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 JUNE 30, 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
July 31, 2002 was 18,294,761.
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 June 30, 2002 (unaudited) and
December 31, 2001..................................................................................3
Condensed Consolidated Statements of Operations (unaudited) for the three months and
six months ended June 30, 2002 and 2001............................................................4
Condensed Consolidated Statement of Shareholders' Equity and Comprehensive Income
(Loss) (unaudited) for the six months ended June 30, 2002..........................................5
Condensed Consolidated Statements of Cash Flows (unaudited) for the six months ended
June 30, 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...........................................20
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.....................................................................................20
Item 4. Submission of Matters to a Vote of Security Holders ..................................................20
Item 6. Exhibits and Reports on Form 8-K......................................................................20
Signatures.......................................................................................................21
2
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
June 30, December 31,
2002 2001
-------- --------
ASSETS (unaudited)
Current assets:
Cash and cash equivalents $ 22,095 $ 21,020
Short-term investments 2,869 4,022
Accounts receivable, net 14,012 12,720
Prepaid expenses and other current assets 1,958 2,420
-------- --------
Total current assets 40,934 40,182
Property and equipment, net 3,490 4,228
Capitalized software costs, net 356 466
Goodwill, net 5,679 5,679
Deferred income taxes, net 8,920 8,920
Other assets 423 650
Net assets of discontinued operations -- 269
-------- --------
Total assets $ 59,802 $ 60,394
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued expenses and other liabilities $ 10,615 $ 13,417
Net liabilities of discontinued operations 697 527
-------- --------
Total current liabilities 11,312 13,944
Other liabilities 698 669
-------- --------
Total liabilities 12,010 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;
19,710,107 shares issued and 18,393,091 shares outstanding at June 30, 2002;
19,332,089 shares issued and 18,015,073 shares outstanding at December 31, 2001 197 193
Capital in excess of par value 74,635 73,550
Unearned stock compensation (67) (128)
Accumulated deficit (18,333) (18,755)
Accumulated other comprehensive income (loss) 36 (42)
Treasury stock, at cost; 1,317,016 shares at June 30, 2002
and December 31, 2001 (8,315) (8,315)
Note receivable from officer for sale of stock (361) (722)
-------- --------
Total shareholders' equity 47,792 45,781
-------- --------
Total liabilities and shareholders' equity $ 59,802 $ 60,394
======== ========
See accompanying notes to condensed consolidated financial statements.
3
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
Three months ended June 30, Six months ended June 30,
--------------------------- ---------------------------
2002 2001 2002 2001
-------- -------- -------- --------
Revenue $ 16,744 $ 15,645 $ 33,614 $ 30,160
-------- -------- -------- --------
Cost of services:
Compensation 9,449 8,711 18,916 17,441
Data processing 2,179 1,515 3,725 3,195
Occupancy 1,540 1,500 3,064 3,163
Direct project costs 2,441 2,202 4,692 4,007
Other operating costs 3,024 2,193 5,984 3,498
Restructuring costs -- 785 -- 785
Amortization of intangibles -- 88 -- 176
-------- -------- -------- --------
Total cost of services 18,633 16,994 36,381 32,265
-------- -------- -------- --------
Operating loss (1,889) (1,349) (2,767) (2,105)
Net interest income 130 189 289 376
-------- -------- -------- --------
Loss from continuing operations before income taxes (1,759) (1,160) (2,478) (1,729)
Income tax benefit -- (422) -- (588)
-------- -------- -------- --------
Loss from continuing operations (1,759) (738) (2,478) (1,141)
Income (loss) from discontinued operations, net 2,900 (4,880) 2,900 (3,953)
-------- -------- -------- --------
Net income (loss) $ 1,141 $ (5,618) $ 422 $ (5,094)
======== ======== ======== ========
Basic and diluted earnings per share data:
Loss per share from continuing operations $ (0.10) $ (0.04) $ (0.14) $ (0.07)
Income (loss) per share from discontinued operations, net 0.16 (0.27) 0.16 (0.22)
-------- -------- -------- --------
Net income (loss) per share $ 0.06 $ (0.31) $ 0.02 $ (0.29)
======== ======== ======== ========
Weighted average common shares outstanding 18,253 17,853 18,152 17,785
======== ======== ======== ========
See accompanying notes to condensed consolidated financial statements.
