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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED OCTOBER 31, 1996
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
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 10016
NEW YORK, NEW YORK (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(212) 685-4545
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Securities registered pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
- ------------------- -------------------
None
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK
Indicate by check mark if disclosure of delinquent files pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
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 aggregate market of the registrant's common stock held by non-affiliates as
of January 15, 1997 was $220,635,524 based on the closing price on the Nasdaq
National Market System on that day.
Number of shares outstanding of the registrant's common stock, $.01 par value,
on January 15, 1997 was 17,635,064.
DOCUMENTS INCORPORATED BY REFERENCE:
DOCUMENT WHERE INCORPORATED
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PROXY STATEMENT FOR THE ANNUAL MEETING PART III
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TO BE HELD ON MARCH 4, 1997
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TABLE OF CONTENTS
Page
Contents Number
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Cover Page ...................................................................... i
PART I
Item 1. Business ............................................................ 1
Item 2. Properties .......................................................... 12
Item 3. Legal Proceedings ................................................... 12
Item 4. Submission of Matters to a Vote of Security Holders ................. 12
PART II
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters 13
Item 6. Selected Financial Data ............................................. 13
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations ............................................... 13
Item 8. Financial Statements and Supplementary Data ......................... 13
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure ................................................ 13
PART III
Item 10. Directors and Executive Officers of the Registrant .................. 14
Item 11. Executive Compensation .............................................. 14
Item 12. Security Ownership of Certain Beneficial Owners and Management ...... 14
Item 13. Certain Relationships and Related Transactions ...................... 14
PART IV
Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K ..... 14
Signatures ................................................................... 18
Index to Consolidated Financial Information .................................. 19
Exhibit Index ................................................................ 20
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PART I
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements in this Form 10-K constitute "forward-looking statements
"within the meaning of the Private Securities Litigation Reform Act of 1995 (the
"Reform Act"). Such forward-looking statements involve known and unknown risks,
uncertainties, and other factors which may cause the actual results,
performance, or achievements of HMSY, or industry results, to be materially
different from any future results, performance, or achievements expressed or
implied by such forward-looking statements. Such factors include, among others,
the following: changes in general economic and business conditions; loss of
market share through competition; introduction of competing services by other
companies; changes in the degree of protection created by HMSY's intellectual
property rights; pressure on prices from competition or from purchasers of
HMSY's services; regulatory changes to the health care reimbursement process;
regulatory obstacles to the introduction of new services that are important to
HMSY's growth; availability of qualified personnel; the loss of any significant
customers; and other factors both referenced and not referenced in this Form
10-K. When used in this Form 10-K, the words "estimate," "project,""anticipate,"
"expect," "intend," "believe," and similar expressions are intended to identify
forward-looking statements.
ITEM 1. BUSINESS
OVERVIEW
Health Management Systems, Inc. ("HMSY" or the "Company") furnishes
proprietary information management and data processing services and software to
hospitals and other health care providers and to government health service
agencies and other health care payors. These services address the various types
of data generated by the interaction of the participants in the health process:
the health care provider, the third-party payor, and the patient. Through its
retrospective, concurrent, and prospective service offerings, the Company acts
as an outsourcer of information management addressing the clinical, operational,
administrative, and financial data which result from the rendering of health
care services. The Company's service offerings benefit its clients by enhancing
revenue and accelerating cash flow (achieved through improved reimbursability
and collectability), reducing operating and administrative costs (by supplying
advanced information analytics), and improving decision making capabilities (via
the provision of useful information).
Hospitals receive payment for services from patients, third-party payors, or
a combination thereof. Third-party payors include commercial insurance
companies, governments or their intermediaries, health maintenance
organizations, preferred provider organizations, third-party administrators for
self-insured companies, and managed care companies. Although patients generally
retain primary responsibility for payment for all health care services,
hospitals usually process claims for which third-party payors bear
responsibility. Obtaining reimbursement from third-party payors has become
increasingly difficult because of frequent changes in reimbursement formulae,
requirements for pre-admission certification and utilization review, and
administrative procedures instituted by third-party payors in an effort to
control costs. To be successful in obtaining payment from third-party payors,
hospitals and other providers of care require regulatory knowledge and technical
skills to manage complex data collection, integration, analysis, and accounts
receivable management requirements. To ensure that program costs are no greater
than required, third-party payors require knowledge and skills analogous to
those required by providers.
Among the Company's diversified services are those designed to minimize the
degree of error that results from the enormous transaction processing and
information management requirements associated with the health care transfer
payment process. Since its founding in 1974, the Company has concentrated on
applying its expertise in health care reimbursement processes and information
systems technology to the liquidation of health care accounts receivable. More
recently, the Company has expanded its product suite from its historic focus on
(i) maximizing liquidations of the accounts receivable at pre-determined
reimbursement rates, to include (ii) decision support software products which
enable health care providers to assemble, analyze, and evaluate mission-critical
cost and quality information, facilitating efforts by the provider to consider
the proposed patient care in terms of its benefit, cost, reimbursability,
profitability, and quality. The Company believes that its development of
proprietary computer software,
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systems, and databases dedicated exclusively to the analysis, management, and
liquidation of health care accounts receivable by providers and payors and the
concentration of its clients among the nation's largest urban health care
provider institutions and large purchasers of health care make HMSY unique among
companies providing accounts receivable management and decision support services
to hospitals, government health care agencies, and other companies serving the
health care industry.
Unless otherwise noted, all information in this report has been adjusted to
give effect to a three-for-two stock split in the form of a 50% stock dividend,
distributed on December 29, 1995 to all shareholders of record as of December
15, 1995.
HEALTH CARE REFORM AND REGULATORY MATTERS
The health care reimbursement process has been subject to constant change,
more recently at an accelerating rate. Federal, state, and local governments, as
well as other third-party payors, have initiated policies designed to reduce the
rate of increase in health care expenditures. Many of these policy initiatives
have contributed to the complex and time consuming process of obtaining health
care reimbursement for medical services provided.
Legislation is continually submitted and acted upon at the federal, state,
and local government levels seeking to "reform" the health care and welfare
systems. Most of these proposals seek to expand or limit health care coverage to
the under and uninsured while reducing the rate of increase in health care costs
by introducing elements of "managed competition" and "managed care," as well as
by reducing the administrative costs of the health care reimbursement process.
It is not possible at this time to predict which, if any, reforms will be
adopted, when such reforms will be implemented, or the impact of such reforms.
However, the Company believes the shifting of traditional insurance risk to
providers of care and the additional information management requirements placed
on the providers contemplated in many of these proposals may increase the demand
for the Company's services. Moreover, the Company believes that patients,
providers, and payors, individually and in various combinations, will seek
information to be derived by the Company's integration of cost and other
financial and clinical data, enabling identification and management of the
outcomes achieved.
The Medicare program is administered by the Health Care Financing
Administration ("HCFA"), an agency of the U.S. Department of Health and Human
Services. HCFA currently contracts with more than 80 insurance carriers and
intermediaries to process regional reimbursement claims. Although HCFA has
established the regulatory framework for Medicare claims administration,
Medicare intermediaries have the authority to develop independent procedures for
administering the claims reimbursement process. The Medicaid program is subject
to regulation by HCFA, but is administered by state governments. State
governments provide for Medicaid claims reimbursement either through the
establishment of state-owned and operated processing centers or through
contractual arrangements with third-party processors. The requirements and
procedures for reimbursement implemented by Medicaid program administrators
differ from state to state. Similar to the claims administration process of
Medicare and Medicaid, many national health insurance companies and self-insured
employers administer reimbursement of claims through local or regional offices.
Consequently, because guidelines for the reimbursement of claims are generally
established by third-party payors at local or regional levels, hospital and
other provider reimbursement managers must remain current with the local
procedures and requirements of third-party payors.
The ownership and operation of hospitals is subject to comprehensive federal
and state regulation, which may affect hospital reimbursement. Since adoption,
the Medicare and Medicaid programs have undergone significant and frequent
changes, and it is realistic to expect additional changes in the future. Such
changes could have an adverse effect on the operations of hospitals and other
providers of health care in general, and consequently reduce the amount of the
Company's revenue. The Company's services also are subject to regulations
pertaining to billing services, which primarily involve recordkeeping
requirements and other provisions designed to prevent fraud. The Company
believes that it operates in a manner consistent with such regulations, the
enforcement of which is increasingly more stringent. Finally, the Social
Security Act imposes certain requirements on the Company with regard to
confidentiality and disclosure of Medicare and Medicaid provider and beneficiary
data. Specifically, the Company is prohibited from disclosing information that
is obtained by or from the Department of Health and Human Services except as
otherwise provided by regulations or other federal law. Generally, the Company
is required to maintain standards of confidentiality that are comparable to
those of an agency administering the Medicare or Medicaid program when the
Company uses data obtained from such programs.
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PRINCIPAL SERVICES
The Company delivers services and software that comprise three business
segments and five principal product offerings. Those three business segments
are: (1) Proprietary Services - Information and Outsourcing ("Proprietary
Services"), (2) Proprietary Analytics - Managed Care Support ("Managed Care
Support") services, and (3) Electronic Data Interchange. The table below sets
forth for the periods indicated the percentage of consolidated revenue
represented by each of these product offerings and is followed by a discussion
summarizing the nature of the product offering.
Fiscal Year Ended October 31,
-----------------------------
1996 1995 1994
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Proprietary Services
Retroactive Claims Reprocessing 28% 26% 26%
Comprehensive Accounts Management 18% 27% 30%
Third-party Liability Recovery 26% 21% 16%
--- --- ---
72% 74% 72%
Managed Care Support 19% 17% 17%
Electronic Data Interchange 9% 9% 11%
--- --- ---
Total 100% 100% 100%
All of the Company's product offerings provide a high level of recurring
revenue. Over 90% of the Company's Proprietary Services revenue, exclusive of
affiliates ("Core Proprietary Revenue"), in fiscal year 1996 was attributable to
entities that became clients of the Company prior to 1996. This is consistent
with revenue patterns experienced by the Company in prior years.
RETROACTIVE CLAIMS REPROCESSING ("RCR")(SM)
As a result of the magnitude and complexity of the information requirements
involved in the health care claims reimbursement process, a hospital's patient
accounting department processes an enormous amount of data each day, normally
recouping a majority of third-party payments due for patient services.
Nevertheless, due to various factors, it is virtually impossible for any
hospital to identify and obtain payment for all of the open balances that are
eligible for third-party reimbursement. These factors include (i) incorrect or
incomplete billing information provided by patients, (ii) difficulties in
verifying patient insurance eligibility and payment status, (iii) problems in
controlling the completeness and accuracy of patient data as it accumulates and
flows through the frequently unintegrated platforms comprising the hospital's
overall information management system, and (iv) the necessity for constant
modification and reprogramming of billing, reporting, and compliance routines
due to the frequent and complex changes to payor information and compliance
requirements.
As a consequence of these and related factors, a hospital's patient
accounting department often has incorrect or incomplete information regarding
certain claims, resulting in such claims either being rejected by third-party
payors or not being billed at all. For most hospitals, rejected or unbilled
claims represent a relatively small percentage of total revenue, and the cost
for any particular hospital to install the data processing systems and hire the
technical personnel that would be necessary to identify every claim covered by
insurance and to accumulate all the information needed to submit each claim on
an on-going basis would be prohibitive. Through the application of the Company's
proprietary technology, the Company's RCR services produce for its hospital
clients incremental revenue, which otherwise would remain uncollected.
RCR services are used by a hospital (most frequently for its emergency room
and outpatient clinics) to realize third-party revenue from patient accounts
after the hospital has expended its own best efforts at billing and collection,
but before the accounts are referred to a collection agency. The Company's
specialized data aggregation, data purification, data editing, and electronic
claim preparation and transmission routines are designed to facilitate the
reimbursement of accounts that remain unpaid because necessary billing
information was missing or because the existence of third-party coverage was not
known. RCR services require the hospital only to provide the Company with copies
of existing data files, demand minimal hospital staff support, and involve no
patient contact.
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Each RCR client determines the scope of the services to be performed by the
Company and the frequency with which such services are delivered. The scope of
RCR services may involve a hospital's emergency room, outpatient, and/or
inpatient departments. The frequency of processing and billing on behalf of a
client is determined by a number of factors, including the client's internal
billing and follow-up processes, as well as applicable statutory and regulatory
time limitations on submission of claims.
Revenue generated on behalf of new RCR clients is generally highest during
the first full year of processing because the Company is able to liquidate the
client's accounts receivable to the maximum extent of the available statutory
claiming limitation. After the initial processing period, billings normally span
shorter processing periods and generate smaller amounts of revenue. The
incremental revenue generated on behalf of the Company's clients will vary
significantly from client to client due to differences in the sophistication of
the clients' data systems and the scope and frequency of the services performed.
Since 1974, RCR services have generated in excess of $1.1 billion in incremental
third-party claims reimbursements for hospitals. Over the last three fiscal
years, such services have generated over $364 million in incremental
reimbursements.
RCR services are currently provided principally to large public and voluntary
(not-for-profit) hospitals and other health care providers in 10 states and the
District of Columbia. RCR contracts generally have three-year terms and are
cancelable by the Company or the client upon 90 days notice. Contingent fees for
RCR services typically range from 20% to 30% of the incremental revenue
generated on behalf of the client. The Company recognizes revenue at the time a
client's billing is submitted to a third-party payor or its intermediary.
COMPREHENSIVE ACCOUNTS MANAGEMENT SERVICES ("CAMS")(SM)
As a result of the technology and expertise developed in providing RCR
services, the Company is able to provide custom institutionalized data
processing, computer software, and operations support services to hospitals,
public health clinics, outpatient treatment facilities, companies that serve the
health care industry, and payors such as state Medicaid agencies. In contrast to
RCR services, which retrospectively reprocess patient accounts receivable data,
CAMS delivered to health care providers provides concurrent third-party claim
identification, editing, preparation, and electronic submission. The Company
integrates data derived from the hospital's disparate data collection systems
and manages the electronic interfaces between the hospital and the transfer
payment agencies upon which the hospital is dependent for reimbursement. CAMS is
designed to provide an integrated and comprehensive solution to a hospital's
accounts receivable liquidation requirements by combining (a) an intimate
familiarity with the principal in-house shared data collection and patient
accounting systems found in large urban hospitals with (b) expertise in the
management and liquidation of accounts receivable, thereby offering a hospital a
unique opportunity to improve the effectiveness of its accounts receivable
management program (enhance revenue and accelerate cash flow) while decreasing
its administrative costs.
As part of CAMS, the Company develops customized automated interfaces between
a hospital's various data collection, billing, and accounts receivable systems,
and the claims processing systems of third-party payors. To establish these
interfaces, the Company must satisfy the unique information and data processing
requirements of each hospital and of the various intermediaries used by
third-party payors in each jurisdiction. The Company obtains information from
the client hospital's internal charge capture, medical records, utilization
review, and patient accounting systems as required to submit electronically
complete and accurate reimbursement claims. The Company then performs
pre-billing edits, uses its computer platforms to facilitate correction of
pre-billing edit failures, and performs electronic billing of valid claims. Upon
payment by the third-party payors, the Company captures remittance data from
intermediaries for electronic posting to the hospital's accounts receivable
system. CAMS systems apply a variety of technologies (including bar coding
devices) to track location and document status information and to extract
requisite information from medical records, utilization review, and patient
accounting systems at the client site. CAMS also generates (for delivery in
paper or electronic media form) automated management reports for use by the
hospital's patient accounting and financial management personnel that would
otherwise be unavailable to them.
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Most of the Company's CAMS clients were former RCR clients. The Company
believes that demand for its CAMS will increase as a result of (a) the trend by
many hospitals and providers of information services to the health care industry
to outsource various administrative, data processing, and patient accounting
functions and (b) the increased data processing requirements caused by the
continuing growth in outpatient services as an alternative to inpatient
treatment. The Company encourages the conversion of RCR clients to CAMS
engagements as a logical product evolution at a client facility. The Company
currently provides CAMS in four states.
CAMS contracts generally have a duration of three to five years. The fee
structure for CAMS varies by the type of patient service involved and the
location of the client, with typical contingent fees ranging from 0.4% to 12.5%
of the client's total inpatient revenue and from 4.0% to 12.5% of the client's
total outpatient revenue. The differences in inpatient and outpatient fees are
attributable principally to the higher volume and smaller per claim amounts for
outpatient claims. In certain cases, the Company's fees are subject to annual
limitations, regardless of the amount of revenue generated on behalf of the
client. The majority of CAMS contracts that are currently subject to fee
limitations provide for a higher level of revenue during the first 24 months of
the contracts to compensate the Company for its start-up costs. The Company
generally recognizes CAMS revenue monthly, based on the revenue generated on
behalf of its client. Revenue derived from CAMS contracts with fee ceilings is
recognized ratably over the limitation period.
