UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002
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 or other jurisdiction of (I.R.S. Employer)
incorporation or organization) Identification No.)
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 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. Yes [X] No [ ]
The number of shares common stock, $.01 par value, outstanding as of
April 30, 2002 was 18,171,225.
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
PAGE
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of March 31, 2002 (unaudited) and December 31, 2001........... 3
Condensed Consolidated Statements of Operations (unaudited) for the three month periods
ended March 31, 2002 and 2001...................................................................... 4
Condensed Consolidated Statement of Shareholders' Equity and Comprehensive Loss (unaudited)
for the three month period ended March 31, 2002.................................................... 5
Condensed Consolidated Statements of Cash Flows (unaudited) for the three month periods
ended March 31, 2002 and 2001...................................................................... 6
Notes to Condensed Consolidated Financial Statements (unaudited)....................................... 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................. 13
Item 3. Quantitative and Qualitative Disclosures About Market Risks........................................... 18
PART II - OTHER INFORMATION...................................................................................... 18
Signatures....................................................................................................... 19
2
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
March 31, December 31,
2002 2001
------------- --------------
ASSETS (unaudited)
Current assets:
Cash and cash equivalents $ 18,218 $ 21,020
Short-term investments 4,000 4,022
Accounts receivable, net 14,873 12,720
Prepaid expenses and other current assets 2,043 2,420
------------- --------------
Total current assets 39,134 40,182
Property and equipment, net 4,131 4,228
Capitalized software costs, net 411 466
Goodwill, net 5,679 5,679
Deferred income taxes, net 8,920 8,920
Other assets 598 650
Net assets of discontinued operations 117 269
------------- --------------
Total assets $ 58,990 $ 60,394
============= ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued expenses and other liabilities $ 12,057 $ 13,417
Net liabilities of discontinued operations 529 527
------------- --------------
Total current liabilities 12,586 13,944
Other liabilities 704 669
------------- --------------
Total liabilities 13,290 14,613
------------- --------------
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;
19,423,589 shares issued and 18,106,573 shares outstanding at March 31, 2002;
19,332,089 shares issued and 18,015,073 shares outstanding at December 31, 2001; 194 193
Capital in excess of par value 73,865 73,550
Unearned stock compensation (155) (128)
Accumulated deficit (19,474) (18,755)
Accumulated other comprehensive loss (54) (42)
Treasury stock, at cost; 1,317,016 shares at March 31, 2002
and December 31, 2001 (8,315) (8,315)
Note receivable from officer for sale of stock (361) (722)
------------- --------------
Total shareholders' equity 45,700 45,781
------------- --------------
Total liabilities and shareholders' equity $ 58,990 $ 60,394
============= ==============
See accompanying notes to condensed consolidated financial statements.
3
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Month Periods ended March 31, 2002 and 2001
(in thousands, except per share amounts)
(unaudited)
2002 2001
--------------- -----------------
Revenue $ 16,870 $ 14,515
--------------- -----------------
Cost of services:
Compensation 9,465 8,730
Data processing 1,545 1,680
Occupancy 1,524 1,663
Direct project costs 2,262 1,805
Other operating costs 2,952 1,305
Amortization of intangibles - 88
--------------- -----------------
Total cost of services 17,748 15,271
--------------- -----------------
Operating loss (878) (756)
Net interest income 159 187
--------------- -----------------
Loss from continuing operations before income taxes (719) (569)
Income tax benefit - (166)
--------------- -----------------
Loss from continuing operations (719) (403)
Discontinued operations:
Income from discontinued operations, net - 927
--------------- -----------------
Discontinued operations - 927
Net income (loss) $ (719) $ 524
=============== =================
Basic and diluted earnings per share data:
Loss per share from continuing operations $ (0.04) $ (0.02)
Income per share from discontinued operations, net - 0.05
--------------- -----------------
Net income (loss) per share $ (0.04) $ 0.03
=============== =================
Weighted average common shares outstanding 18,051 17,774
=============== =================
See accompanying notes to condensed consolidated financial statements.
