CorVel Corp (CRVL) 2006 Q1 法說會逐字稿

Thank you for standing by. Welcome to the CorVel Corporation's earnings release conference call. During the course of this conference call, CorVel Corporation may make projections or other forward-looking statements regarding future events or the future financial performances of the company. CorVel wishes to caution you that these statements are only projection and that actual events or results may differ materially.

CorVel refers you to documents the company files from time-to-time with the Securities and Exchange Commission. Specifically, the company's last form 10K and 10Q files for the most recent fiscal year and quarter. These documents contain and identify important factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements. (OPERATOR INSTRUCTIONS). I would now like turn the conference over to your host, Mr. Gordon Clemons, please go ahead sir.

Thank you Marvin, and welcome to CorVel's June quarter conference call. The June quarter revenues $71 million reflected the ongoing soft claims market. Network solutions results were improved and yet case management volumes were down. Earnings per share of $0.28 cents were down from the same quarter of the prior year, but up sequentially from the March quarter. They did include high corporate overhead expenses.

As you are aware in the last quarter, CorVel has been focused upon the completion of its 404 controls audit. This has been the primary focus of much of our resources. Other issues in the June quarter though, include the soft claims market has continued to reduce business volumes. The current jobs market indicators are positive though not as robust as in some prior recoveries. The June quarter revenues and field profits declined about 7% year-over-year. However, over the same period we also reduced shares outstanding by 6.4%. Consequently, the balance of corporate overhead, had it been down, would have resulted in earnings per share that were more -- more in line with the prior year.

We are working to reposition our revenues into higher value-added services and I'll talk more-- more about that later. During the last year, we have been involved in substantial changes to our internal workflow processes. During the quarter, we made good progress implementing some of those new capabilities. On the 404 audit, I'd say, we are certainly sorry to put you through the consequences of that process. We expect to bring this to conclusion in the coming month. At this time we are working with our auditors to complete the audit.

404 audits are not well understood by most investors or lay people. Companies smaller than CorVel were given first a year exemption after further review, and as they began to get ready for this year's audit, there was a lot of complaining in that exemption was extended for a second full year. At the other end of the spectrum, large firms were able to declare much of their operations immaterial. CorVel, unfortunately falls directly between these two safe outposts and in the gunsights of this audit program.

CorVel operates in a distributor format and employs decentralized processes. We believe our 14-year record as a public company speaks to the strength of our business model, as well as to the reliability of our financial reporting. CorVel did choose to handle this audit without a consulting company's assistance, much as we had also installed PeopleSoft without such assistance. I think it's fair to say we underestimated the whole amount of work involved in this program. The company has been in full compliance and remains so with all of other governance features of Sarbanes-Oxley. Now, I would like to go over some of our business issues in more detail.

First on the marketplace, the market remains soft, but the firming labor market should eventually lead to a stronger claims market. It has not picked up as we had thought it might by this time, but that remains our expectation. Job creation continues, though a little softer than in prior recoveries. I'd say the high prices for insured programs have revived interest in self-insurance.

Some of this interest materializes in either high deductible programs that bring insurance business from insured programs into self-insurance and yet even though still with the insurance company or into TPAs and some of those segments of the market have become more interested in providing managed care profits to themselves and that has put pressure on companies like CorVel that are independent vendors.

The regulatory environment I already alluded to have been difficult. In addition to 404 audits, we also have HIPPA compliance and a number of other regulatory burdens including some legislative change at the state level. Structural changes are occurring in the insurance industry, most of those appear positive to us in the long run. However, it will be a while before those really trickle down and benefit companies like CorVel.

On the operations side, we are still focused on the three big projects we have been talking about for the last few quarters. The first of these is the implementation of our newest generation of medical review software, which is now gaining momentum. At this time we are actively involved settling into the new workflow processes enabled by our new technology. We are just beginning to see some of the efficiencies and they are reflected in the June results.

This new generation of software enables workflow changes that allow us to place work with specialists by type of medical care or by specific geographic jurisdiction. We can now efficiently move work to such people and coordinate multiple stages in the review of medical reimbursement to achieve improved savings outcomes.

The company believes that at this time it is achieving the highest savings results in its industry for its customers. The artificial intelligence investments we've talked about repeatedly and begun in the late '90's have continued to pay off. We see a bright future for that effort. The workflow management changes implemented during the June quarter should lead to a number of related future enhancements as we continue to expand the automation of workflow management.