THIRD-PARTY LIABILITY RECOVERY ("TPLR")(SM)
The Medicaid program, which was established in 1965, exists as the payor of
last resort for health care services required by financially and medically needy
individuals. The Medicaid program is administered by the individual states, with
joint federal and state funding of costs. In 1985, the federal government,
recognizing that state Medicaid agencies were improperly paying substantial
amounts for health care claims for individuals having some other form of
third-party health care insurance, enacted regulations requiring states to take
active measures to pursue the third parties. In 1985, HMSY began to offer TPLR
services, principally to state Medicaid agencies, as a means of identifying
third parties with prior liability for Medicaid claims.
TPLR processing is performed according to the requirements of each individual
client. In providing these services, the Company uses proprietary information
management and analysis methodologies that are similar to those used in
providing RCR services, although TPLR services require the creation of
independent databases of far greater magnitude than is required for RCR clients.
TPLR contracts generally have one to three year terms and provide for
contingent fees that typically range from 7% to 20% of the amounts recovered for
the client. The Company recognizes revenue at the time a recovery to be
submitted on behalf of the client third-party payor or its intermediary is
approved by the client for purposes of initiating the recovery process. TPLR
revenues are subject to annual fluctuations similar to those experienced with
RCR services.
The Company has begun the application of its proprietary information
management and analysis methodologies, similar to those used for providing RCR
and TPLR services, to offer services known as Employer Retroactive Claims
Recovery ("ERCR")sm services to self-insured employers. ERCR contracts generally
have one to three year terms and provide for contingent fees that typically
range from 10% to 30% of the amounts recovered for the client. The Company
recognizes revenue at the time a billing is submitted on behalf of the client to
a third-party payor or administrator. ERCR revenue is subject to annual
fluctuations similar to those experienced with RCR and TPLR services. The
Company currently has six ERCR engagements in three states.
In April 1996, the Company acquired CDR Associates, Inc. ("CDR") to augment
the Company's TPLR services. CDR is a provider of hospital-based claim audits on
behalf of payors for the purpose of recovery. CDR's principal client base is
comprised of Blue Cross and Blue Shield carriers and their related managed care
organizations. In addition, CDR clients include several commercial carriers and
HMOs.
The Company currently has TPLR engagements, inclusive of ERCR and CDR, in 22
states and the District of Columbia.
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MANAGED CARE SUPPORT ("MCS")
MCS services are provided by Health Care microsystems, Inc. ("HCm"), which
merged with HMSY in February 1995. MCS consists of microcomputer based decision
support applications and related consulting services, which assist health care
providers in assembling, analyzing, and evaluating information in order to
provide cost-effective, high quality services. Unlike the Company's other
services, MCS clients retain the Company on a fee for service basis.
HCm is a leading provider of decision support systems and applications for
microcomputer-based platforms. HCm's current service offerings cover a broad
range of financial, clinical, and operational disciplines. These include
application modules for: physician profiling, budgeting and financial modeling,
clinical case management, cost accounting, productivity management, patient
demographics, and contract management. HCm also offers cost management and
general management consulting services, as well as systems integration services
aimed at facilitating the integration of clinical, business, and strategic
decision-making.
The Company recognizes revenue from consulting services as the services are
provided. Revenue from software products sold to customers under license
agreements is deferred and recognized as revenue upon software installation and
satisfaction of significant Company obligations, if any. Revenue from ongoing
maintenance agreements is deferred and recognized as revenue on a straight-line
basis over the periods of the respective maintenance agreements.
HCm has over 400 clients, which include hospitals, clinic facilities, and
physician groups located in 44 states and the District of Columbia.
ELECTRONIC DATA INTERCHANGE ("EDI")
Through its RCR, CAMS, and TPLR offerings, the Company has developed the
capability to submit health care reimbursement data to and receive remittance
data electronically from a diverse array of third-party payors. To further this
capability and to expand its presence in this separate service sector, HMSY
acquired Quality Medi-Cal Adjudication, Incorporated ("QMA") in February 1990.
QMA, based in Sacramento, California, provides approximately 148 hospitals and
health care providers, principally in California with additional clients in
Nevada and New York, with electronic billing and follow-up services for claims
submitted to Medi-Cal (the California Medicaid program) and various commercial
insurance carriers. The Company also provides EDI services to clients through
its Accelerated Claims Processing, Inc. ("ACPI") subsidiary. ACPI provides EDI
services to clients in the Illinois, New York, and Pennsylvania markets.
Since the acquisition of QMA, the Company has been involved in a significant
transfer of its proprietary technology and expertise to the EDI platform of QMA.
As a result, QMA's EDI platform has been converted to encompass the range of
functionality required for an all-payor system. Conversion of the platform to
facilitate distribution and support in major industrial states outside
California has been accomplished and its enhancement continues.
QMA's electronic data interchange services are offered in conjunction with
varying levels of follow-up services under contracts that typically span three
years. Fees for routine electronic billing submissions are established on a per
claim basis and vary depending on the level of follow-up service provided. QMA
also offers billing services at fixed monthly fees regardless of volume to
approximately 40% of its clients. Revenue is recognized at the time billings are
submitted to third-party payors or their intermediaries. For providing follow-up
services relative to certain claims, QMA is entitled to a contingent fee equal
to a percentage of the amount recovered for the hospital. By application of the
Company's RCR technology, QMA has been able to secure additional revenue
pursuant to these contingent fee provisions.
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MARKET FOR THE COMPANY'S SERVICES
Although the Company's services involve various proprietary aspects, its
business is highly competitive. Several companies, some of which may be larger
and have greater financial resources than the Company, compete with the Company
in providing one or more aspects of the Company's services. The Company may also
encounter increased competition from companies attempting to expand the scope of
their services in, or to enter, the health care information management services
industry.
PROPRIETARY SERVICES
The principal market for the Company's RCR services and CAMS consists of the
approximately 600 largest acute care hospitals in the United States having 300
or more beds or more than 100,000 outpatient (including emergency room) visits
per year. The Company's hospital clients are almost exclusively large urban
public and voluntary (not-for-profit) hospitals and other health care providers,
primarily due to (i) the severe financial constraints facing such institutions,
(ii) the significant commitment of such institutions to providing emergency and
other non-elective services, and (iii) the resulting complexities of securing
complete and accurate reimbursement data with respect to such services.
Proprietary hospitals, which tend to be smaller institutions, derive a greater
proportion of their revenue from elective procedures, making the problems of
patient data collection and management less onerous. Although the number of
large acute care hospitals has not changed significantly in recent years, the
intensity of their use of information systems technology has increased rapidly,
primarily as a result of demands for information made by third-party payors and
government regulators, as well as by the need to control costs and better manage
hospital resources. This trend has led many hospitals to install sophisticated
patient registration, charge capture, and patient accounting systems. Rather
than discouraging the use of RCR services, the Company believes that these new
systems have aided the expansion of such services, as the RCR services and CAMS
operate most effectively when they can draw upon more comprehensive service and
patient data already gathered by a hospital's data collection systems.
As of October 31, 1996, the Company believes that institutions comprising
approximately 25% of the potential market are currently RCR clients of the
Company. The Company believes that no other organization provides an offering
directly competitive with its RCR services. The Company's belief is supported by
(i) the frequent instances in which the Company has been the recipient of
"sole-source" contract awards from government entities routinely requiring
competitive bidding unless uniqueness can be conclusively established and (ii)
the frequency with which a competitive bidding situation, when otherwise
required, has resulted in the Company's being adjudged by the governmental
entity the only responsive bidder. In general, RCR services compete on the basis
of the Company's special revenue enhancement expertise, its contingent fee
pricing, and the uniqueness of its approach to interacting with a hospital's
patient accounting and other information systems.
The Company also anticipates that it may offer CAMS to businesses providing
financial, administrative, and information management outsourcing services to
the health care industry. In providing these services, the Company indirectly
competes with several large national and regional consulting and systems
integration firms and with numerous small local firms that deliver some form of
billing services to hospitals.
The market for the Company's TPLR services consists of the Medicaid and
related entitlement program administrative agencies of the 50 states and the
District of Columbia, plus a number of federal agencies, including HCFA, the
Veterans' Administration, the Department of Defense, and the Department of
Housing and Urban Development. The Company believes that its technology is
useful in improving coordination of benefits activities of various third-party
administrators, corporate purchasers of benefits, Blue Cross entities, and other
commercial health insurance carriers, and a number of initiatives are under way.
In addition, the use of TPLR technology in the form of the ERCR product offering
has proven to be applicable to the analysis of claims paid by large self-pay
employers. The Company competes for TPLR contracts with the consulting divisions
of certain national public accounting firms, as well as with several large data
processing service companies, on the basis of its revenue enhancement and
third-party billing expertise and its extensive Medicaid, Medicare, and other
reimbursement program experience.
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MANAGED CARE SUPPORT
Recent changes in the health care marketplace have intensified the
information demands at all levels in provider organizations, whether hospitals
or integrated delivery systems. Competition for covered lives under various
managed care paradigms is forcing providers to deliver health care as
efficiently and cost-effectively as possible without compromising quality. The
focus of health care information technology is changing from collecting
departmental financial data (with a focus on billing and charge capture) to
gathering and aggregating enterprise-wide information with an emphasis on
clinical operations, cost-identification, cost-reduction, and complex
coordination of benefits data. Two requirements emerge from these trends: (i)
future information management requirements must be tailored for complex,
diverse, integrated delivery systems spanning hospital divisions, managed care
business lines, physician group practices, and ancillary services; and (ii)
information systems and services must help providers function in a capitated
payment environment.
HCm's current client base includes over 400 hospitals in the United States.
These hospitals range in size from 50 to 1,100 beds, and include many of the
most progressive health systems in the United States, as well as some of the
largest multi-site hospital chains. The growth of managed care and integrated
health care networks is significantly increasing the demand for decision support
information systems ("DSS"). In the new health care environment, it is believed
that DSS are the linchpin for integrating, analyzing, and understanding key
clinical, financial, and administrative data derived from an institution's
transaction-based, health care information systems. As such, DSS are
increasingly being relied upon to guide the management practices of providers
(in areas ranging from managed care contracting to physician profiling) to
ensure the success and validity of their organizations. As a recognized leader
in the field of DSS, with experience working in partnerships with complex health
care delivery systems, HCm is well positioned to expand its service offering
penetration relative to the 6,000 acute care providers nationwide, along with
newly emergent health care entities. The Company competes for MCS contracts with
hospital computer systems vendors (such as HBO and Company and Shared Medical
Systems Corporation) and decision support vendors (such as Transition Systems
Inc. and Medicus Corporation) on the basis of its advanced microcomputer
software applications.
ELECTRONIC DATA INTERCHANGE
The principal market for QMA's EDI services includes over 400 acute care
hospitals in California. In addition, QMA's all-payor billing workstation, which
permits a hospital's billing office to bill multiple third-party payors
electronically using a single microcomputer workstation, may prove attractive to
acute care hospitals in other states on a stand-alone basis or in conjunction
with the Company's enhanced platform configuration under continuing development.
The stand-alone EDI business is a highly competitive and highly fragmented
industry niche throughout the country. On a national basis, several larger
entities are consolidating many local EDI companies. EDI services provided by
QMA in California compete with Blue Cross and a number of small, primarily
local companies offering Medi-Cal, Medicare, and commercial insurance billing
services, as well as with the hospitals' own billing units.
SIGNIFICANT CONTRACTS
The Company's largest client is a group of health care facilities under the
governance of Los Angeles County for which the Company provides CAMS and RCR
services. During the fiscal years ended October 31, 1996, 1995, and 1994, this
group accounted for 12%, 15%, and 17% of the Company's revenue, respectively.
The group of health care institutions operating under the aegis of The City of
New York was the Company's second largest client in 1996 and 1995, and the
Company's third largest client in 1994, accounting for 8%, 11%, and 6% of the
Company's total revenue in 1996, 1995, and 1994, respectively. The Company's
contract with this client expired on September 30, 1996. The Company continues
to process claims for this client under an interim arrangement, while a new
contract has been bid and is being negotiated. While the Company is optimistic
that negotiations will be successful, there can be no assurance that a new
contract will be consummated; loss of this client could have a material adverse
effect on the Company. The Company's ten largest clients accounted for
approximately 54% of the Company's revenue in fiscal year 1996.
8
11
HHL Financial Services, Inc. ("HHL") has been a significant client of the
Company since 1994, accounting for 5%, 10%, and 13% of the Company's total
revenue in fiscal years 1996, 1995, and 1994, respectively. HHL went into
default of its contractual obligations to the Company during the course of 1996.
As a result, the Company took an after tax charge against earnings of $5,838,000
in fiscal year 1996. See Relationship with HHL Financial Services, Inc.
BUSINESS STRATEGY
This section of Form 10-K contains forward-looking statements involving
various risks that may cause actual results to differ materially. These risks
include but are not limited to the ability of HMSY to grow internally or by
acquisition and to integrate acquired businesses into the HMSY group of
companies, changing conditions in the health care industry which could simplify
the reimbursement process and adversely affect HMSY's business, government
regulatory and political pressures which could reduce the rate of growth of
health care expenditures, competitive actions by other companies, and other
risks referred to in HMSY's registration statements and periodic reports filed
with the Securities and Exchange Commission.
The expertise developed by the Company over the last 23 years in the health
care reimbursement arena provides a solid foundation for the expansion of the
Company's services to non-governmental payors (commercial insurance carriers and
large self-insured corporations) and other companies servicing the health care
industry (accounts receivable management companies and third-party claims
administrators). The Company intends to expand its client base by continuing to
offer technologically innovative, cost-effective services that increase the
ability of health care providers to receive reimbursement for health care
services for which they are eligible but are otherwise unable to collect. The
Company's strategy seeks to exploit its data processing skills and knowledge of
the health care reimbursement process in providing value-added services to
hospitals and third-party payors and their intermediaries. The Company also
intends to take advantage of the current trend among many hospitals to
"outsource" data processing and patient accounting functions, as well as the
recent growth in the volume of outpatient services as an alternative to
inpatient treatment.
NEW SERVICES
In response to the varying needs of individual clients, the Company
historically has devoted significant resources to expanding the range of its
services and will continue to do so. As a result of these efforts, the Company
intends to develop new services that will benefit existing as well as future
hospital, large self-insured corporate, other health care provider, and
government agency clients in managing the reimbursement process. These new
services are expected to include the utilization of the QMA EDI platform in
claiming jurisdictions outside the State of California.
ACQUISITIONS
The Company's strategy includes the expansion of its business through
selective acquisitions. The Company may acquire companies that supply health
care providers with automated billing, electronic media claiming, accounts
receivable management, and health care utilization management information
services if the services or operations of such companies would benefit from
access to the Company's proprietary computer technology or software
applications. The Company believes that many such acquisition opportunities
exist due, in part, to competitive pressures on local service businesses that
lack adequate capital, technical, and management resources. The Company also
believes that consolidation will continue to occur within the health care
information services industry.
CDR ASSOCIATES, INC.
On April 29, 1996, the Company acquired all the outstanding capital stock of
CDR in a merger transaction ("CDR Merger") in exchange for 460,000 shares of the
Company's stock. CDR is a supplier of third-party liability recovery services to
the health care industry. The CDR Merger was treated as a tax-free
reorganization for federal income tax purposes, and was accounted for using the
pooling of interests method of accounting.
9
12
QUALITY STANDARDS IN MEDICINE, INC.
On November 25, 1996, the Company consummated a merger (the "QSM merger")
with Quality Standards in Medicine, Inc. ("QSM"). Founded in 1986, QSM furnishes
clinical quality management and improvement systems to hospital providers in 13
states and the District of Columbia and the United Kingdom. The Company issued
260,000 shares of common stock in the QSM Merger, which is being treated as a
tax-free reorganization for federal income tax purposes and will be accounted
for utilizing the pooling of interests method of accounting.
QSM had calendar year 1995 revenue of $840,000, and will be operationally
joined with HCm, the Company's decision support systems subsidiary.