4
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE LOSS
For the Three Months ended March 31, 2002
(in thousands, except share amounts)
(unaudited)
Common Stock
------------------------------ Capital In Unearned
# of Shares Par Excess Of Stock Accumulated
Issued Value Par Value Compensation Deficit
------------------------------------------------------------------------------------------
Balance at December 31, 2001 19,332,089 $ 193 $ 73,550 $ (128) $ (18,755)
Comprehensive loss:
Net loss -- -- -- -- (719)
Change in net unrealized
appreciation on
short-term investments -- -- -- -- --
Total comprehensive loss
Repayment of note receivable -- -- -- -- --
Exercise of stock options 91,500 1 143 -- --
Remeasurement of unearned
stock compensation -- -- 172 (172) --
Stock compensation expense -- -- -- 145 --
----------- ----------- ----------- ----------- -----------
Balance at March 31, 2002 19,423,589 $ 194 $ 73,865 $ (155) $ (19,474)
=========== =========== =========== =========== ===========
Accumulated Note
Other Treasury Stock Receivable Total
Comprehensive ----------------------------- from Sale Shareholders'
Loss # of Shares Amount of Stock Equity
-------------------------------------------------------------------------------------------
Balance at December 31, 2001 $ (42) 1,317,016 $ (8,315) $ (722) $ 45,781
Comprehensive loss:
Net loss -- -- -- -- (719)
Change in net unrealized
appreciation on
short-term investments (12) -- -- -- (12)
-----------
Total comprehensive loss (731)
Repayment of note receivable -- -- -- 361 361
Exercise of stock options -- -- -- -- 144
Remeasurement of unearned
stock compensation -- -- -- -- --
Stock compensation expense -- -- -- -- 145
----------- ----------- ----------- ----------- -----------
Balance at March 31, 2002 $ (54) 1,317,016 $ (8,315) $ (361) $ 45,700
=========== =========== =========== =========== ===========
See accompanying notes to condensed consolidated financial statements.
5
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Month Periods ended March 31, 2002 and 2001
(in thousands)
(unaudited)
2002 2001
-------- --------
Operating activities:
Net income (loss) $ (719) $ 524
Adjustments to reconcile net income (loss) to net cash
from operating activities:
Income from discontinued operations -- (927)
Depreciation and amortization 602 540
Amortization of intangibles -- 88
Provision for doubtful accounts 75 10
Stock compensation expense 145 --
Decrease in deferred taxes -- 445
Changes in assets and liabilities:
(Increase) decrease in accounts receivable (2,228) 1,097
Decrease in other current assets 377 730
Decrease in other assets 52 54
Increase (decrease) in accounts payable, accrued expenses
and other liabilities (1,325) 1,335
-------- --------
Net cash provided by (used in) operating activities (3,021) 3,896
-------- --------
Investing activities:
Purchases of property and equipment (450) (296)
Investment in software -- (423)
Proceeds from sale of assets, EDI operations, net -- 455
Repayments of note receivable from officer for sale of stock 361 --
Net proceeds from sales/(purchases) of short-term investments 10 (980)
-------- --------
Net cash used in investing activities (79) (1,244)
-------- --------
Financing activities:
Proceeds from exercise of stock options 144 --
Proceeds from issuance of common stock, employee stock purchase plan -- 24
-------- --------
Net cash provided by financing activities 144 24
-------- --------
Net increase (decrease) in cash and cash equivalents (2,956) 2,676
Cash and cash equivalents at beginning of period 21,020 6,187
Cash provided by discontinued operations 154 834
-------- --------
Cash and cash equivalents at end of period $ 18,218 $ 9,697
======== ========
Supplemental disclosure of noncash investing and financing activities:
Service credits received as consideration from sale of assets $ -- $ 2,259
======== ========
Sale of common stock to officer for note receivable $ -- $ 722
======== ========
Supplemental disclosure of cash flow information:
Cash paid for interest $ -- $ 18
======== ========
Cash paid for income taxes $ 75 $ 54
======== ========
See accompanying notes to condensed consolidated financial statements.
6
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED 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 condensed
consolidated financial statements and the related information included in the
notes to the condensed consolidated financial statements. In the opinion of
management, the unaudited interim condensed 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 condensed consolidated financial statements
should be read in conjunction with the audited consolidated financial statements
of the Company as of and for the year ended December 31, 2001 included in the
Company's Annual Report on Form 10-K for such year, as filed with the Securities
and Exchange Commission (the "SEC").
2. BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
(a) Change in Fiscal Year
On October 30, 2001, the Board of Directors approved a change of the
Company's fiscal year to December 31 from October 31. The change was retroactive
to January 1, 2001. Accordingly, the Company changed its fiscal quarters to the
calendar quarters.
(b) Discontinued Operations of Business Segments
During the year ended December 31, 2001, the Company sold its Decision
Support Group ("DSG") business unit and implemented a formal plan to proceed
with an orderly closure of the Payor Systems Group ("PSG") business unit. In
prior periods, DSG and PSG had been separate reportable segments. The current
and historical operating results of DSG and PSG have been reported as
discontinued operations on the accompanying Condensed Consolidated Statements of
Operations. The current and noncurrent assets and liabilities of DSG and PSG are
presented on a net basis as discontinued operations on the Condensed
Consolidated Balance Sheets for all periods presented.
