SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[ ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended
OR
[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from November 1, 2000 to December 31, 2000
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 December 1, 2001
- ---------------------------------- --------------------------------
Common Stock, $.01 Par Value 17,900,361 Shares
HEALTH MANAGEMENT SYSTEMS, INC.
INDEX TO FORM 10-Q
Two Month Transition Period ended December 31, 2000
PART I FINANCIAL INFORMATION Page No.
Item 1 Financial Statements
Condensed Consolidated Balance Sheets 1
(unaudited) as of December 31, 2000 and October
31, 2000
Condensed Consolidated Statements of Operations 2
(unaudited) for the two month periods ended
December 31, 2000 and 1999
Consolidated Statements of Comprehensive Loss 3
(unaudited) for the two month periods ended
December 31, 2000 and 1999
Consolidated Statement of Shareholders' Equity 4
(unaudited) for the two month period ended
December 31, 2000
Condensed Consolidated Statements of Cash Flows 5
(unaudited) for the two month periods ended
December 31, 2000 and 1999
Notes to Consolidated Financial Statements 6
(unaudited)
Item 2 Management's Discussion and Analysis of Financial 13
Condition and Results of Operations
Item 3 Quantitative and Qualitative Disclosures About 16
Market Risks
PART II OTHER INFORMATION 16
SIGNATURES 17
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
($ In Thousands)
(unaudited)
December 31, October 31,
2000 2000
------------ ------------
Assets
Current assets:
Cash and cash equivalents $ 6,187 $10,573
Short-term investments 7,387 6,167
Accounts receivable, net 18,579 19,286
Prepaid expenses and other current assets 7,875 8,548
------- -------
Total current assets 40,028 44,574
Property and equipment, net 5,051 5,509
Capitalized software costs, net 2,049 1,835
Goodwill, net 7,366 7,425
Deferred income taxes, net 7,156 6,643
Other assets 506 489
Net assets of discontinued operations 13,146 11,468
------- -------
Total assets $75,302 $77,943
======= =======
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable and accrued expenses $ 9,005 $10,748
Deferred revenue 36 51
------- -------
Total current liabilities 9,041 10,799
Other liabilities 1,480 1,546
-------
------- -------
Total liabilities 10,521 12,345
------- -------
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;
18,563,922 shares issued and 17,252,256 shares outstanding at December 31, 2000;
18,563,922 shares issued and 17,252,256 shares outstanding at October 31, 2000 186 186
Capital in excess of par value 72,170 72,170
Retained earnings 817 1,652
Accumulated other comprehensive loss (92) (110)
Treasury stock, at cost, 1,311,666 shares at December 31, 2000 and October 31, 2000 (8,300) (8,300)
------- -------
Total shareholders' equity 64,781 65,598
------- -------
Total liabilities and shareholders' equity $75,302 $77,943
======= =======
See accompanying notes to unaudited condensed consolidated financial statements.
1
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Amounts)
(unaudited)
Two months ended December 31,
-----------------------------
2000 1999
-------- --------
Revenue $ 9,207 $ 8,524
-------- --------
Cost of services:
Compensation 6,037 6,204
Data processing 1,173 1,274
Occupancy 1,306 1,192
Direct project costs 737 1,464
Other operating costs 1,381 1,732
Amortization of intangibles 59 61
-------- --------
10,693 11,927
-------- --------
Operating loss (1,486) (3,403)
Net interest and net other income 138 221
-------- --------
Loss from continuing operations before income taxes and
cumulative effect of change in accounting principle (1,348) (3,182)
Income tax benefit (548) (1,320)
-------- --------
Loss from continuing operations before cumulative
effect of change in accounting principle (800) (1,862)
Discontinued operations:
Income (loss) from discontinued operations, net (35) 525
-------- --------
Loss before cumulative effect of
change in accounting principle (835) (1,337)
Cumulative effect of change in accounting
principle, net of tax benefit ("cumulative effect") -- (21,965)
-------- --------
Net loss $ (835) $(23,302)
======== ========
Basic and diluted earnings per share data:
Loss per share from continuing
operations before cumulative effect $ (0.05) $ (0.11)
Income (loss) per share from discontinued operations, net (0.00) 0.03
Loss per share from cumulative effect, net -- (1.26)
-------- --------
Net loss per share $ (0.05) $ (1.34)
======== ========
Weighted average common shares outstanding 17,252 17,403
======== ========
See accompanying notes to unaudited condensed consolidated financial statements.
2
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
($ In Thousands)
(unaudited)
Two months ended
December 31,
-----------------------
2000 1999
---------- ---------
Net loss $ (835) $ (23,302)
Other comprehensive income, net of tax:
Change in net unrealized appreciation on short-term investments 18 10
---------- ----------
Comprehensive loss $ (817) $ (23,292)
========== ==========
See accompanying notes to unaudited condensed consolidated financial statements.