CORPORATE HISTORY
The Company was founded in 1974 and completed an initial public offering in
December 1992. During its first decade, the Company's efforts were directed to
providing RCR services to hospitals principally located in the greater
metropolitan New York City market place. In the early 1980's, the Company
introduced RCR services to hospitals on a national basis. TPLR services were
introduced in 1985, and the hospital-based CAMS services began in 1986. In 1990,
the Company expanded its EDI capabilities with the acquisition of QMA; the
provision of MCS services began with the Company's acquisition of HCm in 1995.
During 1995, the Company entered into an agreement with Welsh, Carson, Anderson
and Stowe VI, L.P. ("WCAS VI"), a Delaware limited partnership affiliated with
the investment firm of Welsh, Carson, Anderson and Stowe ("WCAS"), affiliates of
WCAS, and certain of their respective executive officers and partners to form
Health Information Systems Corporation ("HISCo") for the purpose of investing in
health care information management companies that require significant additional
investment and maturation. That same year HISCo completed its initial
acquisition when it purchased Health Systems Architects, Inc. from Policy
Management Systems Corporation. In 1996 the Company expanded its TPLR offerings
with the acquisition of CDR and subsequent to its fiscal year end augmented its
MCS services with the acquisition of QSM.
RELATIONSHIP WITH HHL FINANCIAL SERVICES, INC.
HHL has been a significant client of the Company since 1994, accounting for
5%, 10%, and 13% of the Company's total revenues during the fiscal years ended
October 31, 1996, 1995, and 1994, respectively. During 1996, the Company
recorded a one-time charge occasioned by HHL's default on its obligations under
a data processing agreement with the Company. The one-time charge consisted of:
(i) a reversal of revenue of $2,180,000, (ii) estimated net costs relating to
the Company's continued contractual obligation with HHL of $3,823,000, (iii) a
write-off of prior period accounts receivable of $2,881,000, and (iv) a
write-off of its investment in HHL of $927,000. The after-tax impact of the
one-time charge was a $5,838,000 reduction to net income.
On October 21, 1996, the Company and HHL entered into an agreement which set
forth interim terms for the Company to continue to provide data processing
services to HHL in exchange for payment in advance. On October 29, 1996, the
Company entered into an agreement with HHL and HHL's primary creditor providing
for mutual general releases and the cessation of all claims. The Company also
settled its liabilities due to HHL of $1,950,000 for a payment of $870,000
resulting in the reversal of $1,080,000 in liabilities as an offset to other
operating expenses. In addition, the Company has agreed to provide for a period
of up to 18 months a reduced level of service to HHL in exchange for payment in
advance. During the 18 month period, HHL has the right to lower the level of
service requested and therefore the amount paid in advance and/or cancel the
service completely on 30 days prior written notice.
10
13
RELATIONSHIP WITH HEALTH INFORMATION SYSTEMS CORPORATION
As of October 31, 1996 and 1995, the Company had a $6,824,000 and $6,746,000
equity investment, respectively, which represented approximately a 43% ownership
interest, in HISCo, a privately owned Delaware corporation. The investment in
HISCo has been accounted for using the equity method. Under the equity method,
the Company recognizes in earnings its proportionate share of net income or loss
of HISCo.
HISCo was organized during 1995 by the Company, together with WCAS VI, and
certain of their respective executive officers and partners, to acquire
interests in health information systems and service companies which do not
satisfy the criteria for acquisitions made directly by the Company.
The Company and HISCo entered into an agreement, dated as of October 31, 1995
(the "HISCo Agreement"), pursuant to which the Company provides HISCo with
certain services ("Basic Services"), including executive, acquisition support,
and corporate support services. For these Basic Services, the Company is
entitled to receive a fee, payable monthly, calculated at the Company's then
current standard hourly rates established for internal allocations plus 20%. The
Company, in addition, may provide to subsidiaries ("Subsidiaries") of HISCo, and
such Subsidiaries may provide to the Company, additional services on such terms
as the parties may mutually agree. The HISCo Agreement also allows HISCo or any
of its Subsidiaries to provide services to the Company pursuant to separate work
orders to which the parties mutually agree. The term of the HISCo Agreement
continues until the later of (i) June 30, 2000 or (ii) the expiration of any
outstanding work order related to additional services. The Company believes that
the terms of the HISCo Agreement are fair and reasonable and are no less
favorable to the Company than those that could have been obtained with respect
to comparable engagements with independent third parties. In fiscal years 1996
and 1995, the Company received approximately $161,000 and $545,000,
respectively, in fees from HISCo for services provided pursuant to the HISCo
Agreement. In fiscal year 1996, HISCo received approximately $569,000 in fees
for software development services provided to the Company pursuant to the HISCo
Agreement. These software development fees were expensed by the Company.
EMPLOYEES
The Company believes that a key to its success will be the ability to
maintain and enhance the skill and experience level of management. To this end,
the Company offers competitive salaries and an annual bonus program in which
substantially all employees participate, a stock option program in which 379 or
50% of employees currently participate, and an employee stock purchase plan in
which 552 or 73% of employees currently participate. As of October 31, 1996, the
Company had 754 employees. No employees are covered by a collective bargaining
agreement or are represented by a labor union.
The Company continues to be led by two of its founders, Paul J. Kerz,
Chairman, President and, Chief Executive Officer, and Laurence B. Simon, Senior
Vice President for Product Development. Since its founding in 1974, the Company
has continually sought to recruit executives with extensive experience in
financial controls, systems development, information processing, health care
information management, and project management.
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
Specific financial information with respect to the Company's industry
segments is provided in Note 13, Business Segment Information, in the Notes to
Consolidated Financial Statements included in this Form 10-K.
11
14
ITEM 2. PROPERTIES
The Company's executive offices and data processing center occupy 146,000
square feet of space in New York City leased through 2006. An additional 9,400
square feet of space is leased for offices in Washington, D.C.; Boston,
Massachusetts; Chicago, Illinois; and Los Angeles and San Francisco, California.
QMA leases 30,000 square feet of space in Sacramento, California. HCm leases
68,900 square feet of space in Torrance and El Segundo, California; Nashville,
Tennessee; Waltham, Massachusetts; Rolling Meadow, Illinois; Tempe, Arizona;
North Palm Beach, Florida; and Seattle, Washington. CDR leases 3,100 square feet
of space in Timonium, Maryland.
The Company operates state-of-the-art CMOS processors leased from IBM to
facilitate product development and production processes, associated peripheral
devices from Hitachi and EMC, communications devices, a large number of
microcomputers, and extensive local and wide area networks.
The Company's data processing operations afford both batch processing and
national on-line network capabilities and are controlled by multiple levels of
physical and software security. Each of the Company's systems is backed up on a
nightly basis. Copies of the Company's operating systems, key applications
software, and critical client data are maintained offsite to ensure continuity
of business. Purchase and maintenance agreements with vendors provide for backup
support in case of computer systems failure. The Company has no reliance on
proprietary hardware or software systems to execute its business.
ITEM 3. LEGAL PROCEEDINGS
No material legal proceedings are pending.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
12
15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Company's common stock is included in the Nasdaq National Market System
(symbol: HMSY). As of the close of business on January 15, 1997, there were
approximately 16,500 holders of the Company's common stock, including the
individual participants in security position listings. The Company has not paid
any cash dividends on its common stock and does not anticipate paying cash
dividends in the foreseeable future. The Company's present intention is to
retain earnings to support the future growth of its business. The Company's
credit agreement with its bank contains limitations on the Company's ability to
pay cash dividends.
The table below summarizes the high and low closing prices per share for the
Company's common stock for the fiscal year periods indicated, as reported on the
Nasdaq National Market System.
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
1996:
Market Price:
High ...... $ 26.83 31.75 37.00 31.75
Low ....... 21.33 24.50 25.50 22.25
1995:
Market Price:
High ...... $ 15.33 17.17 22.83 23.67
Low ....... 11.11 12.55 14.09 17.17
ITEM 6. SELECTED FINANCIAL DATA
The information required by Item 6 is found on pages F-6 to F-7 of this
report.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information required by Item 7 is found on pages F-1 to F-5 of this
report.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by Item 8 is found on pages F-8 to F-27 of this
report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
13
16
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 will be included in the Company's Proxy
Statement for the 1997 Annual Meeting of Shareholders, which will be mailed
within 120 days after the close of the Company's fiscal year ended October 31,
1996, and is hereby incorporated herein by reference to such Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 will be included in the Company's Proxy
Statement for the 1997 Annual Meeting of Shareholders, which will be mailed
within 120 days after the close of the Company's fiscal year ended October 31,
1996, and is hereby incorporated herein by reference to such Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 will be included in the Company's Proxy
Statement for the 1997 Annual Meeting of Shareholders, which will be mailed
within 120 days after the close of the Company's fiscal year ended October 31,
1996, and is hereby incorporated herein by reference to such Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 will be included in the Company's Proxy
Statement for the 1997 Annual Meeting of Shareholders, which will be mailed
within 120 days after the close of the Company's fiscal year ended October 31,
1996, and is hereby incorporated herein by reference to such Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K
A. Financial Statements - See Index to Consolidated Financial Information on
Page 19.
B. Schedule
Schedule II - Valuation and Qualifying Accounts
C. Reports on Form 8-K
Current Report on Form 8-K, dated September 3, 1996 - Item 5, Other
Matters; Item 7, Financial Statements and Exhibits.
D. Exhibits
14
17
Exhibit
Number
- ------
2.1 Agreement and Plan of Merger dated as of January 18, 1995 among
Health Management Systems, Inc., HCm Acquisition Corp., and all the
shareholders of Health Care microsystems, Inc., as amended
(Incorporated by reference to Exhibit 10.18 to the Company's Annual
Report on Form 10-K for the year ended October 31, 1994 and to
Exhibit 10.2 to the Company's Registration Statement on Form S-3,
file no. 33-91518)
2.2 Agreement and Plan of Merger, dated as of April 29, 1996 among
Health Management Systems, Inc., CDR Acquisition Corp., CDR
Associates, Inc., and all the shareholders of CDR Associates, Inc.
(Incorporated by reference to Exhibit 10.1 to the Company's Current
Report on Form 8-K dated April 29, 1996)
* 2.2(i) First Amendment to Agreement and Plan of Merger, dated as of April
29, 1996, among Health Management Systems, Inc., CDR Acquisition
Corp., CDR Associates, Inc., and all the shareholders of CDR
Associates, Inc.
2.3 Agreement and Plan of Merger, dated as of September 3, 1996, by and
among Health Management Systems, Inc., QSM Acquisition Corporation
and Quality Standards in Medicine, Inc. (Incorporated by reference
to Exhibit 2.1 to the Company's Registration Statement on Form S-4,
File No. 333-13513 (the S-4))
2.3(i) Amendment to Agreement and Plan of Merger, dated as of November 20,
1996, by and among Health Management Systems, Inc., QSM Acquisition
Corporation, and Quality Standards in Medicine, Inc. (Incorporated
by reference to Exhibit 10.1 to Post-Effective Amendment No. 1 to
the S-4)
2.4 Form of Escrow Agreement by and among Health Management Systems,
Inc., Quality Standards in Medicine, Inc., Coleman & Rhine LLP,
Rodrigo Rocha, William B. Munier and Peter B. Stovell (Incorporated
by reference to Exhibit 2.2 to the S-4)
3.1 Amended and Restated Certificate of Incorporation of Health
Management Systems, Inc. (Incorporated by reference to Exhibit 3.1
to Amendment No. 1 (Amendment No. 1) to the Company's Registration
Statement on Form S-1, File No. 33-4644 (the Registration
Statement))
3.2 By-Laws of Health Management Systems, Inc. (Incorporated by
reference to Exhibit 3.2 to Amendment No. 1)
10.1(i) Contract, dated January 28, 1980, as amended, between Health
Management Systems, Inc. and New York City Health and Hospitals
Corporation (Incorporated by reference to Exhibit 10.1(i) to the
Registration Statement)
10.1(ii) Contract dated September 8, 1982, as amended, between Health
Management Systems, Inc. and New York City Health and Hospitals
Corporation (Incorporated by reference to Exhibit 10.1(ii) to the
Registration Statement)
10.1(iii) Contract dated October 1, 1993, between Health Management Systems,
Inc. and New York City Health and Hospitals Corporation
(Incorporated by reference to Exhibit 10.4 to the Company's
Quarterly Report on Form 10-Q for the quarter ended January 31,
1994)
10.2 Financial Management Services Agreement, dated August 1, 1989,
between Health Management Systems, Inc. and the County of Los
Angeles (Incorporated by reference to Exhibit 10.2 to the
Registration Statement)
10.3(i) Health Management Systems, Inc. Stock Option and Restricted Stock
Purchase Plan, as amended (Incorporated by reference to Exhibit 10.3
to the Registration Statement, to Exhibit 10.3 to Amendment No. 2
(Amendment No. 2) to the Registration Statement and Exhibit 10.1 to
the Company's Quarterly Report on Form 10-Q for the quarter ended
January 31, 1994)
15
18
Exhibit
Number
- ------
10.3(ii) Health Management System, Inc. Employee Stock Purchase Plan, as
amended (Incorporated by reference to Exhibit 10.2 to the Company's
Quarterly Report on Form 10-Q for the quarter ended January 31, 1994
and to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
for the quarter ended January 31, 1995)
10.3(iii) Health Management Systems, Inc. 1995 Non-Employee Director Stock
Option Plan (Incorporated by reference to Exhibit 10.2 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
January 31, 1995)
10.3(iv) Health Management Systems, Inc. Profit Sharing Plan (Incorporated by
reference to Exhibit 10.3(iv) to the Company's Annual Report on Form
10-K for the year ended October 31, 1995)
10.3(v) Health Management Systems, Inc. Profit Sharing Plan, as amended
(Incorporated by reference to Exhibit 10.3(v) to the Company's
Annual Report on Form 10-K for the year ended October 31, 1995)
10.4 Interim Operating Agreement, dated April 12, 1991, among Health
Management Systems, Inc., HHL Financial Services, Inc., and Welsh,
Carson, Anderson and Stowe V, L.P. (Incorporated by reference to
Exhibit 10.8 to the Registration Statement)
10.5(i) Management and Data Processing Services Agreement, effective as of
January 31, 1992, between HHL Financial Services, Inc. and Health
Management Systems, Inc. (Incorporated by reference to Exhibit 10.9
to the Registration Statement)
10.5(ii) Amendment No. 1 among HHL Financial Services, Inc., Professional
Data Services, Inc., and Health Management Systems, Inc. to
Management and Data Processing Agreement (Incorporated by reference
to Exhibit 10.9(ii) to the Company's Annual Report for the year
ended October 31, 1993)
10.6 Termination Agreement, dated as of January 31, 1992, among HHL
Financial Services, Inc., Health Management Systems, Inc., and the
other parties named therein (Incorporated by reference to Exhibit
10.10 to the Registration Statement)
10.7(i) Credit Agreement and Guaranty among Health Management Systems, Inc.,
as Borrower, Accelerated Claims Processing, Inc., and Quality
Medi-Cal Adjudication, Incorporated, as Guarantors and The Chase
Manhattan Bank, N.A., as Bank, dated April 26, 1993, as amended
(Incorporated by reference to Exhibit 10.12 to the Company's
Quarterly Report on Form 10-Q for the quarter ended April 30, 1993
and to Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q
for the quarter ended January 31, 1995)
10.7(ii) Second Amendment to Credit Agreement and Guaranty, dated as of March
30, 1995 among Health Management Systems, Inc., Accelerated Claims
Processing, Inc., and Quality Medi-Cal Adjudication, Incorporated
and The Chase Manhattan Bank, N.A. (Incorporated by reference to
Exhibit 10.12(iii) to the Company's Annual Report on Form 10-K for
the year ended October 31, 1995)
10.7(iii) Credit Agreement and Guaranty Among Health Management Systems, Inc.,
as Borrower, Accelerated Claims Processing, Inc., Quality Medi-Cal
Adjudication, Incorporated, Health Care microsystems, Inc., and CDR
Associates, Inc., as Guarantors, and The Chase Manhattan Bank, as
Bank (Incorporated by reference to Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended July 31, 1996)
10.7(iv) First Amendment to Credit Agreement and Guaranty and Waiver
(Incorporated by reference to Exhibit 10.1(i) to the Company's
Quarterly Report on Form 10-Q for the quarter ended July 31, 1996)
16
19
Exhibit
Number
- ------
10.8 Leases, dated February 1, 1980, September 24, 1981, September 24,
1982, and January 6, 1986, as amended, between 401 Park Avenue South
Associates and Health Management Systems, Inc. (Incorporated by
reference to Exhibit 10.13 to the Registration Statement and to
Exhibit 10.5 to the Company's Quarterly Report on Form 10-Q for the
quarter ended January 31, 1994)
10.8(i) Lease, dated as of March 15, 1996, by and between 387 PAS
Enterprises, as Landlord, and Health Management Systems, Inc., as
Tenant (Incorporated by reference to Exhibit 10.2 to the Company's
Quarterly Report on Form 10-Q for the quarter ended July 31, 1996)
10.9 Lease, dated March 20, 1990, between Quality Medi-Cal Adjudication,
Incorporated and Kilgore Business Park (Incorporated by reference to
Exhibit 10.14 to the Registration Statement)
10.10 Master Lease Agreement, effective as of December 1, 1991, between
Hitachi Data Systems Credit Corporation and Health Management
Systems, Inc. (Incorporated by reference to Exhibit 10.15 to the
Registration Statement)
10.11(i) Subscription Agreement, dated as of October 31, 1995, among Health
Information Systems Corporation ("HISCo") and the Several Persons
Named in Schedule I thereto (Incorporated by reference to Exhibit
10.19 (i) to the Company's Annual Report on Form 10-K for the year
ending October 31, 1995)
10.11(ii) Registration Rights Agreement, dated as of October 31, 1995, among
HISCo and the Several Persons Named in Annex I thereto (Incorporated
by reference to Exhibit 10.19 (ii) to the Company's Annual Report on
Form 10-K for the year ending October 31, 1995).