4
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME (LOSS)
For the Six Months Ended June 30, 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 income:
Net income -- -- -- -- 422
Change in net unrealized
appreciation on
short-term investments -- -- -- -- --
Total comprehensive income
Repayment of note receivable -- -- -- -- --
Exercise of stock options 368,718 4 512 -- --
Shares issued under employee
stock purchase plan 9,300 -- 26 -- --
Remeasurement of unearned
stock compensation -- -- 22 (22) --
Stock compensation expense -- -- 525 83 --
---------- ---- ------- ----- --------
Balance at June 30, 2002 19,710,107 $197 $74,635 ($ 67) ($18,333)
========== ==== ======= ===== ========
Accumulated Note
Other Treasury Stock Receivable Total
Comprehensive -------------------------- from Sale Shareholders'
Income (Loss) # of Shares Amount of Stock Equity
------------- ----------- ------ -------- ------
Balance at December 31, 2001 ($42) 1,317,016 ($8,315) ($722) $45,781
Comprehensive income:
Net income -- -- -- -- 422
Change in net unrealized
appreciation on
short-term investments 78 -- -- -- 78
-------
Total comprehensive income 500
Repayment of note receivable -- -- -- 361 361
Exercise of stock options -- -- -- -- 516
Shares issued under employee
stock purchase plan -- -- -- -- 26
Remeasurement of unearned
stock compensation -- -- -- -- --
Stock compensation expense -- -- -- -- 608
---- --------- ------- ----- -------
Balance at June 30, 2002 $ 36 1,317,016 ($8,315) ($361) $47,792
==== ========= ======= ===== =======
See accompanying notes to condensed consolidated financial statements.
5
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended June 30, 2002 and 2001
(in thousands)
(unaudited)
2002 2001
-------- --------
Operating activities:
Net income (loss) $ 422 $ (5,094)
Adjustments to reconcile net income (loss) to net cash
from operating activities:
(Income) loss from discontinued operations (2,900) 3,953
Loss on disposal/impairment of property and equipment 612 250
Depreciation and amortization 1,190 1,093
Amortization of intangibles -- 176
Provision for doubtful accounts 38 (84)
Stock compensation expense 608 --
Increase in deferred tax asset -- (2,768)
Changes in assets and liabilities:
Increase in accounts receivable (1,330) (383)
Decrease in other current assets 462 556
Decrease in other assets 227 291
Increase (decrease) in accounts payable, accrued expenses
and other liabilities (2,773) 1,092
-------- --------
Net cash used in operating activities (3,444) (918)
-------- --------
Investing activities:
Purchases of property and equipment (954) (894)
Investment in software -- (757)
Proceeds from sale of assets, EDI operations, net -- 524
Repayments of note receivable from officer for sale of stock 361 --
Net proceeds from sales of short-term investments 1,231 1,645
-------- --------
Net cash provided by investing activities 638 518
-------- --------
Financing activities:
Proceeds from exercise of stock options 516 --
Proceeds from issuance of common stock, employee stock purchase plan 26 48
-------- --------
Net cash provided by financing activities 542 48
-------- --------
Net decrease in cash and cash equivalents (2,264) (352)
Cash and cash equivalents at beginning of period 21,020 6,187
Cash provided by discontinued operations 3,339 5,323
-------- --------
Cash and cash equivalents at end of period $ 22,095 $ 11,158
======== ========
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 $ -- $ 30
======== ========
Cash paid for income taxes $ 131 $ 94
======== ========
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, and the unaudited interim
condensed consolidated financial statements as of and for the quarterly period
ended March 31, 2002 included in the Company's Quarterly Report on Form 10-Q,
both 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 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. 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
Company's 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, $41,000 and $269,000 remained as accrued
liabilities at June 30, 2002 and December 31, 2001, respectively.
7
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
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, $1.3 million and $1.8 million remained as a liability at
June 30, 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. As of July 31, 2001 the Company had estimated a
pre-tax loss on disposal of $1.6 million. As a result of it's success in exiting
various business obligations, the Company reduced its estimated loss to $200,000
as of December 31, 2001. In the quarterly period ended June 30, 2002, the
Company received a $2.7 million contract termination fee which was not included
in the disposal estimate. In addition, during the quarterly period ended June
30, 2002, the Company reduced the estimated loss on disposal by $200,000, based
on actual operating results through that period. Consequently, the Company
recognized income from discontinued operations, in the accompanying condensed
consolidated financial statements, of $2.9 million during the quarterly period
ended June 30, 2002.