The second project is the expansion of our product line of medical review services. This expansion is creating a line of medical review programs that we refer to as network solutions. During the quarter, systems enhancements were completed to provide automation and support of these services. Only modest gains were achieved during the quarter, and at that, they were largely achieved in the last month of the quarter. We expect to continue this expansion in the current and future quarters.

Regional production hubs have been identified and are in the process of being expanded. They create centers of excellence for some of these specialty review services. Improved reporting and analytics are being added in support of this product line.

The third project area focuses on improvements to margins in the patient management service line and at the corporate level. This is a challenging task given the regulatory environment. It does involve price increases and the discontinuance of service to some low-priced accounts in the case management area. In addition to the price increases, we are steadily restructuring our organization to reduce overhead and have brought our headcount down by, I think, well over 10% in the last year.

Now I would like to go over operations by segment. In the patient management area, we had revenues of about $31million. Those were down 6.4% annually and 7% sequentially, profits were down 14% annually and 12% sequentially. It was a softer quarter than we had anticipated for this service.

Volumes continued to reflect the soft claims market. Price increases are also impacting volume to some degree. We continue to rebalance expenses by reducing field management expenses and by closing unproductive offices. The key for this product line is to steadily reposition it to market segments which value such services. Longer-term, we expect to improve the technology in the service area, but in the short-term, due pricing is the only solution to the profitability of this service.

On the network solutions side, we had a nice quarter with revenues approximately $40 million that is down a little sequentially, just 10% down, 7% annually. However, profits are up over 15% sequentially. The length of the soft claims market is also impacting network service volumes. About 65% of medical bill review volume is for prior years claims, which creates a lag in this business so we expect this part of our revenues to continue to be affected by the prior soft claims markets and bill volume is down on a per account basis requiring us to add customers to the service.

In this product line we are expanding the breadth of our medical review services as I previously discussed. This expansion has required improvements to our systems. These have been a major focus of our development efforts and operating efforts over the last quarter.

Artificial intelligence, as I mentioned, is continuing to improve savings and has made a real strong contribution to both our business and certainly to this product line. During the quarter, incremental expenses from our document management efforts continued to see the related efficiencies. We have laid the groundwork, though, to begin achieving processing efficiency in the coming quarters. We're down about 10% in the direct labor in this product line as a result of some of those efficiencies.

On the expense reduction side, we continue to focus in two areas. One is the area I just mentioned that is our Medcheck direct labor content. We expect to see that reduced as we continue to expand the automation in that area. And the second is to improve both the pricing and the overhead control in our case management business.

On the product development side, we had a strong quarter. Four major projects there. Network solutions continues to be a big focus -- this is the ongoing expansion of our medical review product line and contributed to the margin gains in the quarter. Current product development efforts are focused on artificial intelligence initiatives to better manage workflow and processing speeds.

During the quarter we made good progress installing the new workflows in production. In our new systems medical review has now moved to specialty units for improved performance. With the improved workflow, we are also expanding our medical review service breadth. Quite a bit of the product expansion, though, remains to be implemented in coming quarters. The second large project area is our Medcheck software. The development teams involved in this had a strong quarter despite the heavy burden of work to support the 404 audit.

In the June quarter, we finally moved past the portion of this development where changes in workflow were regularly required and entered a phase or period where we're smoothing things out and I think easing the operations management challenge. The results of our processing improvements have come first in savings results for customers and to our knowledge our results lead the industry. We're in a phase of development where additional improvements will come as we work to extend the power of our new architecture.

The third product area is our enterprise comp product, which continues in an introduction mode with the burden of the 404 audit and the soft market in which we are operating. We have been going a little bit slowly on this expansion. This service line extends the breadth of our services to create a more complete workers' compensation claims management solution. We expect to introduce new features for this product line during the coming year. At this time we have four offices delivering introductory level services in this area.

And the last is our document management program, which is tightly integrated with Medcheck. The scan one document management is a growing service and has contributed substantially to the automation that we are implementing in CorVel at this time. Document management is quite synergistic with medical review. CorVel solution allows for the local capture of documents to our systems eliminating the need for the scanning hubs required by competitive offerings. Our ability to produce local and medical review was the key to CorVel's expansion and as we entered that service 15 years ago. We believe CorVel's ability to distribute technology to where claims work is really located is key to meeting the unique needs of the workers' compensation market.

