies to provide comprehensive healthcare services to inmates of prisons and jails, with a focus on those facilities that maintain an average daily population of over 300 inmates.
ASG generally enters into fixed fee contracts to provide comprehensive healthcare to inmates from their admission to the facility through their release. All of ASG's revenues from correctional healthcare services are generated by payments from governmental agencies, none of which are dependent on third party payment sources. Services provided by ASG include a wide range of on-site healthcare programs, as well as off-site hospitalization and specialty outpatient care. See "-- Services Provided." Hospitalization and most outpatient care is performed through subcontract arrangements with independent doctors and local hospitals.
The following table sets forth information regarding ASG's correctional contracts.
- --------------- (1) Indicates the number of contracts in force at the end of the period specified.
(2) Based on an average number of inmates during the last month of each period specified.
ASG's target correctional market consists of state prisons and county and local jails. A prison is a facility in which an inmate is incarcerated for an extended period of time (typically one year or longer). A jail is a facility in which the inmate is held for a shorter period of time, often while awaiting trial or sentencing. The higher inmate turnover in jails requires that healthcare be provided to a much larger number of individual inmates over time. Conversely, the costs of long-term healthcare requirements are greater with respect to state prison contracts. State prison contracts often cover a larger number of facilities and often have longer terms than jail contracts.
Services Provided. Generally, ASG's obligation to provide services to a particular inmate begins upon the inmate's admission into the correctional facility and ends upon the inmate's release. Emphasis is placed upon early identification of serious injuries or illnesses so that prompt and cost-effective treatment is commenced.
Medical services provided on-site include physical and mental health screening upon intake. Screening includes the compilation of the inmate's health history and the identification of any current, chronic or acute healthcare needs. After initial screening, services provided may include regular physical and dental screening and care, psychiatric care, OB-GYN screening and care and diagnostic testing. Sick call is held on a regular basis and infirmary bed care is provided in some facilities. Nursing rounds are regularly conducted and physicians, nurse practitioners, physicians' assistants and others are also involved in the delivery of care on a regular basis. Appropriate medications are administered by nursing staff, as needed.
Medical services provided off-site include specialty out-patient diagnostic testing and care, emergency room care, surgery and hospitalization. In addition, ASG provides administrative support services both on-site and at ASG's headquarters and regional offices. Administrative programs include on-site medical records and management and employee education and licensing. Central and regional offices provide quality assurance, medical audits, credentialing, continuing education and clinical program development activities. ASG maintains a utilization review system to monitor the extent and duration of most healthcare services required by inmates on an inpatient and outpatient basis. See "-- Administrative Systems."
Most of the Company's correctional contracts require it to staff the facilities it serves with nurses 24 hours a day. Doctors at the facilities have regular hours and are generally available on call. In addition, dentists, psychiatrists and other specialists are often available on a routine basis. ASG enters into contractual arrangements with independent doctors and local hospitals with respect to more significant off-site procedures and hospitalization. ASG is responsible for all of the costs of such arrangements, unless the relevant contract contains a limit on ASG's obligations in connection with the treatment costs. See "-- Contract Provisions."
The National Commission on Correctional Health Care (the "NCCHC") sets standards for the correctional healthcare industry and offers accreditation to facilities that meet its standards. These standards provide specific guidance related to a service provider's operations including administration, personnel, support services such as hospital care, regular services such as sick call, records management and medical and legal issues. Although accreditation is voluntary, many contracts require compliance with NCCHC standards.
Contract Provisions. ASG's correctional contracts generally provide for a fixed fee, payable monthly. In addition to the fixed annual fee, some of ASG's contracts provide for per diem price adjustments based upon fluctuations in the size of inmate populations beyond a specified range. Most contracts also provide for annual
increases in the fixed fee based upon the regional medical care component of the Consumer Price Index. In all other contracts that extend beyond one year, ASG utilizes a projection of the future inflation rate when bidding and negotiating the fixed fee for future years. ASG bears the risk of increased or unexpected costs, which could reduce its profits or cause it to sustain losses, and benefits when costs are lower than projected. Certain contracts also contain financial penalties when performance criteria are not achieved.
The Indiana Contract provides for fixed payment on a per inmate, per day basis. The City of Philadelphia Contract provides for a fixed payment on a fixed dollar basis with a per diem price adjustment based on any increase in the size of the inmate population above a set number. The remainder of ASG's largest existing contracts for the year ended December 31, 1999 -- contracts with the Pennsylvania Department of Corrections Western Region, Kansas Department of Corrections, the Delaware Department of Corrections and Alameda County, California -- provide for per diem price adjustments based upon fluctuations in the size of inmate populations beyond a specified range. The fixed fees under all five contracts take into account projected levels of inflation. See "-- Major Contracts."
Contracts accounting for approximately 56% of revenues for the year ended December 31, 1999, including ASG's contracts with the Indiana Department of Correction (the "Indiana Contract"), Pennsylvania Department of Corrections for the Western Region, Delaware Department of Corrections, Kansas Department of Corrections, and Alameda County, California, contain no limits on ASG's exposure for treatment costs related to catastrophic illnesses or injuries to inmates. Although the specific terms of the limits vary, typically a dollar limit is placed on ASG's responsibility for costs related to illness of or injury to an individual inmate, injuries to more than one inmate resulting from an accident or contagious illnesses affecting more than one inmate. When preparing bid proposals, ASG estimates the extent of its exposure to cost increases, severe individual cases and catastrophic events and attempts to compensate for its exposure in the pricing of its bids. ASG's management has experience in evaluating these risks for bidding purposes and maintains an extensive database of historical experience. Nonetheless, increased or unexpected costs against which ASG is not protected could render a contract unprofitable. In an effort to manage risk of catastrophic illness or injury of inmates under contracts that do not limit ASG's exposure to such risk, ASG maintains stop loss insurance from an unaffiliated insurer covering hospitalization for amounts in excess of $200,000 per inmate for PHS contracts and $170,000 per inmate for EMSA Correctional contracts. Such stop loss insurance covers 80% of ASG's exposure for such treatment costs. ASG believes this insurance mitigates its exposure to unanticipated expenses of catastrophic hospitalization. See "-- Risk Management."
In general, contracts may be terminated by the governmental agency, and often by ASG as well, without cause at any time upon proper notice (typically between 30 and 180 days). Governmental agencies may be subject to political influences that could lead to termination of a contract with no fault of the contractor. As with other governmental contracts, ASG's contracts are subject to adequate budgeting and appropriation of funds by the governing legislature or administrative body.
Administrative Systems. ASG has centralized its administrative systems in order to enhance economies of scale and to provide management with accurate, up-to-date field data for forecasting purposes. These systems also enable ASG to refine its bids and help ASG reduce the costs associated with the delivery of consistent healthcare.
ASG maintains a utilization review system to monitor the extent and duration of most healthcare services required by inmates on an inpatient and outpatient basis. The current automated utilization review program is an integral part of the services provided at each facility. The system is designed to ensure that the medical care rendered is medically necessary and is provided safely in a clinically appropriate setting while maintaining traditional standards of quality of care. The program provides for determinations of medical necessity by medical professionals through a process of pre-authorization and concurrent review of the appropriateness of any hospital stay. The program seeks to identify the maximum capability of on-site healthcare units so as to allow for a more timely discharge from the hospital back to the correctional facility. The utilization review staff consists of nurses who are supported by a medical director at the corporate level and a panel of medical specialists who are consultants to ASG.
ASG has developed a variety of customized databases to facilitate and improve operational review including (i) a claims management tracking system that monitors current incidents, claims and litigation against ASG, (ii) a comprehensive cost review system that analyzes ASG's average costs per inmate at each facility and (iii) a daily operating report to control staffing and off-site utilization.
