CorVel Corp (CRVL) 2006 Q2 法說會逐字稿

Welcome to the CorVel Corporation quarterly 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 cau -- wishes to caution you that these statements are only predictions, and that actual events or results may differ materially. CorVel refers to you the documents the Company files from time-to-time with the Securities and Exchange Commission, specifically the Company's last Form 10-K and 10-Q filed for the most recent fiscal year and quarter. These documents contain and identify important factor that could cause the actual results to differ materially from those contained in our projections or forward-looking statements. [OPERATOR INSTRUCTIONS]

I would like to turn the conference over to your host, Mr. Gordon Clemons. Please go ahead, sir.

Thank you, Janice, and welcome to CorVel's September conference call, certainly the most unusual quarter in recent memory. The September quarter revenue was $66 million, regarding the soft claims market and summer seasonality. Network solutions margins, though, continued to improve. Case management volumes declined, as did margins there. Earnings per share for the quarter of $0.22 were down from the same quarter the prior year. Fuel profits on a per share basis, though, were approximately equal to last year's, but high Corporate overhead expenses impacted net income and I will talk more about that later.

Field profits on a per-share basis, though, were approximately equal to last year's, but high Corporate overhead expenses impacted net income, and I'll talk more about that later. Meaningful events in the September quarter included the -- certainly the ongoing industry decline in workers compensation claims volume. Jobs data, though, a leading indicator for our industry continued to improve steadily. Storms and other regulatory events were re -- meaningful and reduced earnings. The 404 audit continued to consume Company resources. A major trading partner experienced processing volumes, which reduced volume in the quarter on a temporary basis. And I'd say progress, though, continued on our four key -- key projects.

Now I'd like to go into each of those in more detail. Turning first to the marketplace, specific events within each quarter bounced that period's profits up and down. However, certainly the most important factor over the last four years has been the significant decline in workers compensation claims volumes. A number of factors are driving these -- these declines. The recession in -- all the way back in 2000 sort of kicked off this change. However, since then, large numbers of illegal immigrants continue to pressure the labor market and create an unreported, unemployment factor, which depresses the mood in the labor market. Events such as 9/11 and the ongoing major storms have had an impact on the labor market mood,as well. Technology moved some jobs offshore, although thats a -- sort of a factor at the edge, and technology is certainly eliminating others.

At this point, the drop in worker's comp claims volume is unprecedented. National industry claims volumes are now off over 50% over the last five or six years. The storms during the quarter were a significant disruption to business. Katrina and Rita impacted smaller CorVel offices and, as a result, our losses were mitigated. The new systems technology implemented over the last couple of years allowed us to move processing away from these storms, maintaining service continuity for our customers. However, in some cases, customers themselves were eliminated ultimately. Wilma, however, later in the quarter and -- and overlapping into this quarter created losses in Florida, where we do have larger operations. Job creation continues and unemployment claims continue to fall. These are positive leading indicators for our business

The regulatory environment has been difficult. Regulatory issues such as HIPPA, 404 audits, local audits, state audit, and the national review of the insurance industry are sort of the more visible events along that line. It is difficult to quantify the impact of these many changes, but collectively, they do create diversions from our business focus and create added overhead expenses. The new legislation in California, which strengthens the role of managed care, is now being copied in other state efforts. These laws expand the role of managed care.

In California, the new law has cribit -- has contributed to a large reduction in claims costs. As you are aware, regulators are exploring inappropriate brokerage relationships, and the insurance industry is not clear to what degree this will open the market for insurance. However, employers are increasingly recognizing that workers compensation can be better managed. Too little of the funding set aside for workers compensation ultimately has been available to pay claims. Regulators are attempting to eliminate the structural inefficiencies that have, for so long, consumed inappropriate portion of worker compensation premiums. Opening the market could benefit smaller independent organizations, such as CorVel.

On the operations side, we continue to focus on the same key priorities I discussed in the last call. The first of those is the ongoing implementation our new MedCheck transaction processing technology. During the quarter, we continued to expand MedCheck's document management and workflow routing capabilities. Implementing the new workflow processes in field operations has required the restructuring of workflows throughout many, or most of our medical review offices. This effort has been ongoing throughout the last two years. We are beginning to see some of the forecasted efficiencies, as is evidenced in the margins in that part of the business.

This new generation of software enables workflow changes that allow specialization of labor by function, by type of medical care or by jurisdiction. The system efficiently moves works to specialty functions and coordinates multiple stages in the review of medical reimbursement to achieve improved savings results. Outcomes or savings, in other words, are the bottom line for payers, and the real significance of the new workflow management is that it is allowing us to improve the savings we achieve for our customers.

