1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________________ to _______________________
Commission File Number 0-20946
Health Management Systems, Inc.
(Exact name of registrant as specified in its charter)
New York 13-2770433
- ---------------------- ---------------------------------------
State of Incorporation (I.R.S. Employer Identification Number)
401 Park Avenue South, New York, New York 10016
- --------------------------------------------------------------------------------
(Address of principal executive offices, zip code)
(212) 685-4545
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Not Applicable
- --------------------------------------------------------------------------------
(Former name, former address, and former fiscal year, if changed since last
report.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. X Yes No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at September 1, 1999
- ---------------------------- --------------------------------
Common Stock, $.01 Par Value 17,386,309 Shares
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HEALTH MANAGEMENT SYSTEMS, INC.
INDEX TO FORM 10-Q
QUARTER ENDED JULY 31, 1999
PART I FINANCIAL INFORMATION Page No.
Item 1 Interim Financial Statements
Condensed Consolidated Balance Sheets as of July 31, 1999 (unaudited) 1
and October 31, 1998
Condensed Consolidated Statements of Operations (unaudited) for the 2
three month and nine month periods ended July 31, 1999 and July 31, 1998
Consolidated Statement of Comprehensive Income (unaudited) for the 3
three month and nine month periods ended July 31, 1999 and July 31, 1998
Consolidated Statement of Shareholders' Equity (unaudited) for the nine 4
month period ended July 31, 1999
Condensed Consolidated Statements of Cash Flows (unaudited) for the 5
nine month period ended July 31, 1999
Notes to Interim Consolidated Financial Statements (unaudited) 6
Item 2 Management's Discussion and Analysis of Financial Condition and Results of 9
Operations
Item 3 None 13
PART II OTHER INFORMATION 14
SIGNATURES 15
EXHIBIT INDEX 16
3
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
($ In Thousands)
July 31, October 31,
1999 1998
--------- -----------
ASSETS (unaudited)
Current assets:
Cash and cash equivalents $ 12,986 $ 13,883
Short-term investments 16,313 14,519
Accounts receivable, billed, net 24,057 28,792
Accounts receivable, unbilled, net 33,277 26,201
Other current assets 4,287 6,361
--------- ---------
Total current assets 90,920 89,756
Property and equipment, net 7,467 6,687
Capitalized software costs, net 6,462 4,203
Goodwill, net 12,930 11,742
Other assets 4,724 5,414
--------- ---------
Total assets $ 122,503 $ 117,802
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 13,240 $ 15,864
Deferred revenue 5,631 5,876
Deferred income taxes 13,085 11,307
--------- ---------
Total current liabilities 31,956 33,047
Other liabilities 1,357 1,486
--------- ---------
Total liabilities 33,313 34,533
--------- ---------
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;
18,435,309 shares issued and 17,386,309 shares outstanding at July 31, 1999;
18,332,367 shares issued and 17,283,367 shares outstanding at October
31, 1998 184 183
Capital in excess of par value 71,654 71,134
Retained earnings 25,072 19,595
Accumulated other comprehensive income 30 107
--------- ---------
96,940 91,019
Less treasury stock, at cost (1,049,000 shares at July 31, 1999 and
October 31, 1998) (7,750) (7,750)
--------- ---------
Total shareholders' equity 89,190 83,269
--------- ---------
Total liabilities and shareholders' equity $ 122,503 $ 117,802
========= =========
See accompanying notes to interim consolidated financial statements.
