CorVel Corp (CRVL) 2006 Q3 法說會逐字稿

Thank you for standing by. 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 caution you that these statements are only predictions and that actual events or results may differ materially. CorVel refers you to 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 files for the most recent fiscal year and quarter. These documents contain and identify important factors that could cause the actual results to differ materially from those contained in our projections or forward-looking statements. (OPERATOR INSTRUCTIONS). As a reminder this conference call is being recorded. I would now like to turn the conference over to your host, Mr. Gordon Clemons. Please go ahead, sir.

Thank you, and welcome to CorVel's December quarter conference call. The December quarter revenues reflected the ongoing soft market and normal holiday seasonality. If you recall, we have two less production days in the quarter. Network solutions margins continued to improve. Case management volumes and margins, though, declined. The earnings per share were up 45% from the same quarter a year ago -- our first turn in this industry cycle.

During the December quarter, market conditions appeared more stable to us. Our network solutions productline expansions began to gain traction in the marketplace, and progress continued on our cost reductions. Now I would like to go into some of the specifics on each of those areas.

First, on the marketplace, the market forces of importance today are soft claims volume, evolving customer needs, regulatory reformation, and ongoing strengthening in the labor market. I will go into each one of those individually. The soft claims environment has been created by a convergence of several forces. These have been well presented in a recent book by Pulitzer prize-winning offer, Thomas Friedman called "The World is Flat." They include offshoring trends, automation and productivity gains, open borders that expand the labor force with unreported workers and, of course, recently weather and even terrorist events that deflate the mood of the market. The net impact of these forces can be seen in our economy's ability to absorb $60 million per barrel oil prices without inflation.

Ongoing technology advances are changing customer needs. Insurers and third-party administrators, for example, now in source some functions traditionally outsourced. Higher value-added services such as PPOs, specialty medical review services and medical review software are the CorVel services of greatest interest to payers today. The regulatory reformation is taking place in several areas, and there was news this morning on the most recent steps forward by the New York Attorney General. States are much more active in addition to modifying their worker's compensation regulations. This creates unique demands by state favoring companies that can work locally in many different markets. CorVel has had success providing total service in each of these unique markets.

In addition, as I mentioned, the New York Attorney General's investigations into the insurance industry hold the promise of a more open marketplace. Though nothing is assured, we are hopeful that this effort will allow employers to be able to purchase the best services available and also to be more fully aware of frictional losses involved in many current industry programs.

In the backdrop, the labor market continues to strengthen, though slowly. Job increases have begun to pressure the labor market. Such conditions typically improve the environment for our services.

Now on the operating side, first of all, the patient management segment, which is certainly the one struggling the most for us, revenues of 27 million were down annually and sequentially, and profits were off 24% annually and 37% sequentially. The volumes continued to reflect the soft claims market. We continue to seek price increases and to reduce field management expenses and close on productive offices. We have more importantly backed away from customers unwilling to accept prices which are appropriate in the marketplace, and this has reduced overall service levels, rebalancing field operations and adding new technology solutions will continue throughout the coming year.

Returning injured workers to productive employment remains the bottom line of worker's compensation, though, and case management activities will continue to be an integral part of our total solution for employers. CorVel's local service capabilities remain the broadest in the industry. Returning this productline to proper margins is also one of our best opportunities to improve our overall results.

On the network solutions side, we had a pretty exciting quarter I think for us. Revenues, though down annually and a little bit sequentially, produced profits that were up 20% annually and up -- or excuse me, down about 2% sequentially in the shorter quarter. The soft claims market is also impacting medical bill review volumes, and bill volume per account has declined. The implementation of new medical review technology has been the major priority for the company over the last two years. The initial impact has been to improve savings for our customers. During the early stages of this major conversion to a paperless more automated process, incremental expenses exceeded the related efficiencies.

Developing the new opportunities the new technology could create had to be deferred. The conversion is now maturing, and efficiencies are improving. Our energies should now be increasingly focused upon new opportunities and product expansions. We are adding to the breadth of our medical review service line. In the quarter, margins expanded as the product expansion continued. The expansions are in high value-added specialty review service areas.

The purpose of the restructuring of our network solutions technology has been and remains to facilitate both improving operations and the delivery of new and expanded services. Undertaking a project of this magnitude as we were entering a cyclical downturn in the worker's compensation industry has made it more difficult and has impacted our earnings. However, the waves of change afoot in our labor markets and in the information technologies that are transforming the financial service industry do not wait for convenient industry conditions. Financial service industry changes are undergoing rapid change, change that has much further to go. It is our plan to do our best to participate in the medical transaction processing portion of this industry change. We believe the period of our project during which there has been an imbalance of expenses to benefits is passing and that operating benefits from new services will become more visible in our results.

We have three key projects that we have talked about in the last couple of years on these calls. The first is the ongoing implementation of this MedCheck bill review technology that I have discussed. The initial phases are settling in at the operating level. Ongoing development will continue as I just described throughout the foreseeable future. This new generation of software enables workflow that allows specialization of labor by function, by type of medical care and even by jurisdiction. The system efficiently moves work to specialty functions and coordinates multiple stages in the review of medical reimbursement to achieve improved savings. In the current months, we are at our all-time highs in producing results for our customers.

The second project is the extension of our product line of medical review services. The expanded network solutions productline improved savings for employers. During the quarter both savings and field profit margins improved as the use of specialty services increased. Ongoing service expansions are included in our plans for the current year. The scope of the underlying software and network solutions is being expanded to include a broader range of services, as well as extensions to the portions of an episode of care in which we are involved.

The third project focuses on improving margins in the patient management service line. This involves price increases, the discontinuance of service to low-priced accounts and the automation of some administration. In addition to the price increases, we are steadily restructuring our organization to reduce overhead.

I would like to cover three financial management projects which are of importance to and had an impact on the quarter. The first is expense reduction. We continue to work on reducing our costs. Capitalizing upon the new metric technology, the newest version of our medical bill review software is expected to reduce our direct labor costs. Progress continued during the quarter; however, our first priority has been to improve savings for customers. Gains in productivity have been postponed, so we have focused on improving results and adding new services.

The second is our effort to improve margins in our case management business. That has been a struggle with volumes coming down, but we are working and making progress on overhead. We have certainly more to do.

The second area is cash management and cash flow. During the quarter we have been managing our use of cash and investments -- excuse me, during this soft market we have been managing our use of cash and certainly being carefully with our investments. In the quarter, receivables were reduced by over 12%, fixed assets net of depreciation were down 5% sequentially and 8.5% annually. We were able to repurchase $6 million worth of common shares in the quarter, and in spite of all of that, cash increased 1 million 6 sequentially in the quarter. I think this strong cash flow reflects the health of the underlying business.

And, of course, SOX compliance continued. We have added consulting help this year and are implementing the changes indicated in last year's audit.

On the product development side, the projects reflect the same emphasis in the business. The first is network solutions, which includes the ongoing extension to our line of medical review services and their sale into worker's comp and even group health marketplaces. Specialty medical review services, as well as expanded PPO programs, are being added to existing and new accounts. Our next generation PPOs sold under the brand name CareIQ have been piloted in one state and are now being added to additional branches. CareIQ fits well with new legislation in a number of key states and will soon also incorporate advances in our systems capabilities designed to improve the program's efficiency and effectiveness.

New legislation in California, Texas, Tennessee and Illinois has required new software and services. Responding to the state level regulatory changes is a unique requirement of the worker's compensation market. Our software with ongoing development is configured to accommodate these differences. During the current year, we are also working on further expansions of both the software and business development programs to further support network solutions.

On the MedCheck side, which is the software for medical bill review, development continues. Work has been focused on supporting our network solutions productline. Projects in the quarter are intended to enable ongoing expansions of our specialty medical review volumes and improve the CareIQ efficiencies and operations and address compliance with new regulations in several states. We are scaling out our document management storage and processing systems. Investments made in the last two years to our two data centers have prepared us to scale our systems. Fixed investments net of depreciation have actually declined in recent quarters.

The third project area is CareMC. CareMC 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 online reporting. Improved reporting and analytics are goals of the coming year. Expansions to CareMC tend to favor Web-based processing, which is increasingly improving workflow, automating portions of claims management and presenting claims information to all appropriate parties.

The fourth project area is our Enterprise Comp productline, which extends the breadth of our services to create a more complete worker's compensation and claims management solution.

Our National Users Conference in October allowed a forum in which we could discuss such new programs. We are working on specific ideas generated during that meeting.

I would like to cover briefly a couple of the measures of cash flow and Accounts Receivable. We had EBITDA of 5.3 million in the quarter, up from 4.9 a year ago. Net income plus depreciation was about flat with a year ago, and cash flow net of fixed assets in working capital was a positive 7.5 million in the quarter, up from 100,000 a year ago. I think these differences bringing into much better focus the difference between this year's December quarter and the one a year ago. Accounts Receivable net of reserves was 54 days, which is on the low-end of our cycles, and cash improved a couple of million to 9 million. As I mentioned earlier, we repurchased $6 million worth of shares in the quarter, which brings our total share repurchase to 7.1 million inception to date.

That concludes my prepared remarks. And I would now like to turn the call open to questions. Thank you.

(OPERATOR INSTRUCTIONS). Mitra Ramgopal, Sidoti.

Just a few questions. I thought you could sort of breakout again the revenue in the quarter for network solutions and patient management services and also what the gross margin was in each segment?

Yes. The revenue for patient management in the quarter was 26.7 million with gross profits of 1.1 million. The network solutions revenue was 36.4 million, and gross profits there were 8.9 million. So margins there moved up from 24.2 to 24.6% in the quarter, although case management margins were down.

Okay. And I think you had mentioned there was some impact from the hurricanes in the quarter?

Yes.

I don't know -- it is probably difficult to quantify, but I don't know if you could maybe share some of that, and also in the last quarter, I know your impact (inaudible) some problems with one of your business partners. I assume that is over with?

That seems to have subsided on the business partner interface. There are a lot of changes going on in the industry, and so those kinds of things come long. But we have not been as involved in that this quarter.

On the weather side, I think people were trying not to blame a lot on that because we are sort of worrying that next year we might see the same thing again. But certainly I think Wilma was a much more serious weather disruption, even though Katrina got a lot more attention, and Wilma occurred in the quarter. So it was difficult for us, particularly in the Florida business area.

Okay. And I believe maybe you can touch a little on the G&A. I know year-over-year it has increased as a percentage of revenue, but it is sort of flat on a sequential basis. I guess going forward should we sort of anticipate current levels continuing?

I don't know. That is a tough one. We certainly would like to see it down from where it is. It is tough. In the regulatory compliance area, these days we are investing in SOX compliance, and there are a number of state regulations changing. We have been undergoing audits in a couple of states which have cost us something. But I think it would be safest to think that it might be a challenge in here to reduce it in the short-term. One thing we have done is to maintain our investment in new technology, and I think we are -- as I mentioned in the discussion, I think we are beginning to see the benefits of that gained some traction for us in the business. So I think we were wise to hang in there on that. But it has been certainly a drag in the business, and overhead as a percentage of revenues is at the highest level in our history.

Okay. And finally, also if you could just guide -- I believe you repurchased some stock in the quarter. I don't know if you could share with us how much, or how much you spent and how much --?

Yes, we spent just short of 6 million in the quarter and repurchased 303,000 shares.

And what is the authorization remaining in terms of --?

At the present time, we have acquired all the shares that are authorized by the Board. We are as I have -- I did not discuss that on this call, but I think over the last six months we have alluded to the fact that we would like to make some investments in the expansion of the business, perhaps some small acquisitions. We are not close to anything at this point, and there is nothing specific to which I could refer, but we are letting the cash creep up a little bit in here.

Okay. So it is safe to assume, though, active repurchasing going forward in the near-term that is?

I would say it is safe -- well, I think right now we don't have an authorization to purchase any more shares.

Ed Kroll, SG Cowen.

First, on the effect of the share buyback just to get kind of the housekeeping item, what is the share count, or what was the actual share count at the end of the quarter or at the end of the buyback, if you will, either one of those?

Let's see. I don't know if I have the hard shares right now. The diluted shares --

Fully diluted is what --

Fully diluted I think were 9553. Let me just check that. I am pretty sure that is right. Well, I have got my CFO racing down the hall here. Just a second. Pardon, Richard? (multiple speakers). Hard shares at the end of the quarter were 9405, and the diluted shares in the earnings per share computation I think were 9513. Excuse me, fully diluted were 9553. I'm sorry. That is down 9.1% from the same quarter the prior year. I think what we are trying -- we have been successful in doing is really adjusting our shares outstanding to the size of the business, and I think that plus our balance sheet changes, which were pretty substantial in the quarter, have really we think kept us in a very healthy situation.

Okay. So the share count going forward then, I mean I guess what I was after is that the 9. -- the diluted number for the quarter, the 9.553, depending on when the share buyback ended, what should be that -- where are we with that number going forward? In other words, is that what the 9.405 is?

Well, the 9.405 won't ever show up in fully diluted because there will be some stock option profits still out there from older options. Richard is giving me an estimate. That is estimated diluted?

For the March quarter, this is pretty rough, and I would want to caution everybody, but I would say we think it might be down in the 9430 range by the end of March quarter. That depends on the share price obviously, but we're not seeing anything fancy there right now. But there is some remaining reduction, and I think that is what you're alluding to?

Yes, yes.

We finished our buyback by pretty much the middle of the quarter I think. So there is some left, and it was larger than most quarters, so -- and maybe I'm wrong. I think we might have gone on into December. We never buy in the black out past the middle of December. So we were done by the middle of December at the latest.

Got it. Thanks. I got that now. You talked about some insourcing by your customers. Overall if you could give us a comment, any change in competitive dynamics that you are seeing in response to this persistently soft claims environment? Just any color you can give us.

I think technology is making it easier for the larger payers, maybe larger carriers and TPAs to do some of the work in-house. And the things they have taken on have been, I would say, textbook, kind of textbook changes in any industry. They have moved into the lower value-added sections of the business, the case management business and some of the simpler things to do, and they continue to purchase bill review services, software for bill review, PPOs, that sort of thing.

But the margins in case management are attractive to them whether they are TPAs or insurance companies, and I think that is an important change in the background over the last maybe three or four years in the industry, and it has led to our interest in expanding the breadth of our services. I think it is important for a company in CorVel's position to be constantly moving into the newer, more complex services.

Okay. Thanks for that. And then finally, at least to me, one of the most interesting new products you have is the CareMC transaction processing website?

Yes, yes.

What are the chances, or what do you see if any opportunity to expand the use of that maybe beyond comp into some other form of insurance whether it be actual, the actual health insurance market, just any color you can give on that? Any thoughts?

Well, I think we see its use as being valuable in addition to the comp market in the auto market where we do an increasing amount of business on the bill review side. The advantage of it in any insurance market is it allows us to integrate our results with the work environment of the payer so that we collect information on their sites. It goes into our website. It is available for immediate use by any workers within their organization or within their customers' organizations such as large employers on a real-time basis. It is a project that would benefit from more investment than perhaps CorVel can put into it in any given quarter, but we have been at it for five or six years.

So it is a robust site. We are adding to it as we go along. We do a little group health in it, but I would not want to say that that is a direction for us, especially within the U.S. We do a little bit of offshore work there. I do think that directionally over the next five years we will see those kinds of tools be used because you can project claims management capabilities anywhere you want, and you can integrate workforces from anywhere. A lot of the kind of trends that are talked about in Friedman's book, I would say, are certainly very much a part of our strategies.

Okay. Thanks, Gordon.

[John Snazbo], [Clinton Clintridge Capital].

Just so I can understand the case situation, you had a pretty significant decline in the Accounts Receivable. Would you expect that there is more room to bring that down? Or I think you alluded to that 54 days being sort of toward the low end of the cycle. What do you think you can do in terms of working capital deficiency in calendar 2006?

Well, I would say that historically we have always felt that we should do a better job with Accounts Receivable. It still reflects lower payment to CorVel than seems to us appropriate. But I think it is important to remember that many of our customers are insurance companies and TPAs, and managing cash flow in their own interest is something they take a lot of pride in. So paying us promptly is not one of their high priorities.

Nonetheless, we do think we can do a better job there. I think one of the benefits of some of the 404 work is just a greater attention to controls to automated processing, to being more vigilant about some of these activities. I'm not a fan of some of the aspects of those regulations, but I do think it is fair to say that we have become a little better at it as we go along. It is an area where as a company we would like to do a better job, but I think I would not want to be projecting great gains. Internally we have the goal of doing a better job with it. There is a portion of that receivable balance that is older than it ought to be. It is not bad debt; it is just slow payment.

Okay. And then so absent your continued improvement in that metric, your operating cash flow should approximate sort of earnings plus in depreciation and amortization? Is that a fair statement?

Yes, I think we would hope to see and expect to see the revenues be bottoming here and improving, and so Accounts Receivable would not be a source of cash flow. I think more than cash flow it is just a measure in my mind of the quality of the balance sheet. I think that for us to be able to clean up assets whether they be Accounts Receivable or fixed assets during a downcycle is not easy to do, and we incur some cost doing that. So it just positions us with a healthy balance sheet going forward.

Right. Okay. So if you sort of look out, you mentioned acquisitions as a potential source of -- or potential use of that cash. What would be sort of a couple of examples of acquisitions that might fit with your business at this point?

I think generally we look for expansions in our product line and certainly those kinds of expansions that are of interest to our customers. We have been working on automation ideas in the broader claims management area and bringing those kinds of tools to insurers and TPAs. We look for regional or even local companies that have -- are large enough to have a franchise, but who do not have national franchises because I think we feel we have a nice distribution organization into which to roll out new services.

At the present time, we have our hands full with some internal developments that have been going well in the last year. But we do have our sights set on some things we would like to pick up. I would rather not be too specific. We certainly have plenty of competition out there in the marketplace as well.

Yes, sure. No, I was just looking for a general answer. That was very helpful. So just in terms of what you might spend for internal development, has that played itself out, or do you see that spending accelerating here over the next 12 months or so?

Well, I think we have tried to manage the cost of our internal development within our income statement. I think it is fair to say that it has been a little tough the last couple of years with revenues down. So we have held it flat. We have not been willing to cut back. If we had a nice pick up in revenue and profitability, that certainly would be a possibility to see some of that going to expanded development. We have I would say a manageable backlog, but at this time there is a very rich bunch of opportunities around medical review and the expansion of our specialty medical review services. We are mindful of some of the -- and I hate to say this, but some of the small companies out in the dot-com world have continued to introduce exciting new ideas, and they relate to financial services transaction processing. So it is pretty easy to see opportunities right in here. But I would say that our goal has always been to maintain our spend rate within our P&L.

Great. Thanks. Just one last question, as an outsider looking into your business, what would be a metric that I could track that might be relevant to your volumes on the worker's comp side? I mean it is industrial employment levels? What could we look toward to get an indication of where the business is going?

You know, that is an excellent question, and before I answer it, I should tell you I have been wrong about the answer to this question the last five years, so you might want to take that into consideration here.

It used to be 10 years ago we could look at unemployment, and when it was low, it was a good indicator. I think the open borders have introduced so many workers that are not counted in unemployment that you really cannot look at that anymore. I do think more recently the Fed particularly has begun to appreciate that the changes in our work force are such that inflation does not follow with the indicators they used to think. So the reason that is important in comp is when the workers are feeling good about their opportunity to find employment, they are more inclined to go out on worker's comp claims than they are when they are less inclined to feel comfortable.

I would say the U.S. workforce is generally uncomfortable these days. It is being downsized. Jobs are being sort of downgraded. The quality of work available is lower in many areas than it used to be, and there is this unreported unemployment. I think it has all become visible in the low -- the very low inflation in spite of just unprecedented oil prices.

So you can look at some comparables. [Crawford] and [Concenture] are two public companies that do report and do provide the opportunity to see how other companies are seeing the volume in worker's compensation. It is hard to look at insurance companies because the premiums for insurance are at all times highs relative to claims. There has never been a period that has been more profitable for insurance companies than worker's compensation. Claims are down and premiums are up. They went through a long period of underpricing, so they are replenishing their balance sheets. But they are nonetheless going through a very unusual period. So it is not easy. There is some very delayed reporting of claims volume from the Department of Labor, but sadly they are a couple of years behind the current quarter.

Okay. So if I could just summarize, I think the point that you are making about sort of the comfort level is kind of the most important driver, and as long as people feel uncomfortable, they are going to be less likely to go out on a claim.

Yes, claims are down about 50% from where they were five years ago. Some of that maybe a permanent reduction. I don't know that we're in a good position to say. But if you can find the measure of the tightness of the labor market, which is beginning to happen, then that would be a pretty good indicator for where things are going in our business.

[Pam Romanowkin], Greenwood Investments.

I have a couple of questions. One is about where do you see opportunities to increase gross margin on the patient management services?

I think in that area it has been a challenge for us to downsize our offices and to also as we back away from some business to actually balance our workforce. So I think some of that will be -- it requires some work, but it will be a natural ongoing process as both our rent expense and our direct labor and indirect labor is steadily balanced. We do see I would not say so much the opportunity, but the need to raise price, and we are pushing for price even at the expense of volume at the present time.

Having said all that, we do I think more a year out we do think that there are some opportunities with technology to improve the management of the business. I would not put it that for out, except that we see the best opportunities in our business right now on the network solutions side, and we are continuing to focus on expansions of that area where the margins are much better.

Was the gross margin for patient management services around 4%?

Yes, just over 4% in the quarter. It is heavily impacted by the loss of the two production days in the December quarter. That is obviously a recurring event every year, but the December quarter is not indicative, and yet nonetheless the margins there are well below where they ought to be.

Okay. And also you mentioned that there is some trend of insourcing case management, so does it suggest that revenues are going to further declines?

Well, we don't give guidance, and I don't know that we could say that. I think the insourcing of case management has been going on for a number of years, especially at the large carriers. So I don't see changes in trends there. The biggest impact in the short run has been low claims volume and then the impact of our having to raise price. So I don't think the insourcing is a change in balanced right in here in the last three or four quarters.

Okay, I see. And just one last question. What was the capital expenditure this quarter?

I don't know that I -- I don't think I have that number. I can say that in the quarter -- let's see, I don't have fixed asset additions in the quarter. Maybe some -- I see them, they will come running down the hall here in a minute. Fixed assets net of depreciation were down about 2.5 million in the quarter, and fixed asset additions in the quarter were only 1 million 3. Boy, that is a low number for us. We have seen some efficiencies from our gradual move from client/server applications to Web-based processing. The larger centralized servers are more efficient on a capital basis than the distributed processing on which the Company was built in the '90s. So there is in efficiency going on there.

Also, I would say in the last two or three years there was kind of an artificial increase in fixed assets because we set up a backup datacenter, and once that was in place, then our spin rate dropped.

Okay. And then what about depreciation during the quarter?

I don't know that I have that or that we normally report that. Our depreciation did reduce fixed assets or net net fixed assets in the quarter sequentially. So it must have been maybe 1 million 3 or something like that greater than the fixed asset number I just gave you.

Okay. I see. Okay. Thank you very much.

Ed Kroll, SG Cowen.

Just back on the cash flow quickly to make sure I have the right number, after adjusting for working capital, was that the $7.5 million number you cited?

Yes. Well, let's see. That number was net income plus depreciation minus the change in both fixed assets and working capital. So yes, that was 7.5 million in the quarter compared to only 100,000 in the December quarter a year ago.

Got it. And that was roughly 5 million I think in the September quarter? That's a number?

That number in this September quarter was 3 million I have. Yes, net income plus depreciation was 5 in the September quarter. The numbers in September were 6.4 for EBITDA, 5.1 for net income plus depreciation, 4.6 for net income plus depreciation minus only working capital, and then minus both working capital and fixed asset changes, it was 3.0. So it was up -- the big change there, of course, is receivables. But I think also this decline in fixed assets relative to depreciation is swinging the cash flow pretty positive in here, too.

So what would it be this quarter, the December quarter, after working capital before fixed assets?

It was 8.8.

8.8, wow!

Yes.

(OPERATOR INSTRUCTIONS). There are no further questions at this time, Mr. Clemons. Do you have any further comments, sir?

No, I don't. I would like to thank everyone for joining and for the active question-and-answer period, and we are certainly available if you have any further questions off-line. Thank you very much, and we will talk to you again next quarter.

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