The second project is the extension of our product line of medical review services. The expanded network solutions product line optimizes savings for employers. During the quarter, both savings and field profit margins improved, as the use of specialty services increased. Field margins for network solutions reach their highest levels in the last two years. We are now a couple of weeks away from one of the largest expansions of this technology we have yet implemented. Though it includes changes to over 150 programs within the MedCheck software, a meaningful focus is the facilitation of expanded use of our new specialty services.

The third project is focused in the area of improving margins in our patient management service line. This a challenging task involving both price increases and the discontinuing of service to low-price accounts. In addition to the price increases, we are steadily restructuring our organization to re -- to reduce overhead.

Now I'd like to turn to some of the operations on a segment basis. In patient management, revenues of $29 million were down about 11% annually and about 7% sequentially. Profits at the field level were off closer to 30%. Volumes continue to reflect the very soft claims market. We continue to seek price increases and to reduce field management expenses and close unproductive offices. Technology is also enabling us to operate in smaller markets, without local offices. Long-term we expect to improve the technology in this service area, but in the short-term, we view pricing as the only solution to the profitability of this service. Without increases in industry claims volumes, though, soft demand for case management leaves excess industry supply in place and that has made pricing difficult. Our field operations have allowed declining sales volumes to get ahead of overhead reductions, rebalancing expenses, and this product line will continue.

On the network solutions side, revenues were off about 6%, both sequentially and annually. Profits were about flat with the prior year and down a little over 3% sequentially. The length of the soft claims market is also impacting medical bill volumes, and bill volume per account has declined. We are expanding the breadth, as I mentioned earlier, of our medical review service line. In the quarter margins expanded, as the product's expansion continued. This project remains a high priority for us.

The implementation of new technology has continued within our operations. The impact has been to improve savings for our customers. During the first year of our paperless process, incremental expenses from our document management efforts exceeded the related efficiencies. The conversion is now largely complete and we expect to begin achieving some efficiencies. During the quarter, a claims processing entity and a major interface to CorVel announced problems implementing new technology. This backed up their processing and reduced processing volume for us.

On the financial management side, we have two areas where we're focused in this difficult market: The first is to capitalize upon our new MedCheck technology to improve efficiencies. The newest version of our medical bill review software is expected to reduce our direct labor cost. Progress continued during the quarter; however, our first priority has been to improve savings for customers. Gains in productivity have been behind our internal plans. The second area is to improve margins in our case management business, as I mentioned earlier, both price increases and field overhead reductions will continue to be important. We plan to continue repositioning this product line.

Another meaningful effort during the quarter, of course, was our ongoing compliance with 404 audits. The 404 audit caused us substantial costs in the quarter, as well as distractions from other business priorities. Work has begun on this year's audit. Last year CorVel chose to handle for 404 compliance without a consulting company's assistance. Much as in the past, we have pe -- pe -- excuse me, PeopleSoft general ledger software without assistance. We plan this year to retain consulting assistance for the current year's audit; see if we can make a little more progress with this. CorVel's distributed business model makes achieving SOX control standards more and more complex. The Company has -- has always, though, been in full compliance with the government standards in the SOX legislation.

Moving now to the product development side, we have four major project areas. The network solutions expansion is the ongoing expansion of our line of medical review services and their sale in both the workers compensation and group health markets. Current product development efforts are focused on the automated management of workflow and on improving processing efficiency and effectiveness. During the quarter, we continued to make progress installing the new workflows in production. In our new system, medical review can be formed -- can be performed in specialty units and automatically combined with more generic work. Using the improved workflow, medical review service breadth is being expanded. During the quarter, we prepared for further implementation of this in the coming year.

The second project area and our major focus in development efforts is MedCheck software. MedCheck development continued at high levels, despite the slowdown in our industry. Work has been focused on supporting our new networks solution product line expansion. Our next major release is scheduled for the middle of this month, as I mentioned earlier, and is designed to help us continue the expansion of specialty review services. Other additions will support new legislations in several states.

A third area, which has been an effort ongoing for about six years now, is the development and continued expansion of our care MC website. Care MC is CorVel's health care transaction processing website. We continue to add features and to transition legacy applications to this platform. Information from payer systems is integrated with CorVel managed care activities, creating value-added on-line reporting. For the coming year, improved reporting and analytics are our primary goal.

And the fourth area is our enterprise compensa -- comp product line, now being introduced, and extends the breadth of our services to create a more complete workers comp enterprise level solution for employers. We work in partnership with third-party administrators in a lot of these implementations. We held our first national users conference in October, where we collected employer and other customer input to guide the next phases of this expansion.