10.11(iii) Asset Purchase Agreement, dated as of June 30, 1995, between HISCo
and Policy Management Systems Corporation (Incorporated by reference
to Exhibit 10.3 to the Company's Current Report on Form 8-K dated
June 19, 1995) (Incorporated by reference to Exhibit 10.19(iii) to
the Company's Annual Report on Form 10-K for the year ending October
31, 1995)
10.11(iv) Services Agreement, dated as of October 31, 1995, between HISCo and
Health Management Systems, Inc. (Incorporated by reference to
Exhibit 10.19(iv) to the Company's Annual Report on Form 10-K for
the year ending October 31, 1995)
* 10.12 Agreement and Release of Claims dated as of October 29, 1996, by and
among HHL Financial Services, Inc., Health Management Systems Inc.
and the First National Bank of Chicago
* 10.13 Lease, dated September 1996, by and between Pacific Corporate Towers
LLC, Health Management Systems, Inc., and Health Care microsystems,
Inc.
* 11.0 Computation of Earnings per Share
* 21.1 List of subsidiaries of Health Management Systems, Inc.
* 24.1 Consent of KPMG Peat Marwick LLP, independent certified public
accountants
* 24.2 Consent of Ernst & Young LLP, independent certified public accountants
* 24.3 Report of independent certified public accountants on the financial
statements of Health Information Systems Corporation as of and for
the period ended October 31, 1996
* 24.4 Consent of Coopers & Lybrand LLP, independent certified public
accountants
24.5 Report of independent certified public accountants on the financial
statements of Health Care microsystems, Inc. as of December 31, 1994
and 1993 and for the years then ended (Incorporated by reference to
Exhibit 24.5 of the Company's Annual Report on Form 10-k for the
year ended October 31, 1995)
* 27 Financial Data Schedule, which is submitted electronically to the
Securities and Exchange Commission for informational purposes only
* Filed herewith
17
20
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
HEALTH MANAGEMENT SYSTEMS, INC.
--------------------------------------
(REGISTRANT)
BY: /S/ PAUL J. KERZ
--------------------------------------
President and Chief Executive Officer
--------------------------------------
January 22, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signatures Title Date
/s/ PAUL J. KERZ Chairman, President and January 22, 1997
- --------------------------- Chief Executive Officer,
Paul J. Kerz and Director
/s/ PHILLIP SIEGEL Vice President and January 22, 1997
- --------------------------- Chief Financial Officer
Phillip Siegel
/S/ ROBERT V. NAGELHOUT Chairman and Chief January 22, 1997
- --------------------------- Executive Officer of HCm
Robert V. Nagelhout and Director
/S/ DONALD J. STAFFA Senior Vice President and January 22, 1997
- --------------------------- Director
Donald J. Staffa
/S/ RUSSELL L. CARSON Director January 22, 1997
- ---------------------------
Russell L. Carson
/S/ WILLIAM W. NEAL Director January 22, 1997
- ---------------------------
William W. Neal
/S/ GALEN D. POWERS Director January 22, 1997
- ---------------------------
Galen D. Powers
/S/ RICHARD H. STOWE Director January 22, 1997
- ---------------------------
Richard H. Stowe
18
21
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL INFORMATION
PAGE
CONTENTS NUMBER
- -------- ------
Management's Discussion and Analysis of Results of Operations and Financial
Condition ....................................................................... F-1
Selected Consolidated Financial Data ............................................ F-6
Report of Independent Certified Public Accountants .............................. F-8
Consolidated Statements of Operations for the Years Ended October 31, 1996, 1995,
and 1994 ........................................................................ F-9
Consolidated Balance Sheets as of October 31, 1996 and 1995 ..................... F-10
Consolidated Statements of Shareholders' Equity for the Years Ended
October 31, 1996, 1995, and 1994 .............................................. F-11
Consolidated Statements of Cash Flows for the Years Ended October 31, 1996,
1995, and 1994 F-12
Notes to Consolidated Financial Statements ...................................... F-13
SCHEDULE:
Schedule II - Valuation and Qualifying Accounts ................................. F-27
19
22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
Certain statements set forth below under this caption constitute
"forward-looking statements" within the meaning of the Reform Act. See "Special
Note Regarding Forward-Looking Statements"on page 1 for additional factors
relating to such statements.
RESULTS OF OPERATIONS
The table below summarizes the Company's results of operations and the
percentage of total revenue of selected line items for the last three fiscal
years.
Years Ended October 31, ($ In Thousands) 1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------
Amount % Amount % Amount %
--------------------- -------------------- ----------------
Revenue:
Proprietary Services:
RCR $ 28,212 28% $ 22,961 26% $ 18,890 26%
CAMS 18,505 18% 23,945 27% 21,941 30%
TPLR 26,407 26% 19,479 21% 11,816 16%
------- --- ------ --- ------ ---
73,124 73% 66,385 74% 52,647 72%
MCS 18,853 19% 15,120 17% 12,500 17%
EDI 8,692 9% 8,222 9% 8,029 11%
------- --- ------ --- ------ ---
100,669 100% 89,727 100% 73,176 100%
Cost of services:
Compensation 48,564 48% 43,373 48% 35,355 48%
Data processing 10,257 10% 8,144 9% 6,872 10%
Occupancy 7,840 8% 6,529 7% 5,920 8%
Other 19,660 20% 13,581 15% 11,167 15%
------- --- ------ --- ------ ---
86,321 86% 71,627 80% 59,314 81%
Operating margin before
amortization of intangibles 14,348 14% 18,100 20% 13,862 19%
Amortization of intangibles 204 -- 243 -- 190 --
------- --- ------ --- ------ ---
Operating income 14,144 14% 17,857 20% 13,672 19%
Net interest and net other income 987 1% 942 1% 464 --
Loss on investment (927) (1)% -- -- -- --
Merger related costs (494) -- (1,045) (1)% (59) --
Equity in earnings of affiliate 50 -- -- -- -- --
------- --- ------ --- ------ ---
Income before income tax expense 13,760 14% 17,754 20% 14,077 19%
Income tax expense (5,574) (6)% (8,152) (9) (6,353) (8)%
------- --- ------ --- ------ ---
Net income $ 8,186 8% $ 9,602 11% $ 7,724 11%
------- --- ------ --- ------ ---
F-1
23
OVERVIEW
The Company has delivered RCR services since 1974 and began to deliver its
TPLR and CAMS offerings in 1985 and 1986, respectively. Together, RCR, TPLR, and
CAMS are considered the Company's Proprietary Services. The Company augmented
its TPLR product line by merging with CDR in April 1996. CDR provides
third-party liability recovery services to the health care industry. The next
most significant segment of the Company's business is proprietary analytics or
MCS. The Company entered the MCS segment in February 1995 when the Company
merged with HCm, which provides microcomputer-based decision support software
and services to the health care industry. The remaining segment of the Company's
business is currently comprised of EDI services. The Company entered the EDI
market in 1990 when the Company acquired QMA, which provides EDI services,
principally in California. The HCm and CDR mergers were accounted for using the
pooling of interests method of accounting, and the QMA acquisition was accounted
for using the purchase method of accounting.
Since 1994, the Company has achieved a compound annual revenue growth rate of
17% with over 90% of Core Proprietary Revenue in each of the years secured from
entities which had become clients of the Company in prior years. During this
two-year period, TPLR has expanded vigorously, with a compound annual growth
rate of 50%, and RCR has consistently shown strong growth with a compound annual
growth rate since 1994 of 22%. One of the Company's strategies is to convert
existing RCR clients to the more comprehensive and stable CAMS offering; this
strategy should result in expanded CAMS revenue, to the detriment of RCR
revenue, but with greater overall revenue to the Company. CAMS revenue has
declined since 1994 primarily due to the reduction of revenue from HHL.
Exclusive of HHL, CAMS revenue has grown nominally since 1994. The Company's
Proprietary Revenue has grown at an annual compound rate of 18% since 1994. The
Company's MCS services revenue, rendered by HCm, has grown at an annual compound
rate of 23% since 1994. The EDI service line has experienced only minor growth
during the period, as the Company's principal objective in this service line has
been to accrete expanded functionality to the EDI platform to offset the pricing
pressures of a highly competitive market.
The Company generally achieves lower recoveries, and therefore lower revenue,
for each RCR and TPLR client in billings subsequent to the first billing for
such clients. In addition, submission of billings is subject to a number of
circumstances beyond the Company's control, including delays in receipt of
client data and changes in client requirements. Due to such characteristics,
revenue for quarters in which processing for new or expanded services for RCR
and TPLR clients is significant will tend to be greater than other quarters.
Although the number of RCR and TPLR clients and their service requirements have
increased significantly over the last several years, there can be no assurance
that the Company's client base or their service requirements will increase at
the same rate in the future.
Due largely to the HHL one-time charge, the Company's operating expense
structure has grown at a compound annual rate of 21% from 1994 to 1996, a rate
of growth that exceeds that of revenue and is therefore reflected in the decline
of the Company's operating margin rate from 19% in 1994 to 14% in 1996.
Exclusive of the effect of the one-time charge associated with the HHL
write-off, operating expenses have grown at a compound annual rate of 16% since
1994 and operating margin has grown to 23%. As a service business, the largest
portion of the Company's costs of services is employee compensation, comprising
approximately 56% of total operating costs in 1996 or 59% before the HHL
one-time charge. The Company offers competitive salaries and maintains an annual
bonus and stock option award program in which substantially all full-time
employees are eligible to participate. Measured as a percentage of revenue, the
Company has been successful at maintaining compensation costs at a self-imposed
target of approximately one-half of total revenue. Other non-compensation
operating expenses during this period have grown at an annual compound rate of
26% since 1994 which is a more rapid rate than the compensation component,
reflecting the growth of direct project costs and the Company's expansion of its
data processing infrastructure. Exclusive of the effect of the one-time charge
associated with HHL, non-compensation operating expenses have grown at an annual
compound rate of 23%.
The Company's income tax dynamics have changed over the two-year period
from 1994. The Company's tax position has evolved from recording an income tax
expense in 1994 of $6,353,000 to $5,574,000 in 1996, representing an effective
income tax rate ranging from 45% in 1994 to 41% in 1996. The somewhat lower
effective tax rate in 1996 reflects the Company's acquisition of CDR, which was
an S corporation for the first two quarters of 1996, and the net effect of the
non-deductibility of merger related costs. Had taxes been computed assuming
CDR had been a C corporation for the first six months of 1996, the effective tax
rate in 1996 would have been 2.4% higher.
F-2
24
YEARS ENDED OCTOBER 31, 1996 AND 1995
Revenue for the year ended October 31, 1996 was $100,669,000, an increase of
$10,942,000 or 12% over the prior year. During the year ended October 31, 1996,
the Company recorded a reversal of $2,180,000 of HHL revenue. Revenue for the
year ended October 31, 1996 before the reversal was $102,849,000, an increase of
$13,122,000 or 15% over the prior year. Revenue from Proprietary Services after
the revenue reversal increased $6,739,000 or 10%, to $73,124,000, principally
due to revenue generated by the Company's RCR and TPLR engagements which
increased by 23% and 36%, respectively. Revenue from MCS services was
$18,853,000, an increase of $3,733,000 or 25% over the prior year. Revenue from
EDI services was $8,692,000, an increase of $470,000 or 6% over the prior year.
Cost of services for the year ended October 31, 1996 was $86,321,000, an
increase of $14,694,000 or 21% over the prior year. During the year ended
October 31, 1996, the Company recorded a one-time charge pertaining to its
relationship with HHL, a major CAMS customer, which defaulted on its obligation
under a data processing agreement with the Company. This charge increased cost
of services by $6,704,000 and accounts for 9% of the increase over the prior
year. The $6,704,000 charge was comprised of (i) $1,362,000 of net compensation
costs, and (ii) $2,199,000 of net data processing costs, both associated with
the continued servicing of the HHL data processing agreement, plus (iii)
$3,143,000 of other operating costs, including $2,881,000 of bad debt expense
related to HHL receivables and $262,000 of net other operating expenses
associated with the continued servicing of the HHL data processing agreement.
Compensation expense, the Company's largest component, totalled $48,564,000,
an increase of $5,191,000 or 12% over the prior year. Compensation expense prior
to the one-time charge of $1,362,000 was $47,202,000, an increase of $3,829,000
or 9%. Exclusive of the effect of the one-time charge, this increase reflected a
17% increase in the average number of employees in support of business growth
and expansion, offset by savings related to the non-recurring fiscal year 1995
CDR S corporation distributions of $1,978,000 and salary savings associated with
employee turnover.
Data processing expense was $10,257,000, an increase of $2,113,000 or 26%
over fiscal year 1995. Data processing expense prior to the one-time charge of
$2,199,000 was $8,058,000, a decrease of $86,000 or 1%. Exclusive of the effect
of the one-time charge, this decrease was attributable to high levels of expense
in fiscal year 1995 associated with the enhancement of the Company's data
processing infrastructure which were not recurring in nature.
Occupancy expense was $7,840,000, an increase of $1,311,000 or 20% over
fiscal year 1995. This increase was primarily due to the expansion of the
Company's facilities, including the Company's headquarters.
Other operating expense was $19,660,000, an increase of $6,079,000 or 45%
over fiscal year 1995. Other operating expense prior to the one-time charge of
$3,143,000 was $16,517,000, an increase of $2,936,000 or 22%. The Company
recorded $1,604,000 in provision for non-HHL bad debts. The Company also settled
its liabilities due to HHL of $1,950,000 for a payment of $870,000, resulting in
the reversal of $1,080,000 in liabilities as an offset to other operating
expenses. Exclusive of the effects of the aforementioned items, the remaining
increase was principally attributable to higher levels of direct project costs,
including professional fees and employee related costs.
Operating margin before amortization of intangible assets for the year ended
October 31, 1996 was $14,348,000, a decrease of $3,752,000 or 21% from the
$18,100,000 amount realized in fiscal year 1995. The Company's operating margin
rate before amortization of intangible assets was 14%, compared to 20% in fiscal
year 1995. Operating margin before amortization of intangibles and prior to the
one-time charge and revenue reversal for HHL was $23,232,000, an increase of
$5,132,000 or 28%. Exclusive of the effect of the one-time charge and revenue
reversal, the operating margin rate would have been 23%, an increase of three
percentage points over the 20% realized in the prior year.
Amortization of intangible assets for the year ended October 31, 1996 was
$204,000, a decrease of $39,000 or 16% from the prior year. The decrease
resulted from the full amortization of one of the Company's intangible assets.
F-3
25
Net interest and net other income of $987,000 in the year ended October 31,
1996 increased by $45,000 from $942,000 in fiscal year 1995; the increase was
primarily due to $47,000 of loan origination fees associated with the Company's
securing a new line of credit with a major money center financial institution.
The Company wrote off its investment in HHL of $927,000 in 1996 as part of the
one-time charge. The Company reported equity in earnings of its HISCo affiliate
of $50,000 and $0 in fiscal years 1996 and 1995, respectively. Merger related
costs of $494,000 were incurred in the year ended October 31, 1996 related to
the Company's merger with CDR in April 1996. Merger related costs of $1,045,000
were incurred in 1995 related to the Company's merger with HCm.