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HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
INTERIM CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Amounts)
(unaudited)
Three months ended Nine months ended
July 31, July 31,
--------------------- ---------------------
1999 1998 1999 1998
------- -------- ------- -------
Revenue $27,655 $26,736 $83,881 $77,412
------- ------- ------- -------
Cost of services:
Compensation 16,137 15,238 47,882 44,404
Data processing 1,598 2,086 5,137 6,827
Occupancy 2,333 2,312 6,730 6,980
Other 4,534 4,631 15,433 13,094
------- ------- ------- -------
24,602 24,267 75,182 71,305
------- ------- ------- -------
Operating margin before amortization of intangibles 3,053 2,469 8,699 6,107
Amortization of intangibles 209 509 609 1,538
------- ------- ------- -------
Operating income 2,844 1,960 8,090 4,569
Net interest and net other income 335 423 932 1,343
------- ------- ------- -------
Income before income taxes 3,179 2,383 9,022 5,912
Income tax expense 1,111 995 3,545 2,464
------- ------- ------- -------
Net income $ 2,068 $ 1,388 $ 5,477 $ 3,448
======= ======= ======= =======
Earnings per share data:
Basic:
Basic earnings per share $ 0.12 $ 0.08 $ 0.32 $ 0.20
======= ======= ======= =======
Weighted average common shares outstanding 17,376 17,468 17,349 17,431
======= ======= ======= =======
Diluted:
Diluted earnings per share $ 0.12 $ 0.08 $ 0.31 $ 0.19
======= ======= ======= =======
Weighted average common shares and common share equivalents 17,442 18,119 17,441 17,950
======= ======= ======= =======
See accompanying notes to interim consolidated financial statements.
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HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
($ In Thousands)
(unaudited)
Three months ended Nine months ended
July 31, July 31,
------------------- -------------------
1999 1998 1999 1998
------- ------- ------- -------
Net income $ 2,068 $ 1,388 $ 5,477 $ 3,448
Other comprehensive income, net of tax:
Change in net unrealized appreciation (depreciation)
on short-term investments (49) 44 (77) 94
------- ------- ------- -------
Comprehensive income $ 2,019 $ 1,432 $ 5,400 $ 3,542
======= ======= ======= =======
See accompanying notes to interim consolidated financial statements.
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HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
($ In Thousands)
(unaudited)
Common Stock Accumulated
--------------------- Capital In Other Total
# of Shares Par Excess Of Retained Comprehensive Treasury Shareholders'
Issued Value Par Value Earnings Income Stock Equity
----------- ------ --------- --------- ------------- --------- ------------
Balance at October 31, 1998 18,332,367 $ 183 $ 71,134 $ 19,595 $ 107 ($ 7,750) $ 83,269
Net income 0 0 0 5,477 0 0 5,477
Stock option activity 41,247 1 205 0 0 0 206
Employee stock purchase
plan activity 61,695 0 286 0 0 0 286
Disqualifying dispositions 0 0 29 0 0 0 29
Change in net unrealized
appreciation (depreciation)
on short-term investments 0 0 0 0 (77) 0 (77)
---------- ------ -------- -------- ----------- -------- --------
Balance at July 31, 1999 18,435,309 $ 184 $ 71,654 $ 25,072 $ 30 ($ 7,750) $ 89,190
========== ====== ======== ======== =========== ======== ========
See accompanying notes to interim consolidated financial statements.
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HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
($ In Thousands)
(unaudited)
Nine
months ended
July 31,
----------------------
1999 1998
-------- --------
Net cash provided by (used in) operating activities $ 9,128 $ (1,930)
-------- --------
Investing activities:
Acquisition of net assets of Health Receivables Management, LLC, net of cash acquired (4,024) 0
Capital asset expenditures (1,651) (931)
Software capitalization (3,048) (2,266)
Net purchases of short-term investments (1,794) (981)
-------- --------
Net cash used in investing activities (10,517) (4,178)
-------- --------
Financing activities:
Proceeds from issuance of common stock 206 127
Proceeds from exercise of stock options 286 2,822
Common stock repurchases 0 (4,597)
-------- --------
Net cash provided by (used in) financing activities 492 (1,648)
-------- --------
Net decrease in cash and cash equivalents (897) (7,756)
Cash and cash equivalents at beginning of period 13,883 20,694
-------- --------
Cash and cash equivalents at end of period $ 12,986 $ 12,938
======== ========
See accompanying notes to interim consolidated financial statements.