Bid Process. Contracts with governmental agencies are obtained primarily through a competitive bidding process, which is governed by applicable state and local statutes and ordinances. Although practices vary, typically a formal request for proposal ("RFP") is issued stating the scope of work to be performed, length of contract, performance bonding requirements, minimum qualifications of bidders, selection criteria and the format to be followed in the bid or proposal. Usually, a committee appointed by the governmental agency reviews bids and makes an award determination. The committee may award the contract to a particular bidder or decide not to award the contract to the private sector. The award of a contract may be subject to formal or informal protest, through a governmental appeals process, by unsuccessful bidders.
Many RFPs for significant contracts require the bidder to post a bid bond. Performance bonding requirements are for the length of the contract and at December 31, 1999, generally ranged between 4% and 60% (and in one case, 100%) of the 1999 contract fee.
A successful bidder must often agree to comply with numerous additional requirements regarding record-keeping and accounting, non-discrimination in the hiring of personnel, safety, safeguarding classified information, management qualifications, professional licensing requirements, emergency healthcare needs of corrections employees and other matters. Upon a violation of the terms of an applicable contractual or statutory provision, a contractor may be debarred or suspended from obtaining future contracts for specified periods of time in the applicable location. ASG has never been debarred or suspended in any jurisdiction.
Marketing. ASG gathers and analyzes information on prisons and jails around the country in order to identify the ones that best meet its marketing criteria. Relevant factors include the quality and costs of healthcare in the region, the management and operations of the correctional facility, the financial stability of the governmental agency and the composition of the inmate population. ASG then devotes a substantial portion of its marketing resources to such potential customers. State prison systems, because of their more stable inmate populations and, in many cases, larger number of facilities and longer contract terms, are an important focal point of ASG's marketing plans. Also, ASG will continue to identify those county and local jails that fit its market profile and will pursue contracts with those facilities.
ASG maintains a staff of sales and marketing representatives assigned to specific geographic areas of the United States. In addition, ASG uses consultants to help identify marketing opportunities, to determine the needs of specific potential customers and to engage customers on ASG's behalf. ASG uses paid advertising and promotion to reach prospective clients as well as to reinforce its image with existing clients.
Risk Management. Prior to December 1, 1997, Harbour Insurance, Inc. ("Harbour"), a wholly owned subsidiary of PHS and a captive insurance company, provided insurance covering PHS's medical professional and general liability arising out of its provision of healthcare services. Since December 1, 1997, the Company has maintained professional and general liability insurance through an unaffiliated insurer. In October 1998, ASG liquidated Harbour and entered into a novation agreement pursuant to which an unaffiliated insurer assumed substantially all of the liabilities of Harbour for outstanding claims as of August 31, 1998 incurred prior to December 1, 1997.
For contracts where ASG's exposure to the risk of inmates' catastrophic illness or injury is not limited, ASG maintains stop loss insurance to cover 80% of ASG's exposure with respect to hospitalization for amounts in excess of $200,000 per inmate. ASG believes this insurance mitigates its exposure to unanticipated expenses of catastrophic hospitalization.
There can be no assurance that third-party commercial insurance will continue to be available in the future or will be available at reasonable prices. ASG believes its insurance coverage is maintained at reasonable levels, but there can be no assurance that it will cover all claims that may be asserted against ASG and its employees and agents.
MILITARY SERVICES
EMSA Military provides a broad range of emergency medicine and primary healthcare services to active and retired military personnel and their dependents in medical facilities operated by the United States Department of Defense ("DOD") and the United States Veterans Administration ("VA"). EMSA Military began providing healthcare services to DOD clients in 1988 and has provided in excess of 3.5 million patient visits. During the fiscal year ended December 31, 1999, EMSA Military provided services under nine contracts.
Most military contracts are for a period of five years, with an initial one year base period and four one year options. EMSA Military's bidding strategy is to seek contract opportunities that will be awarded on a best value, rather than a low cost basis. This allows EMSA Military to highlight the Company's operational expertise and the overall quality of its provider staff. Margins are determined by the size and risk associated with a specific contract.
EMPLOYEES AND INDEPENDENT CONTRACTORS
The services provided by ASG require an experienced staff of healthcare professionals and facilities administrators. In particular, a nursing staff with experience in correctional healthcare and specialized skills in all necessary areas contributes significantly to ASG's ability to provide efficient service. In addition to nurses, ASG's staff of employees or independent contractors includes physicians, dentists, psychologists and other healthcare professionals.
As of December 31, 1999, ASG had approximately 3,100 full-time equivalent employees, including 2,250 medical personnel. ASG also had under contract 186 independent contractors, most of whom are part-time, including physicians, dentists, psychiatrists and psychologists. ASG's employees at its Alameda County, California, City of Philadelphia, York County and Delaware facilities are represented by labor unions. ASG believes that its employee relations are good.
COMPETITION
The business of providing correctional healthcare services to governmental agencies is highly competitive. ASG is in direct competition with local, regional and national correctional healthcare providers. ASG believes that one competitor may have larger staffs and greater resources than ASG. As the private market for providing correctional healthcare matures, ASG's competitors may gain additional experience in bidding and administering correctional healthcare contracts. In addition, new competitors, some of whom may have extensive experience in related fields or greater financial resources than ASG, may enter the market.
MAJOR CONTRACTS
ASG's operating revenue with respect to its correctional healthcare operations is derived exclusively from contracts with state, county and local governmental agencies. No one contract accounted for 10% of revenues during the year ended December 31, 1999.
CAUTIONARY STATEMENTS
All statements made by ASG that are not historical facts are based on current expectations. These statements are forward looking in nature and involve a number of risks and uncertainties. Actual results may differ materially. Among the factors that could cause actual results to differ materially are the following: dependence on major contracts; price competition in the prison healthcare industry; ASG's ability to provide adequate staffing to meet its contractual commitments; changes in performance bonding requirements; substantial damage awards against ASG in connection with medical malpractice claims; changes in laws or regulations or the application thereof; general business and economic conditions; and the other risk factors described in ASG's reports filed from time to time with the Securities and Exchange Commission. Certain of these factors are described in greater detail below.
Dependence on Major Contracts. ASG's operating revenue is derived exclusively from contracts with federal, state, county and local governmental agencies. Generally, contracts may be terminated by the governmental agency at will and without cause upon proper notice (typically between 30 and 180 days). Governmental agencies may be subject to political influences that could lead to termination of a contract through no fault of the contractor. Although ASG generally attempts to renew or renegotiate contracts at or prior to their termination, contracts that are put out for bid are subject to intense competition. The loss of one or more of the major contracts could have a material adverse effect on ASG's business.
Contracts with government agencies are generally complex in nature and subject contractors to extensive regulation under federal, state, county and local law. Under certain circumstances, a government contractor may be debarred or suspended from obtaining future contracts. While ASG considers the possibility remote, such debarment or suspension could have a material adverse effect on ASG.
Privatization of Government Services, Competition and Correctional Population. ASG's future financial performance will depend in part on continued privatization by state, county and local governmental agencies of healthcare services for correctional facilities. There can be no assurance that this market will continue to grow or that existing contracts will continue to be made available to the private sector. The business of providing correctional healthcare services to governmental agencies is highly competitive. ASG is in direct competition with local, regional and national correctional healthcare providers. ASG believes that one of its competitors may have larger staffs and greater resources than ASG. As the private market for providing correctional healthcare matures, ASG's competitors may gain additional experience in bidding and administering correctional healthcare contracts. In addition, new competitors, some of whom may have extensive experience in related fields or greater financial resources than ASG, may enter the market. ASG's business could also be adversely affected by material decreases in the inmate population of correctional facilities.