The Company's income tax expense for the year ended October 31, 1996 was
$5,574,000, resulting in an effective tax rate of approximately 41%. This
compares to income tax expense of $8,152,000 and an effective tax rate of
approximately 46% for fiscal year 1995. The reduction in the effective tax rate
results from the non-taxability of income from CDR for the first six months of
the fiscal year due to its status as an S corporation, and from the decrease of
non-tax deductible merger costs from the comparable prior year period. Had taxes
been computed assuming CDR had been a C corporation for the first six months of
1996, the effective tax rate in 1996 would have been 2.4% higher. Income tax
expense without the HHL one-time charge and revenue reversal would have been
$9,547,000, an increase of $1,395,000 or 17% over fiscal year 1995.
Net income and earnings per share for the year ended October 31, 1996 were
$8,186,000 and $0.45, a 15% and 18% decrease, respectively, from net income of
$9,602,000 and $0.55 in earnings per share reported in the prior year. Net
income and earnings per share prior to the one-time charge, revenue reversal,
and merger costs were $14,518,000 and $0.79, an increase of $3,871,000 and $0.18
over the prior year, or 36% and 30%, respectively.
YEARS ENDED OCTOBER 31, 1995 AND 1994
Revenue for the year ended October 31, 1995 was $89,727,000, an increase of
$16,551,000 or 23% over fiscal year 1994. Revenue from Proprietary Services
increased $13,738,000 or 26%, to $66,385,000, reflecting strong performance in a
number of RCR, TPLR, and CAMS engagements, as well as the continued extension of
services to existing clients. Revenue from MCS services was $15,120,000, an
increase of $2,620,000 or 21% over the prior year. Revenue from EDI services was
$8,222,000, an increase of $193,000 or 2% over fiscal year 1994.
Cost of services for the year ended October 31, 1995 was $71,627,000, an
increase of $12,313,000 or 21% over fiscal year 1994, trailing the rate of
revenue growth for the same period. Compensation expense of $43,373,000
increased $8,018,000 or 23% compared to fiscal year 1994. This increase
reflected: (i) a 12% increase in the average number of employees, in support of
business growth and expansion, (ii) a bonus accrual for the principals of CDR of
approximately $1,067,000, an increase of $801,000 or over 300%; and (iii)
routine salary and benefit cost increases.
Data processing expense was $8,144,000, an increase of $1,272,000 or 19% over
fiscal year 1994. This increase was attributable to costs associated with the
continuing enhancement of the Company's data processing environments.
Occupancy expense was $6,529,000, an increase of $609,000 or 10% over fiscal
year 1994, related primarily to the expansion of the Company's New York City
facilities begun in the first quarter of 1994.
Other operating expense of $13,581,000 represented an increase of $2,414,000
or 22% over fiscal year 1994 and was principally attributable to higher levels
of costs directly associated with professional fees and the increased number of
employees over the prior year.
Operating margin before amortization of intangibles for the year ended
October 31, 1995 was $18,100,000, an increase of $4,238,000 or 31% over the
$13,862,000 amount realized in fiscal year 1994. The Company's operating margin
rate was 20%, as compared to 19% in fiscal year 1994.
Amortization of intangibles for the year ended October 31, 1995 was $243,000,
an increase from $190,000 reported in the year ended October 31, 1994. This
increase was primarily associated with amortization related to acquired EDI
software rights.
Net interest and net other income of $942,000 in the year ended October 31,
1995 increased by $478,000 from $464,000 in fiscal year 1994, due to the
investment in higher interest yielding securities and the implementation of an
F-4
26
enhanced cash management system. Merger related costs of $1,045,000 were
incurred in the year ended October 31, 1995 related to the merger with HCm in
February 1995. The Company reported no equity in earnings of affiliate during
the year ended October 31, 1995 (see Note 1(g) of Notes to Consolidated
Financial Statements).
The Company's income tax expense for the year ended October 31, 1995 was
$8,152,000, resulting in an effective tax rate of approximately 46%. This
compares to income tax expense of $6,353,000 and an effective tax rate of
approximately 45% for the prior year. The 28% increase in income tax expense in
1995 was primarily attributable to the Company's improved pre-tax profitability,
which increased 26% from the comparable prior year, offset by a higher effective
tax rate as a result of the non-deductibility of the costs incurred in
connection with the merger with HCm.
As a result of the Company's expanded revenue base, improved operating
results, and increased interest income, net income for the year ended October
31, 1995 rose to $9,602,000, a 24% increase when compared to $7,724,000 reported
in the prior year. The Company's performance translated to earnings per share
for the year ended October 31, 1995 of $0.55, an increase of $0.09 or 20% from
the $0.46 reported in the prior year.
LIQUIDITY AND CAPITAL RESOURCES
At October 31, 1996, the Company had $56,621,000 in net working capital, an
increase of $14,978,000 over the level at October 31, 1995. The Company's
principal sources of liquidity at October 31, 1996 consisted of cash, cash
equivalents, and short-term investments aggregating $39,455,000, and net
accounts receivable of $42,418,000. Accounts receivable at October 31, 1996
reflected an increase of $10,788,000 or 34% over the October 31, 1995 balance.
This increase was attributable to a change in the age and composition of the
Company's accounts receivable portfolio from the prior year due to the growth of
receivables related to TPLR services. TPLR has a longer collection cycle than
RCR and CAMS receivables which comprised a higher percentage of the prior year
receivables.
On July 15, 1996, the Company entered into a $40,000,000 unsecured revolving
credit facility with a major money center financial institution. The credit
facility, which was fully available as of October 31, 1996, has a term of three
years, carries an unused commitment fee of 20 basis points, and bears interest
at the institution's prime lending rate, or LIBOR plus 5/8%, at the Company's
option.
As part of the formation of HISCo, the Company has committed to invest up to
an additional $41,000,000 in HISCo as transactions and operations of HISCo
warrant such investment. The Company's ongoing HISCo funding commitment,
combined with the Company's continued expansion of its business through possible
future acquisitions and ventures, may require the Company to seek additional
financing on relatively short notice.
INFLATION
The Company's business is technologically and labor intensive. The relative
cost of technology has not changed significantly over the last several years.
Wages and other employee-related expenses increase during periods of inflation
and when shortages in the skilled labor marketplace occur. Although the moderate
inflation rates of the past several years have not posed significant problems
for the Company, a substantial increase in the rate of inflation could adversely
affect the Company.
RECENTLY ISSUED ACCOUNTING STANDARDS
In October 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based
Compensation." SFAS 123 provides elective accounting for stock-based employee
compensation arrangements using a fair value model. Companies currently
accounting for such arrangements under Accounting Principles Board Opinion 25
("APB 25"), "Accounting for Stock Issued to Employees," may continue to do so;
however, SFAS 123 supersedes the disclosure requirements of APB 25 and is
applicable to all companies with stock-based compensation arrangements. The
Company proposes to adopt the disclosure provisions of SFAS 123. The disclosure
provisions of the Statement are effective for the Company's fiscal year
beginning November 1, 1996 with comparative information being provided for the
Company's fiscal year ended October 31, 1996. The impact of the disclosure
provisions of SFAS 123 is not reasonably determinable at this time.
F-5
27
SELECTED CONSOLIDATED FINANCIAL DATA
Years Ended October 31,
($ In Thousands, Except Per Common Share Data) 1996 1995 1994 1993 1992 (a)
- ---------------------------------------------- ---- ---- ---- ---- --------
STATEMENT OF OPERATIONS DATA:
Revenue $ 100,669 89,727 73,176 59,949 47,468
Cost of services 86,321 71,627 59,314 48,989 39,420
--------- ------ ------ ------ ------
Operating margin before amortization of intangibles 14,348 18,100 13,862 10,960 8,049
Amortization of intangibles (b) 204 243 190 303 3,166
--------- ------ ------ ------ ------
Operating income 14,144 17,857 13,672 10,657 4,883
Net interest and net other income (expense) 987 942 464 (114) (2,586)
Loss on investment (927) -- -- -- --
Merger related costs (494)(c) (1,045)(d) (59)(d) -- (7,133)
Equity in earnings of affiliate (e) 50 -- -- -- --
--------- ------ ------ ------ ------
Income (loss) before income taxes
and extraordinary item 13,760 17,754 14,077 10,543 (4,837)
Income tax (expense) (5,574) (8,152) (6,353) (4,766) (1,280)
--------- ------ ------ ------ ------
Income (loss) before extraordinary item 8,186 9,602 7,724 5,777 (6,117)
Extraordinary loss, net of tax benefit -- -- -- (306)(f) --
--------- ------ ------ ------ ------
Net income (loss) 8,186 9,602 7,724 5,471 (6,117)
--------- ------ ------ ------ ------
Accretion of preferred stock redemption value -- -- -- (33) (185)
Net income (loss) attributable to
common shareholders $ 8,186 9,602 7,724 5,438 (6,302)
--------- ------ ------ ------ ------
PER COMMON SHARE DATA:
Income (loss) before extraordinary item $ 0.45 0.55 0.46 0.37 (0.63)
Net income (loss) 0.45 0.55 0.46 0.35 (0.63)
Weighted average shares outstanding (g) 18,289 17,407 16,674 15,508 9,967
--------- ------ ------ ------ ------
SELECTED OPERATING DATA:
Operating margin as a percentage of revenue 14% 20% 19% 18% 17%
Operating income as a percentage of revenue 14% 20% 19% 18% 10%
October 31,
1996 1995 1994 1993 1992(a)
--------- ------ ------ ------ -----
BALANCE SHEET DATA:
Cash and short-term investments $ 39,455 30,088 27,760 26,447 7,792
Working capital 56,621 41,643 35,942 28,319 13,128
Total assets 109,181 87,195 69,777 60,802 37,592
Long-term debt obligations -- -- -- -- 18,971
Redeemable preferred stock -- -- -- -- 1,134
Common shareholders' equity 76,529 59,224 47,043 38,181 273
========= ====== ====== ====== =====
F-6
28
SELECTED CONSOLIDATED FINANCIAL DATA
NOTES TO SELECTED CONSOLIDATED FINANCIAL DATA
(a) The financial results as of and for the year ended October 31, 1992
reflect the effects of a merger termination agreement between HMS and HHL.
(b) Intangible assets were principally recorded in connection with HMS's 1989
recapitalization and its acquisition in 1990 of QMA. See Notes 1(e) and 5
of Notes to Consolidated Financial Statements.
(c) Includes costs associated with HMS's acquisition of CDR. See Note 1(n) of
Notes to Consolidated Financial Statements.
(d) Includes costs associated with HMS's acquisition of HCm. See Note 1(m) of
Notes to Consolidated Financial Statements.
(e) HMS has an investment in HISCo, a privately held Delaware corporation,
which is accounted for under the equity method of accounting. See Note
1(g) of Notes to Consolidated Financial Statements.
(f) The extraordinary loss of $306,000, net of income tax benefit of $257,000,
reflects the write-off of the unamortized debt discount attributable to
the prepayment of subordinated debentures.
(g) Common stock equivalents have not been included in the computation of
weighted average number of shares outstanding in 1992 since the effect
would have been antidilutive, except for 234,698 common stock equivalents
that have been included relating to stock options issued during 1992 at an
exercise price deemed, for financial reporting purposes, to be below fair
market value.
F-7
29
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors and Shareholders
Health Management Systems, Inc.:
We have audited the accompanying consolidated financial statements of Health
Management Systems, Inc. and subsidiaries as listed in the accompanying index.
In connection with our audits of the consolidated financial statements, we also
have audited the financial statement schedule as listed in the accompanying
index. These consolidated financial statements and financial statement schedule
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements and financial
statement schedule based on our audits. We did not audit the financial
statements of Health Care microsystems, Inc. (HCm), a wholly owned consolidated
subsidiary, for the year ended October 31, 1994 and Health Information Systems
Corporation (HISCo), a 43% owned investee company, for the years ended October
31, 1996 and 1995. The financial statements of HCm reflect total revenue
constituting 17% in 1994 of the related consolidated totals. The Company's
investment in HISCo at October 31, 1996 and 1995 was $6,824,000 and $6,746,000
and its equity in earnings of HISCo was $50,000 for the year ended October 31,
1996 and $0 for the period from June 19, 1995 through October 31, 1995. The
financial statements of HCm and HISCo for the aforementioned periods were
audited by other auditors whose reports were furnished to us, and our opinion,
insofar as it relates to the amounts included for HCm and HISCo, is based solely
on the reports of the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the reports of the other auditors provide a
reasonable basis for our opinion.
In our opinion, based on our audits and the reports of the other auditors,
the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Health Management Systems, Inc. and
subsidiaries as of October 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the years in the three-year period
ended October 31, 1996 in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly, in all material respects, the information set forth
therein.
KPMG Peat Marwick
New York, New York
November 22, 1996
F-8
30
CONSOLIDATED STATEMENTS OF OPERATIONS
Health Management Systems, Inc. and Subsidiaries
Years Ended October 31,
($ In Thousands, Except Per Common Share Amounts) 1996 1995 1994
- ------------------------------------------------- ---- ---- ----
Revenue:
Trade $ 95,062 80,305 63,275
Affiliates 5,607 9,422 9,901
--------- ------ ------
100,669 89,727 73,176
Cost of services:
Compensation 48,564 43,373 35,355
Data processing 10,257 8,144 6,872
Occupancy 7,840 6,529 5,920
Other 19,660 13,581 11,167
--------- ------ ------
86,321 71,627 59,314
--------- ------ ------
Operating margin before amortization of intangibles 14,348 18,100 13,862
Amortization of intangibles 204 243 190
--------- ------ ------
Operating income 14,144 17,857 13,672
Net interest and net other income 987 942 464
Loss on investment (927) 0 0
Merger related costs (494) (1,045) (59)
Equity in earnings of affiliate 50 0 0
--------- ------ ------
Income before income tax expense 13,760 17,754 14,077
Income tax expense (5,574) (8,152) (6,353)
--------- ------ ------
Net income $ 8,186 9,602 7,724
--------- ------ ------
Net income per common share $ 0.45 0.55 0.46
--------- ------ ------
Weighted average shares outstanding 18,289 17,407 16,674
--------- ------ ------
See accompanying notes to consolidated financial statements.
F-9
31
CONSOLIDATED BALANCE SHEETS
Health Management Systems, Inc. and Subsidiaries
As of October 31,
($ In Thousands, Except Per Share Amounts) 1996 1995
- ------------------------------------------ ---- ----
Assets:
Current assets:
Cash and cash equivalents $ 22,274 10,801
Short-term investments 17,181 19,287
Accounts receivable, net 42,418 31,630
Other current assets 4,936 4,139
-------- ------
Total current assets 86,809 65,857
Property and equipment, net 7,774 5,874
Intangible assets, net 5,257 5,461
Capitalized software costs, net 1,472 865
Investments in affiliates 6,824 7,673
Other assets 1,045 1,465
-------- ------
Total assets $109,181 87,195
-------- ------
Liabilities and Shareholders' Equity:
Current liabilities:
Accounts payable and accrued expenses $ 17,551 14,842
Amounts payable to affiliates 902 0
Deferred revenue 4,767 3,941
Deferred income taxes 6,968 5,431
-------- ------
Total current liabilities 30,188 24,214
Other liabilities 2,407 1,739
Deferred income taxes 57 2,018
-------- ------
Total liabilities 32,652 27,971
-------- ------
Shareholders' Equity:
Preferred stock - $.01 par value; 5,000,000 shares authorized;
none issued and outstanding 0 0
Common stock - $.01 par value; 45,000,000 shares authorized;
17,348,841 shares issued and outstanding at October 31, 1996;
16,390,762 shares issued and outstanding at October 31, 1995 174 164
Capital in excess of par value 57,583 48,481
Retained earnings 18,301 10,115
Unrealized appreciation on short-term investments 471 464
-------- ------
Total shareholders' equity 76,529 59,224
-------- ------
Commitments and contingencies
Total liabilities and shareholders' equity $109,181 87,195
-------- ------
See accompanying notes to consolidated financial statements.