In the quarter -- I'd like to cover the cash flow here now. In the quarter, we had EBITDA of $6.4 million, net income plus depreciation of $5 million, and generally strong cash flow, due to reductions in accounts receivable balances and some less expense in the capital additions area. Accounts receivable was 59 days and cash finished the quarter at $7 million. We did have stock repurchases of 6.5 million on the quarter, bringing that total to 126 million inception-to-date. We purchased 272,000 shares in the quarter, bringing that total to 6.8 million shares inception-to-date. Our shares outstanding at the end of the quarter were 9.682 million and diluted shares as reported were 9.9 million.

And that concludes my prepared comments. I'd like to turn the call back over to question and answer period. Thank you.

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Ed Kroll of SG Cowan.

Hi, Gordon.

Hi.

Could you quantify the -- what you think the impact was from that business partner's processing problems, say from a revenue and profit standpoint for CorVel?

Yes. I've -- I would say probably in the order of $0.02 a share. It was a -- a slowdown at their end. They discussed it with their employees and customers in terms of a change in scanning technology that backed them up, and they've since. I'd say, generally recovered. There are some other issues involved and it'll just remain to be seen how that all works out, but it's a fairly unusual event in our industry.

And are they a customer of yours or a subcontractor to you?

Not a subcontractor. Third-party administrators often function either as customers or sometimes we might have business directly with an employer and the third-party administrator is involved and we have interfaces to them. But I would not say they're necessarily a customer. They're the claims processor or administrator for the employer to whom we have sold managed care.

And, let's see -- but would you say for the December quarter that that situation's been corrected? And do you get the $0.02 back in the December quarter?

The -- I think they have resolved -- it's still a little unclear. We have to analyze daily processing volumes, and we have a very large number of -- of customers and clients. So it's -- it can be a little taxing to analyze all of them. But it appears that their issues have been largely resolved, and we are now studying the pick-up in claims volume to see how much of the backlog we will pick back up. It is possible -- it appears that they may have introduced a process which delays claims on a permanent basis by perhaps a week, compared to normal processing. And so we would maybe get back to normal processing levels, but we might not pick up all of the claims we lost in the quarter.

I see. And were there any other seasonal issues this -- in the September quarter, you know, in terms of number of processing days, anything like that, that might have pinched the revenue?

The -- I think it's fair to say that the revenue decline, which certainly was more than we had anticipated, is largely due to claims volume reductions. I -- there is a -- the September quarter is seasonally soft for us because of the summer season. However, it did have a normal number of processing days. So I -- and as we analyze the -- the variances in the quarter, I think we would say that, far and away, the largest impact on revenue came from the decline in claims volume on a per customer basis year-over-year and also sequentially.

Okay. And then just to make sure I got this right, you said the profits on the patient management business were down 30%. Is that year-over-year?

Yes. It was -- well, they were actually down 30% year-over-year and sequentially. The -- I can give you those numbers. The patient management revenues were 28.6 million, down 11% year-over-year and 7% sequentially. The margins were 8.3% in the June quarter and declined to 6.1% at the field level in the September quarter.

Got it. And -- how about the margin -- margins in the Network Solutions business?

The Network Solutions revenues were off 5.6% sequentially and 5.8% annually. Margins increased from -- from -- well, they were as low in the December quarter a year ago of 19.3% increased to 20.5 in March, increased again in June to 23.7 and increased in the September quarter to 24.2, which has been a strong point for us, as we continue this expansion in the technology in that area. So that's -- you know, there's been an ongoing improvement in the mix of that business.

Very good. Thanks, Gordon.

Our next question is from Mitra Ramgopal of Sidoti.

Yes, hi, good morning. Just a couple of questions. I don't know if you could quantify a little for us in terms of the storms you referred to?

Yes, I'd be glad to do that. I think the -- it's a little tough because the direct impact was, I'd say, in the order of a penny a share, and that was because -- I'd say two reasons. One, generally hit us in areas where we had smaller offices and we'd liked to have been doing better in those regions, but we just hadn't been. The storms were not as impactful as they might have been. On the other hand, we tied up the management team, both Corporately and in the southeast region, for major portions of the quarter dealing with -- I'd say Katrina first kind of eliminated largely three offices. A couple of them had come back, but appropriately everybody's kind of pretty much lost their business in New Orleans for a while. Rita was a little different, in that it just shut down one of our offices in Texas for, say, a week to ten days, and generally other than that, didn't have a big impact.

As I mentioned, we were able, over the last couple of years, to change our technology platform so we can move processing to other states and we did have people helping out from around the country during those storms. We -- we were also impacted offshore. We do some -- some data processing, and we were impacted by the storms offshore during the quarter, as well. And then toward the end Wilma was, of course, a much stronger storm. I think not covered by the press nearly to the degree Katrina was, but I think had a meaningfully larger impact on economic issues.