Acquisitions. ASG's expansion strategy involves both internal growth and, as attractive opportunities become available, acquisitions. The Company took a significant step toward implementing this strategy with the EMSA acquisition in January of 1999. ASG has limited experience acquiring businesses and integrating them into its operations.
Catastrophic Limits. Contracts accounting for 56% of revenues for the year ended December 31, 1999 contain no limits on ASG's exposure for treatment costs related to catastrophic illnesses or injuries to inmates. For those contracts that contain no catastrophic limits, ASG maintains stop loss insurance for 80% of its exposure with respect to catastrophic illnesses or injuries for amounts in excess of $200,000 per inmate. ASG attempts to compensate for the increased financial risk when pricing contracts that do not contain catastrophic limits. Although, the occurrence of severe individual cases without such limits could render the contract unprofitable and could have a material adverse effect, ASG believes the potential impact of any such occurrences is mitigated by such insurance.
Dependence on Key Personnel. The success of ASG depends in large part on the ability and experience of its senior management. The loss of services of one or more key employees could adversely affect ASG's operations. ASG has employment contracts with Michael Catalano, President and Chief Executive Officer, Gerard F. Boyle, Executive Vice President and Chief Operating Officer of the Company, and Bruce A. Teal, Executive Vice President and Chief Financial Officer.
Dependence on Healthcare Personnel. ASG's success depends on its ability to attract and retain highly skilled healthcare personnel. A shortage of trained and competent employees and/or independent contractors may result in overtime costs or the need to hire less efficient temporary staff. Attracting qualified nurses at a reasonable cost has been and continues to be of concern to ASG. There can be no assurance that ASG will be successful in attracting and retaining a sufficient number of qualified healthcare personnel in the future.
Corporate Exposure to Professional Liability. ASG periodically becomes involved in medical malpractice claims with the attendant risk of substantial damage awards. The most significant source of potential liability in this regard is the risk of suits brought by inmates alleging lack of timely or adequate healthcare services. ASG may be liable, as employer, for the negligence of healthcare professionals who are employees of ASG. ASG may also have potential liability for the negligence of healthcare professionals engaged by ASG as
independent contractors. ASG's contracts generally provide for ASG to indemnify the governmental agency for losses incurred related to healthcare provided by ASG and its agents. ASG maintains professional liability insurance and requires its independent contractors to maintain professional liability insurance in amounts deemed appropriate by management based upon ASG's claims history and the nature and risks of its business. There can be no assurance that a future claim or claims will not exceed the limits of available insurance coverage or that such coverage will continue to be available at a reasonable cost.
ITEM 2.
ITEM 2. PROPERTIES
The Company occupies approximately 18,700 square feet of leased office space in Brentwood, Tennessee, where it maintains its corporate headquarters. The Company's lease on its current headquarters expires in October 2003. The Company leases additional office facilities in Newark, Delaware; Indianapolis, Indiana; Alameda, California; Topeka, Kansas; Fort Lauderdale, Florida; Burlington, Vermont and Concordville and Pittsburgh, Pennsylvania. While the Company may open additional offices to meet the local needs of future contracts awarded in new areas, management believes that its current facilities are adequate for its existing contracts for the foreseeable future.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is subject to claims and suits in the ordinary course of business. In management's opinion, such currently pending legal proceedings and claims against the Company will not, in the aggregate, have a material adverse effect on the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Common Stock is traded on The Nasdaq Stock Market's National Market System under the symbol "ASGR." As of March 20, 2000, there were approximately 67 holders of record of the Common Stock. The high and low prices of the Common Stock as reported on The Nasdaq Stock Market during each quarter from January 1, 1998 through December 31, 1999 are shown below:
The Company did not pay cash dividends on the Common Stock during the years ended December 31, 1999 and December 31, 1998. The Company does not currently intend to pay cash dividends on the Common Stock in the foreseeable future because, under the terms of its Credit Facility, the Company is prohibited from paying cash dividends on the Common Stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
See Management's Discussion and Analysis of Financial Condition and Results of Operations and Notes to Consolidated Financial Statements describing the financial impact for 1999 due to the EMSA acquisition, 1998 due to the MedPartners' Settlement Agreement and 1997 for the impact of the nonrenewal of the contract with the Georgia Department of Corrections.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The following table sets forth, for the years indicated, the percentage relationship to total revenue of certain items in the Consolidated Income Statements.
1999 Compared to 1998
Healthcare revenues increased $159.6 million from $113.3 million in 1998 to $272.9 million in 1999, representing a 141% increase. The increase in revenues resulted primarily from the Company's acquisition of EMSA Correctional and EMSA Military on January 26, 1999. EMSA Correctional and EMSA Military generated revenues of $139.2 million in the year ended December 31, 1999. Apart from the EMSA acquisition, the Company added sixteen new contracts in 1999, which generated $12.6 million in new revenues, and experienced $8.1 million of revenue growth from existing contracts through contract renegotiations, automatic price adjustments and from contracts being in effect a full year. Revenues were negatively impacted by the loss of two PHS contracts during 1999, which generated $1.8 million of revenues in 1999, compared to $2.1 million of revenues in 1998.
The cost of healthcare increased $143.6 million due mainly to the EMSA acquisition. Healthcare expenses as a percentage of revenues were unchanged at 89.9% in both 1999 and 1998. Personnel costs and fringe benefits (including subcontractors) related to inmate care were 61% of revenues in 1999 versus 57% of revenues in 1998. The increase is attributable to the Company's focus on more fully utilizing its on-site infirmaries. Costs related to outside services (defined as hospitalization, emergency room and ambulance and outpatient surgeries and visits) were 13% of revenues in 1999 and 15% in 1998. The Company was also able to improve its pharmacy cost from 10% of revenue in 1998 to 9% in 1999.
Selling, general and administrative expenses were $12.3 million or 4.5% of revenue in 1999 compared to $9.8 million in 1998. The dollar increase relates primarily to the EMSA acquisition, but also demonstrates the ability to leverage corporate support services.
Depreciation and amortization increased $2.5 million in 1999 to $3.7 million. The increase is directly related to the amortization expense related to the EMSA acquisition of approximately $2.4 million between goodwill, noncompete agreements and deferred finance costs.
The provision for income taxes was $3.1 million of expense in 1999 for an effective tax rate of 40%, compared to $0.6 million of benefit in 1998, when the Company recognized net operating loss carryforwards. As of December 31, 1999, the Company had approximately $2.0 million in net operating loss carryforwards.
The preferred stock dividends of $2.3 million relate to the redeemable preferred stock and include a $1.9 million noncash nonrecurring dividend, related to a beneficial conversion feature at the date the stock was issued, which increased additional paid-in capital.
With the inmate population increasing an average of approximately 6% compounded annually, the medical Consumer Price Index increasing by an average of 3%, the trend towards privatization of correctional healthcare and the Company being the second largest provider of healthcare to incarcerated individuals, management anticipates opportunities for revenue growth, medical loss ratio improvement and leveraging of selling, general and administrative costs.
1998 Compared to 1997
Healthcare revenues decreased $15.9 million from $129.2 million in 1997 to $113.3 million in 1998, representing a 12% decrease. The decline in revenues resulted from the termination of the Georgia Department of Corrections Contract (the "Georgia Contract") which expired in June 1997, and provided revenue of $31.3 million in the year ended December 31, 1997. The Company added three new contracts in 1998, which generated $0.8 million in new revenues, and experienced $14.6 million of revenue growth from existing contracts through population increases, contract renegotiations, automatic price adjustments and from contracts being in effect a full year. The Company did not lose any contracts in 1998.