F-10
32
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Health Management Systems, Inc. and Subsidiaries
Unrealized
Appreciation
Common Stock
---------------------- Capital In Retained (Depreciation)
Par Excess Of Earnings on Short-term Shareholders'
($ In Thousands) Shares Value Par Value (Deficit) Investments Equity
- ---------------- ----------- ----- ------ --------- ------------- ------------
Balance at October 31, 1993 15,511,831 $156 44,394 (6,539) 170 38,181
Net income 0 0 0 7,724 0 7,724
Stock option activity 348,659 3 480 0 0 483
Employee Stock Purchase Plan activity 115,933 1 801 0 0 802
Unearned compensation 0 0 35 0 0 35
Depreciation on short-term investments 0 0 0 0 (182) (182)
---------- ---- ------ ------ --- ------
Balance at October 31, 1994 15,976,423 160 45,710 1,185 (12) 47,043
Net income 0 0 0 9,602 0 9,602
Stock option activity 272,595 3 1,078 0 0 1,081
Employee Stock Purchase Plan activity 141,744 1 1,202 0 0 1,203
Disqualifying dispositions 0 0 477 0 0 477
Unearned compensation 0 0 14 0 0 14
Appreciation on
short-term investments 0 0 0 0 476 476
Adjustment to reflect change in Health
Care microsystems, Inc. fiscal year 0 0 0 (672) 0 (672)
----------- --- ------ ------ --- ------
Balance at October 31, 1995 16,390,762 164 48,481 10,115 464 59,224
Net income 0 0 0 8,186 0 8,186
Stock option activity 794,994 8 5,629 0 0 5,637
Employee Stock Purchase Plan activity 163,085 2 2,330 0 0 2,332
Disqualifying dispositions 0 0 1,143 0 0 1,143
Appreciation on short-term investments 0 0 0 0 7 7
----------- --- ------ ------ --- ------
Balance at October 31, 1996 17,348,841 $174 57,583 18,301 471 76,529
----------- --- ------ ------ --- ------
See accompanying notes to consolidated financial statements.
F-11
33
CONSOLIDATED STATEMENTS OF CASH FLOWS
Health Management Systems, Inc. and Subsidiaries
Years Ended October 31, ($ In Thousands) 1996 1995 1994
- ---------------------------------------- -------- ------ ------
Operating activities:
Net income $ 8,186 9,602 7,724
Adjustments to reconcile net income to net cash
provided by operating activities:
Loss on investment 927 0 0
Depreciation and amortization 3,093 2,750 2,524
Software capitalization (1,151) (840) (721)
Amortization of intangibles 204 243 190
Write-down of software development costs 0 0 332
Amortization of unearned compensation 0 14 35
Provision for doubtful accounts 4,485 183 277
Loss on disposals of assets 0 (19) 0
Deferred tax (benefit) expense (424) 1,203 1,007
Equity in earnings of affiliate (50) 0 0
Other 0 (3) 40
Changes in assets and liabilities:
Increase in accounts receivable (15,273) (9,289) (7,308)
Increase in other current assets (797) (1,046) (159)
Increase in accounts payable
and accrued expenses 2,709 5,165 1,266
Increase in amounts payable to affiliates 902 0 0
Increase (decrease) in deferred revenue 826 (728) (755)
Increase (decrease) in other assets and liabilities, net 2,238 644 (386)
-------- ------ ------
Net cash provided by operating activities 5,875 7,879 4,066
-------- ------ ------
Investing activities:
Capital asset expenditures (4,449) (1,503) (2,827)
Investments in affiliates (28) (7,268) 0
Intangible assets resulting from acquisitions 0 0 (550)
Purchase of short-term investments 0 (7,252) (9,025)
Proceeds from sale of short-term investments 2,106 1,788 0
-------- ------ ------
Net cash used in investing activities (2,371) (14,235) (12,402)
-------- ------ ------
Financing activities:
Proceeds from issuance of common stock, net 2,332 1,203 802
Proceeds from exercise of stock options 5,637 1,081 483
Repayment of notes payable 0 (342) (479)
-------- ------ ------
Net cash provided by financing activities 7,969 1,942 806
-------- ------ ------
Net increase (decrease) in cash and cash equivalents 11,473 (4,414) (7,530)
Cash and cash equivalents at beginning of year 10,801 14,962 22,492
Adjustment to cash to reflect change in Health Care
microsystems, Inc. fiscal year 0 253 0
-------- ------ ------
Cash and cash equivalents at end of year $ 22,274 10,801 14,962
-------- ------ ------
See accompanying notes to consolidated financial statements.
F-12
34
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Founded in 1974, Health Management Systems, Inc. ("HMSY" or the "Company")
furnishes proprietary data processing and information management services and
software to providers of health care, public and commercial payors of health
care expenses, and other companies serving the health care industry.
(a) Principles of Consolidation
The consolidated financial statements include the accounts of HMSY and its
wholly-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
(b) Cash and Cash Equivalents
For purposes of financial reporting, the Company considers all highly liquid
investments purchased with an original maturity of three months or less
(including money market instruments of $5,873,000 and $2,741,000 at October 31,
1996 and 1995, respectively) to be cash equivalents. The Company has had
significant disqualifying disposition transactions during the three years ended
October 31, 1996. Disqualifying dispositions are non-cash transactions and are
excluded from the statements of cash flows. Disqualifying dispositions
aggregated $1,143,000, $477,000, and $0 during the fiscal years ended October
31, 1996, 1995, and 1994.
(c) Short-Term Investments
Short-term investments are recorded at fair value. Included in short-term
investments are investments classified as available for sale and carried at fair
value. Debt securities that the Company does not have the intent and ability to
hold to maturity are classified either as "available for sale" or as "trading"
and are carried at fair value. Unrealized gains and losses on securities
classified as available for sale are carried as a separate component of
shareholders' equity. Unrealized gains and losses on securities classified as
trading are reported in earnings. Management determines the appropriate
classification of its investments in debt and equity securities at the time of
purchase and reevaluates such determination at each balance sheet date.
At October 31, 1996 and 1995, the Company recorded cumulative unrealized
appreciation of $471,000 and $464,000, respectively, on these short-term
investments.
(d) Depreciation and Amortization of Property and Equipment
Property and equipment are recorded at cost. Depreciation is provided over
the estimated useful lives of the property and equipment utilizing the
straight-line method. Amortization of leasehold improvements is provided over
the estimated useful lives of the assets or the terms of the leases, whichever
is shorter, utilizing the straight-line method. The estimated useful lives are
as follows:
Equipment 3-5 years
Leasehold improvements 5-8 years
Furniture and fixtures 5-7 years
(e) Intangible Assets
Intangible assets have been recorded primarily as a result of the
recapitalization of the Company in 1989 and the acquisition of Quality Medi-Cal
Adjudication, Incorporated ("QMA") in 1990. Intangible assets consist of
software, non-compete agreements, and goodwill, which are being amortized on a
straight-line basis over three years, 43 months, and between 10 and 40 years,
respectively.
F-13
35
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
(f) Software Development Costs
The Company capitalizes software development costs (related to software
developed for resale) incurred subsequent to the establishment of technological
feasibility of the product, including costs incurred to develop upgrades
subsequent to the commercial release of the product. Amortization of software
development costs is determined on a product-by-product basis to be the greater
of the amount computed on a straight-line basis over the expected economic life
of the product, generally estimated to be 36-60 months, or using the ratio of
current gross revenue to total current and anticipated future gross revenue,
whichever is greater. Software development costs are stated at original cost of
$2,257,000 and $3,929,000 less accumulated amortization of $785,000 and
$3,064,000 at October 31, 1996 and 1995, respectively. Amortization expense for
the years ended October 31, 1996, 1995, and 1994 was $543,000, $587,000, and
$486,000, respectively. During 1996, fully amortized software development costs
of $2,822,000 and the related accumulated amortization were written off the
balance sheet.
(g) Investment in Health Information Systems Corporation
At October 31, 1996 and 1995, the Company had an investment of $6,824,000 and
$6,746,000, respectively, which represented approximately a 43% ownership
interest in Health Information Systems Corporation ("HISCo"), a privately owned
Delaware corporation. The investment in HISCo has been accounted for using the
equity method of accounting. Under the equity method, the Company recognizes in
earnings its proportionate share of net income or loss of HISCo. During June
1995, the Company, together with Welsh, Carson, Anderson & Stowe VI, L.P., a
Delaware limited partnership affiliated with Welsh, Carson, Anderson & Stowe
("WCAS"), affiliates of WCAS, and certain of their respective executive officers
and partners, formed HISCo for the purpose of investing in health care
information management companies that require significant additional investment
and maturation.
Condensed financial information of HISCo as of and for the year ended October
31, 1996 and four months ended October 31, 1995, respectively, is summarized
below:
As of October 31, 1996 1995
HISCo Consolidated Balance Sheets:
Current assets $ 8,355,000 6,318,000
Total assets $16,616,000 15,833,000
- --------------------------------------------------------------------------------------------------
Current liabilities $ 2,473,000 1,807,000
- --------------------------------------------------------------------------------------------------
Stockholders' equity 14,143,000 14,026,000
Total liabilities and stockholders' equity $16,616,000 15,833,000
- --------------------------------------------------------------------------------------------------
Periods Ended October 31, 1996 1995
- --------------------------------------------------------------------------------------------------
HISCo Consolidated Statements of Operations:
Revenue $16,296,000 5,284,000
- --------------------------------------------------------------------------------------------------
Operating margin 167,000 550,000
- --------------------------------------------------------------------------------------------------
Net income $ 117,000 1,000
- --------------------------------------------------------------------------------------------------
F-14
36
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
(h) Revenue Recognition
The Company generally recognizes revenue for financial reporting purposes
when billings are submitted to third-party payors or their third-party
intermediaries as a consequence of services performed by the Company for a
client. Several client contracts contain periodic fee limitations that the
Company believes will be exceeded in the normal course of business. As a result,
the fees allowable under these contracts are recognized on a straight-line basis
over the fee limitation period as services are performed, and amounts billed in
excess of revenue recognized are deferred. Other contracts have sliding fee
scales for which revenue is fairly predictable. For these, the Company
recognizes revenue, at the estimated effective fee rate, ratably over the
client's contract year. Finally, certain contracts are subject to fixed-fee
arrangements covering specified periods, which the Company realizes on a
straight-line basis over the corresponding periods.
The Company recognizes revenue from consulting services as the services are
provided. Revenue from software products sold to customers under license
agreements is deferred and recognized as revenue upon software installation and
satisfaction of significant Company obligations, if any. Revenue from ongoing
maintenance agreements is deferred and recognized as revenue on a straight-line
basis over the periods of the respective maintenance agreements.
(i) Income Taxes
Income taxes are accounted for under the asset and liability method. Under
the asset and liability method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates is
recognized as income in the period that includes the enactment date.
(j) Net Income Per Common Share
Net income per common share has been computed by dividing net income
attributable to common shareholders by the weighted average number of common
shares outstanding during each year. Common stock equivalents utilizing the
treasury stock method are included in the computation of weighted average number
of shares outstanding for the years ended October 31, 1996, 1995, and 1994.
(k) Use of Estimates
Management of the Company has made a number of estimates and assumptions
relating to the reporting of assets and liabilities and the disclosure of
contingent assets and liabilities to prepare these consolidated financial
statements in conformity with generally accepted accounting principles. Actual
results could differ from those estimates.
(l) Reclassifications
Certain reclassifications were made to prior year amounts to conform to the
1996 presentation.
(m) Merger with Health Care microsystems, Inc.
On February 14, 1995, the Company acquired all of the outstanding capital
stock of Health Care microsystems, Inc. ("HCm") in a merger transaction which
was accounted for using the pooling of interests method of accounting.
Accordingly, the accompanying consolidated financial statements have been
retroactively restated for all periods presented to include the financial
position, results of operations, and cash flows of HCm. In addition, the
accompanying consolidated financial statements reflect certain adjustments to
conform the accounting policies of the two companies.
F-15
37
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
HCm previously used the fiscal year ended December 31 for its financial
reporting. To conform to the Company's October 31 fiscal year end, HCm's
operating results for the period November 1, 1994 through December 31, 1994 have
been included in the operating results of the Company for the fiscal years ended
October 31, 1995 and 1994. The resulting duplication of revenue and net income
of HCm for the period November 1, 1994 through December 31, 1994 amounted to
$2,842,000 and $672,000, respectively, which has been adjusted by a $672,000
charge to retained earnings during the year ended October 31, 1995.
(n) Merger with CDR Associates, Inc.
On April 29, 1996, the Company acquired all the outstanding capital stock of
CDR Associates, Inc. ("CDR") in exchange for 460,000 shares of the Company's
stock in a merger transaction which was accounted for using the pooling of
interests method of accounting. Accordingly, the accompanying consolidated
financial statements have been retroactively restated for all periods presented
to include the financial position, results of operations, and cash flows of CDR.
(o) Recently Issued Accounting Standards
In October 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"), which requires pro forma disclosure of net income
and earnings per share using a fair value based method of accounting for all
employee stock options or similar equity instrument plans. The Company will
implement the disclosure provisions of SFAS 123 effective October 31, 1997.
(p) Fair Value of Financial Instruments
The fair value of a financial instrument is the amount at which the
instrument could be exchanged in a current transaction between willing parties.
With the exception of short-term investments (see note 1(c)), the carrying
amounts of the Company's financial instruments included in the accompanying
consolidated balance sheets approximate estimated fair value as of October 31,
1996 and 1995.
2. ACCOUNTS RECEIVABLE
Accounts receivable as of October 31, 1996 and 1995 consisted of the
following:
1996 1995
- -----------------------------------------------------------------------
Trade $42,018,000 31,517,000
Affiliates 400,000 113,000
- -----------------------------------------------------------------------
$42,418,000 31,630,000
- -----------------------------------------------------------------------
Trade accounts receivable are reflected net of an allowance for doubtful
accounts of $1,682,000 and $296,000 at October 31, 1996 and 1995, respectively.
F-16
38
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. FEES HELD IN ESCROW
The Company is obligated to maintain a portion of fees received from two
clients in escrow accounts. The Company's obligation to maintain such fees in
escrow terminates at either: (a) the earlier of six years from the dates of
service associated with fees generated and settlement of the client's Medicaid
and/or Medicare audits for each applicable year, and/or (b) the termination of
contract. Due to the 1994 renewal of one client contract that eliminated future
escrow requirements and the Company's fulfillment of its maximum escrow deposit
for the second client, the Company completed its obligation to make escrow
deposits as of October 31, 1994. For the years ended October 31, 1996, 1995, and
1994, revenue subject to such escrow requirements approximated $378,000,
$260,000, and $4,738,000, respectively.
4. PROPERTY AND EQUIPMENT
Property and equipment as of October 31, 1996 and 1995 consisted of the
following:
1996 1995
- -------------------------------------------------------------------------------------------
Equipment $ 12,472,000 9,697,000
Leasehold improvements 5,510,000 3,438,000
Furniture and fixtures 3,903,000 2,034,000
- -------------------------------------------------------------------------------------------
21,885,000 15,169,000
Less accumulated depreciation and amortization (14,111,000) (9,295,000)
- -------------------------------------------------------------------------------------------
$ 7,774,000 5,874,000
- -------------------------------------------------------------------------------------------
Depreciation and amortization expense related to property and equipment
charged to operations for the years ended October 31, 1996, 1995, and 1994 was
$2,550,000, $2,205,000, and $2,038,000, respectively.
5. INTANGIBLE ASSETS
Intangible assets as of October 31, 1996 and 1995 consisted of the following:
Accumulated
Cost Amortization Balance
- ------------------------------------------------------------------------------------
1996
Software costs $ 1,756,000 (1,746,000) 10,000
Goodwill 6,487,000 (1,240,000) 5,247,000
- ------------------------------------------------------------------------------------
$ 8,243,000 (2,986,000) 5,257,000
- ------------------------------------------------------------------------------------
1995
Software costs $ 10,356,000 (10,312,000) 44,000
Goodwill 6,487,000 (1,070,000) 5,417,000
- ------------------------------------------------------------------------------------
$ 16,843,000 (11,382,000) 5,461,000
- ------------------------------------------------------------------------------------
Amortization expense related to intangible assets charged to operations for
the years ended October 31, 1996, 1995, and 1994, was $204,000, $243,000, and
$190,000, respectively. During the year ended October 31, 1996, the fully
amortized costs and related accumulated amortization associated with software
costs and non-compete agreements were written off the balance sheet.