3
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
($ In Thousands)
(unaudited)
Common Stock
--------------------------- Capital In
# of Shares Par Excess Of Retained
Issued Value Par Value Earnings
----------- ------ ---------- ---------
Balance at October 31, 2000 18,563,922 $ 186 $ 72,170 $ 1,652
Net loss -- -- (835)
Change in net unrealized
appreciation on
short-term investments -- -- -- --
---------- ---------- ---------- ----------
Balance at December 31, 2000 18,563,922 $ 186 $ 72,170 $ 817
========== ========== ========== ==========
Accumulated
Other Treasury Stock Total
Comprehensive ----------------------------- Shareholders'
Income/(Loss) # of Shares Amount Equity
--------------- ------------ --------- -----------
Balance at October 31, 2000 ($110) 1,311,666 ($8,300) $ 65,598
Net loss -- -- -- (835)
Change in net unrealized
appreciation on
short-term investments 18 -- -- 18
---------- ---------- ---------- ----------
Balance at December 31, 2000 ($ 92) 1,311,666 ($ 8,300) $ 64,781
========== ========== ========== ==========
See accompanying notes to unaudited condensed consolidated financial statements.
4
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
($ In Thousands)
(unaudited)
Two months
ended December 31,
--------------------------
2000 1999
----------- -----------
Net cash used in operating activities $ (1,237) $ (9,939)
----------- -----------
Investing activities:
Purchases of property and equipment (55) (85)
Investment in software (214) -
Net purchases of short-term investments (1,202) (2,932)
----------- -----------
Net cash used in investing activities (1,471) (3,017)
----------- -----------
Cash provided by (used in) financing activities - -
----------- -----------
Net decrease in cash and cash equivalents (2,708) (12,956)
Cash and cash equivalents at beginning of period 10,573 16,310
Cash (used in) provided by discontinued operations (1,678) 1,475
----------- -----------
Cash and cash equivalents at end of period $ 6,187 $ 4,829
=========== ===========
See accompanying notes to unaudited condensed consolidated financial statements.
5
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Item 1 Notes to Unaudited Financial Statements:
1. Unaudited Interim Financial Information
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the accounting principles generally accepted in
the United States of America for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they
do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. 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, April 30, 2001 and July 31, 2001 included in
the Company's Quarterly Reports on Form 10-Q, each as filed with the
Securities and Exchange Commission (the "SEC").
On October 30, 2001, the Board of Directors of Health Management Systems,
Inc. elected to change the Company's fiscal year end from October 31 to
December 31 effective with the year beginning January 1, 2001, as announced
in its current report on Form 8-K filed on November 13, 2001. The two month
period ended December 31, 2000 is the Company's transition period. This
Transition Report on Form 10-Q presents the Company's results of operations
for the two month periods ended December 31, 2000 and 1999.
2. Reclassifications
Certain reclassifications were made to prior period amounts to conform to the
current presentation.
3. 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 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 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 $27.9 million subsequently completed its
cycle and was included in the Company's revenue and operating
6
results through December 31, 2000 of which $3.3 million and $7.2 million
related to the two months ended December 31, 2000 and 1999, respectively.
4. Restructuring
In the fourth quarter of fiscal year 2000, having completed a full-scale
strategic planning process, the Company began implementation of a
restructuring plan and recorded a restructuring charge of $3,483,000. At
December 31, 2000, the remaining liabilities associated with this
restructuring charge consist of $442,000 for occupancy costs, and $1,009,000
for compensation costs, of which $542,000 is presented as a long term
liability.
5. Credit Facility
The Company's credit facility, consisting of a $10 million committed revolver
and $20 million advised line of credit, expired on February 13, 2001. The
Company had never drawn on this facility and did not intend to draw on this
facility, and therefore the Company did not renew the facility.
6. Segment Information
The Company measures the performance of its operating segments utilizing
operating income (loss), as reflected in the accompanying condensed
consolidated statements of operations. Certain reclassifications were made to
prior year amounts to conform to the current presentation.
Provider Payor
Revenue Revenue
TOTAL Services Services
($ in Thousands) HMS Group Group
- -------------------------------------------------------------------------------
Two months ended December 31, 2000
Revenue 9,207 5,731 3,476
Operating loss (1,486) (1,103) (383)
Two months ended December 31, 1999
Revenue 8,524 6,774 1,750
Operating loss (3,403) (1,609) (1,794)
The difference between "Operating loss" and "Loss from continuing operations
before income taxes and cumulative effect of change in accounting principle"
is "Net interest and net other income," which totaled $138,000 and $221,000
for the two months ended December 31, 2000 and 1999, respectively.