The results of PSG's operations have been reported as discontinued
operations in the Consolidated Statements of Operations for all 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 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, zero and $422,000 in lease termination and related facility costs
remain as liabilities at June 30, 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 for a total sale price of $9.8 million. As a
result of the sale of this business segment, DSG has been reflected in the
accompanying financial statements as a discontinued operation.
(iii) Discontinued Operations Information
Results of operations from discontinued operations were as follows ($
in thousands):
8
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
Three Months Ended Three Months Ended
June 30, 2002 June 30, 2001
------------------------------- -------------------------------------
PSG DSG Total PSG DSG Total
------ --- ------ ------- ------ -------
Revenue $2,743 $-- $2,743 $ 2,330 $6,233 $ 8,563
------ --- ------ ------- ------ -------
Income (loss) before income taxes 2,900 -- 2,900 (9,167) 1,495 (7,672)
Income tax expense (benefit) -- -- -- (3,336) 544 (2,792)
------ --- ------ ------- ------ -------
Income (loss) from discontinued operations $2,900 $-- $2,900 $(5,831) $ 951 $(4,880)
------ --- ------ ------- ------ -------
Six Months Ended Six Months Ended
June 30, 2002 June 30, 2001
------------------------------- ---------------------------------------
PSG DSG Total PSG DSG Total
------ --- ------ ------- ------- --------
Revenue $3,923 $-- $3,923 $ 5,052 $12,162 $ 17,214
------ --- ------ ------- ------- --------
Income (loss) before income taxes 2,900 -- 2,900 (8,729) 2,594 (6,135)
Income tax expense (benefit) -- -- -- (3,162) 980 (2,182)
------ --- ------ ------- ------- --------
Income (loss) from discontinued operations $2,900 $-- $2,900 $(5,567) $ 1,614 $ (3,953)
------ --- ------ ------- ------- --------
Assets and liabilities of the discontinued operations of PSG were as
follows ($ in thousands):
June 30, December 31,
2002 2001
----- -------
Current assets $ 0 $ 852
Current liabilities (697) (1,379)
----- -------
Net current liabilities ($697) ($ 527)
----- -------
Property and equipment $ 0 $ 78
Capitalized software costs 0 191
----- -------
Net noncurrent assets $ 0 $ 269
----- -------
9
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
4. STOCK BASED COMPENSATION PLANS
On June 4, 2002, as ratified by the shareholders at the Company's
annual meeting, the Company granted 250,000 stock options at an exercise price
of $2.48 per share to a member of the Board of Directors. All of the options
were fully vested on the grant date, June 4, 2002. This grant represented 60,000
options for service as a board member consistent with a similar grant to the
other board members in December 2001, and 190,000 options as an inducement to
join the board.
The Company immediately recognized a total of $525,000 in
compensation expense consisting of $478,800 based on the fair value of the
options using the Black-Scholes option pricing model for the 190,000 options
and $46,200 for the 60,000 options based on the difference between the current
market price of the stock on the grant date and the exercise price.
5. SEGMENT INFORMATION
The Company's Provider Services Division provides outsourced business
office services to hospitals. The Company's Payor Services Division provides
third liability identification and recovery services to state Medicaid agencies.
The Company measures the performance of its operating segments utilizing
operating income (loss), as reflected in the accompanying condensed consolidated
statements of operations. Certain reclassifications were made to prior year
amounts to conform to the current presentation.