F-17
39
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses as of October 31, 1996 and 1995
consisted of the following:
1996 1995
- ------------------------------------------------------------------------------------------
Accrued compensation $ 6,009,000 8,011,000
Accrued HHL one-time charges 3,658,000 0
Accounts payable and other accrued expenses 7,884,000 6,831,000
- ------------------------------------------------------------------------------------------
$ 17,551,000 14,842,000
- ------------------------------------------------------------------------------------------
7. CREDIT FACILITIES
On July 15, 1996, the Company entered into a $40,000,000 unsecured revolving
credit facility with a major money center financial institution which replaced a
similar $10,000,000 unsecured revolving credit facility with the same
institution. The credit facility has a term of three years, carries an unused
commitment fee of 20 basis points, and bears interest at the institution's prime
lending rate, or LIBOR plus 5/8%, at the Company's option. The revolving credit
facility contains, among other things, restrictions on additional borrowings,
capital expenditures, leases, sales of assets, and payments of dividends. The
revolving credit facility also contains covenants that require the Company to
maintain minimum tangible consolidated shareholders' equity and limit
debt-to-equity and debt-to-asset relationships as defined in the agreement. As
of October 31, 1996 and 1995, no amounts were outstanding under this credit
facility. As of October 31, 1996, the Company had a $50,000 letter of credit
outstanding related to leased telephone equipment at its QMA subsidiary.
Cash interest payments including bank charges attributable to the
aforementioned debts for the years ended October 31, 1996, 1995, and 1994 were
$68,000, $60,000, and $88,000, respectively.
8. INCOME TAXES
Income tax expense for the years ended October 31, 1996, 1995, and 1994 was
comprised of the following:
1996 1995 1994
- ---------------------------------------------------------------------------------------------------------
Current tax expense:
Federal $(4,264,000) (4,677,000) (3,286,000)
State and local (1,734,000) (2,272,000) (2,060,000)
- ---------------------------------------------------------------------------------------------------------
(5,998,000) (6,949,000) (5,346,000)
- ---------------------------------------------------------------------------------------------------------
Deferred tax benefit (expense):
Federal 448,000 (1,285,000) (578,000)
State and local (24,000) 82,000 (429,000)
- ---------------------------------------------------------------------------------------------------------
424,000 (1,203,000) (1,007,000)
- ---------------------------------------------------------------------------------------------------------
Income tax expense, net $(5,574,000) (8,152,000) (6,353,000)
- ---------------------------------------------------------------------------------------------------------
F-18
40
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. INCOME TAXES, CONTINUED
A reconciliation of the income tax expense to the federal statutory rate of
34% follows:
1996 1995 1994
- --------------------------------------------------------------------------------------------------------
Income tax expense
computed at Federal
statutory rate $ (4,678,000)(34.0)% $(6,036,000)(34.0)% $(4,786,000) (34.0)%
State and local tax expense,
net of federal benefit (1,160,000) (8.4) (1,445,000) (8.1) (1,643,000) (11.7)
Amortization of goodwill (55,000) (0.4) (55,000) (0.3) (55,000) (0.3)
Merger related costs (157,000) (1.1) (355,000) (2.0) -- --
CDR "S" Corp income 325,000 2.4 -- -- -- --
Other, net 151,000 1.0 (261,000) (1.5) 131,000 0.9
- --------------------------------------------------------------------------------------------------------
Total income tax expense $ (5,574,000)(40.5)% $(8,152,000)(45.9)% $(6,353,000) (45.1)%
- --------------------------------------------------------------------------------------------------------
Deferred income taxes are recognized for the future tax consequences of
temporary differences between the financial statement and tax bases of assets
and liabilities. The types of temporary differences that give rise to the
deferred tax liability, and the effect on the deferred income tax benefit
(expense) of changes in those temporary differences, are as follows:
1996 1995 1994
Accounts receivable $(3,294,000) (1,609,000) (1,263,000)
Fees held in escrow 108,000 117,000 107,000
Depreciable and amortizable assets 397,000 (400,000) 456,000
Allowance for doubtful accounts 653,000 0 0
Unbilled costs (156,000) (6,000) 17,000
Non-compete agreements, net 0 0 (224,000)
Accounts payable and accrued expenses (170,000) 403,000 81,000
Deferred revenue 275,000 (543,000) (723,000)
Deferred rent 237,000 72,000 352,000
Contract termination contingency 479,000 0 0
HHL one-time charges 2,070,000 0 0
Other (175,000) 763,000 190,000
- ----------------------------------------------------------------------------------------------------------
Deferred income tax benefit (expense) $ 424,000 (1,203,000) (1,007,000)
- ----------------------------------------------------------------------------------------------------------
F-19
41
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. INCOME TAXES, CONTINUED
Temporary differences that give rise to a significant portion of the deferred
tax assets and deferred tax liabilities at October 31, 1996 are as follows:
Deferred tax assets Deferred tax liabilities
- --------------------------------------------------------------------------------------------------------
Accounts receivable/deferred items $ 678,000 9,979,000
Property and equipment 1,539,000 664,000
HHL one-time charges 2,070,000 0
Allowance for doubtful accounts 759,000 0
Accounts payable and accrued expenses 603,000 0
Contract termination contingency 0 3,096,000
Other 1,432,000 367,000
Total deferred taxes 7,081,000 14,106,000
- --------------------------------------------------------------------------------------------------------
Net deferred tax liability $ -- 7,025,000
- --------------------------------------------------------------------------------------------------------
Based on the Company's financial history and current situation, management
believes it is more likely than not that the Company will realize the benefits
of the deferred tax assets as shown above. Accordingly, no valuation allowance
has been provided.
Cash payments attributable to income taxes for the years ended October 31,
1996, 1995, and 1994 were $5,896,000, $6,355,000, and $4,917,000, respectively.
9. PROFIT SHARING AND 401(k) PLAN
The Company has a discretionary defined contribution profit sharing plan in
which a substantial number of its employees participate. For the years ended
October 31, 1996, 1995, and 1994, profit sharing expense was $944,000, $800,000,
and $582,000, respectively.
Effective January 1, 1992, the Company amended its profit sharing plan to
include for its employees a 401(k) plan, which permits an employee to contribute
a portion of the employee's compensation, subject to certain limitations. At its
discretion, the Company may make annual contributions to the 401(k) plan for the
benefit of participating employees. For the years ended October 31, 1996, 1995,
and 1994, 401(k) plan expense was $611,000, $543,000, and $368,000,
respectively.
10. EMPLOYEE STOCK PURCHASE PLAN
On May 28, 1993, the Board of Directors adopted the Health Management
Systems, Inc. Employee Stock Purchase Plan (the "ESPP"), which was subsequently
approved by shareholders at the Annual Meeting of Shareholders held on February
28, 1994. The Company has reserved for issuance up to 1,125,000 shares of common
stock pursuant to the ESPP, which is intended to qualify as an "employee stock
purchase plan" within the meaning of Section 423 of the Internal Revenue Code of
1986. The plan provides that all full-time employees of the Company and its
subsidiaries may elect to participate in the ESPP without regard to length of
service if their customary employment is a minimum of 20 hours per week.
F-20
42
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. EMPLOYEE STOCK PURCHASE PLAN, CONTINUED
For the years ended October 31, 1996 and 1995, the Company had sold 163,085
and 141,744 shares, respectively, of common stock pursuant to the ESPP for
aggregate consideration of $2,332,000 and $1,203,000, which activity is
reflected in the accompanying financial statements.
11. STOCK OPTION PLAN AND RESTRICTED STOCK PURCHASE PLAN
Effective May 31, 1989, the Company adopted the Health Management Systems,
Inc. Stock Option and Restricted Stock Purchase Plan (the "Plan") under which:
(a) options can be granted to purchase shares of the Company's common stock at
an exercise price equal to (incentive stock options) or less than (non-qualified
stock options) the estimated fair market value of the Company's common stock, or
(b) rights can be granted in the form of an award to purchase shares of the
Company's common stock at a price equal to, more than, or less than the
estimated fair market value of the Company's common stock. Subsequent amendments
to the Plan, which have been approved by shareholders, have increased the number
of shares allowed to be issued under the Plan to 6,750,000 shares.
Stock option activity for the years ended October 31, 1996, 1995, and 1994
was as follows:
1996 1995 1994
- --------------------------------------------------------------------------------------------------------
Options outstanding, beginning of period 2,754,383 2,143,641 1,921,679
Options granted 127,700 906,042 626,120
Options surrendered (153,895) (22,705) (55,499)
Options exercised (794,994) (272,595) (348,659)
- --------------------------------------------------------------------------------------------------------
Options outstanding, end of period 1,930,194 2,754,383 2,143,641
- --------------------------------------------------------------------------------------------------------
Options exercisable, end of period 1,358,006 1,774,925 1,425,509
- --------------------------------------------------------------------------------------------------------
Average exercise price of options granted $ 26.47 16.97 9.99
- --------------------------------------------------------------------------------------------------------
The stock options become exercisable on various dates through December 1999
and expire at various dates through October 2005. As of October 31, 1996, no
stock appreciation rights or stock purchase awards had been granted. Fiscal 1996
stock option awards totaling 421,000, and normally granted during the fiscal
year, were granted in November 1996.
F-21
43
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN
The Company's 1995 Non-Employee Director Stock Option Plan (the "NEDP") was
adopted by the Board of Directors on November 30, 1994, which action was
subsequently approved by shareholders at the Annual Meeting of Shareholders held
on March 7, 1995. The purpose of the NEDP is to provide compensation in the form
of equity participation in the Company, in consideration of the services
provided by directors not employed by the Company. Under the NEDP, directors of
the Company who are not employees of the Company or its subsidiaries are granted
options to purchase common stock of the Company. Options for the purchase of up
to 112,500 shares of common stock may be granted under the NEDP and the Company
will reserve the same number of shares for issuance. The options available for
grant are automatically increased to the extent any granted options expire or
terminate unexercised.
The NEDP provides that a grant of options to purchase 1,500 shares of common
stock will be made to each non-employee director during the fourth fiscal
quarter of each fiscal year commencing with fiscal year 1995. The exercise price
of options issued under the NEDP will be the fair market value of the common
stock as of the date of grant, and must be paid in cash at the time of exercise.
Options granted under the NEDP will have a term of ten years, with 25% of the
options exercisable immediately upon grant and an additional 25% exercisable at
the end of each of the three subsequent fiscal years. In the event that the
holder of options granted under the NEDP ceases to be a director for any reason,
all outstanding vested options will be exercisable for one year following the
date the director's service on the Board of Directors of the Company terminates,
or until their expiration date, whichever period is shorter. Unvested options
lapse immediately upon cessation of the director's service on the Board of
Directors. No options may be granted under the NEDP after October 31, 2004.
The NEDP is administered by the Compensation Committee of the Company's Board
of Directors. The Compensation Committee may amend the NEDP, except that
shareholder approval is required to increase the number of shares available
under the NEDP other than for anti-dilution purposes, to change the class of
participants eligible to participate in the NEDP, or to increase materially the
benefits to such participants. The provisions of the NEDP relating to the number
of options to be awarded to directors, the exercise price of such options, and
the timing of awards may not be amended more than once every six months, other
than to conform to changes in certain statutes.
NEDP stock option activity for the years ended October 31, 1996 and 1995 was
as follows:
1996 1995
- --------------------------------------------------------------------------------
Options outstanding, beginning of period 11,250 0
Options granted 6,000 11,250
Options surrendered (563) 0
Options exercised 0 0
Options outstanding, end of period 16,687 11,250
- --------------------------------------------------------------------------------
Options exercisable, end of period 7,683 2,813
- --------------------------------------------------------------------------------
Average exercise price of options granted $ 23.00 17.50
- --------------------------------------------------------------------------------
F-22
44
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
13. BUSINESS SEGMENT INFORMATION
The Company delivers services and software that comprise three business
segments: Proprietary Services-Information and Outsourcing ("Proprietary
Services"), Proprietary Analytics-Managed Care Support Services ("MCS"), and
Other, which is currently comprised of EDI services. Proprietary Services
include the Company's RCR, CAMS, and TPLR product offerings which constitute an
outsourcing of various aspects of the information processing functions
associated with the health care transfer payment process. MCS provides
microcomputer based decision support applications and related consulting
services, which assist health care providers assemble, analyze, and evaluate
information in order to support provision of cost-effective, high quality
services.
Proprietary
Services MCS Other Consolidated
- -----------------------------------------------------------------------------------------------------------------
1996
Sales $ 73,124,000 18,853,000 8,692,000 100,669,000
Operating income 9,302,000 3,392,000 1,450,000 14,144,000
Total assets 95,618,000 11,798,000 1,765,000 109,181,000
Depreciation and amortization 2,403,000 712,000 182,000 3,297,000
Capital expenditures 4,067,000 1,528,000 5,000 5,600,000
1995
Sales $ 66,385,000 15,120,000 8,222,000 89,727,000
Operating income 14,183,000 2,465,000 1,209,000 17,857,000
Total assets 75,181,000 10,046,000 2,157,000 87,384,000
Depreciation and amortization 2,106,000 753,000 134,000 2,993,000
Capital expenditures 1,240,000 843,000 260,000 2,343,000
1994
Sales $ 52,647,000 12,500,000 8,029,000 73,176,000
Operating income 9,855,000 2,274,000 1,543,000 13,672,000
Total assets 58,775,000 9,103,000 1,899,000 69,777,000
Depreciation and amortization 1,932,000 657,000 125,000 2,714,000
Capital expenditures 2,525,000 951,000 72,000 3,548,000
F-23
45
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
14. COMMITMENTS
The Company leases office space and equipment under operating leases which
expire at various dates through May 31, 2006. The lease agreements provide for
rent escalations. Total rent expense for the years ended October 31, 1996, 1995,
and 1994, including escalations, was $6,214,000, $5,193,000, and $4,037,000,
respectively.
Minimum annual lease payments for each of the next five years ending October
31 and thereafter are as follows:
Year Payments
--------------------------------------------------------------
1997 $ 4,652,000
1998 3,946,000
1999 3,406,000
2000 2,881,000
2001 2,832,000
Thereafter 9,097,000
--------------------------------------------------------------
Total $ 26,814,000
--------------------------------------------------------------
15. SIGNIFICANT CONTRACTS
For the years ended October 31, 1996, 1995, and 1994, the Company's largest
client accounted for 12%, 15%, and 17%, respectively, of the Company's
consolidated revenue. The next largest client accounted for approximately 8%,
11%, and 6%, respectively, of the Company's consolidated revenue for the same
periods. The Company's contract with this client expired on September 30, 1996.
The Company continues to process claims for this client under an interim
arrangement, while a new contract has been bid and is being negotiated. While
the Company is optimistic that negotiations will be successful, there can be no
assurance that a new contract will be consummated; loss of this client could
have a material adverse effect on the Company.
16. RELATED PARTY TRANSACTIONS
(a) HHL Financial Services, Inc.
Effective January 31, 1992, the Company entered into a management and data
processing services agreement ("Management Agreement") with HHL Financial
Services, Inc. ("HHL"). Under the Management Agreement, the Company provides HHL
with executive management, data processing, and technical support services
through June 30, 1996, subject to certain termination and renewal provisions.
Effective July 1, 1993, the Management Agreement was amended ("Outsourcing
Amendment") to include the Company's provision of comprehensive data processing
and information management services to HHL. The five-year term of the
Outsourcing Amendment called for fixed annual fees that range from $6,700,000 to
$9,500,000 subject to upward adjustment in the event of material changes in the
scope of service and/or growth in HHL revenue in excess of 7% annually.
On August 21, 1996, the Company announced a one-time charge and revenue
reversal pertaining to its relationship with HHL, which was in default of the
Outsourcing Amendment. The Company's one-time charge related to (i) the full
reservation of prior period accounts receivable of $2,881,000, (ii) accrual of
net costs to be incurred in excess of anticipated revenue relating to the
Company's continued contractual obligation with HHL of $3,823,000, and (iii) the
write-off of its investment in HHL of $927,000, resulting in a total one-time
charge of $7,631,000. Additionally, revenue of $2,180,000 earned and initially
recorded in the third quarter was reversed. The result of the total write-off
and revenue reversal recognized in the third quarter of $9,811,000 translates to
an after-tax impact of $5,838,000, or $0.32 per share.
F-24
46
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
16. RELATED PARTY TRANSACTIONS, CONTINUED
As of October 31, 1996, the Company has incurred and offset $165,000 in net
expenses for its contractual obligations with HHL. The remaining accrual at
October 31, 1996 was $3,658,000 for probable future net cash expenditures
related to the Company's continuing contractual obligations with HHL. The
Company anticipates that substantially all amounts accrued as of October 31,
1996 will be paid out or otherwise satisfied by the end of fiscal year 1997.