(c) Principles of Consolidation
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany balances
and transactions have been eliminated in consolidation.
(d) Reclassifications
Certain reclassifications were made to prior amounts to conform to the
current presentation.
3. INCOME TAXES
For the three months ended March 31, 2002, the Company generated an
additional gross deferred tax asset of $288,000 resulting from the Company's
net operating loss of $719,000. Correspondingly, the Company recognized an
increase in the valuation allowance related to the realizability of its deferred
tax assets in the amount of $288,000. The net deferred tax asset balance was
therefore $8.9 million at March 31, 2002 and December 31, 2001. The increase in
the valuation allowance was specifically associated with the Company's net
operating loss carryforwards ("NOLs"), which account for the majority of the
Company's deferred tax assets. The Company believes the available objective
evidence, principally its recent taxable losses, creates sufficient uncertainty
regarding the realizability of its NOLs, that it is more likely than not, that
some of the NOLs are not realizable. The Company determined the amount of the
valuation allowance based on its assessment of the recoverability of the
deferred tax assets by projecting future taxable income. The realizability of
the Company's deferred tax assets and the corresponding valuation allowance will
be adjusted in the future
7
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
based on the Company's actual taxable income results and updated estimates of
future taxable income. The Company believes that it is more likely than not that
the results of future operations will generate sufficient taxable income to
realize the deferred tax assets, net of valuation allowance, based on its
projection of future operating results.
4. RESTRUCTURINGS AND DISCONTINUED OPERATIONS
(a) Restructurings
In April 2001, the Company recognized a restructuring charge of
$785,000. This charge was subsequently adjusted by $38,000 in November 2001, to
a net charge of $747,000. This net charge related to the closure of the
Washington, D.C. office, consisting of $198,000 in employee costs (representing
4 employees), $299,000 in office lease and fixed asset costs, and $250,000 for
the write-off of an initial fee paid for a third party liability recovery system
which the Company had determined would not be put into use. Of the total
restructuring charges, $209,000 and $269,000 remained as accrued liabilities at
March 31, 2002 and December 31, 2001, respectively.
In December 2001, the Company recognized a restructuring charge of $1.8
million consisting of $1.3 million for facility costs associated with reducing
the amount of space the Company occupies at its headquarters in New York City,
and $500,000 for severance costs associated with reducing 20 employees in the
information technology and facilities maintenance departments. Of the total
restructuring charges, $1.6 million and $1.8 million remained as a liability at
March 31, 2002 and December 31, 2001, respectively.
(b) Discontinued Operations of Business Segments
(i) Discontinuance of Payor Systems Group ("PSG")
On July 31, 2001, the Company implemented a formal plan to proceed with
an orderly closing of PSG. The Company's formal plan of
discontinuance is expected to be substantially executed by June 2002. As of
July 31, 2001 the Company had estimated a pre-tax loss on disposal of $1.6
million. As a result of experiencing significant success in exiting various
business obligations, the Company reduced its estimated loss to $200,000 as of
December 31, 2001 and it has remained unchanged as of March 31, 2002.
The results of PSG's operations have been reported as discontinued
operations in the Consolidated Statements of Operations for both periods
presented.
In April 2001, the Company incurred a restructuring charge of $5.1
million related to PSG, resulting from the decision to discontinue development
of its managed care system offering. The charge consisted of $3.5 million 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 July 2001, the Company
recognized a net reduction to these restructuring charges of $315,000 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, $290,000 and $422,000 in lease termination and related facility costs
remain as liabilities at March 31, 2002 and December 31, 2001, respectively, and
are reflected in the net liability of discontinued operations.
(ii) Sale of Decision Support Group ("DSG")
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 DSG
business segment, to HCm's executive management team ("Purchaser") for a total
sale price of $9.8 million.
As a result of the sale of this business segment, DSG has been
reflected in the accompanying financial statements as a discontinued operation.