7. 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 two month
period ended December 31, 1999 there was net income after provision for
income tax from discontinued operations of $0.5 million. 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
7
Operations for this period. The diluted weighted average number of shares
outstanding for the two months ended December 31, 1999 was 17,456,000.
8. Supplemental Cash Flow Disclosures
Cash paid for income taxes during the two months ended December 31, 2000 and
1999 was $1,000 and $11,000, respectively. Cash paid for interest during the
two months ended December 31, 2000 and 1999 was zero and $13,000,
respectively.
9. 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 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
8
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 December 31, 2000, the Company had unamortized goodwill in the amount
of $7.4 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 $59,000 and $947,000 for the two months ended December 31, 2000
and the twelve months ended October 31, 2000, respectively. The expense for
the twelve months ended October 31, 2000, includes the now discontinued Payor
Systems Group 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.
10. Subsequent Events
On December 11, 2001, the Company sold its healthcare decision support
software systems and services business, Health Care microsystems, Inc.
("HCm"), a wholly owned subsidiary, which operated as the Company's Decision
Support Group, for $9.8 million. Proceeds from the sale, which are subject to
certain post close price adjustments and transaction costs estimated at $0.3
million and $0.4 million, respectively, were $9.2 million in cash and the
assumption of $0.6 million of the Company's liabilities by the Purchaser. HCm
was purchased by its executive management team. The HCm business generated
revenues of $21.8 million and $3.2 million, and operating income of $2.4
million and $85,000 for the year ended October 31, 2000 and the two months
ended December 31, 2000, respectively.
HCm has previously been reported as the Decision Support Group ("DSG") of the
Company. As a result of the sale of this business segment, DSG has been
reflected in the accompanying financial statements as a discontinued
business.
During the period ended July 31, 2001, the Company determined to discontinue
its Payor Systems Group ("PSG"). The facts and circumstances relating to the
discontinuance of this business segment is disclosed in the Company's Report
on Form 10-Q as of and for the period ended July 31, 2001.
The net assets of the Company's discontinued business segments which consist
of PSG and DSG are as follows:
9
As of December 31, 2000 As of October 31, 2000
PSG DSG Total PSG DSG Total
------- ------- ------- ------- ------- -------
Current assets $ 1,704 $ 2,928 $ 4,632 $ 1,784 $ 2,393 $ 4,177
Property and equipment 856 821 1,677 806 901 1,707
Capitalized software
costs 3,260 5,458 8,718 2,579 5,508 8,087
Goodwill 4,579 -- 4,579 4,630 -- 4,630
Other assets 388 21 409 236 21 257
------- ------- ------- ------- ------- -------
Total assets 10,787 9,228 20,015 10,035 8,823 18,858
Current
liabilities 1,702 5,167 6,869 1,349 6,041 7,390
------- ------- ------- ------- ------- -------
Net assets $ 9,085 $ 4,061 $13,146 $ 8,686 $ 2,782 $11,468
======= ======= ======= ======= ======= =======
The results of operations for the discontinued business segments are presented
on one line item in the accompanying statements of operations for the periods
ended December 31, 2000 and 1999. The components of the operations of the
discontinued business segments are as follows:
Two month period Two month
ended period ended
December 31, 2000 December 31, 1999
----------------- -----------------
PSG DSG Total PSG DSG Total
------------------------------- ------------------------------
Revenue $ 1,361 $ 3,186 $ 4,547 $ 2,254 $ 3,816 $ 6,070
Operating
income/(loss) (149) 85 (64) 200 680 880
Income tax
expense/(benefit) (60) 36 (24) 88 283 371
Net income/(loss) (88) 53 (35) 126 399 525
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 Bankruptcy Court on June 5, 2001. At that
time, the Bankruptcy Court dismissed the first cause of action and ruled that
it would abstain on dismissal of the second cause of action. In September
2001, plaintiffs filed in New York State Court an Amended Complaint alleging
the second cause of action, and in November 2001, defendants filed a motion
to dismiss the Amended Complaint. Defendants' motion to dismiss the Amended
Complaint is expected to be fully briefed and submitted to the New York State
Court in January 2002. The Company intends to continue its vigorous defense
this lawsuit. Management believes the risk of loss is not
10
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.
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
11
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
Company withdrew its lawsuit and filed an appeal to the District Board of
Contract Appeals of the decision of the Chief Contracting Officer.