On October 29, 1996, the Company entered into an agreement with HHL and HHL's
primary financial creditor providing for mutual general releases and the
cessation of all claims. The Company also settled its liabilities due to HHL of
$1,950,000 for a payment of $870,000 resulting in the reversal of $1,080,000 in
liabilities as an offset to other operating expenses. In addition, the Company
has agreed to provide, for a period of up to 18 months, a reduced level of
services to HHL in exchange for payment in advance. During this 18 month period,
HHL has the right to lower the level of services requested and therefore lower
the amount paid in advance. Also, HHL has the right to cancel the service
completely on 30 days prior written notice.
During the years ended October 31, 1996, 1995, and 1994, the Company received
approximately $5,446,000, $8,877,000, and $9,548,000 in fees from HHL related to
these agreements, and, in connection with jointly executed client projects, HHL
has charged the Company expenses for services totaling $1,557,000, $1,337,000,
and $1,091,000, in 1996, 1995, and 1994, respectively.
(b) HISCo
To finance additional proposed acquisitions, effective October 31, 1995, the
Company and HISCo entered into a subscription agreement (the "Subscription
Agreement"). The Subscription Agreement contemplated that, for a period of three
years commencing on October 31, 1995, HISCo may require the Company to purchase,
on a pro rata basis, up to an aggregate additional 4,136,700 shares of HISCo
common stock ("Additional Shares") for a per share purchase price of $10.00, or
an aggregate purchase price of $41,367,000. With respect to each acquisition,
the Subscription Agreement requires HISCo to deliver written notice to the
Company specifying, among other information, the terms of the proposed
acquisition and the aggregate number of Additional Shares that HISCo proposes to
sell to the Company. The Company cannot decline to purchase its respective pro
rata portions of Additional Shares.
The Company and HISCo entered into an agreement, dated as of October 31, 1995
(the "HISCo Agreement"), pursuant to which the Company will provide HISCo with
certain services ("Basic Services"), including executive, acquisition support,
and corporate support services. For these Basic Services, the Company is
entitled to receive a fee, payable monthly, calculated at the Company's then
current standard hourly rates established for internal allocations plus 20%. The
Company, in addition, may provide to subsidiaries ("Subsidiaries") of HISCo, and
such Subsidiaries may provide to the Company, additional services on such terms
as the parties may mutually agree. The term of the HISCo Agreement continues
until the later of (i) June 30, 2000 or (ii) the expiration of any outstanding
work order related to additional services. The Company believes that the terms
of the HISCo Agreement are fair and reasonable and are no less favorable to the
Company than those that could have been obtained with respect to comparable
engagements with independent third parties. In fiscal year 1996 and 1995, the
Company received approximately $161,000 and $545,000 in fees from HISCo for
services provided pursuant to the HISCo Agreement. In fiscal year 1996, HISCo
received approximately $569,000 in fees for software development services
provided the Company pursuant to the HISCo agreement. These software development
fees were expensed by the Company.
The Company's total revenue from related parties was $5,607,000, $9,422,000
and $9,901,000 in 1996, 1995, and 1994, respectively.
F-25
47
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
17. QUARTERLY FINANCIAL DATA (UNAUDITED)
The table below summarizes the Company's unaudited quarterly operating
results for its last three fiscal years.
(In Thousands, Except Earnings Per Common Share) First Quarter Second Quarter Third Quarter Fourth Quarter
- -----------------------------------------------------------------------------------------------------------------------------
1996:
Revenue $ 25,390 25,577 25,785 23,917
Cost of services 19,558 19,872 28,135 18,756
- -----------------------------------------------------------------------------------------------------------------------------
Operating margin (loss) before amortization of intangibles 5,832 5,705 (2,350) 5,161
Operating income (loss) 5,777 5,650 (2,401) 5,118
Net income (loss) 3,743 3,338 (1,827) 2,932
Net income (loss) per common share $ 0.21 0.18 (0.11) 0.16
- -----------------------------------------------------------------------------------------------------------------------------
1995:
Revenue $ 20,985 21,041 23,020 24,681
Cost of services 16,471 16,752 18,786 19,618
- -----------------------------------------------------------------------------------------------------------------------------
Operating margin before amortization of intangibles 4,514 4,289 4,234 5,063
Operating income 4,434 4,234 4,180 5,009
Net income 1,807 2,417 2,413 2,965
Net income per common share $ 0.11 0.14 0.14 0.17
- -----------------------------------------------------------------------------------------------------------------------------
1994:
Revenue $ 17,091 17,620 18,742 19,723
Cost of services 14,093 14,481 14,966 15,774
- -----------------------------------------------------------------------------------------------------------------------------
Operating margin before amortization of intangibles 2,998 3,139 3,776 3,949
Operating income 2,958 3,099 3,734 3,881
Net income 1,647 1,706 2,238 2,133
Net income per common share $ 0.10 0.10 0.13 0.13
- -----------------------------------------------------------------------------------------------------------------------------
18. SUBSEQUENT EVENTS
On November 25, 1996, the Company completed the acquisition of Quality
Standards in Medicine, Inc. ("QSM"), a Boston-based company providing clinical
quality management systems, for 260,000 shares of the Company's common stock.
This transaction is being treated as a pooling of interests. Founded in 1986,
QSM provides hospitals with sophisticated systems and consulting services to
help define and measure the quality of care. QSM had 1995 revenue of $840,000,
and has clients in 13 states, the District of Columbia, and the United Kingdom.
Operationally, QSM will be combined with HCm, the Company's decision support
systems subsidiary as part of the Managed Care Support business segment.
F-26
48
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
Allowance for doubtful Accounts:
- --------------------------------
Balance, October 31, 1993 $ 154,000
Provision 190,000
Recoveries 0
Charge-offs (75,000)
Balance, October 31, 1994 269,000
Provision 111,000
Recoveries 0
Charge-offs (84,000)
----------
Balance, October 31, 1995 296,000
Provision 4,485,000
Recoveries 0
Charge-offs (3,099,000)
Balance, October 31, 1996 $ 1,682,000
============
F-27
49
Exhibit
Number
- ------
2.1 Agreement and Plan of Merger dated as of January 18, 1995 among
Health Management Systems, Inc., HCm Acquisition Corp., and all the
shareholders of Health Care microsystems, Inc., as amended
(Incorporated by reference to Exhibit 10.18 to the Company's Annual
Report on Form 10-K for the year ended October 31, 1994 and to
Exhibit 10.2 to the Company's Registration Statement on Form S-3,
file no. 33-91518)
2.2 Agreement and Plan of Merger, dated as of April 29, 1996 among
Health Management Systems, Inc., CDR Acquisition Corp., CDR
Associates, Inc., and all the shareholders of CDR Associates, Inc.
(Incorporated by reference to Exhibit 10.1 to the Company's Current
Report on Form 8-K dated April 29, 1996)
* 2.2(i) First Amendment to Agreement and Plan of Merger, dated as of April
29, 1996, among Health Management Systems, Inc., CDR Acquisition
Corp., CDR Associates, Inc., and all the shareholders of CDR
Associates, Inc.
2.3 Agreement and Plan of Merger, dated as of September 3, 1996, by and
among Health Management Systems, Inc., QSM Acquisition Corporation
and Quality Standards in Medicine, Inc. (Incorporated by reference
to Exhibit 2.1 to the Company's Registration Statement on Form S-4,
File No. 333-13513 (the S-4))
2.3(i) Amendment to Agreement and Plan of Merger, dated as of November 20,
1996, by and among Health Management Systems, Inc., QSM Acquisition
Corporation, and Quality Standards in Medicine, Inc. (Incorporated
by reference to Exhibit 10.1 to Post-Effective Amendment No. 1 to
the S-4)
2.4 Form of Escrow Agreement by and among Health Management Systems,
Inc., Quality Standards in Medicine, Inc., Coleman & Rhine LLP,
Rodrigo Rocha, William B. Munier and Peter B. Stovell (Incorporated
by reference to Exhibit 2.2 to the S-4)
3.1 Amended and Restated Certificate of Incorporation of Health
Management Systems, Inc. (Incorporated by reference to Exhibit 3.1
to Amendment No. 1 (Amendment No. 1) to the Company's Registration
Statement on Form S-1, File No. 33-4644 (the Registration
Statement))
3.2 By-Laws of Health Management Systems, Inc. (Incorporated by
reference to Exhibit 3.2 to Amendment No. 1)
10.1(i) Contract, dated January 28, 1980, as amended, between Health
Management Systems, Inc. and New York City Health and Hospitals
Corporation (Incorporated by reference to Exhibit 10.1(i) to the
Registration Statement)
10.1(ii) Contract dated September 8, 1982, as amended, between Health
Management Systems, Inc. and New York City Health and Hospitals
Corporation (Incorporated by reference to Exhibit 10.1(ii) to the
Registration Statement)
10.1(iii) Contract dated October 1, 1993, between Health Management Systems,
Inc. and New York City Health and Hospitals Corporation
(Incorporated by reference to Exhibit 10.4 to the Company's
Quarterly Report on Form 10-Q for the quarter ended January 31,
1994)
10.2 Financial Management Services Agreement, dated August 1, 1989,
between Health Management Systems, Inc. and the County of Los
Angeles (Incorporated by reference to Exhibit 10.2 to the
Registration Statement)
10.3(i) Health Management Systems, Inc. Stock Option and Restricted Stock
Purchase Plan, as amended (Incorporated by reference to Exhibit 10.3
to the Registration Statement, to Exhibit 10.3 to Amendment No. 2
(Amendment No. 2) to the Registration Statement and Exhibit 10.1 to
the Company's Quarterly Report on Form 10-Q for the quarter ended
January 31, 1994)
20
50
Exhibit
Number
- ------
10.3(ii) Health Management System, Inc. Employee Stock Purchase Plan, as
amended (Incorporated by reference to Exhibit 10.2 to the Company's
Quarterly Report on Form 10-Q for the quarter ended January 31, 1994
and to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
for the quarter ended January 31, 1995)
10.3(iii) Health Management Systems, Inc. 1995 Non-Employee Director Stock
Option Plan (Incorporated by reference to Exhibit 10.2 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
January 31, 1995)
10.3(iv) Health Management Systems, Inc. Profit Sharing Plan (Incorporated by
reference to Exhibit 10.3(iv) to the Company's Annual Report on Form
10-K for the year ended October 31, 1995)
10.3(v) Health Management Systems, Inc. Profit Sharing Plan, as amended
(Incorporated by reference to Exhibit 10.3(v) to the Company's
Annual Report on Form 10-K for the year ended October 31, 1995)
10.4 Interim Operating Agreement, dated April 12, 1991, among Health
Management Systems, Inc., HHL Financial Services, Inc., and Welsh,
Carson, Anderson and Stowe V, L.P. (Incorporated by reference to
Exhibit 10.8 to the Registration Statement)
10.5(i) Management and Data Processing Services Agreement, effective as of
January 31, 1992, between HHL Financial Services, Inc. and Health
Management Systems, Inc. (Incorporated by reference to Exhibit 10.9
to the Registration Statement)
10.5(ii) Amendment No. 1 among HHL Financial Services, Inc., Professional
Data Services, Inc., and Health Management Systems, Inc. to
Management and Data Processing Agreement (Incorporated by reference
to Exhibit 10.9(ii) to the Company's Annual Report for the year
ended October 31, 1993)
10.6 Termination Agreement, dated as of January 31, 1992, among HHL
Financial Services, Inc., Health Management Systems, Inc., and the
other parties named therein (Incorporated by reference to Exhibit
10.10 to the Registration Statement)
10.7(i) Credit Agreement and Guaranty among Health Management Systems, Inc.,
as Borrower, Accelerated Claims Processing, Inc., and Quality
Medi-Cal Adjudication, Incorporated, as Guarantors and The Chase
Manhattan Bank, N.A., as Bank, dated April 26, 1993, as amended
(Incorporated by reference to Exhibit 10.12 to the Company's
Quarterly Report on Form 10-Q for the quarter ended April 30, 1993
and to Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q
for the quarter ended January 31, 1995)
10.7(ii) Second Amendment to Credit Agreement and Guaranty, dated as of March
30, 1995 among Health Management Systems, Inc., Accelerated Claims
Processing, Inc., and Quality Medi-Cal Adjudication, Incorporated
and The Chase Manhattan Bank, N.A. (Incorporated by reference to
Exhibit 10.12(iii) to the Company's Annual Report on Form 10-K for
the year ended October 31, 1995)
10.7(iii) Credit Agreement and Guaranty Among Health Management Systems, Inc.,
as Borrower, Accelerated Claims Processing, Inc., Quality Medi-Cal
Adjudication, Incorporated, Health Care microsystems, Inc., and CDR
Associates, Inc., as Guarantors, and The Chase Manhattan Bank, as
Bank (Incorporated by reference to Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended July 31, 1996)
10.7(iv) First Amendment to Credit Agreement and Guaranty and Waiver
(Incorporated by reference to Exhibit 10.1(i) to the Company's
Quarterly Report on Form 10-Q for the quarter ended July 31, 1996)
21
51
Exhibit
Number
- ------
10.8 Leases, dated February 1, 1980, September 24, 1981, September 24,
1982, and January 6, 1986, as amended, between 401 Park Avenue South
Associates and Health Management Systems, Inc. (Incorporated by
reference to Exhibit 10.13 to the Registration Statement and to
Exhibit 10.5 to the Company's Quarterly Report on Form 10-Q for the
quarter ended January 31, 1994)
10.8(i) Lease, dated as of March 15, 1996, by and between 387 PAS
Enterprises, as Landlord, and Health Management Systems, Inc., as
Tenant (Incorporated by reference to Exhibit 10.2 to the Company's
Quarterly Report on Form 10-Q for the quarter ended July 31, 1996)
10.9 Lease, dated March 20, 1990, between Quality Medi-Cal Adjudication,
Incorporated and Kilgore Business Park (Incorporated by reference to
Exhibit 10.14 to the Registration Statement)
10.10 Master Lease Agreement, effective as of December 1, 1991, between
Hitachi Data Systems Credit Corporation and Health Management
Systems, Inc. (Incorporated by reference to Exhibit 10.15 to the
Registration Statement)
10.11(i) Subscription Agreement, dated as of October 31, 1995, among Health
Information Systems Corporation ("HISCo") and the Several Persons
Named in Schedule I thereto (Incorporated by reference to Exhibit
10.19 (i) to the Company's Annual Report on Form 10-K for the year
ending October 31, 1995)
10.11(ii) Registration Rights Agreement, dated as of October 31, 1995, among
HISCo and the Several Persons Named in Annex I thereto (Incorporated
by reference to Exhibit 10.19 (ii) to the Company's Annual Report on
Form 10-K for the year ending October 31, 1995).
10.11(iii) Asset Purchase Agreement, dated as of June 30, 1995, between HISCo
and Policy Management Systems Corporation (Incorporated by reference
to Exhibit 10.3 to the Company's Current Report on Form 8-K dated
June 19, 1995) (Incorporated by reference to Exhibit 10.19(iii) to
the Company's Annual Report on Form 10-K for the year ending October
31, 1995)
10.11(iv) Services Agreement, dated as of October 31, 1995, between HISCo and
Health Management Systems, Inc. (Incorporated by reference to
Exhibit 10.19(iv) to the Company's Annual Report on Form 10-K for
the year ending October 31, 1995)
* 10.12 Agreement and Release of Claims dated as of October 29, 1996, by and
among HHL Financial Services, Inc., Health Management Systems,Inc.,
and the First National Bank of Chicago
* 10.13 Lease, dated September 1996, by and between Pacific Corporate Towers
LLC, Health Management Systems, Inc., and Health Care microsystems,
Inc.
* 11.0 Computation of Earnings per Share
* 21.1 List of subsidiaries of Health Management Systems, Inc.
* 24.1 Consent of KPMG Peat Marwick LLP, independent certified public
accountants
* 24.2 Consent of Ernst & Young LLP, independent certified public accountants
* 24.3 Report of independent certified public accountants on the financial
statements of Health Information Systems Corporation as of and for
the period ended October 31, 1996
* 24.4 Consent of Coopers & Lybrand LLP, independent certified public
accountants
24.5 Report of independent certified public accountants on the financial
statements of Health Care microsystems, Inc. as of December 31, 1994
and 1993 and for the years then ended (Incorporated by reference to
Exhibit 24.5 of the Company's Annual Report on Form 10-k for the
year ended October 31, 1996.)
* 27 Financial Data Schedule, which is submitted electronically to the
Securities and Exchange Commission for informational purposes only
* Filed herewith
22