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HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Unaudited Interim Financial Information
The management of Health Management Systems, Inc. ("HMS" or the "Company")
is responsible for the accompanying unaudited interim consolidated
financial statements and the related information included in these notes to
the unaudited interim consolidated financial statements. In the opinion of
management, the unaudited interim consolidated financial statements reflect
all adjustments, consisting of normal recurring adjustments necessary for
the fair presentation of the Company's financial position and results of
operations and cash flows for the periods presented. Results of operations
of interim periods are not necessarily indicative of the results to be
expected for the entire year.
These unaudited interim consolidated financial statements should be read in
conjunction with: the audited consolidated financial statements of the
Company as of and for the fiscal year ended October 31, 1998 included in
the Company's Annual Report on Form 10-K for such year; and the unaudited
interim consolidated financial statements of the Company as of and for the
quarterly periods ended January 31, 1999 and April 30, 1999 included in the
Company's Quarterly Reports on Form 10-Q, all as filed with the Securities
and Exchange Commission (the "Commission").
2. Business Combinations
As of June 30, 1999, the Company's Quality Standards in Medicine, Inc.
("QSM") subsidiary acquired substantially all of the assets and specified
liabilities of Health Receivables Management, LLC for approximately $4
million, net of cash acquired and subject to certain purchase price
adjustments. In connection with the transaction, QSM changed its name to
Health Receivables Management Inc. ("HRM"). HRM currently furnishes
electronic billing, eligibility verification, accounts receivable
management and collection services to healthcare clients, principally in
the State of Illinois.
The acquisition was accounted for using the purchase method of accounting
and, accordingly, the results of operations of HRM from the date of
acquisition through July 31, 1999 are included in the accompanying
unaudited interim consolidated financial statements. The excess purchase
price over the fair market value of the identifiable assets acquired is
recorded as goodwill and is being amortized over a period not to exceed 15
years. The Company is in the process of finalizing the allocation of the
excess of the purchase price over the fair market value of the identifiable
assets acquired. This process will be finalized when all information is
available and within the prescribed one year period.
3. Supplemental Cash Flow Disclosures
Cash paid for income taxes during the nine months ended July 31, 1999 and
1998 was $486,000 and $2,571,000, respectively.
The Company recorded $29,000 and $566,000 for the nine months ended July
31, 1999 and 1998, respectively, as disqualified dispositions related to
the sale of stock acquired through the exercise of certain compensatory
stock options, thereby reducing the Company's tax liability and increasing
shareholders' equity by like amounts.
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4. Earnings Per Share
Basic earnings per share is calculated as net income divided by the
weighted average common shares outstanding. Diluted earnings per share is
calculated as net income divided by the weighted average common shares
outstanding including the dilutive effects of potential common shares,
which include the Company's stock options. A reconciliation of the
numerator and denominator of the calculations for the three month periods
and nine month periods ended July 31, 1999 and 1998, respectively, is
presented below.
($ and shares in 000's, except per share data)
Three months ended Nine months ended
July 31, July 31,
------------------ ------------------
1999 1998 1999 1998
------- ------- ------- -------
Numerator:
Net Income $ 2,068 $ 1,388 $ 5,477 $ 3,448
======= ======= ======= =======
Denominator:
Weighted average common shares 17,376 17,468 17,349 17,431
Potential common shares: stock options 66 651 92 519
------- ------- ------- -------
Weighted average common shares and
common share equivalents 17,442 18,119 17,441 17,950
======= ======= ====== ======
Basic earnings per share $ 0.12 $ 0.08 $ 0.32 $ 0.20
======= ======= ====== =======
Diluted earnings per share $ 0.12 $ 0.08 $ 0.31 $ 0.19
======= ======= ====== =======
5. Legal Proceedings
In April and May 1997, five purported class action lawsuits were commenced
in the United States District Court for the Southern District of New York
against the Company and certain of its present and former officers and
directors alleging violations of the Securities Exchange Act of 1934 in
connection with certain allegedly false and misleading statements. These
lawsuits, which sought damages in an unspecified amount, were consolidated
into a single proceeding captioned In re Health Management Systems, Inc.,
Securities Litigation (97 CIV-1965 (HB) and a Consolidated Amended
Complaint was filed. Defendants made a motion to dismiss the Consolidated
Amended Complaint, which was submitted to the Court on December 18, 1997
following oral argument. On May 27, 1998, the Consolidated Amended
Complaint was dismissed by the Court for failure to state a claim under the
federal securities laws, with leave for the plaintiffs to replead. On July
17, 1998, a Second Consolidated Amended Complaint was filed in the United
States District Court of the Southern District of New York, which
reiterates plaintiffs' allegations in their prior Complaint. On September
11, 1998, the Company and the other defendants filed a motion to dismiss
the second Complaint. The motion was fully briefed in late November 1998,
at which time the motion was submitted to the Court. The consolidated
proceeding has been reassigned to another judge. Oral argument was heard by
the Court on the motion to dismiss on June 11, 1999 and the motion is now
sub judice. Prior to rendering its decision on the motion to dismiss, the
Court has ordered the parties to attempt settlement of the case. In the
event no settlement is reached and the motion to dismiss is denied, the
Company intends to continue its vigorous defense of this lawsuit.