The cost of healthcare decreased $16.7 million or 14% to $101.9 million in 1998. Healthcare expenses as a percentage of revenues were 89.9% in 1998 versus 91.8% in 1997. Healthcare expenses exclusive of the Georgia Contract were 89% in 1997. Personnel costs and fringe benefits (including subcontractors) related to inmate care were 57% of revenues in 1998 and 1997. Costs related to outside services (defined as hospitalization, emergency room and ambulance and outpatient surgeries and visits) were 15% of revenues in 1998 and 17% of revenues in 1997. The decline is due to the Company's continued emphases on network development and case management.
Selling general and administrative expenses were $9.7 million in 1998 compared to $8.3 million in 1997. The increase is due to $0.6 million and $0.7 million of costs associated with the UniSource disposal and employee stay bonuses, respectively, both relating to the terminated MedPartners merger. In connection with the anticipated, then terminated, merger, all of the UniSource employees were informed of the Company's intent to cease UniSource operations and sell or dispose of all of UniSource's operating assets. In addition, the Company incurred corporate employee stay bonus and severance costs to either retain the employees when the anticipated MedPartners merger was terminated or honor severance agreements.
The Company recorded a gain of $4.0 million related to the MedPartners Settlement Agreement. Pursuant to the Settlement Agreement, MedPartners agreed to pay the Company approximately $3.5 million in cash and to assume certain other costs incurred by the Company in connection with the merger in the amount of approximately $1.5 million. Of the amount received from MedPartners, $1.0 million reimbursed the Company for direct costs of the terminated merger that were included in prepaid expenses and other current assets at December 1997.
Interest income of $0.6 million in 1998 declined from $0.7 million in 1997 due to the dissolution of Harbour and the subsequent liquidation of its long-term restricted investments.
The income tax benefit was $0.6 million in 1998 compared to $0.1 million expense in 1997. The benefit relates to the elimination of valuation allowances on the Company's deferred tax assets during the fourth quarter of 1998, based on the trend of future earnings, projected pre-tax income for 1999 and, other than for 1996, the Company's history of taxable income. The allowance was eliminated as it is more likely than not that the deferred tax assets will be realized over the reversion period of existing taxable temporary differences and the carry forward period of the Company's net operating losses. As of December 31, 1998, the Company had approximately $5.7 million in net operating loss carry forwards.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents decreased from $7.2 million at December 31, 1998 to $0.4 million at December 31, 1999. The decrease is related specifically to the EMSA acquisition and the Company's focus on repaying the debt incurred to purchase EMSA. Between cash provided from operating activities of $22.5 million and the cash at December 31, 1998, the Company was able to repay $21.5 million of the Senior Revolving Credit Facility and $7.5 million of the Convertible Subordinated Notes. In addition to the $29 million in debt repayments, the remaining $7.5 million of Convertible Subordinated Notes was converted to preferred stock, which is mandatorily redeemable on July 26, 2005 and carries a 5% coupon rate. The Company was able to reduce its total outstanding debt by 47% in the first eleven months subsequent to the EMSA acquisition through repayments and conversion and now maintains a debt to cash flow ratio of less than 1.7:1.0. Interest was paid through December 25, 1999 and preferred stock dividends were paid through December 31, 1999.
Accounts receivable including acquired EMSA receivables declined $13.5 million and reflects the impact of incorporating the same internal practices for EMSA contracts as existed for PHS accounts, including weekly aging and operational conference calls. Prepaids and other current assets increased $5.5 million due to an inventory build-up in contemplation of potential Year 2000 issues and prepaid insurance for malpractice insurance. Accounts payable and accrued expenses increased $3.6 million, which is expected with the growth of the Company from $111.6 million in cash operating expenses to $257.8 million.
As part of the EMSA acquisition, the Company increased its $20 million line of credit facility to a $52 million Credit Facility, which has been reduced to $40 million as of December 31, 1999. Outstanding borrowings under such facility are $25.5 million as of December 31, 1999. As part of the Credit Facility, the Company has available a $10 million line of credit for general corporate purposes, including working capital and the funding of acquisitions. The interest rate is based upon LIBOR or prime rate, subject to the quarterly operating performance of the Company and other funding criteria, as defined in the Credit Facility. The Credit Facility is subject to certain quarterly covenants, with which the Company was in compliance throughout 1999.
Management believes that the current levels of cash, cash equivalents and investments, when coupled with the internally generated funds and available credit, are sufficient to meet the Company's immediate foreseeable future cash needs and anticipated contract renewal activity.
INFLATION
The increase in healthcare costs in 1999 over 1998 was 3.5%, compared to an overall increase in the Consumer Price Index of 2.7% for all costs for the same period.
Some of the Company's contracts provide for annual increases in the fixed base fee upon changes in the regional medical care component of the Consumer Price Index. In all other contracts that extend beyond one year, the Company utilizes a projection of the future inflation rate when bidding and negotiating the fixed fee for future years. If the rate of inflation exceeds the levels projected, such excess will be absorbed by the Company. Conversely, the Company will benefit should the actual rate of inflation fall below the estimate used in the bidding and negotiation process.
IMPACT OF YEAR 2000
In prior years, the Company discussed the nature and progress of its plans to become Year 2000 ready. In late 1999, the Company completed its remediation and testing of systems. As a result of those planning and implementation efforts, the Company experienced no significant disruptions in mission critical information technology and non-information technology systems and believes those systems successfully responded to the Year 2000 date change. The Company expended approximately $0.1 million during 1999 in connection with remediating its systems. The Company is not aware of any material problems resulting from Year 2000 issues, either with its products, its internal systems, or the products and services of third parties. The Company will continue to monitor its mission critical computer applications and those of its suppliers and vendors throughout the Year 2000 to ensure that any latent Year 2000 matters that may arise are addressed promptly.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's Consolidated Financial Statements, together with the report thereon of Ernst & Young LLP, dated February 11, 2000, begin on page of this Report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There are no disagreements with accountants on accounting and financial disclosure required to be reported in this annual report pursuant to Item 304 of Regulation S-K.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
For information regarding the Directors of the Company, the heading "Information as to Directors, Nominees and Executive Officers" and the subsection "Compliance with Section 16(a) of the Securities Exchange Act" under the heading "Additional Information" in the Company's Proxy Statement for its 2000 Annual Meeting of Stockholders (the "Company's Proxy Statement") is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The subsection under the heading "Additional Information" entitled "Committees and Meetings" and the heading entitled "Executive Compensation" in the Company's 2000 Proxy Statement are incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The headings "Information as to Directors, Nominees and Executive Officers" and "Principal Stockholders" in the Company's 2000 Proxy Statement are incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The heading "Certain Transactions" in the Company's 2000 Proxy Statement is incorporated hereby by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K
(a) (1) Financial Statements
Listed on the Index to the Consolidated Financial Statements and Schedule on page of this Report.
(2) Financial Statement Schedule
Listed on the Index to the Consolidated Financial Statements and Schedule on page of this Report.
(3) Exhibits
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the fourth quarter of 1999.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registration has duly caused this report to be signed on behalf of the undersigned, thereunto duly authorized, on March 30, 2000.
AMERICA SERVICE GROUP INC.
By: /s/ MICHAEL CATALANO ------------------------------------ Michael Catalano President and Chief Executive Officer
Pursuant to the Requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities indicated on March 30, 2000.