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
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
Two Months Ended December 31, 2000 Compared to the Two Months Ended December
31,1999
The Company's revenue from continuing operations increased by $0.7 million to
$9.2 million for the two month period ended December 31, 2000 compared with $8.5
million for the comparable prior year period. The net increase of $0.7 million
consists of a $1.7 million increase in Payor Revenue Service Group ("Payor")
revenue reduced by a $1.0 million decrease in Provider Revenue Service Group
("Provider") revenue. The increase in Payor revenue primarily consisted of $0.8
million resulting from increased activities with one client during the current
year period compared with the prior year period, $0.6 million associated with an
expansion in the scope of services provided to one state client and $0.6 million
of additional revenue generated from a new client, offset by a $0.3 million
decrease from the expiration of one client relationship. The net decrease in
Provider revenue consisted of: (1) $1.0 million associated with the loss of two
clients, and (2) a decrease of $0.8 million resulting from a decrease in
activity with three clients, offset by (3) an increase of $0.9 million resulting
from increased activities with one client and (4) an increase of $0.3 million
resulting from an expansion in the scope of services provided to one client.
The Company's total cost of services for the two month period ended December 31,
2000 was $10.7 million, a decrease of $1.2 million compared with the same period
in the prior year. The Company experienced cost of services expense fluctuations
compared with the prior year period as follows. Compensation expense of $6.0
million decreased by $0.2 million from the prior year two month period largely
reflective of reduced staff levels resulting from the Company's restructuring
initiatives undertaken during October 31, 2000. Data processing costs of $1.2
million decreased by $0.1 million from the prior year period, reflective of
nominal fluctuations in a few cost categories. Occupancy costs of $1.3 million
increased by $0.1 million from the prior year two month period primarily due to
increased rent costs. Direct project costs of $0.7 million decreased by $0.7
million from the prior year period substantially due to $0.6 million in
subcontractor fees incurred in the prior year period for a Provider client
account which was not active during the current year period, and consulting fees
incurred in the prior year period for a Payor client that did not have similar
business needs during the current period. Other operating costs of $1.4 million
decreased by $0.3 million from the prior year two month
13
period mostly related to $0.3 million in technology consulting fees for a small
system enhancement project during the prior year period.
Net interest and net other income of $138,000 for the two month period ended
December 31, 2000, compared with $221,000 during the comparable prior year
period is reflective of a decrease in the average cash balance available for
investment.
The effective income tax rates of 40.6 % and 41.5% for the two month periods
ended December 31, 2000 and 1999, respectively, represent the combined federal
and state income tax rates as necessary. 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.
The Company implemented a change in accounting for revenue recognition 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 cumulative effect of this change in accounting principle
as of the beginning of the Company's fiscal year 2000 is $22.0 million, net of
income tax benefit.
Discontinued operations includes the results of operations of the Company's
Payor Systems Group and Decision Support Group. Regarding the 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. See the related
discussion in note 6 to the interim financial statements as reported in the Form
10-Q filing for the period ended July 31, 2001. Regarding the Decision Support
Group, on December 11, 2001, the Company sold Health Care microsystems, Inc.
("HCm"), a wholly owned subsidiary, which operated as the Company's Decision
Support Group, as disclosed in Note 10 to the Notes to Interim Consolidated
Financial Statements, above.
For the two months ended December 31, 2000, the Company incurred a net loss of
$0.8 million or $0.05 per common share, compared to a net loss of $23.3 million
or $1.34 per common share during the prior year comparable period. The decrease
in net loss principally resulted from the cumulative effect of the change in
accounting principle incurred during the prior year two 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
December 31, 2000, the Company's cash and short-term investments and net working
capital were $13.6 million and $31.0 million, respectively, compared with $16.7
million and $33.8 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 two months ended December 31, 2000, cash used by operating activities
was $1.2 million. This use of cash primarily resulted from a decrease in
accounts payable and accrued expenses of $1.7 million. During this period the
Company invested $0.3 million in internally developed software and property and
14
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 non-strategic
assets and business operations. The Company has reported transactions of this
nature in its Form 10-Q filings subsequent to its Form 10-K filing for the
fiscal year ended October 31, 2000. Additionally, the Company has also
subsequently reported on financial commitments made to certain key employees to
induce them to stay during the Company's restructuring. 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.
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 $10.0 million. Since the inception of the repurchase program
the Company has repurchased 1,311,666 shares having an aggregate purchase price
of $8.3 million. No shares have been repurchased in fiscal year 2001. The
Company may make additional repurchases in the future based on its assessment of
the Company's cash position and the current market price of the shares.
15
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 December 31, 2000, and the related weighted
average interest rates by year of maturity:
Total Total
2001 2002 2003 Historical Cost Fair Value
- ---------------------------------------------------------------------------------------------------
Fixed income assets:
Governmental Securities $3,810,000 $2,645,000 $1,001,000 $7,456,000 $7,387,000
Average interest rate 5.49% 5.78% 4.15% 5.41%
- ---------------------------------------------------------------------------------------------------
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 - None
Reports on Form 8-K - None
16
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: December 19, 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
------------------------------------
Robert M. Holster
President, Chief Operating Officer,
and Interim Chief Financial Officer
17