The -- the other major effort, which seems a ways off now, but for at least half the quarter, we put a lot of energy into the 404 audit. And that had a more significant impact, in that it raised overhead for reasons, you know, related to compliance and working on the audit.

Right. Would you say most of that is out the way?

Well, it is on a -- hopefully on an unusual basis. However, ongoing compliance with 404 audits is going to be a part of our expenses. We -- we're hopeful they'll be at lower levels than they have been in the past, but I guess I think it's safe to say that remains to be seen. It is a fairly meaningful compliance effort. We are a distributed Company and, therefore, compliance with some of the control ideas involved in that regulation is -- is particularly difficult for us. We have processing going on in over 140 offices. So it's -- it's more taxing to be involved in the kinds of controls they would like than perhaps for other companies. But it's -- we certainly hope to level it out and to have it in a -- you know -- not be as disruptive in the future as we allowed it to be in this last year.

Right. In terms of just looking at sort of, for example, G&A as a percentage of sales, up significantly this half versus say a year ago, in terms of going forward, I mean. Should we sort of assume it is going to hold at these levels? Or do you see ways of improving that?

Well, I think -- the first thing I'd like to say on that is I've been wrong about that, even though that is something we have under our own control. We historically used to think we could operate at 8% of revenue for Corporate overhead. It went north of 11% in the last quarter. I certainly hope that is an unusual level. But returning it quickly to 8% I think, is probably not in the cards.

We -- as I mentioned somewhat briefly, perhaps, in my prepared remarks, we have chosen to maintain our investment rate in software development and service development, in spite of the softness in our business. And that is the biggest chunk of our Corporate overhead expenses, comprising over 60% of Corporate overhead is involved in systems development and operations. We feel we have an exceptionally strong group of people and capability in that area. We think we're making good progress, in spite of the -- the economic results in our business. So, I've chosen to feel that we should invest for the long-term, and that -- that is keeping our overhead expenses up. But in the last quarter, we had both regulatory and accounting expenses that were meaningful, and I hope we'll be able to bring those a little more in line.

Right. And, finally, in terms of just the pricing, especially in case management, I don't know if you can give us a sense of, you know, how initial increases might be received by customers.

Yes -- [ LAUGHTER ] -- or not received. This is a -- this is, really, the most challenging part of our business. We have made an effort, as I think most investors are aware, to reduce our shares outstanding and had it not been for some of the overhead items, actually, our share reduction equaled our revenue losses over the last year. so that it is possible to balance our income statement on a per share basis. We, on the other hand, have lost about -- let's see -- I think almost half or a little over of our field case management profits. I guess it is over half over the last two years, and this is a combination of volume, but also margin. The margins two years ago in September were 11.6%, and they were 6.1% this year. So, if we had those back in line, our earnings per share would be, you know, sort of close to our all-time highs.

On the other hand, this is a commodity product area where -- where retaining margins is difficult. We do have a major competitor, though, that has done better in this area than we have, and I think we have room to improve our performance. National accounts are particularly difficult. They do have contracts that protect them, and they also have a lot of leverage and they have chosen do so -- you know, to apply that in this soft market.

There are also situations where we deal with states and other municipalities who simply don't comply with -- with the kind of pricing you would expect. Just to give you an example, the mileage reimbursement for our employees. The IRS has raised that to $0.48. We have one state entity that will only reimburse us for $0.29, even though the IRS has approved $0.48. And I think going through the economics these days with gas prices, it's pretty easy to see that it costs well over $0.40 a mile to drive a car. And we have -- and we have a number customers that have stayed around $0.40. So we're -- there's some parts of our business where we're actually under pressure from customers to price below our costs.

We are working hard to make changes here, and I think that part of the business has to change. But, obviously, we have struggled to keep up with the -- the pace of the decline in -- in industry claims volumes. The -- the reverse can be -- can take place when claims volumes are exceptionally strong. That is a piece of business that does improve rapidly, too.

Okay, thanks.

Our next question is from Jay Hill of Tweedy Browne.

Hi, Gordon.

Hi.

Just wondering if maybe the board has given any thought to, maybe, borrowing, you know, maybe $25 million to $50 million and maybe getting a little bit more aggressive on the -- on the share repurchase here?

Well, I -- it wouldn't be appropriate for me to comment about, you know, the board's thought processes. Obviously, they're very, very seriously involved in our business and take a lot of -- you know, take everything that we do very, very seriously. I -- that is an option.