AMERICA SERVICE GROUP INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
All other schedules are omitted as the required information is inapplicable or is presented in the Company's Consolidated Financial Statements or the Notes thereto.
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders America Service Group Inc.
We have audited the accompanying consolidated balance sheets of America Service Group Inc. as of December 31, 1999 and 1998, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1999. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of America Service Group Inc. at December 31, 1999 and 1998, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects the information set forth therein.
/s/ ERNST & YOUNG LLP
Nashville, Tennessee February 11, 2000
AMERICA SERVICE GROUP INC.
CONSOLIDATED BALANCE SHEETS
See accompanying notes.
AMERICA SERVICE GROUP INC.
CONSOLIDATED STATEMENTS OF INCOME
See accompanying notes.
AMERICA SERVICE GROUP INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
See accompanying notes.
AMERICA SERVICE GROUP INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes.
AMERICA SERVICE GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999
1. DESCRIPTION OF BUSINESS
America Service Group Inc. (the "Company") and its consolidated subsidiaries provide managed healthcare services to correctional facilities under capitated contracts (with certain adjustments) with state and local governments and medical facilities operated by the Department of Defense and Veterans Administration. The health status of inmates may impact results of operations under such contractual arrangements.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Prison Health Services, Inc. (PHS), EMSA Correctional Care, Inc. and EMSA Military Services, Inc. (EMSA), and its wholly-owned captive insurance subsidiary, Harbour Insurance, Inc. (Harbour), Southern Health Partners, Inc. (SHP) and UniSource, Inc. (UniSource). The Company liquidated and dissolved Harbour in November 1998 and sold all fixed operating assets of UniSource during 1998. The Company disposed of 90% of its interest in SHP in July 1996 and the remaining 10% in July 1997. All significant intercompany transactions and account balances have been eliminated.
Use of Estimates
The preparation of the consolidated financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Estimates are used primarily in the recording of the accruals of unbilled medical services calculated based upon a claims payment lag methodology and professional and general liability claims. The claims payment lag methodology utilized for recording amounts for unbilled medical claims is based upon historical payment patterns using actual utilization data including hospitalization, one day surgeries, physician visits and emergency room and ambulance visits and their corresponding costs. Estimates change as new events occur, more experience is acquired, or additional information is obtained. A change in an estimate is accounted for in the period of change.
Fair Value of Financial Instruments
The carrying amounts of the Company's financial instruments reported in the Consolidated Balance Sheets, consist of cash and cash equivalents, accounts receivable, accounts payable and long-term debt and approximate their fair values.
Revenue and Cost Recognition
The Company engages principally in fixed price contracts with correctional institutions adjusted for census fluctuations. 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.
Healthcare expenses include the compensation of physicians, nurses and other healthcare professionals including any related benefits and all other direct costs of providing the managed care. The cost of healthcare services provided or contracted for are recognized in the period in which they are provided based in part on estimates, including an accrual for unbilled medical services rendered through the balance sheet dates based upon a claims payment lag methodology. Additionally, reserves have been recorded for certain reported and unreported professional and general liability claims associated with the delivery of medical services.
AMERICA SERVICE GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company accrues losses under its fixed price contracts when it is probable that a loss has been incurred (i.e., expected future healthcare costs and maintenance costs will exceed anticipated future revenue and stop-loss insurance recoveries if material) and the amount of the loss can be reasonably estimated. The Company performs this loss accrual analysis on a specific contract basis.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, demand deposits, money market funds and investments with original maturities of three months or less.
Inventory
Pharmacy and medical supplies inventory is stated at the lower of cost (first-in, first-out method) or market.
Depreciation
Depreciation is provided using straight-line and accelerated methods over the estimated useful lives of the assets.
Cost in Excess of Net Assets Acquired
Cost in excess of net assets acquired represents the unamortized excess of the acquisition cost over the fair value of the net assets received at the date of acquisition. Amortization expense of $2.2 million, $14,000 and $42,000 for 1999, 1998 and 1997, respectively, was computed using the straight-line method over 20 years relating to the EMSA acquisition and over 15 years relating to the UniSource acquisition. Accumulated amortization as of December 31, 1999 was $2.2 million. The Company wrote off the unamortized portion of cost in excess of net assets acquired of $0.4 million in June 1998 with the sale of UniSource.
The carrying value of costs in excess of net assets acquired is reviewed if the facts and circumstances suggest that it may be impaired. If this review indicates that cost in excess of net assets acquired will not be recoverable based on the undiscounted cash flows of the entity acquired over the remaining amortization period, the Company's carrying value of the cost in excess of net assets acquired will be reduced to estimated fair value.
Other Assets
Other assets include $0.5 million of deferred financing costs related to the $52 million Credit Facility (see Note 3) and a $0.4 million noncompete agreement relating to the EMSA acquisition. Amortization expense of $0.3 million related to the deferred finance costs and noncompete agreement was computed using the straight-line method over the corresponding lives of the agreements. Accumulated amortization as of December 31, 1999 was $0.3 million.
Long-Lived Assets
Statement of Financial Accounting Standards (SFAS) No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, requires that companies consider whether indicators of impairment of long-lived assets held for use are present. If such indicators are present, companies determine whether the sum of the estimated undiscounted future cash flows attributable to such assets is less than their carrying amount, and if so, companies recognize an impairment loss based on the excess of the carrying amount of the assets over their fair value. Accordingly, management periodically evaluates the ongoing value of property and equipment and cost in excess of net assets acquired and considers events,
AMERICA SERVICE GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
circumstances and operating results, including consideration of contract performance at the fixed price contract level.
Treasury Stock
Prior to December 1996, the Board of Directors had authorized the Company to purchase treasury stock to be available for issuance under stock options and other benefits under the Company's Incentive Stock Plan. Upon exercise of the stock options, the difference between the cost of the treasury shares, on a first-in, first-out basis, and the price of options exercised is reflected in additional paid-in capital. Treasury stock includes 31,000 common shares at December 31, 1996, which were issued during 1997.
Preferred Stock
The Board of Directors has the power and authority to establish preferences related to dividends, redemptions, payment on liquidation, conversion privileges and voting rights. During 1999, the Company authorized 500,000 shares of mandatory redeemable convertible preferred stock, with a $100 per share liquidation value and a 5% coupon. During 1999, a total of 125,000 of such shares were issued as part of the EMSA acquisition discussed in Note 3.
Income Taxes
The Company uses the liability method of accounting for federal and state income taxes. Under the liability method, deferred tax assets and liabilities are determined based on the difference between the financial statement carrying amounts and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. Differences between taxable income and income for financial statement purposes result from the recognition of certain income and expense items for tax purposes in periods which differ from those used for financial statement purposes.
Stock Options
The Company has elected to follow Accounting Principles Board Opinion No. 25, (Accounting for Stock Issued to Employees) ("APB 25"), and related Interpretations in accounting for its employee stock options because the alternative fair value accounting provided for under SFAS No. 123, (Accounting for Stock-Based Compensation), requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, compensation expense is recognized as the difference between the exercise price of the Company's employee stock options and the market price of the underlying stock on the date of grant.
Recently Issued Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS No. 133) which was required to be adopted in years beginning after June 15, 1999. In July 1999, SFAS No. 137 was issued as Accounting for Derivative Investments and Hedging Activities -- Deferral of the Effective Date of FASB Statement No. 133 which defers for one year the effective date of SFAS No. 133 to all fiscal quarters of all fiscal years beginning after June 15, 2000. Accordingly, the Company plans to adopt SFAS No. 133 effective January 1, 2001. The Company does not anticipate that the adoption of SFAS No. 133 will have a significant effect on the financial position or the results of operations of the Company.