Total HMSY,
Excluding Provider Payor
Discontinued Services Services
($ in Thousands) Operations Division Division
- ---------------- ---------- -------- --------
THREE MONTHS ENDED JUNE 30, 2001
Revenue $ 15,645 $ 7,223 $ 8,422
Operating income (loss) ($ 1,349) ($ 1,805) $ 456
THREE MONTHS ENDED JUNE 30, 2002
Revenue $ 16,744 $ 8,244 $ 8,500
Operating income (loss) ($ 1,889) ($ 3,347) $ 1,458
SIX MONTHS ENDED JUNE 30, 2001
Revenue $ 30,160 $ 14,969 $15,191
Operating income (loss) ($ 2,105) ($ 2,604) $ 499
SIX MONTHS ENDED JUNE 30, 2002
Revenue $ 33,614 $ 17,268 $16,346
Operating income (loss) ($ 2,767) ($ 5,432) $ 2,665
6. 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 and six months ended June 30,
2002, the diluted earnings per share calculation excludes common stock
equivalents from the weighted average shares as it would be antidilutive to the
loss per share from continuing operations. The diluted weighted average number
of shares outstanding for the three months and six months ended June 30, 2002
were 20,609,370 and 20,508,563, respectively. The diluted weighted average
number of shares outstanding for the three months and six months ended June 30,
2001 were 18,603,798 and 18,295,417, respectively.
10
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
7. 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.
The law suit was filed simultaneously in the Bankruptcy Court in
Delaware, and the New York Supreme Court Nassau County. By decision dated June
5, 2001, the District Court of Delaware dismissed one of the plaintiffs' two
causes of action, deferring to the New York State courts to determine if the
plaintiffs' remaining cause of action, alleging tortious interference with
contract, stated a valid claim. The Company's (and the individual defendants')
motion in Supreme Court to dismiss the remaining cause of action was denied by
decision dated February 20, 2002. The Company has appealed the decision to the
New York State Supreme Court-Appellate Division Second Department and has
perfected its Appeal. In the interim, the Company has obtained a stay of all
depositions pending a decision on the Appeal. The Appeal has not yet been fully
briefed, and a decision is not expected for a number of months.
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.
8. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In 2002, the Company adopted SFAS 142 and SFAS 144. SFAS 144
establishes a single model for the impairment of long-lived assets and broadens
the definition of discontinued operations to include disposal of components of
an individual business. SFAS 142 eliminates amortization of goodwill and
indefinite-lived intangible assets, addresses the amortization of intangible
assets with finite lives and addresses impairment testing and recognition for
goodwill and intangible assets. As a result of adoption, amortization ceased for
goodwill. The Company completed its impairment review of goodwill in the second
quarter and no impairment charge resulted from this impairment evaluation.
The Company assesses goodwill for impairment annually unless events
occur that require more frequent reviews. Long-lived assets are tested for
impairment if impairment triggers occur. Undiscounted cash flow analyses are
used to assess long-lived asset impairment. If an assessment indicates
impairment, the impaired asset is written down to its fair market value based on
the best information available. Estimated fair market value is generally
measured with discounted estimated future cash flows.
The following reflects the impact that SFAS 142 would have had on prior
year net income and earnings per common share if adopted in 2001 ($ in
thousands):
11
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
Three Months Ended Six Months Ended
June 30, 2001 June 30, 2001
------------- -------------
Loss from continuing operations, as reported ($738) ($1,141)
Add back: goodwill amortization, net of tax 56 119
------ ------
Adjusted loss from continuing operations (682) (1,022)
Adjusted income from discontinued operations
(as adjusted for add back of goodwill amortization
of $16 and $62, net of tax) (4,864) (3,891)
------ ------
Adjusted net income ($5,546) ($4,913)
====== ======
Loss per share from continuing operations, as reported ($0.04) ($0.07)
Goodwill amortization 0.00 0.01
------ ------
Adjusted loss per share from continuing operations (0.04) (0.06)
Adjusted loss per share from discontinued operations (0.27) (0.22)
------ ------
Adjusted loss per share ($0.31) ($0.28)
====== ======
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, FROM 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 judgments, 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 June 30,
2002, the PSG business remaining liabilities principally consist of 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 June 30, 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
13
to the extent the Company believes the recovery is not likely, the Company has
established a valuation allowance.
Significant management judgment is required in determining this
valuation allowance. The Company has recorded a valuation allowance of $8.3
million as of June 30, 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 June 30, 2002 was $8.9 million, net of
a valuation allowance of $8.3 million.
Valuation of long lived and intangible assets and goodwill. The Company
assesses the impairment of 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 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 $5.7
million of goodwill (net of accumulated amortization of $2.7 million) which
would have resulted in approximately $134,000 of amortization in the first six
months of 2002. No impairment charges resulted from the required
impairment evaluations.