I'd like to talk a little bit now about some of the cash flow numbers for the quarter, which were also improved. We had EBITDA of $7.4 million, up from $6.8 in the sequentially preceding quarter and $4.9 in the December quarter. Net income plus depreciation was $5.7 million, up from both of the preceding quarters in a similar fashion. Net income plus depreciation minus working capital was $9.3 million, which is a pretty high number for us and exceeds all the prior three quarters, and cash flow minus working capital and fixed asset changes was about $6 million or almost double the March quarter of $3.1 million.

Those were the summary numbers on cash flow and we can talk more about that later if you would like. Accounts receivable is 56.5 days, which is, kind of, middle of the road for us. We are hoping to improve that but certainly in a strong position. Cash for the quarter was $10 million, which is up $1 million from the prior year but down a couple of million from March 31, largely because we spent $6.2 million in the quarter on share repurchases, bringing the total of that program to $120 million inception-to-date. We bought 260,000 shares in the quarter, bringing the total share repurchase to 6.5 million. Diluted shares have dropped now to 10 million, so we had a nice drop in the denominator in our EPS calculation there.

And that concludes my comments. I have to stop here and I would like to turn it over for questions at this point.

Ladies and Gentlemen we will now begin the question and answer session. (OPERATOR INSTRUCTIONS). Our first question comes from Joe Michael with DJS Securities.

Good morning, Gordon. Congratulations on the quarter. You referred to somewhere in the neighborhood of 230,000 shares over the course of the quarter. Where do you stand on the repurchase plan?

Well, let's see. I think it was 260,000 shares and we discontinued the purchase of shares once we realized we were going to not file our 10-K on time, and we have continued not to purchase shares since that time. I do not know just how many shares we have left in the repurchase authorization, but I would think it is over half a million. We were on a dribble by program, so it has been kind of steady over the last six years.

Got it. And I am assuming that will pick up again once the K is filed?

Well, we do not forecast and I would say we do look for acquisitions. We are looking in one particular market segment at this time for some opportunities, so I would not want to assure people that we would continue the buyback, but it has been a steady program, as I said, over the last six or seven years.

Okay. And sequentially, you had a pretty substantial improvement in your gross margins. Could you just talk about what some of the drivers were there?

Yes. I will talk a little bit about the two product segments. Case management was tough for us in the quarter, and I don't know that we anticipated that. Our margins there were 8.3% down from 9% in the March quarter, but in the Network solutions area, we moved up from 20.5% to 23.7%. So that was a nice gain for us.

We had been looking for some improvements there as we began to implement some of these programs on which we were working for a year now. We also had some mixed change in that area where some of the higher value added services are beginning to pick up a little momentum and we had a little bit of a slowdown, actually, in some of the lower margin products or services in network solutions. So there was mixed change, both in the aggregates between the two large blocks of business and then there was a favorable mixed change as well in network solutions.

Got it, thank you.

Our next question comes from Mitral Ramgopal with Sidoti.

Yes, hi. Good morning. I have a couple of questions. You just alluded to, essentially, an acquisition down the road. Would it be accretive immediately or -- ?

I'm really not talking about anything specific and we do not have anything in the hopper. I - I'd like to be real clear on that. We have preferred to acquire volume as opposed to just buy back shares. We have not seen opportunities that met our hurdles, so we have not done much in the way of acquisitions. We did couple of years ago, move into the scanning business through an acquisition and that has been worked out very nicely for us. But at this time, we are just continuing to look as we always do. I just meant to say that I did not want to commit that our share buyback would necessarily continue, although it has been steady over the past six years.

Okay. And you'd mentioned about increased regulatory compliance costs. Is most of that already in there now or as we look out for example to the rest of the year or, going into '07, further increases?

Well, I guess I am afraid to say that I think the cost of 404 audits will be a recurring item for most public companies. I do not expect it to be quite as severe in the second year as it was in the first, but I do not have a lot of optimism about it going down much unless the government decides to change that program.

We have had some other items that appear to us to be things we could work our way past, but it is a difficult period in here, and my impression is the government has a pretty hefty appetite for regulatory legislation. So I do not know, but we certainly feel our corporate overhead has been higher than it should be. It has been our intention to reduce it. I think the main thing I would say in the quarter is that our operating people did an excellent job reducing costs and we struggled corporately to keep up with them.

Is there a way of quantifying how much of an increase in compliance cost you will see in say, fiscal 2006 versus 2005 or?

Well, I think at least $0.750 million for just the auditing alone and I do not know, I would not want to quantify some of the other things are out there as well and hopefully we'll worked our way past some of the other items, but I think we are probably picking up $0.750 million in expense that may or may not ever be able to be reduced.