Reclassifications
Certain prior period amounts have been reclassified in order to conform to current period presentation.
AMERICA SERVICE GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. ACQUISITION OF GOVERNMENT SERVICES DIVISION
On January 26, 1999, the Company purchased all of the outstanding stock of EMSA Government Services, Inc. ("EMSA") from InPhyNet Administrative Services, Inc. ("InPhyNet") for $67.0 million in cash pursuant to a Stock Purchase Agreement, dated as of December 18, 1998 (the "Stock Purchase Agreement"), as amended by the First Amendment to Stock Purchase Agreement, dated as of January 26, 1999 (the "First Amendment"), between the Company and InPhyNet. InPhyNet was a wholly-owned subsidiary of MedPartners, Inc. ("MedPartners").
EMSA conducts its operations through two wholly-owned subsidiaries, EMSA Correctional Care, Inc. and EMSA Military Services, Inc., each of which became indirect subsidiaries of the Company pursuant to its acquisition of EMSA. EMSA Correctional provides comprehensive managed healthcare solutions to state and local correctional facilities, managing healthcare for approximately 70,000 inmates. Following the EMSA acquisition, the Company, through EMSA Correctional and PHS, manages healthcare for approximately 133,000 inmates in 25 states. EMSA Military contracts with the U.S. Department of Defense (the "DOD") and the Veterans Administration (the "VA") to provide emergency medicine and primary healthcare services to active and retired military personnel and their dependents at medical facilities operated by the DOD and the VA.
The purchase price paid to InPhyNet was subject to increase or decrease on a dollar-for-dollar basis by an amount equal to the amount by which EMSA's working capital, as defined, and as reflected on its balance sheet as of January 25, 1999 (the "Closing Date Balance Sheet"), was in excess of or was less than $27.6 million. The Closing Date Balance Sheet reflected working capital, as defined, of $24.0 million. Accordingly, the Company received $3.6 million in March 1999 as part of the purchase price adjustment. The Company accounted for the EMSA acquisition using the purchase method of accounting.
In connection with the EMSA acquisition: (i) the Company and all of its subsidiaries, including EMSA, EMSA Military and EMSA Correctional, entered into an Amended and Restated Credit Agreement, dated as of January 26, 1999, with NationsBank, N.A., as Administrative Agent and Issuing Bank ("NationsBank"), which provides for a Revolving Credit Facility of up to $52.0 million (the "Credit Facility") and (ii) the Company entered into a Securities Purchase Agreement, dated as of January 26, 1999 (the "Securities Purchase Agreement") with Health Care Capital Partners L.P. ("Capital Partners") and Health Care Executive Partners L.P. ("Executive Partners"), investment funds managed by Ferrer Freeman Thompson & Co. (collectively, with Capital Partners and Executive Partners, "FFT"). On January 26, 1999, pursuant to the Securities Purchase Agreement, the Company issued to Capital Partners and Executive Partners (i) $15.0 million aggregate principal amount of the Company's 12% Subordinated Convertible Bridge Notes due January 26, 2000 (the "Notes") with detachable warrants (the "Warrants") to purchase an aggregate 135,000 shares of the Company's common stock, par value $0.01 per share (the "Common Stock"), and (ii) 50,000 shares of the Company's Series A Convertible Preferred Stock, par value $0.01 per share (the "Convertible Preferred Stock"), for $5.0 million. The Notes, Warrants and Preferred Stock are referred to collectively as the "Convertible Securities."
The Company used $47.0 million in borrowings under the Credit Facility and the aggregate $20 million in proceeds received from its issuance of the Convertible Securities to Capital Partners and Executive Partners to finance, in part, the EMSA acquisition. As of December 31, 1999, the Company has repaid $29 million of borrowings under the Credit Facility and the Notes and converted the remaining $7.5 million of the Notes to mandatory redeemable Preferred Stock.
The Company obtained an independent valuation computation of the fair values of the Warrants ($4.88 per Warrant). Significant assumptions used in the fair value calculation include: risk-free interest rate (4.79%); expiration period (7 years); volatility (49%); and dividend per share (zero). The proceeds from the sale of the Notes and Warrants were allocated based on the relative fair values of the Warrants and Notes,
AMERICA SERVICE GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
with the fair value of the Warrants being accounted for as an addition to paid-in capital. The resulting discount on the Notes is accounted for as such and is being accreted and accounted for accordingly.
At a meeting of the Emerging Issues Task Force (the "EITF"), the Securities and Exchange Commission (the "SEC") recommended an accounting treatment for securities similar to the Convertible Preferred Stock that have a "beneficial conversion" feature. Although the EITF issued clarifying guidance, effective for transactions consummated after May 20, 1999, indicating that whether a beneficial conversion feature exists with respect to a convertible security should be determined at the date the issuer enters into a commitment to issue the security and that, if a beneficial conversion feature exists, it should be recorded upon the issuance of the security, the Company is required to follow the accounting guidance existing for transactions prior to May 21, 1999. The Company recorded $1.9 million, which increases paid-in capital, representing the beneficial conversion feature of $3.68 non-cash, nonrecurring dividend on each outstanding share of Convertible Preferred Stock. The dividend equals the increase in the fair market value of a share of the Company's Common Stock from the date the Company entered into a commitment to issue the Convertible Preferred Stock ($9.45 per share) to the Company's issuance of the Convertible Preferred Stock on January 26, 1999 ($13.125 per share). If the acquisition of EMSA had occurred subsequent to May 20, 1999, the Company would not have recorded the beneficial conversion feature dividend.
The following unaudited pro forma results of operations give effect to the operations of EMSA as if the transaction had occurred at the beginning of the year presented.
4. RELEASE AND SETTLEMENT AGREEMENT
On October 1, 1997, the Company entered into a Plan and Agreement of Merger (the "Merger Agreement") with MedPartners, Inc., a Delaware corporation ("MedPartners"), and a wholly owned subsidiary of MedPartners, pursuant to which the Company would have been acquired by MedPartners (the "Merger").
On February 26, 1998, the Company announced the termination of the Merger Agreement and the execution of a Release and Settlement Agreement (the "Settlement Agreement") with MedPartners relating to the Merger Agreement. Pursuant to the Settlement Agreement, MedPartners agreed to pay the Company approximately $3.5 million in cash and to assume certain other base and employee healthcare benefit costs incurred by the Company of approximately $1.5 million. Approximately $1.0 million of these payments reimbursed the Company for costs directly associated with the terminated merger that were included in prepaid expenses and other current assets at December 31, 1997. The resulting $4.0 million is reported in 1998 as the MedPartners settlement gain.
In connection with the anticipated merger, all of the UniSource employees were informed of the Company's intent to cease operations and sell or dispose of all of UniSource's operating assets. Costs of approximately $0.6 million associated with the disposal of UniSource, including $0.4 million of unamortized cost in excess of net assets acquired, severance and other miscellaneous expenses are included in selling, general and administrative expenses in 1998. Also in connection with the MedPartners transaction, the Company incurred employee stay bonuses and severance costs of $0.7 million, which is included in selling, general and administrative expenses in 1998.
AMERICA SERVICE GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. PREPAID EXPENSES AND OTHER CURRENT ASSETS
Prepaid expenses and other current assets are stated at cost and comprised of the following:
6. PROPERTY AND EQUIPMENT
Property and equipment is stated at cost and comprised of the following:
Depreciation expense for the years ended December 31, 1999, 1998 and 1997 was $1.2 million, $0.8 million and $1.1 million, respectively.