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
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
14
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 $14.0 million, net of allowance for doubtful
accounts of $3.4 million, as of June 30, 2002.
Management has estimated a certain amount of charges as of June 30,
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 accounting principles
generally accepted in the United States of America, 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 accounting
principles generally accepted in the United States of America.
THREE MONTHS ENDED JUNE 30, 2002 COMPARED TO THREE MONTHS ENDED JUNE 30, 2001
CONTINUING OPERATIONS:
Revenue for the quarter ended June 30, 2002, was $16.7 million, an
increase of $1.1 million or 7% compared to revenue of $15.6 million in the prior
year second quarter.
The Payor Services Division, which provides third party liability
identification and recovery services to state Medicaid agencies, generated
revenue of $8.5 million in the current year quarter, a $0.1 million or 1%
increase over the prior year first quarter revenue of $8.4 million. This
increase reflected $1.2 million in revenue during the current year for three new
state clients including a contract re-award with an expanded scope of services.
This increase was substantially offset by: (1) a decrease of $0.4 million
resulting from the expiration of one client relationship since the prior year
period, (2) a $0.3 million decrease resulting from the sale of the CDR business
in July 2001, and (3) a net decrease of $0.4 million across the comparable
client base reflecting non-recurring revenue opportunities, timing differences,
and changes in the volume, yields and scope of client projects.
The Provider Services Division, which provides outsourced business
office services for hospitals, generated revenue of $8.2 million in the current
year quarter, a $1.0 million or 14% increase from the prior year quarter revenue
of $7.2 million. This increase primarily consists of $1.2 million in revenue
from fifteen new customers since the prior year period, and a $0.6 million
increase with one customer resulting from an expansion in the scope of services
provided and an increase in yields. These increases were partially offset by a
decrease of $0.9 million associated with five terminated or inactive customer
relationships.
15
Total operating expenses for the current year second quarter were $18.6
million, an increase of $1.6 million or 10% compared to the prior year second
quarter operating expense of $17.0 million. The Company experienced cost of
service fluctuations as follows. Direct project costs for the current year
second quarter were $2.4 million, an increase of $0.2 million or 9% compared to
the prior year second quarter. This net increase generally follows from the
increase in revenue and reflects fluctuations in the mix of business for the
period based on the specific requirements of client projects. Compensation
expense for the current year second quarter was $9.4 million, an increase of
$0.7 million or 8% compared to the prior year second quarter. This increase
reflects a general increase in compensation rates and an increase in staff in
the information technology development team, partially offset by a decrease of
$0.6 million from the sale of the CDR business in July 2001. Data processing
costs for the current year second quarter were $2.2 million, an increase of $0.7
million or 44% compared to the prior year second quarter, reflecting $0.6
million for the disposal and impairment of hardware and software items resulting
from the termination of certain internal projects. Other operating costs for the
current year second quarter were $3.0 million, an increase of $0.8 million or
38% compared to the prior year second quarter, principally associated with $0.5
million of expense related to stock option grants to three members of the Board
of Directors.
Net interest income of $130,000 for the current year second quarter
compared to $189,000 in the prior year second 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.
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 a decrease 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.
Loss from continuing operations was $1.8 million in the current year
second quarter compared to a loss of $738,000 during the prior year second
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 Note 2(b) of the Notes to Condensed
Consolidated Financial Statements, the Company reported the results of its PSG
and DSG as discontinued operations for all periods presented. During the current
quarterly period income from discontinued operations of $2.9 million principally
resulted from a termination fee received from a former customer of the PSG,
which was not included in the prior disposal estimate. Loss from discontinued
operations in the prior year second quarter reflected the then on-going
activities of PSG and DSG.
Net income was $1.1 million for the second quarter of fiscal year 2002
or $0.06 per common share compared to a net loss of $5.6 million or $0.31 per
common share in the second quarter of the prior fiscal year. The current year
results include a loss from continuing operations of $0.10 per common share and
income from discontinued operations of $0.16 per common share compared to a loss
from continuing operations of $0.04 per common share and loss from discontinued
operations of $0.27 per common share in the prior year second quarter.