Okay, and finally also in terms of the price increases you talked about on the case management side. Has it been easy to sort of implement those or is it hurting volume?

I would say it has not been easy at all. We do have one competitor that did lead the way, I think, and raised prices and that helped somewhat. But our industry has kind of addicted our customers to low prices in that segment over the last 10 years and I think it is quite difficult to make a change there. I would say that the price increases are -- we do not feel we have a choice at this time. We will just have to gradually reposition the volume in that business to customers. I would say direct sales to employers for instance is an area in the market where the customer more highly values those services than do insurance companies and TPAs.

Okay, thank you.

Sure.

Our next question comes from Ed Crowe with SG Cowen & Co.

Hi, Gordon.

Hi.

I'm wondering, given the distraction of this Sarbanes-Oxley or part of the Sarbanes-Oxley compliance, would you say that, or could you quantify perhaps, any opportunity cost in terms of revenue that might have been generated in the quarter that the senior team was otherwise occupied? Is that possible?

Well, I mean I talk to my dog a lot about it and I have usually some opinions in that regard. I think it is difficult to quantify. I do feel it has been a big distraction -- it has been a very big distraction at the corporate level. I think another big issue is just the morale impact on companies. I do feel that it is not a very empowering process and so it is tough on field morale. Our organization is nursing based and we are more like an Army than an Air Force in the sense that I think morale and emotion have a lot to do with momentum, and I think it is damaging for a company to go through the process that we have been through.

We are just going to have to do a better job handling it in the coming year ourselves. I think we have to, myself included, accept responsibility for doing a better job on this and not having it be as disruptive in the coming year as it has been in the past year.

Okay. And then you mentioned, when you gave those cash-flow figures, the -- what was the comparable number to the $9.3 million of this quarter? What was the comparable number in the March quarter?

$5.5 million.

$5.5 million.

Yes. I would say that maybe some specifics in there, I think, let's see, working capital I think contributed $3.6 million to that $9.3 million because with net income plus depreciation on loan was $5.7. So we picked up $3.6 million in working capital improvements in terms of cash flow, and then we spent $3.3 million on fixed assets to draw that $9.3 million down to $6.0 million after you include both fixed assets and working capital changes.

Recently, our capitals additions have been about flat with depreciation, but in this most recent quarter, I think we had $300,000 more in fixed asset additions that we did in depreciation, but roughly speaking our cash flow from fixed assets and depreciation has been about balanced. And so the pickup in the quarter on that cash flow number was largely due to some improvements in working capital.

Very good. And then finally, you mentioned that you had noticed some more interest among employers in moving to a self-insured status for workers' comp. Is that something that would be a -- if that were to gain momentum, is that something that would be in neutral for CorVel? Good? Bad?

Historically that would be good for us. We used to do a lot more with TPAs and I would say that there have been some issues involved that we cannot talk about too much, but there is investigations going on with regard to the placement of business in the market place. There is some difficulty these days in having CorVel be treated equally when those kinds of self-insured decisions are made. A lot of that we have to deal with ourselves, I would say. We are going to have to be more effective selling directly into the employer market place because I'd say TPAs tend to favor programs these days where they have some financial interest in the outcomes and it is a more difficult market than it was five or 10 years ago.

Got it, thanks Gordon.

Sure.

[OPERATOR INSTRUCTIONS]. We do have a follow-up question from Mitral Ramgopal.

Yes hi. I don't know if you could comment a little in terms of the seasonality in the next couple of quarters and sort of, if you have to - I know you do not provide guidance, but looking at the first quarter from the top line, I mean, do you expect, relative to fiscal 2005, to grow at a top line in 2006?

Well I do not know that I have a comment on how revenues are compared year-over-year. I would say that the number of workdays in the September quarter are roughly equal to those in the June quarter and yet the December quarter is a shorter quarter, the holidays take two workdays out of that quarter. So we will need to make ongoing gains in either the high margin products we sell or our Network Solutions product line in total in order to offset that in the December quarter. The September quarter should be, at least in terms of workdays available, comparable to the June quarter.

Okay, thank you.

Umm hmm.

Are there any further questions? There are no further questions. Mr. Clemons, do you have any further comments?

I would like to thank everyone for joining us today and we certainly look forward to talking to you in a quarter where we are not as bogged down in our auditing as we - in our auditing -- have been this last quarter, so we will hopefully have a brighter discussion in the September quarter. Thanks a lot for joining us today and we will see you then. Bye-bye.

This concludes our conference call for today. Thank you for your participation. Please disconnect now.