7. ACCRUED EXPENSES
Accrued expenses consist of the following:
AMERICA SERVICE GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. BANKING ARRANGEMENTS
In connection with the EMSA acquisition, the Company entered into the aforementioned $52 million Credit Facility expiring September 30, 2002, which replaced the Company's $20 million Credit Facility dated March 28, 1997. The Credit Facility includes a $10 million sub-limit for working capital and issuance of letters of credit for performance bonds. The interest rate is based on LIBOR or prime rates subject to the quarterly operating performance of the Company, as defined in such facility. The Credit Facility is collateralized by all assets of the Company and its operating subsidiaries and is also subject to certain quarterly financial covenants, with which the Company was in compliance throughout 1999. No borrowings were outstanding under the working capital portion of the Credit Facility at December 31, 1999 and 1998.
Under the Credit Facility's step-down schedule of availability, amounts outstanding under the Credit Facility as of December 31, 1999 mature in January and September 2002.
The Company did not have open letters of credit as of December 31, 1999 and had $0.5 million at December 31, 1998.
9. INCOME TAXES
The Company's provision (benefit) for income taxes consists of the following:
Deferred tax assets (liabilities) are comprised of the following at December 31:
AMERICA SERVICE GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A valuation allowance for deferred tax assets of $2.7 million was eliminated at December 31, 1998 as it was more likely than not that the deferred tax assets will be realized through the future reversion of existing taxable temporary differences and the generation of future taxable income. As of December 31, 1999, the Company had federal and state net operating loss carryforwards of $2.0 million expiring in 2005 through 2006.
A reconciliation of the federal statutory rate to the effective tax rate is as follows:
10. MANDATORY REDEEMABLE PREFERRED STOCK
Mandatory redeemable preferred stock (Convertible Preferred Stock) consists of 50,000 shares issued on January 26, 1999 and 75,000 shares issued on August 30, 1999 to Health Care Capital Partners L.P. and Health Care Executive Partners L.P. as part of the EMSA acquisition. The Preferred Stock contains a 5% coupon rate and is mandatorily redeemable on July 26, 2005. Dividends have been paid through December 31, 1999. Each share of Preferred Stock is convertible into such number of fully paid and nonassessable shares of common stock as is determined by dividing $100.00 by the Conversion Price ($9.45) at the option of the holder at any time after the issue date and prior to the close of business on the day prior to a date which the Company has set to redeem such shares of Preferred Stock. If the Company elects to redeem any shares of Preferred Stock, the rights of the holders of the Preferred Stock to convert such shares of Preferred Stock will terminate the close of business on the business day preceding the date fixed for redemption. The Company shall pay to each holder of shares of Preferred Stock an amount equal to any accrued and unpaid dividends on the shares of Preferred Stock surrendered for conversion to the date of such conversion.
Beginning on June 30, 2000 and ending on June 30, 2001, if the Current Market Price of Common Stock per share does not exceed 225% of the Initial Conversion Price for 45 consecutive Trading Days, the Conversion Price shall be reduced to $8.00 for all outstanding shares of the Preferred Stock. If (i) the Conversion Price exceeds $8.00 per share and (ii) during the period between June 30, 2000 and June 30, 2001, the Current Market Price of Common Stock per share is more than 225% but less than 250% of the Initial Conversion Price for 45 consecutive Trading Days, the Conversion Price shall be reduced to an amount equal to the product of the Conversion Price multiplied by a quotient, the numerator of which shall equal the sum of the Initial Conversion Price and $8.00 and the denominator of which shall be 2.
The 75,000 shares issued on August 30, 1999 related to conversion of the remaining $7.5 million of subordinated notes which had been issued at a discount. Accordingly, the remaining $125,000 discount is being recognized through the mandatory redemption date of July 26, 2006 through additional noncash dividends.
11. MANDATORY REDEEMABLE COMMON STOCK
During 1996, the Company sold 146,000 shares of mandatory redeemable common stock (purchased shares) and awarded 40,000 shares (awarded shares) of mandatory redeemable common stock to its then Chief Executive Officer. The 146,000 shares were sold at the then current fair market value of $8.75 per share. The vesting of the awarded shares could be, and was accelerated under the terms of the award and a
AMERICA SERVICE GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
compensation charge of $8.75 per share was recorded representing the fair market value of the shares on the date of issuance. As of March 31, 1997, the redemption price was fixed at $9.90 per share, through an amendment to the employment agreement. Changes in the redemption value of the purchased and awarded shares were recorded as adjustments to retained earnings and compensation expense, respectively. During 1997, the Company decreased the redemption value of the purchased and awarded shares, respectively, by $57,000 and $17,000. The impact on basic earnings per share for the purchased and awarded shares was an increase of $0.02 per share and $0.00 per share, respectively, for 1997. At December 31, 1999, the Company or the former Chief Executive Officer is permitted to redeem the common stock at $9.90 per share.
12. STOCKHOLDERS' NOTES RECEIVABLE
On August 30, 1999, stockholders of the Company approved the America Service Group Inc. 1999 Incentive Stock Plan (the "1999 Plan") to allow for the issuance of stock options, restricted stock, stock appreciation rights and for the purchase of shares of Common Stock and the extension of recourse loans to certain of the Company's key employees and outside directors to permit them to purchase such shares of Common Stock. There are 786,000 shares of Common Stock available under the 1999 Plan and the ability for the Company to have outstanding $1.3 million in loans.
During 1999, a total of $1,039,000 of loans bearing market interest rates and payable five years from the date of issuance were extended in order for certain Company employees and directors to purchase 72,895 shares of Common Stock. In connection with the purchase of the Common Stock, 225,657 non-incentive stock options and 63,171 incentive stock options were issued at fair market value on the date of grant.
Both the non-incentive and incentive stock options issued expire ten years from date of grant, with the non-incentive stock options vesting pro rata over four years and the incentive stock options having a four-year cliff vesting.
13. STOCK OPTION PLANS
In addition to the 1999 Incentive Stock Plan discussed in Note 12, the Company has an Incentive Stock Plan, which provides for the granting of options, stock awards and stock appreciation rights to officers, key employees and non-employee directors for up to 1,483,000 shares of the Company's common stock. Awards and vesting periods under the plan are discretionary and are administered by a committee of the Board of Directors. The exercise price of the options can not be less than the fair market value at the date of grant. Options and other benefits expire at such times as the committee determines at the time of grant, but no later than ten years from the grant date.
AMERICA SERVICE GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following is a summary of stock option activity under the Plans:
Total options available for future grants at December 31, 1999 and 1998, were 566,000 and 280,000, respectively.
As of December 31, 1999, 535,000 options were exercisable under all plans. The Company has reserved 2,543,000 shares of common stock for options outstanding and for options which may be granted in the future.
Options exercisable at December 31, 1999 had a weighted average exercise of $10.62.
Pro forma information regarding net income and earnings per share is required by SFAS No. 123 which also requires that the information be determined as if the Company has accounted for its employee stock options granted subsequent to December 31, 1994 under the fair value method of that Statement. The fair value of these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions:
AMERICA SERVICE GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information for the years ended December 31, 1999, 1998 and 1997 are as follows:
The resulting pro forma disclosures may not be representative of that to be expected in future years. The weighted average fair value of options granted during 1999, 1998 and 1997 is $5.43, $4.26, and $5.41, respectively.
14. NET INCOME PER SHARE
The table below sets forth the computation of basic and diluted earnings per share as required by FASB Statement No. 128 for the three years in the period ended December 31, 1999.