We certainly think that the cash flow in our business should be evident to investor, and does make it obvious that we could use leverage to take advantage of this situation. It goes back a ways, but when we first went public, our stock -- this is unadjusted for splits -- got as high as 25, and then during the period where the government was talking about potentially eliminating Workers' Compensation, the stock fell from 25 to nine. During that time, you know, it didn't seem as alarming as it does at this time. But there have been other periods where pressure from HMOs or respective changes in legislation have -- have scared the stock and have also hurt our business at -- for different periods. I'd like to think this is the cyclical decline in Workers' Compensation claims. It is good for employers and the costs have declined quite a bit.

I -- we could use debt to buy back stock. We are looking to expand our business to pick up a complimentary service area in Workers' Comp. As I mentioned I think in the last couple of calls, if we found an opportunity to buy a business to fit in the Company, we'd like to be able to do that. So, kind of using up our fire power by buying back stock is at least a choice we have to take seriously. But it is always an option and clearly, perhaps, a little bit of that depends on -- on how the stock does in here.

Gordon, I've got one follow-up question. Guess back in August, Concentra bought a company called Beech Street?

Yes.

And I wanting to know if -- I guess, how comparable Beech Street was to your business? And I don't know, it looked like it was an awfully large multiple that was paid for Beech Street.

Yes, Beech Street is -- was at one time in -- primarily in Workers' Comp. Over the years, they expanded into the group market and built a group health PPO. I -- it's probably not right for me to speculate too much, but my sense is that the group held synergies with Concentra's business, which was referred to as CPS, was the primary reason for that acquisition. And I think Concentra has done a good job expanding into the group market in the last five or ten years. I don't see the reason floor acquisition being exactly parallel with CorVel's. We -- but, you know, some of the -- the capabilities are at least similar. We do a lot of claims processing. We do have a national PPO, and we are especially proud of our technology in support of transaction processing and health care. But I -- you know other than that, I don't know that the parallels are -- at least Beech Street is involved primarily in the group market I would say, at this point.

Okay. Less Workers' Comp?

Yes, I think so. They still do -- or are a PPO in the Workers' Comp market ,and I'm sure that is an important part of their business. But I think the bulk of the business is on -- is on the group side.

Okay. Thank you.

Are there any further questions at this time? You have a follow-up question from the line of Mitra Ramgopal of Sidoti.

Just wondering in terms of if you have a sense of what the stock-base compensation expense might be to EPS?

I don't have that in front of me right at the moment. It has been, you know, I think in the $0.05 a share range iv we went to the new reporting and, of course, that changes with the stock down. It may look artificially low. I guess I'm hoping we do better and the penalty increases, because there would be more profit in the -- in the shares. During the quarter, we did reimburse employees for stock options that could not be exercised during the period when we were potentially exposed to being delisted by NASDAQ, so there was some expense in the quarter that was unusual in that it was compensation expense that was paid out in lieu of -- of stock options. But that was, hopefully, a one-time event.

So I -- I'd say that it depends an awful lot on the shares. We have reduced the options outstanding little by little over the last few years. On the other hand, this has been an important part of the Company's way of attracting and attaining key people, and we would like to do that. Certainly FASB is making things a little different for us, but that is a cost that'll be incurred by a lot of other companies as well. We -- we did cut back on the benefits in our stock purchase program, in order to avoid earnings per share penalties from that program. So it -- it was largely restructured to comply with -- with the way that FASB has changed accounting for stock-purchase programs. So, I'd say that we -- I think we take very seriously the expense to shareholders from stock option plans, and have tried to reflect that in our grants. I think you can see by looking at the shares outstanding that we've kept them at a fairly low level.

Okay. Great, thank you.

[OPERATOR INSTRUCTIONS] There are no further questions. Mr. Clemons, do you have any further comments?

Yes, I'd like to conclude. I certainly -- as I said at the outset, perhaps the most difficult quarter we've ever been through. I hope that the storms are behind us, although I think we can begin to anticipate them in the United States from now going forward, and we will make efforts to either harden or relocate processing away from the Gulf Coast in the future. I think we have -- have done a good job with the flexibility in our technology that allows us to move processing around. We certainly want to continue serving that part of the country and -- and yet we have to anticipate that there will be repeated occurrences of major storms.

On the -- and on the audit and regulatory compliance area, we had a very challenging quarter in that regard, and from -- from an expense standpoint and hope to smooth that out in the coming year. I hope that this's been a period that we won't see again, being quite as difficult as this last quarter has been. Thank you for joining us today, and we'll look forward to talking to you again next quarter.

This concludes our conference call for today. Thank you for your participation. Please disconnect at this time.