On June 1, 1998, MedE America Corp. commenced a lawsuit against the Company
and others in the United States District Court for the Southern District of
New York. In its complaint, plaintiff alleges copyright infringement
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and other violations of its rights relating to the Company's development
and sale of certain computer software, known as the Universal Billing
Platform, which was developed for the Company by certain former employees
of plaintiff, who are also defendants in the action, acting as independent
contractors. Plaintiff, among other relief, seeks (i) to restrain the
Company from continuing to market and sell the alleged infringing software,
and (ii) monetary damages in excess of $10,000,000. Over a period of in
excess of nine months prior to the filing of the complaint, the parties
engaged in an extensive exchange of communications, as a result of which
the Company concluded, after investigation, that plaintiff's claims were
without merit. On July 22, 1998, the Company answered the complaint,
denying the material allegations of the complaint. Discovery has commenced
and the Company intends to vigorously contest plaintiff's claims. Pursuant
to the Rules of the Court, this matter has been referred to a
court-appointed mediator, who, in the context of non-binding mediation and
independent of the Court proceeding, has attempted to assist in settling
the matter or narrowing the issues between the parties. A number of
mediation sessions with counsel and the experts retained by both parties
have been held, progress has been made towards reaching a settlement and
discussions are continuing. Absent a settlement of this matter through
mediation, the Company intends to continue its vigorous defense of this
lawsuit.
On June 28, 1998, eight holders of promissory notes (the "Notes") of HHL
Financial Services, Inc. ("HHL") commenced a lawsuit against the Company
and others in the Supreme Court of the State of New York, County of Nassau,
alleging various breaches of fiduciary duty on the part of the defendants
against HHL. The complaint alleges that, as a result of these breaches of
duty, HHL was caused to make substantial unjustified payments to the
Company which, ultimately, led to defaults on the Notes and to HHL's filing
for Chapter 11 bankruptcy protection. On June 30, 1998, the same Note
holders commenced a virtually identical action (the "Adversary Proceeding")
in the United States Bankruptcy Court for the District of Delaware, where
HHL's Chapter 11 proceeding is pending. The Adversary Proceeding alleges
the same wrongdoing as the New York State Court proceeding and seeks the
same damages, i.e., $2,300,000 (the unpaid amount of the Notes) plus
interest. Plaintiffs have moved in the Bankruptcy Court to have the Court
abstain from hearing the Adversary Proceeding in deference to the New York
State Court action. The Company has opposed plaintiffs' motion for
abstention and on September 15, 1998, filed a motion in the Bankruptcy
Court to dismiss the Adversary Proceeding. This motion was briefed in
December 1998. Oral argument on the motions was heard by the Court on April
22, 1999 and the motions are now sub judice. The Company intends to
continue its vigorous defense of this lawsuit.
Other legal proceedings to which the Company is a party, in the opinion of
the Company's management, are not expected to have a material adverse
effect on the Company's financial position, results of operations or
liquidity.
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Certain statements in this document 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 HMS, or industry results, to be materially
different from any future results, performance, or achievements expressed or
implied by such forward-looking statements. The important factors that could
cause actual results to differ materially from those indicated by such
forward-looking statements include, but are not limited to (i) the information
being of a preliminary nature and therefore subject to further adjustment; (ii)
the ability of HMS to contain costs and to grow internally or by acquisition and
to integrate acquired businesses into the HMS group of companies; (iii) the
uncertainties of litigation; (iv) HMS's dependence on significant customers; (v)
changing conditions in the healthcare industry which could simplify the
reimbursement process and adversely affect HMS's business; (vi) government
regulatory and political pressures which could reduce the rate of growth of
healthcare expenditures; (vii) competitive actions by other companies, including
the development by competitors of new or superior services or products or the
entry into the market of new competitors; (viii) the ability of HMS to deal with
the Year 2000 Problem on a timely basis; (ix) all the risks inherent in the
development, introduction, and implementation of new products and services; and
other factors both referenced and not referenced in this document. When used in
this document, the words "estimate," "project," "anticipate," "expect,"
"intend," "believe," and similar expressions are intended to identify
forward-looking statements, and the above described risks inherent therein.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Three Months Ended July 31, 1999 Compared to Three Months Ended July 31, 1998
Consolidated revenue for the third quarter of fiscal year 1999 of $27,655,000
represents an increase of $919,000 or 3% from the comparable period in 1998. The
Company's Revenue Services division, which includes the Provider revenue
services group and Payor revenue services group, accounted for $16,921,000 or
61% of the Company's consolidated revenue for the third fiscal quarter of 1999,
an increase of $2,386,000 or 16% from the comparable period in 1998. Of these
amounts, the Provider revenue services group revenue totaled $10,918,000, an
increase of $2,275,000 or 26% from the comparable period in 1998 and the Payor
revenue services group revenue totaled $6,003,000, an increase of $111,000 or 2%
from the comparable period in 1998. Other than the $588,000 in revenue growth
attributable to the HRM acquisition, the balance of the revenue growth realized
by both groups in the Revenue Services Division was internally generated from
both (1) "new clients," defined as clients generating revenue in the third
quarter of fiscal year 1999 who were not revenue generating clients in the third
quarter of fiscal year 1998, and (2) delivery of services of expanded scope to
"existing clients," defined as clients who generated revenue in the prior year
comparable period.
Revenue from the Software Systems and Services ("Software") division, comprised
of the Decision Support group and the Payor Systems group, totaled $10,734,000
or 39% of the Company's consolidated revenue for the third fiscal quarter of
1999, a decrease of $1,467,000 or 12% from the comparable period in 1998.
Revenue from the Decision Support group was $5,368,000, a decrease of $989,000
or 16% from the comparable period in 1998, and revenue from the Payor Systems
group was $5,366,000, a decrease of $478,000 or 8% from the comparable period in
1998. The decrease in this Division's revenue is the result of an elongated
sales cycle, attributable to what is perceived as client reluctance to make
decisions regarding the implementation of new software in the year immediately
preceding their "Y2K" conversion, partially offset by the revenues earned from
the Company's recurring base of clients and implementation of its sales backlog.
Cost of services for the third fiscal quarter of 1999 of $24,602,000, increased
$335,000 or 1% from the comparable period in 1998. The increase in cost of
services reflects increases in Compensation and Occupancy expenses, partially
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offset by decreases in Data Processing and Other expenses. Compensation expense,
the Company's largest expense component, totaled $16,137,000 for the third
fiscal quarter of 1999, an increase of $899,000 or 6% over the comparable period
in 1998. This increase was principally attributable to the addition of
approximately 90 employees associated with the HRM acquisition, and increases in
average salaries to reflect prevailing market conditions. Data processing
expense decreased $488,000 to $1,598,000, a decrease of 23% from the comparable
period in 1998. This decrease was primarily attributable to: the continued
consolidation by the Company of its data processing platforms and reduced
support of older versions of the Company's systems, products and services; the
capitalization of additional software development costs incurred to enhance
existing products; and the timing differences associated with amortization of
multiple-period maintenance and software license fees. Other operating expense
for the third fiscal quarter of 1999 decreased to $4,534,000, a decrease of
$97,000 or 2% from the comparable period in 1998. The decrease was primarily
attributable to a savings in professional fees and employee related costs,
including recruiting fees, which were partially offset by increased direct
project costs for subcontractor expense incurred in connection with the Revenue
Services Division's realization of increased revenue.