AMERICA SERVICE GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During any given quarter for the years ended December 31, 1999, 1998, and 1997 there were no more than 414,000, 388,000 and 175,000 options, respectively, to purchase common stock with weighted average exercise prices of $14.38, $12.04 and $12.84, respectively, not included in the computation of diluted earnings per share because the options' exercise price was greater than the average market price for the period of the common shares and, therefore, the effect would be antidilutive. The effect of converting 125,000 shares of preferred stock into 1,322,751 shares of common stock is not included in the compution of diluted earnings per share because the effect would be antidilutive.
In addition, during any given quarter for the year ended December 31, 1999 and 1998 there were no more than 186,000 shares of common stock which the Company is required to repurchase upon termination of the former Chief Executive Officer, as part of the written put option included in the employment agreement, which were not included in the computation of diluted earnings per share because the exercise (redemption) price was less than the average market price of the common shares for the period and, therefore, the effect would be antidilutive.
Under Financial Accounting Standards Board Statement No. 128, Earnings Per Share, when one or more quarters has a loss available to common stockholders, the treasury stock method of computing earnings per share may yield diluted earnings per share amounts for annual periods that do not equal the sum of the individual quarter's diluted earnings per share amounts, as is the case for the Company in 1999.
15. EMPLOYEE BENEFIT PLAN
The Company has a 401(k) Retirement Savings Plan (the Plan) covering substantially all employees who have completed one year and 1,000 hours of service. The Plan permits eligible employees to defer and contribute to the plan a portion of their compensation. The Company matches such employee contributions to the Plan ranging from 1% to 3% of eligible compensation, depending on his or her years of participation. The Company recorded an expense of $0.7 million, $0.3 million and $0.3 million for the years ended December 31, 1999, 1998 and 1997, respectively, related to the matching contributions of the Plan.
AMERICA SERVICE GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company instituted an Employee Stock Purchase Plan during 1996. The Employee Stock Purchase Plan allows full-time employees to elect to purchase shares of Common Stock through voluntary automatic payroll deductions of up to 10% of his or her annual salary. Purchases of stock under the plan are made at the end of two six month offering periods each year, one beginning on January 1 and one beginning on July 1. At the end of each six-month period, the employee's contributions during that six-month period are used to purchase shares of Common Stock from the Company at 85% of the fair market value of the Common Stock on the first day of that six-month period. The employee may elect to discontinue participation in the plan for future periods at the end of any six-month period.
16. PROFESSIONAL AND GENERAL LIABILITY INSURANCE
Subsequent to December 1, 1997, the Company has maintained third party commercial insurance on a claims-made basis with primary limits of $1 million each occurrence and $3 million in the aggregate. In addition, the Company has maintained excess liability insurance of $15 million for each claim and $15 million annual aggregate. For the period prior to December 1, 1997, Harbour Insurance, Inc., a wholly-owned captive insurance company incorporated under the laws of the State of Delaware, provided professional and general liability coverage to PHS with limits of $1 million per claim and various aggregate limits per policy year. The aggregate limit for policy years ended 1997 and 1996 was $3.5 million and $3.3 million, respectively.
Any liabilities in excess of the third-party insurance limits are assumed by the Company. The Harbour policy relative to the contract with the Georgia Department of Corrections, which terminated on June 30, 1997, is an occurrence-based policy with similar levels of self-insured retention.
The Company records a liability for reported and unreported professional and general liability claims based upon an actuarial estimate of the cost of settling losses and loss adjustment expenses. Amounts accrued were $4.1 million and $2.4 million at December 31, 1999 and 1998, respectively, and are included in accrued expenses and non-current portion of accrued expenses. 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. Reserves for medical malpractice exposures are subject to fluctuations in frequency and severity. Given the inherent degree of variability in any such estimates, the reserves reported at December 31, 1999, represent management's best estimate of the amounts necessary to discharge the Company's obligations.
In exchange for a one time premium to a third party insurance company, all of the liabilities and obligations associated with the insurance policies written by Harbour Insurance, a wholly owned captive insurance company of the Company, open as of August 31, 1998 and relating to the periods as of December 1, 1997, were transferred to a third party insurance company. Harbour ceased writing policies as of December 1, 1997. The Company has no continuing liability for open cases disclosed on the loss run of Harbour as of August 31, 1998. The Company's dissolution of Harbour resulted in no significant gain or loss to the Company.
17. COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company leases office space and equipment through October 2003 under certain noncancelable operating leases.
The Company has a sublease agreement with a third party for its former corporate office space in New Castle, Delaware. The sublease is for the period May 1, 1997 through April 30, 2000. The original lease term expires July 31, 2000.
AMERICA SERVICE GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In connection with the MedPartners Settlement Agreement, the Company closed its regional offices in Atlanta, Georgia, and Newark, Delaware and assigned future lease payments to MedPartners.
Future minimum annual lease payments at December 31, 1999 are as follows:
Rental expense under operating leases was $1.2 million, $0.4 million and $0.5 million for the years ended December 1999, 1998 and 1997, respectively.
Catastrophic Limits
Many of the Company's contracts require reimbursement to the Company for all treatment costs or, in some cases, only out-of-pocket treatment costs related to certain catastrophic events, and/or for AIDS or AIDS-related illnesses. Certain 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 AIDS-related limits. However, the occurrence of severe individual cases, AIDS-related 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 Company's operations. The Company maintains insurance from an unaffiliated insurer for contracts, which do not contain catastrophic protection for hospitalization amounts in excess of $125,000 per inmate through September 1998 and $200,000 per inmate thereafter. The Company believes this insurance significantly mitigates its exposure to unanticipated expenses of catastrophic hospitalization.
Catastrophic insurance premiums and recoveries, neither of which are significant, are included in healthcare expenses. Receivables for insurance recoveries, which are not significant, are included in accounts receivable.
Litigation and Claims
The Company is a party to various legal proceedings incidental to its business. Certain claims, suits and complaints arising in the ordinary course of business have been filed or are pending against the Company. An estimate of the amounts payable on existing claims for which the liability of the Company is probable is included in accrued expenses at December 31, 1999 and 1998. The Company is not aware of any material unasserted claims and, based on its past experience, would not anticipate that potential future claims would have a material adverse effect on its consolidated financial position or results of operations.
18. MAJOR CUSTOMERS AND GEOGRAPHICAL CONCENTRATIONS
The Company generally views its operating segments on a managed healthcare contract basis. The Company considers its managed healthcare services contract business to be one reportable segment under Financial Accounting Standards Board Statement No. 131, Disclosures about Segments of an Enterprise and Related Information, as the economic characteristics, the nature of the services, and type and class of customers for the services and the methods used to provide the services are similar. Consequently, other than
AMERICA SERVICE GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the following enterprise-wide disclosures relating to major customers and geographic concentrations, reportable segment information is not applicable. The following is a summary of revenues from major customers:
Estimated credit losses associated with the receivables are provided for in the consolidated financial statements. The contract with the State of Georgia expired June 30, 1997.
19. FOURTH QUARTER ADJUSTMENTS
The Company made a year end adjustment in 1997 resulting from a change in estimate relating to medical malpractice reserves. The adjustment, which was based on facts and circumstances obtained or occurring during the fourth quarter of 1997, resulted from improvements in the Company's utilization management processes, reducing the Company's claims exposure, favorable 1997 claim payment experience, and a significant reduction in the total inmate population primarily as a result of the termination of the Georgia Department of Corrections contract at June 30, 1997. The adjustment of $1,400,000 increased basic and diluted earnings per share by $.40 and $.39, respectively.
The Company made a year end adjustment in 1998 resulting from a change in estimate relating to the valuation allowance for deferred tax assets. The adjustment of $0.8 million increased basic and diluted earnings per share by $.21.
SCHEDULE II
AMERICA SERVICE GROUP INC.
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES