1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended July 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 0-20946
Health Management Systems, Inc.
(Exact name of registrant as specified in its charter)
New York 13-2770433
State of Incorporation (I.R.S. Employer
Identification Number)
401 Park Avenue South, New York, New York 10016
(Address of principal executive offices, zip code)
(212) 685-4545
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address, and former fiscal year, if changed since last
report.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. [X] Yes [ ] No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at September 7, 2001
---------------------------- --------------------------------
Common Stock, $.01 Par Value 17,865,361 Shares
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HEALTH MANAGEMENT SYSTEMS, INC.
INDEX TO FORM 10-Q
QUARTER ENDED JULY 31, 2001
PART I FINANCIAL INFORMATION Page
No.
Item 1 Interim Financial Statements
Condensed Consolidated Balance Sheets 1
(unaudited) as of July 31, 2001 and
October 31, 2000
Condensed Consolidated Statements of Operations 2
(unaudited) for the three month and nine month
periods ended July 31, 2001 and 2000
Consolidated Statements of Comprehensive Income 3
(Loss) (unaudited) for the three month and
nine month periods ended July 31, 2001 and 2000
Consolidated Statement of Shareholders' Equity 4
(unaudited) for the nine month period ended
July 31, 2001
Condensed Consolidated Statements of Cash Flows 5
(unaudited) for the nine month periods ended
July 31, 2001 and 2000
Notes to Consolidated Financial Statements 6
(unaudited)
Item 2 Management's Discussion and Analysis of Financial 15
Condition and Results of Operations
Item 3 Quantitative and Qualitative Disclosures About 20
Market Risks
PART II OTHER INFORMATION 20
SIGNATURES 21
EXHIBIT INDEX 22
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HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
($ IN THOUSANDS)
(UNAUDITED)
July 31, October 31,
2001 2000
-------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 15,783 $ 10,573
Short-term investments 4,675 6,167
Accounts receivable, net 17,228 22,853
Income tax receivable -- 829
Prepaid expenses and other current assets 4,548 6,545
-------- --------
Total current assets 42,234 46,967
Property and equipment, net 4,895 6,410
Capitalized software costs, net 7,452 7,343
Goodwill, net 7,160 7,425
Deferred income taxes, net 11,086 6,643
Other assets 1,894 510
Net assets of discontinued operation -- 8,686
-------- --------
Total assets $ 74,721 $ 83,984
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 11,718 $ 13,460
Deferred revenue 2,715 3,380
Net liabilities of discontinued operation 835 --
-------- --------
Total current liabilities 15,268 16,840
Other liabilities 1,039 1,546
-------- --------
Total liabilities 16,307 18,386
-------- --------
Commitments and contingencies
Shareholders' equity:
Preferred stock - $.01 par value; 5,000,000 shares authorized; none issued -- --
Common stock - $.01 par value; 45,000,000 shares authorized;
19,177,027 shares issued and 17,865,361 shares outstanding at July 31, 2001;
18,563,922 shares issued and 17,252,256 shares outstanding at October 31, 2000 192 186
Capital in excess of par value 72,945 72,170
Retained earnings/(accumulated deficit) (5,650) 1,652
Accumulated other comprehensive loss (51) (110)
Treasury stock, at cost, 1,311,666 shares at July 31, 2001 and October 31, 2000 (8,300) (8,300)
Note receivable from sale of stock (722) --
-------- --------
Total shareholders' equity 58,414 65,598
-------- --------
Total liabilities and shareholders' equity $ 74,721 $ 83,984
======== ========
See accompanying notes to unaudited condensed consolidated financial statements.
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HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three months ended July 31, Nine months ended July 31,
--------------------------- --------------------------
2001 2000* 2001 2000*
-------- -------- -------- --------
Revenue $ 20,606 $ 19,495 $ 62,129 $ 61,476
-------- -------- -------- --------
Cost of services:
Compensation 11,173 11,736 34,484 36,390
Data processing 2,254 2,014 7,074 6,799
Occupancy 1,966 2,274 6,218 6,735
Direct project costs 4,636 1,642 9,259 8,090
Other operating costs 3,202 3,172 7,514 9,425
Restructuring costs -- -- 785 --
-------- -------- -------- --------
23,231 20,838 65,334 67,439
-------- -------- -------- --------
Operating loss before amortization of intangibles (2,625) (1,343) (3,205) (5,963)
Amortization of intangibles 88 90 264 270
-------- -------- -------- --------
Operating loss (2,713) (1,433) (3,469) (6,233)
Gain on sale of assets 1,614 -- 1,614 --
Net interest and net other income 197 300 582 864
-------- -------- -------- --------
Loss from continuing operations before income taxes and
cumulative effect of change in accounting principle (902) (1,133) (1,273) (5,369)
Income tax benefit (328) (471) (463) (2,216)
-------- -------- -------- --------
Loss from continuing operations before cumulative
effect of change in accounting principle (574) (662) (810) (3,153)
Discontinued operations:
Income (loss) from discontinued operations, net 299 (13) (5,473) 552
Estimated loss on disposal of discontinued operations, net (1,019) -- (1,019) --
-------- -------- -------- --------
Loss before cumulative effect of
change in accounting principle (1,294) (675) (7,302) (2,601)
Cumulative effect of change in accounting
principle, net of tax benefit ("cumulative effect") -- -- -- 21,965
-------- -------- -------- --------
Net loss $ (1,294) $ (675) $ (7,302) $(24,566)
======== ======== ======== ========
Basic and diluted earnings per share data:
Loss per share on continuing
operations before cumulative effect $ (0.03) $ (0.04) $ (0.04) $ (0.18)
Income (loss) per share from discontinued operations, net (0.04) -- (0.37) 0.03
Loss per share from cumulative effect, net -- -- -- (1.26)
-------- -------- -------- --------
Net loss per share $ (0.07) $ (0.04) $ (0.41) $ (1.41)
======== ======== ======== ========
Weighted average common shares outstanding 17,859 17,496 17,694 17,481
======== ======== ======== ========
See accompanying notes to unaudited condensed consolidated financial statements.
*restated for 2000, see note 4.
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HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
($ IN THOUSANDS)
(UNAUDITED)
Three months ended Nine months ended
July 31, July 31,
------------------------ ------------------------
2001 2000* 2001 2000*
-------- -------- -------- --------
Net loss $ (1,294) $ (675) $ (7,302) $(24,566)
Other comprehensive income, net of tax:
Change in net unrealized appreciation/(depreciation)
on short-term investments 8 (180) 59 (129)
-------- -------- -------- --------
Comprehensive loss $ (1,286) $ (855) $ (7,243) $(24,695)
======== ======== ======== ========
See accompanying notes to unaudited condensed consolidated financial statements.
*restated for 2000, see note 4.
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HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
($ IN THOUSANDS)
(UNAUDITED)
Common Stock Retained Accumulated Note
------------------ Capital In Earnings/ Other Receivable Total
# of Shares Par Excess Of (Accumulated Comprehensive Treasury From Sale Shareholders'
Outstanding Value Par Value Deficit) Income/(Loss) Stock of Stock Equity
------------------ ---------- ------------ ------------- -------- ---------- -------------
Balance at October 31, 2000 17,252,256 $186 $72,170 $ 1,652 $(110) $(8,300) $ - $65,598
Net loss - - - (7,302) - - - (7,302)
Shares issued for note receivable 550,000 5 717 - - - (722) -
Shares issued under employee
stock purchase plan 63,105 1 58 - - - - 59
Change in net unrealized
appreciation/(depreciation)
on short-term investments - - - - 59 - - 59
----------- ----- ---------- ----------- ------ -------- ---------- ----------
Balance at July 31, 2001 17,865,361 $192 $72,945 $(5,650) $ (51) $(8,300) $(722) $58,414
=========== ===== ========== =========== ====== ======== ========== ==========
See accompanying notes to unaudited condensed consolidated financial statements.
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HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
($ IN THOUSANDS)
(UNAUDITED)
Nine months ended July 31,
---------------------------
2001 2000*
----------- -----------
Net cash provided by (used in) operating activities $ 1,240 $ (11,119)
----------- -----------
Investing activities:
Purchases of property and equipment (1,013) (1,852)
Investment in software (2,960) (3,308)
Proceeds from sale of assets, EDI operations 450 -
Proceeds from sale of assets, CDR operations 2,854 -
Net proceeds from sales of short-term investments 1,551 6,668
----------- -----------
Net cash provided by investing activities 882 1,508
----------- -----------
Financing activities:
Proceeds from issuance of common stock 59 52
Proceeds from exercise of stock options - 346
----------- -----------
Net cash provided by financing activities 59 398
----------- -----------
Net increase (decrease) in cash and cash equivalents 2,181 (9,213)
Cash and cash equivalents at beginning of period 10,573 16,310
Cash provided by (used in) discontinued operations 3,029 (297)
----------- -----------
Cash and cash equivalents at end of period $ 15,783 $ 6,800
=========== ===========
See accompanying notes to unaudited condensed consolidated financial statements.
*restated for 2000, see note 4.
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HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Unaudited Interim Financial Information
The management of Health Management Systems, Inc. ("HMSY" or the "Company")
is responsible for the accompanying unaudited interim consolidated
financial statements and the related information included in these notes to
the unaudited interim consolidated financial statements. In the opinion of
management, the unaudited interim consolidated financial statements reflect
all adjustments, including normal recurring adjustments necessary for the
fair presentation of the Company's financial position and results of
operations and cash flows for the periods presented. Results of operations
for interim periods are not necessarily indicative of the results to be
expected for the entire year.
These unaudited interim consolidated financial statements should be read in
conjunction with the audited consolidated financial statements of the
Company as of and for the fiscal year ended October 31, 2000 included in
the Company's Annual Report on Form 10-K for such year, and the unaudited
interim consolidated financial statements as of and for the quarterly
periods ended January 31, 2001 and April 30, 2001 included in the Company's
Quarterly Reports on Form 10-Q, each as filed with the Securities and
Exchange Commission (the "SEC").
2. Reclassifications
Certain reclassifications were made to prior amounts to conform to the
current presentation.
3. Divestitures
Effective June 30, 2001, the Company sold substantially all of the assets
of CDR Associates, Inc. ("CDR"), a wholly owned subsidiary, to CDR
Associates, L.L.C., a Delaware limited liability corporation. The purchase
price of $3.2 million consisted of $2.9 million in cash at closing and
$280,000 in four scheduled payments to be made over the next seven months.
The net assets sold and related transaction costs totaled $1.6 million,
resulting in a gain on the sale of $1.6 million for the period ended July
31, 2001. The Company's CDR business generated net income of $436,000 on
$2.7 million in revenue for the eight months ended June 30, 2001 and total
operating assets as of June 30, 2001 were approximately $1.3 million. The
Company's CDR business generated net income of $434,000 on $2.8 million in
revenue for the fiscal year ended October 31, 2000.
Effective January 1, 2001, the Company sold its electronic transaction
processing ("EDI") business, consisting of substantially all of the assets
of the Company's wholly owned subsidiary, Quality Medi-Cal Adjudication,
Inc., and certain of the assets of its wholly owned subsidiary, Health
Receivables Management, Inc., to Medi, Inc. ("Medi"), a privately held
entity. The total sale price of $3.0 million consisted of: (i) $450,000 in
cash at closing, (ii) a one-year secured promissory note in the principal
amount of $275,000 and, (iii) $2.3 million of service credits. The Company
applies these service credits against invoices for services rendered by
Medi to the Company pursuant to a services agreement entered into between
the parties at the time of closing. Through July 31, 2001, the Company has
utilized $352,000 in service credits. The Company's EDI business generated
a net loss of approximately $200,000 on $4.0 million in revenue during
fiscal year 2000. The assets sold and related transaction costs totaled
$3.0 million. Accordingly, no gain or loss resulted from this transaction.
4. Change in Accounting Principle for Revenue Recognition
After analyzing the SEC's "Frequently Asked Questions and Answers" bulletin
released on October 12, 2000 pertaining to Staff Accounting Bulletin No.
101, Revenue Recognition in Financial Statements ("SAB 101"), the Company
elected early adoption in the fourth quarter of its fiscal year ended
October
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31, 2000, implementing a change in accounting principle with regard to
revenue generated from clients seeking reimbursement from third party
payors where the Company's fees are contingent upon the client's
collections from third parties. The Company now recognizes revenue
pertaining to such clients once the third party payor has remitted payment
to its client, thereby eliminating unbilled receivables and substantially
reducing deferred income tax liabilities. As a result of this change in
accounting principle, the prior year first, second, and third quarters
ended January 31, 2000, April 30, 2000, and July 31, 2000, respectively,
have been restated to reflect the new policy. The cumulative effect of this
change in accounting principle as of the beginning of the Company's fiscal
year 2000 was $22.0 million, net of income tax benefit of $18.2 million.
As of October 31, 1999, the Company had unbilled accounts receivable of
$41.7 million under its historic accounting policy, pre-dating the SEC
release of SAB 101. Of this amount, a total of $37.2 million has
subsequently completed its cycle and has been included in the Company's
revenue and operating results through July 31, 2001, of which $3.9 and
$12.6 million occurred in the three months and nine months ended July 31,
2001, respectively.
5. Restructuring
In the second quarter of fiscal year 2001, the Company recognized a
restructuring charge of $785,000 primarily related to the closure of its
Washington, D.C. office, consisting of $503,000 in employee costs, $32,000
in office lease costs, and $250,000 for the write-off on an initial fee
paid for a third party liability recovery system which the Company has
determined will not be put into use. Of the total restructuring charges,
$422,000 remain as accrued liabilities at July 31, 2001.
6. Discontinued Operations
On July 31, 2001, the Company determined to discontinue the operations of
its Payor Systems Group ("PSG") and pursue an orderly closure of the
business. This decision followed from the notice of contract termination
the Company received from the largest customer of PSG, which accounted for
$1.1 million of the total $1.95 million of revenue in PSG for the quarterly
period ended July 31, 2001. The Company's formal plan of discontinuance is
expected to be substantially executed by June 2002, and includes provisions
for on-going service to existing clients according to the current contract
terms while pursuing early release from existing contract relationships or
opportunities to assign the contracts to other service providers. As of
July 31, 2001 the Company has estimated a pre-tax loss on disposal of $1.6
million, or $1.0 million after benefit for income taxes, as an estimate of
the future results of operations for PSG until the final cessation of
operations, largely reflective of employee severance costs and a general
deterioration in operating results as the revenue base declines. The
remaining net liabilities of PSG at July 31, 2001 include total assets of
$2.5 million consisting of trade accounts receivable, property and
equipment, and software development costs, and total liabilities of $3.3
million consisting of trade accounts payable and accrued expenses, and
accrued operating losses and restructuring charges as described below.
The results of PSG's operations have been reported separately as
discontinued operations in the Statements of Operations. Prior year amounts
have been restated to present the operations of PSG as a discontinued
operation. PSG's results of operations for the three and nine month periods
ended July 31, 2001 and 2000 are as follows:
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Three Months Nine Months
ended July 31, ended July 31,
2001 2000 2001 2000
------------------- ------------------
Revenue $ 1,946 $ 2,363 $ 7,048 $ 9,219
Income/(Loss) before income taxes $ 469 $ (23) $(8,592) $ 940
Income tax
expense/(benefit) $ 170 $ (10) $(3,119) $ 388
Estimated loss on disposal of
discontinued operation, net of
income tax benefit of $581 $ 1,019 $ -- $ 1,019 $ --
In the second quarter of fiscal year 2001, the Company incurred a
restructuring charge of $5,080,000 related to PSG, resulting from the
decision to discontinue development of its managed care system offering,
after considering alternatives to its development partner's notification
that it neither wished to purchase PSG nor continue to financially
participate in the development of the system. The charge consisted of
$3,464,000 for the write-off of capitalized software development and
equipment, $810,000 for employee severance and consulting costs associated
with approximately 60 positions, $678,000 for lease termination costs and
leasehold improvement write-offs, and $128,000 in other miscellaneous
costs. In the third quarter of fiscal year 2001, the Company recognized a
net reduction to these restructuring charges resulting from a $635,000
negotiated settlement received from the development partner, and additional
lease termination costs of $320,000. Of the total restructuring charges,
$755,000 in lease termination and related facility costs and $34,000 of
employee severance costs remain as liabilities at July 31, 2001.
Also, during the second quarter of fiscal year 2001, as a result of the
events leading to the restructuring charge discussed above, the Company
recognized an asset impairment charge of $4,586,000 relating to the
write-off of the goodwill and other intangible assets associated with the
Company's prior acquisition of PSG.
7. Accounts Receivable from the District of Columbia
In July 2001 the Company recognized bad debt expense in the total amount of
$2.7 million for the full amount of outstanding accounts receivable from
the District of Columbia ("District"). This $2.7 million of accounts
receivable consisted of $1.6 million for retroactive Disproportionate Share
Hospital ("DSH") revenue recovery services for the D.C. Medicaid program,
and $1.1 million for retroactive Medicaid rate adjustment services rendered
to D.C. General Hospital. This bad debt expense is reflected on the Direct
Project Costs line in the Company's Condensed Consolidated Statement of
Operations for the periods ended July 31, 2001.
With regard to the $1.6 million account receivable item, as a result of the
Company's efforts in seeking payment the Chief Contracting Officer of the
Department of Health informed the Company of the decision through a letter
dated May 23, 2001, that the contract pursuant to which the Company
rendered services in connection with the DSH revenue recovery project,
including eight amendments to that contract, had been signed by a
Contracting Officer of the Department of Human Services without the
requisite contracting authority and therefore the contract was determined
by the Chief Contracting Officer to be void ab initio. The Company believes
the decision of the Chief Contracting Officer is erroneous. Nonetheless, in
light of the decision and the complex and prolonged administrative process
that will accompany an effort to resolve this issue, the Company has
determined to recognize bad debt expense for this receivable.
With regard to the $1.1 million account receivable item, the Company had
asserted a claim against the District of Columbia Public Benefit
Corporation ("PBC") for services rendered to D.C. General
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Hospital. The Company received a letter dated April 6, 2001, from the Chief
Executive Officer of the PBC stating why he believed no additional amounts
were due the Company for the services rendered. The Company requested
additional information and documentary support for the CEO's denial but
these materials have not been provided. Effective April 30, 2001, the PBC
was dissolved and responsibility for the Company's claim was transferred to
the Executive Director of the D.C. Financial Responsibility and Management
Assistance Authority. After the Company's further efforts to pursue
collection with the Executive Director, the Company was informed by letter
dated July 18, 2001 from the D.C. Corporation Counsel, that the matter was
referred to the Department of Health for investigation. In light of the PBC
CEO's denial, the subsequent correspondence between the parties, the
unwillingness of the D.C. government to provide documentary support for the
denial of payment, and the complex and prolonged administrative process
that will accompany an effort to resolve this issue, the Company has
determined to recognize bad debt expense for this receivable.
In conjunction with the total bad debt expense of $2.7 million discussed
above, the Company recognized a reduction in subcontractor expense in the
amount of $2.5 million, for the related contingency based payment that
would have been due to the main service provider to the Company in
fulfillment of these projects for the District. This reduction in
subcontractor expense is reflected on the Direct Project Costs line in the
Company's Condensed Consolidated Statement of Operations for the periods
ended July 31, 2001. Also, the Company has determined that an advance of
$2.5 million it had made to this same subcontractor is uncollectible and
has recognized expense in the amount of the advance. This additional
expense is reflected on the Direct Project Costs line in the Company's
Condensed Consolidated Statement of Operations for the periods ended July
31, 2001.
8. Equity Transactions
In March 2001, as a condition of joining the Company as President and Chief
Operating Officer, Robert H. Holster was granted options to purchase
700,000 shares of the Company's common stock at $1.19 per share, the then
current market price. On March 30, 2002, 100,000 of the options fully vest
and the remaining 600,000 options vest ratably in eight equal quarterly
installments, commencing June 30, 2002. The grant of options to Mr. Holster
was exempt from the registration provisions of the Securities Act of 1933,
as amended ("the Act"), pursuant to Section 4(2) thereof relating to
transactions not involving a public offering.
In January 2001, as a condition of the employment of William F. Miller III
as Chairman and Chief Executive Officer of the Company, the Company's
Accelerated Claims Processing, Inc. subsidiary, a Delaware corporation,
provided the financing for Mr. Miller to purchase directly from the Company
550,000 shares of the Company's common stock in exchange for a full
recourse loan for $721,875, bearing interest at the rate of 6.5% per annum,
with the principal and interest payable annually in two equal installments
commencing January 9, 2002. The sale of common stock to Mr. Miller was
exempt from the registration provisions of the Act pursuant to Section 4(2)
thereof relating to transactions not involving a public offering.
9. Credit Facility
The Company's credit facility, consisting of a $10 million committed
revolver and $20 million advised line of credit, expired on February 13,
2001. The Company had not drawn and did not intend to draw on this
facility, and therefore the Company did not renew the facility.
10. Segment Information
The Company measures the performance of its operating segments utilizing
operating income (loss), excluding restructuring costs, as reflected in the
accompanying condensed consolidated statements of operations. Certain
reclassifications were made to prior year amounts to conform to the current
presentation.
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Total Provider Payor
Revenue Revenue Revenue Total Decision
Total Services Service Services Software Support
($ in Thousands) HMS Division Group Group Division Group
------------------------------------------------------------------------------------------------------------------------------------
Three months ended July 31, 2001
Revenue $ 20,606 $ 15,236 $ 8,351 $ 6,885 $ 5,370 $ 5,370
Operating income (loss), excluding
restructuring costs (2,713) (2,734) (3,919) 1,185 21 21
------------------------------------------------------------------------------------------------------------------------------------
Three months ended July 31, 2000
Revenue 19,495 14,163 9,911 4,252 5,332 5,332
Operating income (loss), excluding
restructuring costs (1,433) (2,159) (322) (1,837) 726 726
------------------------------------------------------------------------------------------------------------------------------------
Nine months ended July 31, 2001
Revenue 62,129 45,207 25,623 19,584 16,922 16,922
Operating income (loss), excluding
restructuring costs (2,684) (4,254) (5,662) 1,408 1,570 1,570
------------------------------------------------------------------------------------------------------------------------------------
Nine months ended July 31, 2000
Revenue 61,476 45,651 33,578 12,073 15,825 15,825
Operating income (loss), excluding
restructuring costs (6,233) (7,873) (2,384) (5,489) 1,640 1,640
------------------------------------------------------------------------------------------------------------------------------------
The difference between "Operating income (loss), excluding restructuring
charges" and "Income (loss) before income taxes and cumulative effect of
change in accounting principle" is "Restructuring costs", "Gain on sale of
assets" and "Net interest and net other income," which totaled $1,811,000
and $300,000 for the three months ended July 31, 2001 and 2000,
respectively, and $1,411,000 and $864,000 for the nine months ended July
31, 2001 and 2000, respectively.
11. Legal Proceedings
a) HHL Financial Services, Inc.
On June 28, 1998, eight holders of promissory notes (the "Notes") of HHL
Financial Services, Inc. ("HHL") commenced a lawsuit against the Company
and others in the Supreme Court of the State of New York, County of Nassau,
alleging various breaches of fiduciary duty on the part of the defendants
against HHL (the first cause of action) and that defendants intentionally
caused HHL's default under the Notes (the second cause of action). The
complaint alleges that, as a result of the alleged breaches of fiduciary
duty, HHL was caused to make substantial unjustified payments to the
Company which, ultimately, led to defaults on the Notes and to HHL's filing
for Chapter 11 bankruptcy protection. On June 30, 1998, the same Note
holders commenced a virtually identical action (the "Adversary Proceeding")
in the United States Bankruptcy Court for the District of Delaware, where
HHL's Chapter 11 proceeding is pending. The Adversary Proceeding alleges
the same wrongdoing as the New York State Court proceeding and seeks the
same damages, i.e., $2.3 million (the unpaid amount of the Notes) plus
interest. Plaintiffs moved in the Bankruptcy Court to have the Court
abstain from hearing the Adversary Proceeding in deference to the New York
State Court action. The Company opposed plaintiffs' motion for abstention
and on September 15, 1998 filed a motion in the Bankruptcy Court to dismiss
the Adversary Proceeding. This motion was decided by the Court on June 5,
2001. At that time, the Court dismissed the first cause of action and ruled
that it would abstain on dismissal of the second cause of action. The
Company intends to continue its vigorous defense of the remaining second
cause of action in the lawsuit in the New York State Court. Management
believes the risk of loss is not probable and accordingly has not
recognized any accrued liability for this matter. Although the outcome of
this matter cannot be predicted with certainty, the Company believes that
any liability that may result will not, in the aggregate, have a material
adverse effect on the Company's financial position or cash flows, although
it could be material to the Company's operating results in any one
accounting period.
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b) IHHS, Inc.
In July 2000, the Supreme Court of the State of New York, County of New
York ("New York Supreme Court"), granted the Company's motion for summary
judgment against The Institutes for Health & Human Services, Inc. ("IHHS")
in the amount of $270,000 on an unpaid promissory note (together with
interest and attorneys' fees assessed at an inquest in January 2001 in the
amount of $27,000), but stayed enforcement of the judgment pending
assertion and resolution of claims IHHS represented it had against the
Company. Later in July 2000, IHHS asserted such claims against the Company
in an action filed in New York Supreme Court. The complaint alleged that
the Company fraudulently withheld information from IHHS to induce it to
enter into various specified contracts with the Company, and that the
Company breached various contractual obligations to IHHS. The complaint
sought an aggregate of $9,100,000 in compensatory damages, and punitive
damages in an unspecified amount. The action came on for trial in January
2001, at which time the Court directed entry for judgement, dismissing the
case, and awarding the Company damages on its counterclaims in an amount
to be assessed at an inquest. IHHS has filed a notice of appeal of the
Court's decision, although it has not moved for a stay of the decision
pending appeal. Therefore, the Company will continue in its enforcement
efforts against IHHS. The Company's position is that it will prevail on
the merits on any appeal of this matter. Although the ultimate outcome of
this matter cannot be predicted with certainty, the Company believes that
any liability that may result will not, in the aggregate, have a material
adverse effect on the Company's financial position or cash flows, although
it could be material to the Company's operating results in any one
accounting period.
c) Davis & Associates, Inc.
On May 1, 2001, the United States District Court for the Southern District
of New York issued an Opinion and Order granting the Company's motion for
summary judgement and dismissing the complaint alleged in a lawsuit
commenced by Davis & Associates, Inc. ("D&A"). The complaint alleged,
among other things, that the Company breached contractual obligations to
D&A, wrongfully induced D&A to enter into various contracts with the
Company, and wrongfully interfered with D&A's ability to perform under
several contracts and pursue unspecified business opportunities. D&A
sought compensatory and punitive damages in unspecified amounts and
injunctive and other equitable relief. D&A filed a Notice of Appeal on
June 4, 2001, which was dismissed by the Second Circuit Court of Appeals
on July 2, 2001.
d) District of Columbia
In March, 2001, the Company commenced a lawsuit in the Superior Court of
the District of Columbia, Civil Division, against the District of Columbia
("D.C." or the "District"), Carolyn N. Graham, in her official capacity as
Interim Director of the District of Columbia Department of Human Services
(the "DHS"), and Ivan C. A. Walks, M.D., in his official capacity as
Director of the District of Columbia Department of Health, seeking to
recover amounts owed to the Company by the District for services rendered
in conducting a retroactive Disproportionate Share Hospital ("DSH")
revenue recovery project for the D.C. Medicaid program. In June 2001, the
District made a motion to dismiss the Company's complaint on the grounds
that the Court lacks jurisdiction and that any legal proceedings related
to the Company's claims are to be brought before the D.C. Board of
Contract Appeals. In the interim, the Chief Contracting Officer of the
Department of Health has taken the position that the Company has no claim,
issuing a decision dated May 23, 2001, that the contract pursuant to which
the Company rendered services in connection with the DSH revenue recovery
project, including eight amendments to that contract, had been signed by a
Contracting Officer of the DHS without the requisite contracting authority
and therefore the contract was determined by the Chief Contracting Officer
to be void ab initio, noting that the Company may submit a request for
compensation of its actual costs allocable to the work performed under the
contract. A decision of a Contracting Officer is subject to appeal to the
District Board of Contract Appeals. The Company believes that the decision
of the Chief Contracting Officer was erroneous and an attempt on the part
of the District to avoid paying fees properly owing for revenue recovered
by the District as a result of services rendered by the Company. In August
2001, the
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Company withdrew its lawsuit and filed an appeal to the District Board of
Contract Appeals of the decision of the Chief Contracting Officer. See
note 7 above regarding the bad debt expense the Company has recognized for
these receivables.
Other legal proceedings to which the Company is a party, in the opinion of
the Company's management, are not expected to have a material adverse
effect on the Company's financial position, results of operations, or
liquidity.
12. Earnings Per Share
Basic earnings per share is calculated as net income divided by the
weighted average common shares outstanding. Diluted earnings per share is
calculated as net income divided by the weighted average common shares
outstanding including the dilutive effects of potential common shares,
which include the Company's stock options. For all periods presented,
except as provided below, the common stock equivalents are excluded from
the weighted average shares as it would be antidilutive to the per share
calculation. For the nine month period ended July 31, 2000 there was net
income after provision for income tax from discontinued operations of
$552,000. The diluted weighted average number of shares outstanding for
this period however, was only nominally larger than the basic weighted
average number of shares outstanding (as provided below), such that the
basic earnings per share as presented on the Condensed Consolidated
Statements of Operations is the same as the diluted earnings per share
amount. Consequently, the Company has not presented the diluted weighted
average number of shares on the Condensed Consolidated Statements of
Operations for this period. The diluted weighted average number of shares
outstanding for the nine months ended July 31, 2000 was 17,513,000.
13. Supplemental Cash Flow Disclosures
Cash paid for income taxes during the nine months ended July 31, 2001 and
2000 was $109,000 and $170,000, respectively. Cash paid for interest
during the nine months ended July 31, 2001 and 2000 was $30,000 and
$72,000, respectively.
The Company recorded zero and $36,000 for the nine months ended July 31,
2001 and 2000, respectively, as disqualified dispositions related to the
sale of stock acquired through the exercise of certain compensatory stock
options, thereby reducing the Company's tax liability and increasing
shareholders' equity in like amounts.
Non-cash investing activities for the nine months ended July 31, 2001
consist of: (1) a $275,000 note receivable and $2.3 of service credits,
received as consideration in the sale of the Company's EDI business in
January 2001, and (2) a receivable of $280,000 resulting from the sale of
the Company's CDR business in July 2001.
Non-cash financing activities for the nine months ended July 31, 2001
consist of a $721,875 note receivable received from the Company's new
Chief Executive Officer and Chairman of the Board of Directors in exchange
for 550,000 shares of common stock.
14. Impact of Recently Issued Accounting Standards
In July 2001, the FASB issued Statement No. 141, Business Combinations,
and Statement No. 142, Goodwill and Other Intangible Assets. Statement 141
requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001 as well as all purchase method
business combinations completed after June 30, 2001. Statement 141 also
specifies criteria intangible assets acquired in a purchase method
business combination must meet to be recognized and reported apart from
goodwill, noting that any purchase price allocable to an assembled
workforce may not be accounted for separately. Statement 142 will require
that goodwill and intangible assets with indefinite useful lives no longer
be amortized, but instead tested for impairment at least annually in
accordance
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with the provisions of Statement 142. Statement 142 will also require that
intangible assets with definite useful lives be amortized over their
respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with SFAS No. 121, Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of.
The Company is required to adopt the provisions of Statement 141
immediately, except with regard to business combinations initiated prior
to July 1, 2001, which it expects to account for using the
pooling-of-interests method, and Statement 142 effective for fiscal years
beginning after December 15, 2001. Furthermore, any goodwill and any
intangible asset determined to have an indefinite useful life that are
acquired in a purchase business combination completed after June 30, 2001
will not be amortized, but will continue to be evaluated for impairment in
accordance with the appropriate pre-Statement 142 accounting literature.
Goodwill and intangible assets acquired in business combinations completed
before July 1, 2001 will continue to be amortized prior to the adoption of
Statement 142.
Statement 141 will require upon adoption of Statement 142, that the
Company evaluate its existing intangible assets and goodwill that were
acquired in a prior purchase business combination, and to make any
necessary reclassifications in order to conform with the new criteria in
Statement 141 for recognition apart from goodwill. Upon adoption of
Statement 142, the Company will be required to reassess the useful lives
and residual values of all intangible assets acquired in purchase business
combinations, and make any necessary amortization period adjustments by
the end of the first interim period after adoption. In addition, to the
extent an intangible asset is identified as having an indefinite useful
life, the Company will be required to test the intangible asset for
impairment in accordance with the provisions of Statement 142 within the
first interim period. Any impairment loss will be measured as of the date
of adoption and recognized as the cumulative effect of a change in
accounting principle in the first interim period.
In connection with the transitional goodwill impairment evaluation,
Statement 142 will require the Company to perform an assessment of whether
there is an indication that goodwill [and equity-method goodwill] is
impaired as of the date of adoption. To accomplish this the Company must
identify its reporting units and determine the carrying value of each
reporting unit by assigning the assets and liabilities, including the
existing goodwill and intangible assets, to those reporting units as of
the date of adoption. The Company will then have up to six months from the
date of adoption to determine the fair value of each reporting unit and
compare it to the reporting unit's carrying amount. To the extent a
reporting unit's carrying amount exceeds its fair value, an indication
exists that the reporting unit's goodwill may be impaired and the Company
must perform the second step of the transitional impairment test. In the
second step, the Company must compare the implied fair value of the
reporting unit's goodwill, determined by allocating the reporting unit's
fair value to all of it assets (recognized and unrecognized) and
liabilities in a manner similar to a purchase price allocation in
accordance with Statement 141, to its carrying amount, both of which would
be measured as of the date of adoption. This second step is required to be
completed as soon as possible, but no later than the end of the year of
adoption. Any transitional impairment loss will be recognized as the
cumulative effect of a change in accounting principle in the Company's
statement of earnings.
And finally, any unamortized negative goodwill (and negative equity-method
goodwill) existing at the date Statement 142 is adopted must be written
off as the cumulative effect of a change in accounting principle.
As of July 31, 2001, the Company has unamortized goodwill in the amount of
$6.7 million, no unamortized identifiable intangible assets and no
unamortized negative goodwill, all of which will be subject to the
transition provisions of Statements 141 and 142. Amortization expense
related to goodwill was $0.3 million and $0.9 million for the nine months
ended July 31, 2001 and the twelve months ended October 31, 2000,
respectively. The expense for the twelve months ended October 31,
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2000, includes the now discontinued PSG operations. Because of the
extensive effort needed to comply with adopting Statements 141 and 142, it
is not practicable to reasonably estimate the impact of adopting these
Statements on the Company's financial statements at the date of this
report, including whether any transitional impairment losses will be
required to be recognized as the cumulative effect of a change in
accounting principle.
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Certain statements in this report constitute "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Such
forward-looking statements involve known and unknown risks, uncertainties, and
other factors which may cause the actual results, performance, or achievements
of HMSY, or industry results, to be materially different from any future
results, performance, or achievements expressed or implied by such
forward-looking statements. The important factors that could cause actual
results to differ materially from those indicated by such forward-looking
statements include, but are not limited to (i) the information being of a
preliminary nature and therefore subject to further adjustment; (ii) the ability
of HMSY to reduce costs in view of its revised revenue outlook, to grow
internally or by acquisition, to effectively integrate acquired businesses, and
to divest non-strategic assets; (iii) the uncertainties of litigation; (iv)
HMSY's dependence on significant customers; (v) changing conditions in the
healthcare industry which could simplify the reimbursement process and adversely
affect HMSY's business; (vi) government regulatory and political pressures which
could reduce the rate of growth of healthcare expenditures and/or discourage the
assertion of claims for reimbursement against and delay the ultimate receipt of
payment from third party payors; (vii) competitive actions by other companies,
including the development by competitors of new or superior services or products
or the entry into the market of new competitors; (viii) all the risks inherent
in the development, introduction, and implementation of new products and
services; and other factors both referenced and not referenced in this document.
When used in this document, the words "estimate," "project," "anticipate,"
"expect," "intend," "believe," and similar expressions are intended to identify
forward-looking statements, and the above described risks inherent therein.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Three Months Ended July 31, 2001 Compared to Three Months Ended July 31, 2000
The Company's revenue from continuing operations increased by $1.1 million to
$20.6 million for the third quarter ended July 31, 2001 compared with $19.5
million for the comparable prior year quarter. The increase in revenue from the
prior year period reflects an increase in one of the Company's three operating
groups, a decrease in one of the operating groups, and no change in the third
operating group.
The Revenue Services Division, comprised of the Provider Revenue Services Group
("Provider") and the Payor Revenue Services Group ("Payor"), generated revenue
of $15.2 million for the third quarter of fiscal year 2001, an increase of $1.0
million from the comparable prior year period. This net increase of $1.0 million
consists of a $2.6 million increase in Payor revenue reduced by a $1.6 million
decrease in Provider revenue. The increase in Payor revenue resulted from an
expansion in the scope of services provided to two state clients and an increase
in revenue with two other state clients resulting from the completion of certain
revenue generating events during the current period. The net decrease in
Provider revenue resulted from: (1) a decrease associated with the sale of the
Company's EDI business during the first quarter of the current fiscal year, (2)
a decrease associated with the loss of three clients, (3) a decrease resulting
from certain one-time revenue opportunities with a customer in the prior year
period, (4) an increase in revenue associated with an increase in activities
with three clients, and (5) an increase in revenue associated with several new
clients.
The Software Division, currently comprised of the Decision Support Group
("Decision Support"), generated revenue of $5.4 million for the third quarter of
fiscal year 2001, unchanged from the comparable prior year period. The Software
Division previously also included the Payor Systems Group, which effective July
31, 2001, the Company determined to be a discontinued operation. See note 6 to
the interim financial statements for a complete discussion of this decision and
the results of operations for this Group. The Decision Support revenue for the
current period compared with the prior year comparable period includes increases
in license and maintenance revenue associated with new product versions offset
by decreases in consulting service revenue and a decrease in other revenue
resulting from more hardware sales in the prior year period.
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The Company's total cost of services for the third quarter of fiscal year 2001
was $23.2 million, an increase of $2.4 million compared with the prior year
third quarter. This net increase was largely due to $2.7 million in bad debt
expense associated with certain accounts receivable from the District of
Columbia ("District"). See note 7 to the interim financial statements for
additional discussion of this bad debt expense. The Company experienced other
cost of services expense fluctuations compared with the prior year period as
follows. Compensation expense of $11.2 million decreased by $0.6 million from
the prior year third quarter largely reflective of reduced staff levels
resulting from the Company's various restructuring efforts and business
divestitures, partially offset by increased performance and retention bonuses.
Data processing costs of $2.3 million increased by $0.2 million from the prior
year third quarter resulting from increased amortization costs for internally
developed product costs in the Decision Support Group, increased general office
desktop computer expenses, and offset by decreased mainframe hardware and
software equipment rental costs. Occupancy costs of $2.0 million decreased by
$0.3 million from the prior year third quarter reflective of a general decrease
in telecommunications and utilities associated with the decreased staff levels,
and a reduction in expense resulting from a recent subleasing arrangement.
Direct project costs of $4.6 million increased by $3.0 million from the prior
year third quarter substantially due to the $2.7 million of bad debt expense
associated with the accounts receivable from the District discussed in note 7 to
the interim financial statements, and due to subcontractor service fees incurred
for the types of services previously fulfilled internally by the recently sold
EDI and CDR operations. See note 3 to the interim financial statements. Other
operating costs of $3.2 million remained unchanged from the prior year third
quarter reflecting the offsetting impact of an increase in technology consulting
fees associated with a new product development effort, greater provisional bad
debt expense in the prior year period, and decreases in marketing/advertising
and travel costs.
Net interest and net other income and expense of $1.8 million for the current
year third quarter includes a $1.6 million gain on sale. The gain on sale
resulted from the June 30, 2001 sale of substantially all of the assets and
certain liabilities of the Company's wholly owned subsidiary, CDR Associates,
Inc., for $3.2 million. See note 3 to the interim financial statements.
The effective income tax rates of 36% and 41% for the third quarter of fiscal
year 2001 and 2000, respectively, represent the combined federal and state
income tax rates as necessary. The decrease in the current period tax rate was
attributable to the tax effect of the non-deductible portion of impairment
charges incurred during the current fiscal year. Management believes that it is
more likely than not that the results of future operations will generate
sufficient taxable income to realize its deferred tax assets, net of valuation
allowance. In addition, the resultant increase in the net deferred income tax
asset may be offset in part by future taxable gains from additional
divestitures, although there can be no assurances that such divestitures will be
concluded or produce taxable gains.
Loss from discontinued operations includes the results of operations and
estimated loss on disposal of the Company's Payor Systems Group. During July
2001, in light of the loss of two significant customers during 2001 and a
determination that this segment did not fit with the long-term strategies and
operations of the business at-large, the Company implemented a formal plan to
dispose of this business segment through an orderly wind-down of operations
expected to largely be completed by June 2002. The total loss related to the
discontinued operations of $0.7 million in the current year third quarter
includes a pre-tax accrual of $1.6 million for the estimated future operating
losses during the disposal period. See note 6 to the interim financial
statements.
For the third quarter ended July 31, 2001, the Company incurred a net loss of
$1.3 million or $0.07 per common share, compared to a net loss of $0.7 million
or $0.04 per common share during the prior year third quarter. The increase in
net loss was principally the net result of the increase in cost of services
related to the accounts receivable bad debt expense, the gain on sale of CDR,
and the increased loss from discontinued operations, all as discussed above.
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Nine Months Ended July 31, 2001 Compared to Nine Months Ended July 31, 2000
The Company's revenue increased by $0.6 million to $62.1 million for the nine
months ended July 31, 2001 compared with $61.5 million for the comparable prior
year period. The increase in revenue from the prior year period reflects an
increase in two of the Company's three operating groups, and a decrease in one
of the operating groups.
The Revenue Services Division, comprised of the Provider Revenue Services Group
("Provider") and the Payor Revenue Services Group ("Payor"), generated revenue
of $45.2 million for the nine month period ended July 31, 2001, a decrease of
$0.5 million from the comparable prior year period. This net decrease of $0.5
million consists of a $8.0 million decrease in Provider revenue partially offset
by a $7.5 million increase in Payor revenue. The decrease in Provider revenue
resulted from: (1) the non-recurrence of significant revenue during the prior
year period for disproportionate share and retroactive Medicaid rate adjustment
services performed for the District of Columbia, (2) the loss of eight clients
which had been on-going or one-time project clients during the prior year
period, (3) the sale of the Company's EDI business during the first quarter of
the current fiscal year, (4) a temporary slowdown in activities with one client,
and (5) the non-recurrence of a significant revenue opportunity with a client
that occurred in the prior year period. These Provider revenue decreases were
offset by increases resulting from: (1) increased revenue with two clients
associated with an increase in the scope of services provided, for several
facilities and several fiscal years of activity, (2) increased revenue from five
clients associated with a new service offering, and (3) three particular new
clients.
The increase in Payor revenue resulted from: (1) increased revenue on three
state projects which had not yet produced significant revenue during the prior
year period, (2) improved yields on one state project, and (3) specific expanded
scope services on one state project. These Payor revenue increases were slightly
offset by a decrease resulting from the termination of two state clients since
the comparable prior year period.
The Software Division, currently comprised of the Decision Support Group
("Decision Support"), generated revenue of $16.9 million for nine months ended
July 31, 2001 an increase of $1.1 million compared with the prior year period.
Tbe Software Division previously also included the Payor Systems Group, which
effective July 31, 2001 the Company determined to be a discontinued operation.
See note 6 to the interim financial statements for a complete discussion of this
decision and the results of operations for this Group. The Decision Support
revenue for the current period compared with the prior year comparable period
includes increases in license and maintenance revenue associated with the sale
of new product versions, offset by decreases in consulting service revenue
particularly with the Groups' largest client, and a decrease in other revenue
resulting from fewer hardware sales.
The Company's total cost of services for the nine months ended July 31, 2001 was
$65.3 million, a decrease of $2.1 million compared with the prior year period.
This net decrease, which occurred across almost all of the Company's regular
operating cost categories, was reflective of the sale of the Company's EDI
business during the first quarter of the current fiscal year and general cost
decreases resulting from the Company's restructuring efforts reported at the end
of fiscal year 2000. The Company experienced cost of services expense
fluctuations compared with the prior year nine month period as follows.
Compensation expense of $34.5 million decreased by $1.9 million from the prior
year period largely reflective of reduced staff levels resulting from the
Company's various restructuring efforts and business divestitures, partially
offset by increased performance bonuses which are awarded quarterly during the
current year but did not exist in the prior year, and retention bonuses to key
employees as an inducement for them to stay with the Company during the
strategic refocusing process. Data processing costs of $7.1 million increased
by $0.3 million from the prior year nine month period resulting from
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increased amortization costs for internally developed products costs in the
Decision Support Group, increased mainframe hardware and software maintenance
costs, reduced by a decrease in hardware rental costs. Occupancy costs of $6.2
million decreased by $0.5 million from the prior year nine month period due to
the previously noted sale of the Company's EDI business and a general decrease
in voice/data telecommunications and utilities associated with the decreased
staff levels. Direct project costs of $9.3 million increased by $1.2 million
from the prior year nine month period due to: (1) the current year $2.7 million
of bad debt expense associated with account receivables from the District
discussed in note 7 to the interim financial statements, (2) increased marketing
partner fees associated with the conclusion of a vendor relationship, and (3)
increased subcontractor service fees incurred for the types of services
previously fulfilled internally by the recently sold EDI operations, see note 3
to the interim financial statements. These direct project cost increases were
offset by a decrease resulting from the non-recurrence of significant
subcontractor fees recognized in the prior year period associated with the
District projects, and a decrease in keypunch and data costs due the specific
needs of project activities in the prior year period. Other operating costs of
$7.5 million, decreased by $1.9 million from the prior year nine month period
due to significant non-recurring programming costs incurred in the prior year
period and decreases in marketing/advertising and travel costs. These other
operating cost decreases were offset by increases for technology consulting fees
associated with new product development and professional fees associated with
the Company's divestiture activities.
In the second quarter of fiscal year 2001, the Company recognized a
restructuring charge of $785,000 related to the closure of its Washington, D.C.
office, consisting of $503,000 in employee costs, $32,000 in office lease costs,
and $250,000 for the write-off on an initial fee paid for a third party
liability recovery system which the Company has determined will not be put into
use.
Net interest and net other income and expense of $2.2 million for the current
year nine month period includes a $1.6 million gain on sale. The gain on sale
resulted from the June 30, 2001 sale of substantially all of the assets and
certain liabilities of the Company's wholly owned subsidiary, CDR Associates,
Inc., for $3.2 million. See note 3 to the interim financial statements.
The effective income tax rates of 36% and 41% for the nine month periods ended
July 31, 2001 and 2000, respectively, represent the combined federal and state
income tax rates as necessary. The decrease in the current period tax rate was
attributable to the tax effect of the deductible portion of impairment charges
incurred during the current fiscal year. Management believes that it is more
likely than not that the results of future operations will generate sufficient
taxable income to realize its deferred tax assets, net of valuation allowance.
In addition, the resultant increase in the net deferred income tax asset may be
offset in part by future taxable gains from divestitures, although there can be
no assurances that such divestitures will be concluded or produce taxable gains.
Loss from discontinued operations includes the operations of the Company's Payor
Systems Group. During July 2001, in light of the loss of two significant
customers during 2001 and a determination that this segment did not fit with the
long-term strategies and operations of the business at-large, the Company
implemented a formal plan to dispose of this business through an orderly
wind-down of operations. The loss from discontinued operations of $6.5 million
in the current year nine month period includes an accrual of $1.6 million for
the estimated future operating losses during the disposal period, and previously
reported restructuring charges of $5.1 million and impairment of asset charges
of $4.6 million. See note 6 to the interim financial statements.
The cumulative effect of change in accounting principle, net of income tax
benefit of $22.0 million recognized in the prior year nine month period,
reflects the Company's early adoption of SAB 101, as previously reported.
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For the nine months ended July 31, 2001, the Company incurred a net loss of $7.3
million or $0.41 per common share, compared to a net loss of $24.6 million or
$1.41 per common share during the prior year nine month period. The decrease in
net loss was principally the result of the $22.0 million cumulative effect of
change in accounting principle, net of income tax benefit, in the prior year
nine month period and the $1.6 million gain on sale of assets in the current
year period, offset by the significant loss from discontinued operations during
the current period resulting from restructuring and asset impairment charges,
and the $2.7 million of bad debt expense associated with the District projects,
during the current year nine month period.
Liquidity and Capital Resources
Historically, the Company's principal sources of funds are operations and the
remaining proceeds from the Company's initial public offering in 1992. At July
31, 2001, the Company's cash and short-term investments and net working capital
were $20.5 million and $27.0 million, respectively, compared with $16.7 million
and $30.1 million, respectively, at October 31, 2000. The Company's credit
facility, consisting of a $10 million committed revolver and $20 million advised
line of credit, expired on February 13, 2001. The Company had not drawn and did
not intend to draw on this facility, and therefore the Company did not renew the
facility.
For the nine months ended July 31, 2001, cash provided by operating activities
was $1.2 million. During the same period the Company received proceeds of $3.3
million from the sale of the assets of its EDI and CDR operations, and invested
$4.0 million in internally developed software and property and equipment. The
Company anticipates devoting increasingly more resources to product and system
development and enhancements and believes that significant continuing
development efforts will be necessary to adapt to changing marketplace
requirements, and to sustain its operations.
As previously reported, the Company is considering divesting other non-strategic
assets and business operations. As noted above the Company sold its EDI and CDR
businesses during the first nine months of fiscal year 2001 and retained an
investment banking firm to assist in other potential divestitures. Additionally,
the Company has made financial commitments to certain key employees to induce
them to stay during the Company's restructuring, which it currently estimates
could total $1.6 million depending on the completion of divestitures, and of
which, $0.9 million has been paid as of July 31, 2001. Further, the Company is
also in the midst of developing additional restructuring plans focused on
reducing and re-engineering information systems and administrative
infrastructures which may result in additional operating and restructuring
charges, although currently no additional restructuring charges are expected for
the balance of fiscal year 2001.
As the Company divests non-strategic assets and develops new service offerings,
it may seek to acquire companies that supply targeted healthcare providers
and/or payors with information management software, systems, or services which
complement its existing technology, software applications, or client base. The
Company believes that such acquisition opportunities exist, in part, due to the
competitive pressures on local service businesses that lack adequate capital,
technical, and management resources. There can be no assurances that the Company
will have or be able to obtain the necessary resources to acquire subsequently
identified candidates.
On May 28, 1997, the Board of Directors authorized the Company to repurchase
such number of shares of its common stock that have an aggregate purchase price
not in excess of $10,000,000. Since the inception of the repurchase program the
Company has repurchased 1,311,666 shares having an aggregate purchase price of
$8,300,000. No shares have been repurchased in fiscal year 2001.
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Item 3. Quantitative and Qualitative Disclosures About Market Risks
The Company's holdings of financial instruments are comprised of federal, state
and local government debt. All such instruments are classified as securities
available for sale. The Company does not invest in portfolio equity securities
or commodities or use financial derivatives for trading purposes. The Company's
debt security portfolio represents funds held temporarily, pending use in the
Company's business and operations. The Company manages these funds accordingly.
The Company seeks reasonable assuredness of the safety of principal and market
liquidity by investing in rated fixed income securities while, at the same time,
seeking to achieve a favorable rate of return. The Company's market risk
exposure consists principally of exposure to changes in interest rates. The
Company's holdings are also exposed to the risks of changes in the credit
quality of issuers. The Company typically invests in the shorter-end of the
maturity spectrum or highly liquid investments.
The table below presents the historic cost basis and fair value for the
Company's investment portfolio as of July 31, 2001, and the related weighted
average interest rates by year of maturity:
2001 2002 2003 Historical Cost Fair Value
-----------------------------------------------------------------------------------------------------------------------------------
Fixed income assets:
Governmental Securities $ 0 $ 4,648,000 $ 0 $4,648,000 $ 4,675,000
Average interest rate 0.00% 5.01% 0.00% 5.01%
-----------------------------------------------------------------------------------------------------------------------------------
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings -- See Note 11 of Notes to Interim Consolidated
Financial Statements for discussion of certain pending legal
proceedings.
Item 2. Changes in Securities -- None
Item 3. Defaults Upon Senior Securities -- Not applicable
Item 4. Submission of Matters to a Vote of Security Holders -- None
Item 5. Other Information -- None
Item 6. Exhibits and Reports on Form 8-K
Exhibits - See exhibit index
Reports on Form 8-K - None
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: September 14, 2001 HEALTH MANAGEMENT SYSTEMS, INC.
--------------------------------
(Registrant)
By: /s/ William F. Miller III
------------------------------------
William F. Miller III
Chairman and Chief Executive Officer
By: /s/ Robert M. Holster
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Robert M. Holster
President, Chief Operating Officer, and
Interim Chief Financial Officer
21
24
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
EXHIBIT INDEX
Exhibit Number Description of Exhibits
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2 Asset Purchase Agreement by and among Health Management
Systems, Inc., CDR Associates, Inc., CDR Associates,
L.L.C., Joseph H. Czajkowski, and Jeffrey R. Donnelly
22