8
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
(iii) Discontinued Operations Information
Results of operations from discontinued operations were as
follows (in thousands):
Three Months Three Months
Ended March 31, 2002 Ended March 31, 2001
PSG DSG Total PSG DSG Total
------------------------------------------ -------------------------------------------
Revenue $1,179 $ - $1,179 $2,722 $ 5,929 $ 8,651
------------------------------------------ -------------------------------------------
Income before income taxes - - - 439 1,100 1,539
Income tax expense - - - 174 438 612
------------------------------------------ -------------------------------------------
Income from discontinued operations $ - $ - $ - $ 265 $ 662 $ 927
------------------------------------------ -------------------------------------------
Assets and liabilities of the discontinued operations of PSG were as
follows (in thousands):
March 31, December 31,
2002 2001
------- -------
Current assets $ 1,052 $ 852
Current liabilities (1,581) (1,379)
------- -------
Net current liabilities ($ 529) ($ 527)
------- -------
Property and equipment $ 21 $ 78
Capitalized software costs 96 191
------- -------
Net noncurrent assets $ 117 $ 269
------- -------
5. 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 the Company's client. 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 $40.3 million has subsequently completed
its cycle and has been included in the Company's revenue and operating results
through March 31, 2002, of which $19,000 occurred during the three months ended
March 31, 2002. The remaining balance is for services that the Company performed
associated with claims for uncollectible bad debts and disproportionate share
credits that are in process of settlement through the Medicare cost report
appeal procedure. These items have been filed and accepted for processing and
are currently pending before the Provider Reimbursement Review Board, one of the
final administrative steps in the Medicare cost report appeal process. This
process can routinely take several years to complete. These receivables will be
invoiced when the Company's clients receive settlements.
9
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
6. SEGMENT INFORMATION
The Company's Provider Services Division offers hospitals and other
healthcare providers Extended Business Office and Reimbursement services. The
Company's Payor Services Division offers Third Party Liability Recovery services
to governmental agencies that administer health care entitlement programs, most
notably Medicaid agencies. The Company measures the performance of its operating
segments utilizing operating income (loss), as reflected in the accompanying
condensed consolidated statements of operations. Certain reclassifications were
made to prior year amounts to conform to the current presentation.
Total HMSY,
Excluding Provider Payor
Discontinued Services Services
($ in Thousands) Operations Division Division Corporate
- ----------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31, 2001
Revenue $ 14,515 $ 7,745 $ 6,770 $ --
Operating income (loss) ($ 756) ($ 783) $ 67 ($ 40)
THREE MONTHS ENDED MARCH 31, 2002
Revenue $ 16,870 $ 9,024 $ 7,846 $ --
Operating income (loss) ($ 878) ($ 1,951) $ 1,073 $ --
Goodwill amortization expense related to goodwill arising from the
Company's 1989 recapitalization is shown in the corporate category. Upon the
adoption of SFAS 142 in 2002, as discussed in note 9 below, the Company
ceased to amortize goodwill.
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 the three months ended March 31, 2002,
the common stock equivalents are excluded from the weighted average shares as it
would be antidilutive to the per share calculation. For the three months ended
March 31, 2001 the Company had net income from discontinued operations and net
income of $927,000 and $524,000, respectively. 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 accompanying
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 accompanying condensed
consolidated statements of operations. The diluted weighted average number of
shares outstanding for the three months ended March 31, 2002 and 2001 were
20,738,351 and 18,094,605, respectively.
8. COMMITMENTS -- LEGAL PROCEEDINGS
As more fully discussed in Note 17(b) of the Notes to the Consolidated
Financial Statements as filed on Form 10-K for the year ended December 31, 2001,
the Company is subject to a lawsuit which commenced in June 1998. The lawsuit
was filed by certain holders of promissory notes of HHL Financial Services, Inc.
("HHL"), alleging the defendants, including the Company, breached various
fiduciary duties between 1990 and 1996, and that the defendants intentionally
caused HHL's default under the promissory notes, and ultimately led to HHL's
filing for bankruptcy protection in 1997. The Plaintiffs are seeking damages
for the unpaid promissory notes in the amount of $2.3 million, plus interest.
There have been no changes in the status of this litigation during the interim
period. The Company intends to continue its vigorous defense of this lawsuit.
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.
9. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets", which is effective for fiscal years beginning after December
15, 2001. The Company has adopted the provisions of Statement 142 as of January
1, 2002. At December 31, 2001 the Company had approximately $5.7 million of
unamortized goodwill and no identifiable intangible assets, which are subject to
the new provisions.
10
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
SFAS No. 142 requires, among other things, the discontinuance of
goodwill amortization. In the first quarter of 2002, the Company ceased
amortizing all goodwill. In the first quarter of 2001, the Company recorded
$165,000 of goodwill amortization. In addition, the standard includes provisions
upon adoption for the reclassification of certain existing recognized
intangibles as goodwill, reassessment of the useful lives of existing
recognized intangibles and reclassification of certain intangibles out of
previously reported goodwill. As is required, upon adoption, the Company has
assessed the goodwill balance and has not made any reclassifications. In
addition, the Company is required to perform an impairment review of the
existing goodwill balance upon adoption. The impairment review involves a
two-step process as follows:
- Step 1 - The Company will compare the fair value of its
reporting units to the carrying value, including goodwill of
each of those units. For each reporting unit where the
carrying value, including goodwill, exceeds the unit's fair
value, the Company will apply step 2. If a unit's fair value
exceeds the carrying value, no further work is performed and
no impairment charge is necessary.