16
SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO SIX MONTHS ENDED JUNE 30, 2001
CONTINUING OPERATIONS:
Revenue for the six months ended June 30, 2002, was $33.6 million, an
increase of $3.4 million or 11% compared to revenue of $30.2 million for the
prior year six month period.
The Payor Services Division, which provides third party liability
identification and recovery services to state Medicaid agencies, generated
revenue of $16.3 million in the current year six month period, a $1.1 million or
8% increase over the prior year six month period revenue of $15.2 million. This
increase primarily reflects $1.9 million in revenue during the current year for
three new state clients, including a contract re-award with an expanded scope of
services. This increase was substantially offset by: (1) a $1.4 million decrease
resulting from the sale of the CDR business in July 2001 and (2) a $1.1 million
decrease resulting from a non-recurring revenue opportunity for one client in
the prior year period. In addition, revenue increased by $1.7 million across the
comparable client base reflecting non-recurring revenue opportunities, timing
differences, and changes in the volume, yields and scope of client projects.
The Provider Services Division, which outsources business office
services for hospitals, generated revenue of $17.3 million in the current year
quarter, a $2.3 million or 15% increase from the prior year period of $15.0
million. This increase primarily consists of $2.4 million in revenue from
sixteen new customers since the prior year period, and a $1.5 million increase
with one customer resulting from an expansion in the scope of services provided
and an increase in yields. These increases were partially offset by a decrease
of $1.5 million associated with five terminated or inactive customer
relationships.
Total operating expenses for the current year six month period were
$36.4 million, an increase of $4.1 million or 13% compared to the prior year six
month period. The Company experienced cost of service fluctuations as follows.
Direct project costs for the current year six month period were $4.7 million, an
increase of $0.7 million or 17% compared to the prior year period. This net
increase generally follows from the increase in revenues and reflects
fluctuations in the mix of business for the period based on the specific
requirements of client projects. Compensation expense for the current year six
month period was $18.9 million, an increase of $1.5 million or 8% compared to
the prior year six month period. This increase reflects a general increase in
compensation rates and an increase in staff in the information technology
development team, partially offset by a decrease of $1.2 million from the sale
of the CDR business in July of 2001. Data processing costs for the current year
six month period were $3.7 million, an increase of $0.5 million or 17% compared
to the prior year period, reflecting $0.6 million for the disposal and
impairment of hardware and software items resulting from the termination of
certain internal projects. Other operating costs for the current year six month
period were $6.0 million, an increase of $2.5 million or 71% compared to the
prior year six month period. This increase primarily includes: (1) $1.5 million
for consulting and professional service fees associated with service development
initiatives, on-going system enhancement, and HIPAA (Health Insurance
Portability and Accountability Act) compliance, (2) $0.6 million of expense
related to stock option grants to three members of the Board of Directors, and
(3) a non-recurring insurance reimbursement of $250,000 received in the prior
year.
Net interest income of $289,000 for the current year six month period,
compared to $376,000 in the prior year six month period, 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 current period.
17
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 a decrease 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 fiscal 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.
Loss from continuing operations was $2.5 million in the current year
six month period compared to a loss of $1.1 million during the prior year
period. 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 Note 2(b) of the Notes to the Condensed
Consolidated Financial Statements, the Company reported the results of its PSG
and DSG as discontinued operations for all periods presented. During the current
year six month period income from discontinued operations of $2.9 million
principally resulted from a termination fee received from a former customer of
the PSG, which was not included in the prior disposal estimate. Loss from
discontinued operations in the prior year six month period of $4.0 million
reflected the then on-going activities of the PSG and DSG.