- Step 2 - The Company will perform an allocation of the fair
value of the reporting unit to its identifiable tangible and
non-goodwill intangible assets and liabilities. This will
derive an implied fair value for the reporting unit's
goodwill. The Company will then compare the implied fair value
of the reporting unit's goodwill with the carrying amount of
reporting unit's goodwill. If the carrying amount of the
reporting unit's goodwill is greater than the implied fair
value of its goodwill, an impairment loss must be recognized
for the excess.
The Company has up to six months from the date of the adoption to
complete step one and the Company expects to complete this review during the
second quarter of 2002. The second step, if necessary, 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
operations. Because of the extensive effort needed to complete the transitional
impairment test, it is not practicable to reasonably estimate whether any
goodwill transitional impairment losses will be required to be recognized as
the cumulative effect of a change in accounting principle.
The table below presents the pro forma effect of this change in
accounting principle on the three months ended March 31, 2001 (in thousands
except per share amounts):
Three Months Ended
March 31, 2001
Loss from continuing operations, as reported $ (403)
Add back: goodwill amortization, net of tax 63
-------------
Adjusted loss from continuing operations (340)
Adjusted income from discontinued operations
(as adjusted for add back of goodwill
amortization of $46, net of tax) 973
-------------
Adjusted net income $ 633
-------------
Loss per share from continuing operations,
as reported $(0.02)
Goodwill amortization 0.00
-------------
Adjusted loss per share from continuing operations (0.02)
Adjusted earnings per share from discontinued
operations 0.06
-------------
Adjusted earnings per share $ 0.04
-------------
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses significant
issues relating to the implementation of SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,"
and develops a single accounting method under which long-lived assets that are
to be
11
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
disposed of by sale are measured at the lower of book value or fair value less
cost to sell. Additionally, SFAS No. 144 expands the scope of discontinued
operations to include all components of an entity with operations that (1) can
be distinguished from the rest of the entity and (2) will be eliminated from the
ongoing operations of the entity in a disposal transaction. SFAS No. 144 is
effective for financial statements issued for fiscal years beginning after
December 15, 2001 and its provisions are to be applied prospectively. The
Company adopted SFAS 144 as of January 1, 2002.
12
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS "FORWARD-LOOKING"
STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS
AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. FOR
THIS PURPOSE ANY STATEMENTS CONTAINED HEREIN THAT ARE NOT STATEMENTS OF
HISTORICAL FACT MAY BE DEEMED TO BE FORWARD-LOOKING STATEMENTS. WITHOUT LIMITING
THE FOREGOING, THE WORDS "BELIEVES," "ANTICIPATES," "PLANS," "EXPECTS" AND
SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS. THESE
STATEMENTS INVOLVE UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS, WHICH MAY
CAUSE OUR ACTUAL RESULTS TO DIFFER MATERIALLY, FORM THOSE IMPLIED BY THE FORWARD
LOOKING STATEMENTS. AMONG THE IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS
TO DIFFER MATERIALLY FROM THOSE INDICATED BY SUCH FORWARD-LOOKING STATEMENTS
INCLUDE THOSE RISKS IDENTIFIED IN "ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" AND OTHER RISKS IDENTIFIED IN
THIS FORM 10-Q AND PRESENTED ELSEWHERE BY MANAGEMENT FROM TIME TO TIME. SUCH
FORWARD-LOOKING STATEMENTS REPRESENT MANAGEMENT'S CURRENT EXPECTATIONS AND ARE
INHERENTLY UNCERTAIN. INVESTORS ARE WARNED THAT ACTUAL RESULTS MAY DIFFER FROM
MANAGEMENT'S EXPECTATIONS.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
A "critical accounting policy" is defined as important to the portrayal
of a Company's financial condition and results and requires management's most
difficult, subjective or complex judgements, often as a result of the need to
make estimates about the effect of matters that are inherently uncertain. The
Company believes that the following accounting policies fit this definition:
Discontinued Operations. The accompanying financial statements are
prepared using discontinued operations accounting for the Company's discontinued
Decision Support Group ("DSG") and Payor Systems Group ("PSG") businesses. Under
discontinued operations accounting, amounts are accrued for estimates of the
Company's expected liabilities related to discontinued operations through their
eventual discharge. The DSG business was sold in December 2001. At March 31,
2002, the PSG business remaining liabilities principally consist of lease
termination and related facility costs, and employee severance expenses. The
Company believes that these liabilities will be discharged by December 31, 2002.
Accordingly, the Company believes that its accrual for discontinued operations
liabilities is adequate. However, these amounts include certain estimates which
could vary from actual results.
Revenue Recognition. The Company principally recognizes revenue for its
service offerings when third party payors remit payment to the Company's
customers. This policy is in effect because the Company's fees are principally
contingent upon its customers' collections from third parties. Under this
revenue recognition policy, the Company's operating results may vary
significantly from quarter to quarter due to the timing of such collections by
the Company's customers and the fact that a significant portion of the Company's
operating expenses are fixed.
Accounting for Income Taxes. The Company has generated net operating
losses for tax purposes each of the last three years. These losses generated
federal net operating loss carryforwards of $21 million as of March 31, 2002. In
addition, due to the Company's restructuring efforts certain charges written off
in prior years are not currently deductible for income tax purposes. These
differences result in gross deferred tax assets. The Company must assess the
likelihood that the gross deferred tax assets, net of any deferred tax
liabilities will be recovered from future taxable income and to the extent the
Company believes the recovery is not likely, the Company has established a
valuation allowance.
13
Significant management judgment is required in determining this
valuation allowance. The Company has recorded a valuation allowance of $8.8
million as of March 31, 2002, due to uncertainties related to the Company's
ability to utilize some of its net deferred tax assets, primarily consisting of
certain net operating loss carryforwards before they expire. The valuation
allowance is based on the Company's estimates of taxable income and the period,
over which the net deferred tax assets will be recoverable. In the event that
these estimates differ or the Company adjusts these estimates in future periods,
the Company may need to establish an additional valuation allowance which could
materially impact its financial position and results of operations.
Conversely, if the Company is profitable in the future at levels which
cause management to conclude that it is more likely than not that the Company
will realize all or a portion of the net deferred tax assets, currently for
which a valuation is provided for, the Company would record the estimated net
realizable value of the net deferred tax asset at that time and would then
provide income taxes at a rate equal to the Company's combined federal and state
effective rate of approximately 40%.
The net deferred tax asset as of March 31, 2002 was $8.9 million, net
of a valuation allowance of $8.8 million.
Valuation of long lived and intangible assets and goodwill. The Company
assesses the impairment of identifiable intangibles, enterprise level goodwill
and other long-lived assets whenever events or changes in circumstances indicate
that the carrying value may not be recoverable. Factors the Company considers
important which could trigger an impairment review include the following:
- - Significant underperformance relative to expected historical or
projected future operating results;
- - Significant changes in the manner of the Company's use of the acquired
assets or the strategy for its overall business;
- - Significant negative industry or economic trends;
- - Significant decline in our stock price for a sustained period; and
- - The Company's market capitalization relative to net book value.
The Company determines the recoverability of the carrying
value of its long-lived assets based on a projection of the estimated
undiscounted future net cash flows expected to result from the use of the asset.
When the Company determines that the carrying value of long-lived assets may not
be recoverable, the Company measures any impairment by comparing the carrying
amount of the asset with the fair value of the asset. For identifiable
intangibles and enterprise level goodwill, the Company determines fair value
based on a projected discounted cash flow method using a discount rate
reflective of the Company's cost of funds.
In 2002, SFAS No. 142, "Goodwill and Other Intangible Assets" became
effective and as a result, the Company ceased to amortize approximately $8.4
million of enterprise level goodwill which would have resulted in approximately
$67,000 of amortization in the first quarter of 2002. In lieu of amortization,
the Company is required to perform an initial impairment review of goodwill in
2002 and an annual impairment review thereafter. The Company expects to complete
the initial review during the second quarter of 2002.
Because of the extensive effort needed to complete the transitional
impaitment test, it is not practicable to reasonably estimate whether any
goodwill transitional impairment losses will be required to be recognized as
the cumulative effect of a change in accounting principle.
Estimating valuation allowances and accrued liabilities, such as bad
debts, and restructuring charges. The preparation of financial statements
requires the Company's management to make estimates and assumptions that affect
the reported amount of assets and liabilities and disclosure of contingent
14
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reported period. Specifically,
management must make estimates of the uncollectability of the Company's accounts
receivable. Management specifically analyzes accounts receivable and analyzes
historical bad debts, customer concentrations, customer credit-worthiness,
current economic trends and changes in its customer payment terms when
evaluating the adequacy of the allowance for doubtful accounts. The accounts
receivable balance was $14.9 million, net of allowance for doubtful accounts of
$3.4 million, as of March 31, 2002.
Management has estimated a certain amount of charges as of March 31,
2002 related to restructuring activities. The Company has recorded an estimated
liability based on a reasonable assessment of the probable costs to be incurred
throughout 2002. As additional information becomes available throughout 2002,
the Company may revise the estimates. Such revisions in estimates of the
potential restructuring liabilities could materially impact the results of
operation and financial position.
The above listing is not intended to be a comprehensive list of all of
the Company's accounting policies. In many cases, the accounting treatment of a
particular transaction is specifically dictated by generally accepted
accounting principles, with no need for management's judgment in their
application. There are also areas in which the audited consolidated financial
statements and notes thereto, included in the Company's Annual Report on Form
10-K as of December 31, 2001, as filed with the SEC, contain accounting
policies and other disclosures required by generally accepted accounting
principles.
THREE MONTHS ENDED MARCH 31, 2002 COMPARED TO THREE MONTHS ENDED MARCH 31, 2001
CONTINUING OPERATIONS:
Revenue for the quarter ended March 31, 2002, was $16.9 million, an
increase of $2.4 million or 16% compared to revenue of $14.5 million in the
prior year quarter.
The Payor Services Division, which provides third party liability
identification and recovery services to state Medicaidagencies, generated
revenue of $7.9 million in the current year quarter, a $1.1 million or 16%
increase over the prior year first quarter revenue of $6.8 million. This
increase reflected: (1) $2.1 million in revenue during the current year for
three new state clients including a contract re-award with increased scope of
services, and (2) $1.9 million in revenue during the current year reflecting a
shift in the timing of certain revenue recognition events between this year and
last year with three customers. Partially offsetting these increases was a $2.1
million decrease resulting from certain non-recurring revenue opportunities and
a shift in the timing of certain revenue recognition events with two clients
compared to the prior year, and a $0.8 million decrease resulting from the sale
of the CDR business in July 2001.
The Provider Services Division, which outsources business office
services for hospitals, generated revenue of $9.0 million in the current year
quarter, a $1.3 million or 17% increase from the prior year quarter revenue of
$7.7 million. This increase consisted of: (1) $2.0 million resulting from the
timing of certain revenue recognition events with five customers this year
compared with the prior year, (2) $0.6 million from an expansion in the scope of
services provided to one customer, and (3) $0.3 million in revenue from seven
new customers. Partially offsetting these increases was a decrease of $1.0
million associated with nine terminated or inactive customer relationships and
$0.7 million resulting from the timing of certain revenue recognition events
with four customers this year compared with the prior year.
15
Operating expense for the current year first quarter was $17.7 million,
an increase of $2.4 million or 16% compared to the prior year first quarter
operating expense of $15.3 million. The Company experienced cost of service
fluctuations as follows. Direct project costs for the current year first quarter
were $2.3 million, an increase of $0.5 million or 28% compared to the prior year
first quarter. This net increase represented increases of (1) $0.5 million in
subcontractor fees incurred with the Company's former CDR business, (2) $0.3
million increase in electronic claims processing service fees based on higher
transaction volumes with the Company's customers, and (3) $0.3 million increase
in temporary help and consulting expense primarily related to a special billing
project for an existing client, and the support of some new clients. These
increases were partially offset by decreases of $0.2 in marketing partner fees
and $0.4 million in subcontractor fees reflecting a variation in revenue
composition from the first quarter of last year. Compensation expense for the
current year first quarter was $9.5 million, an increase of $0.8 million or 9%
compared to the prior year first quarter. This increase reflects a general
increase in compensation rates and an increase in staff in the information
technology development team, offset by a decrease of $0.6 million from the sale
of the CDR business in July of 2001. Other operating costs for the current year
first quarter were $3.0 million, an increase of $1.7 million or 131% compared to
the prior year first quarter. The current year costs include increases for: (1)
consulting and professional service fees including related travel costs
associated with product development initiatives and on-going system enhancement
and re-configuration activities of approximately $1.1 million, (2) the
non-recurring nature of a $250,000 insurance policy reimbursement of legal fees
received in the prior year, and (3) a current year charge of $145,000 for
expense related to a stock option grant to two members of the Board of
Directors.
In the current year, the Company did not recognize any income tax
benefit against its losses from continuing operations. This absence of an income
tax benefit reflects an increase in the Company's valuation allowance for the
recovery of its net deferred income tax assets. The Company has incurred
significant taxable losses the last few years and expects to incur a tax loss
during calendar year 2002. Most of the Company's deferred income tax assets are
in the form of net operating loss carryforwards. The recoverability analysis was
performed based on the Company's recent taxable loss history and projections of
future taxable operating results.
Net interest income of $159,000 for the current year first quarter
compared to $187,000 in the prior year first quarter reflects a significant
decrease in the prevailing market interest rates which more than offset an
increase resulting from the generally greater average balances in cash and short
term investments available during the quarter.
Loss from continuing operations was $719,000 in the current year first
quarter compared to a loss of $403,000 during the prior year first quarter. This
increase in operating loss results from the absence of an income tax benefit and
the increases in costs of operations, as discussed above.
DISCONTINUED OPERATIONS:
As more fully discussed in Item 1 and Note 1(b) of the Notes to
Consolidated Financial Statements, the Company reported the results of its Payor
Systems Group ("PSG") and Decision Support Group ("DSG") as discontinued
operations for all periods presented. There was no income or loss from
discontinued operations in the current quarter, compared to income of $0.9
million in the prior year first quarter.
Net loss was $0.7 million in the first quarter of fiscal year 2002 or
$0.04 per common share compared to net income of $0.5 million or $0.03 per
common share in the first quarter of the prior fiscal year. The prior year first
quarter results included net loss from continuing operations of $0.02 per common
share and net income from discontinued operations of $0.05 per common share.
16
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 March 31, 2002, the Company's cash and short-term investments and net working
capital were $22.2 million and $26.5 million, respectively. Although the Company
expects that operating cash flows will be a primary source of liquidity, the
current significant cash and short term investment balances and working capital
position are also fundamental sources of liquidity and capital resources. The
current cash and short term investment balances are more than sufficient to meet
the Company's short term funding needs that are not met by operating cash flows.
Operating cash flows could be adversely effected by a decrease in demand for the
Company's services. The Company's typical customer relationship, however,
usually has a duration of several years, such that the Company does not expect
any current decrease in demand. The Company estimates that it will purchase
approximately $2.5 million of property and equipment during fiscal year 2002,
which is consistent with the amounts purchased during recent years. The payments
due by period for the Company's contractual obligations, consisting principally
of facility lease obligations and equipment rental and software license
obligations, are as follows as of March 31, 2002 (in thousands):
Nine
Total Months 1-3 Years 4-5 Years After 5 years
----- -------- --------- --------- -------------
$25,589 4,475 8,216 5,117 7,781
The Company has entered into sublease arrangements for some of its
facility obligations and expects to receive the following rental receipts as of
March 31, 2002 (in thousands):
Nine
Total Months 1-3 Years 4-5 Years After 5 years
----- -------- --------- --------- -------------
$7,725 1,287 3,409 2,637 392
For the current quarter ended March 31, 2002, cash used by operating
activities was $3.0 million compared with cash provided by operating activities
of $3.9 million for the quarter ended March 31, 2001. The current year use of
cash in operations included an increase in accounts receivable of $2.2 million
reflective of the growth in the Company's revenue and a decrease in accounts
payable and accrued expenses of $1.3 million resulting from the timing of
payment on certain liabilities. Investing activities in the current quarter
consisted primarily of $450,000 in purchases of property and equipment and
$361,000 of note payments received from the Company's Chief Executive Officer
pursuant to a loan used to purchase Company common stock. Financing activities
in the current quarter consisted of $144,000 received as proceeds from stock
option exercises.
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. Cumulatively since the inception of
the repurchase program, the Company has repurchased 1,317,016 shares having an
aggregate purchase price of $8,315,000.
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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 the fair value
for the Company's investment portfolio as of March 31, 2002, and the related
weighted average interest rates by year of maturity (in thousands):
Matures Year Ending Total Total
December 31, 2002 Historical Cost Fair value
Fixed income governmental securities $4,000 $3,950 $4,000
Average interest rate 4.87% 4.87%
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings -- See Note 8 of Notes to Condensed Consolidated
Financial Statements for discussion of certain pending legal
proceedings.
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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: May 15, 2002 HEALTH MANAGEMENT SYSTEMS, INC.
--------------------------------
(Registrant)
BY: /S/ WILLIAM F. MILLER III
--------------------------
William F. Miller III
Chairman and Chief Executive Officer
(Principal Executive Officer)
BY: /S/ PHILIP RYDZEWSKI
--------------------------
Philip Rydzewski
Senior Vice President and
Chief Financial Officer (Principal
Financial Officer and Accounting Officer)
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