Net income was $0.4 million for the first six months of fiscal year
2002 or $0.02 per common share compared to a net loss of $5.1 million or $0.29
per common share in the prior year six month period. The current year results
include loss from continuing operations of $0.14 per common share and income
from discontinued operations of $0.16 per common share compared to a loss from
continuing operations of $0.07 per common share and loss from discontinued
operations of $0.22 per common share in the prior year six 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 June 30, 2002, the Company's cash and short-term investments and net working
capital were $25.0 million and $29.6 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 $3.0 million of property and equipment during fiscal year 2002,
which is consistent with the amounts purchased during recent years. The payments
due by period for the Company's contractual obligations, consisting principally
of facility lease obligations and equipment rental and software license
obligations, are as follows as of June 30, 2002 ($ in thousands):
Total Six Months 1-3 Years 4-5 Years After 5 years
----- ---------- --------- --------- -------------
$24,098 $2,984 $8,216 $5,117 $7,781
18
The Company has entered into sublease arrangements for some of its
facility obligations and expects to receive the following rental receipts as of
June 30, 2002 ($ in thousands):
Total Six Months 1-3 Years 4-5 Years After 5 years
----- ---------- --------- --------- -------------
$7,296 $858 $3,409 $2,637 $392
For the six month period ended June 30, 2002, cash used by operating
activities was $3.4 million compared with cash used by operating activities of
$0.9 million for the six month period ended June 30, 2001. The current year use
of cash in operations included an increase in accounts receivable of $1.3
million reflective of the growth in the Company's revenue and a decrease in
accounts payable and accrued expenses of $2.8 million resulting from the timing
of payment on certain liabilities. Investing activities in the current year
period consisted primarily of $954,000 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 year period principally consisted of $516,000 received
as proceeds from stock option exercises. During the current year six month
period, cash provided by discontinued operations was $3.3 million, principally
reflecting a termination fee received from a former customer of the PSG.
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 1,441,416 shares having an
aggregate purchase price of $8,658,000. This includes 124,400 shares repurchased
during July 2002 at an aggregate cost of $343,000.
19
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
The Company's holdings of financial instruments are comprised of
federal, state and local government debt. All such instruments are classified as
securities available for sale. The Company does not invest in portfolio equity
securities or commodities or use financial derivatives for trading purposes. The
Company's debt security portfolio represents funds held temporarily, pending use
in the Company's business and operations. The Company manages these funds
accordingly. The Company seeks reasonable assuredness of the safety of principal
and market liquidity by investing in rated fixed income securities while, at the
same time, seeking to achieve a favorable rate of return. The Company's market
risk exposure consists principally of exposure to changes in interest rates. The
Company's holdings are also exposed to the risks of changes in the credit
quality of issuers. The Company typically invests in the shorter-end of the
maturity spectrum or highly liquid investments.
The table below presents the amortized cost basis, and the fair value
for the Company's investment portfolio as of June 30, 2002, and the related
weighted average interest rates by year of maturity ($ in thousands):
Matures Year Ending Total Total
December 31, 2002 Amortized Cost Fair value
----------------- -------------- ----------
Fixed income governmental securities $ 2,833 $ 2,833 $2,869
Average interest rate 4.57% 4.57%
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings - See Note 7 of Notes to Condensed
Consolidated Financial Statements for discussion of a pending legal proceeding.
Item 4. Submission of Matters to a Vote of Security Holders - The
Annual Meeting ("Meeting") of Shareholders of the Company was held on June 4,
2002. The 16,792,358 shares of common stock ("Common Stock") present at the
Meeting out of a then total 18,159,373 shares outstanding and entitled to vote,
acted as follows with respect to the following proposals:
Approved, by a vote of: 15,391,049 shares of Common Stock for and
1,401,309 shares against the election of Randolph G. Brown as a director of the
Company; 15,276,734 shares of Common Stock for and 1,515,624 shares against the
election of James T. Kelly as a director of the Company; and 15,389,748 shares
of Common Stock for and 1,402,610 shares against the election of Galen D. Powers
as a director of the Company;
Ratified, by a vote of 6,075,582 shares of Common Stock for, 1,350,485
shares against and 55,875 shares abstain, the grant of 250,000 options to James
T. Kelly;
Failed to ratify, by a vote of 3,476,655 shares of Common Stock for,
3,973,789 shares against and 31,498 shares abstain, the proposed amendments to
the Company's 1999 Long-Term Incentive Stock Plan; and
Ratified, by a vote of 16,666,813 shares of Common Stock for, 99,319
shares against and 26,226 shares abstain, the selection of KPMG LLP as the
Company's independent certified public accountants for the fiscal year ending
December 31, 2002.
Item 6. Exhibits and Reports on Form 8-K
Exhibit 99.1 - Certification of Chief Executive Officer
Exhibit 99.2 - Certification of Chief Financial Officer
20
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: August 14, 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)
21