As a result of the above factors, operating margin for the third fiscal quarter
of 1999, before amortization of intangible assets, increased to $3,053,000, an
increase of $584,000 or 24% from the comparable period in 1998.
Amortization of intangible assets for the third fiscal quarter of 1999 was
$209,000, a decrease of $300,000 or 59% from the comparable period in 1998. The
decrease was due primarily to completion, in fiscal year 1998, of the
amortization of software related to the Company's acquisition of HSA Managed
Care Systems, Inc. (now the Payor Systems Group) in 1997.
Net interest and net other income in the third fiscal quarter of 1999 was
$335,000, a decrease of $88,000 or 21% from the comparable period in 1998, based
upon both lower cash balances and interest rates.
Income tax expense for the third fiscal quarter of 1999 was $1,111,000, an
increase of $116,000 or 12% from the comparable period in 1998. The increase in
income tax expense was due primarily to the Company's higher pre-tax profit for
the third fiscal quarter of 1999, offset by a more favorable effective tax rate
realized from the Company's ability to file consolidated state tax returns in
specific jurisdictions and from the newly enacted provision of the tax code
pertaining to utilization of existing net operating tax loss carryforwards, for
which the company had previously provided a valuation allowance.
As a result of the above factors, net income for the third fiscal quarter of
1999 increased to $2,068,000, an increase of $680,000 or 49% from the comparable
period in 1998. Thus, fully diluted earnings per share for the third fiscal
quarter of 1999 was $0.12, an increase of $0.04 or 50% from the comparable
period in 1998.
Nine Months Ended July 31, 1999 Compared to Nine Months Ended July 31, 1998
Consolidated revenue for the nine months ended July 31, 1999 of $83,881,000
represents an increase of $6,469,000 or 8% from the comparable period in 1998.
The Revenue Services division accounted for $47,390,000 or 56% of the
consolidated revenue for the nine months ended July 31, 1999, an increase of
$5,641,000 or 14% from the comparable period in 1998. Of these amounts, revenue
from the Provider revenue services group totaled $29,105,000, an increase of
$3,406,000 or 13% from the comparable period in 1998 and revenue from the Payor
revenue services group totaled $18,285,000, an increase of $2,235,000 or 14%
from the comparable period in 1998. Other than the $588,000 in revenue growth
attributable to the HRM acquisition, the balance of the revenue growth realized
by each of these two groups comprising the Revenue Services division was
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internally generated from both (1) new clients, and (2) delivery of services of
expanded scope to existing clients.
Revenue from the Software Systems and Services division totaled $36,491,000 or
44% of the Company's consolidated revenue for the nine months ended July 31,
1999, an increase of $828,000 or 2% from the comparable period in 1998. Revenue
from the Decision Support group was $17,019,000, a decrease of $1,981,000 or 10%
from the comparable period in 1998, while revenue from the Payor Systems group
increased $2,809,000 to $19,472,000, an increase of 17% from the comparable
period in 1998. The decrease in the Decision Support group is attributable to
both what is perceived as client reluctance to make decisions regarding the
implementation of new software in the year immediately preceding the "Y2K"
conversion and a robust first quarter in the prior fiscal year. The decrease in
revenue from the Decision Support group was more than offset by the increased
revenue realized in the Payor Systems group, with approximately 40% of the
increased revenue in the Payor Systems group attributable to the group's earning
a non-recurring revenue incentive bonus from one client in the second quarter of
the Company's current fiscal year, with this Division expecting to continue to
face the Y2K marketplace-incurred slowdown in client spending for the near term.
Cost of services for the nine months ended July 31, 1999 of $75,182,000,
increased $3,877,000 or 5% from the comparable period in 1998. The increase in
cost of services reflects increases in Compensation and Other expenses,
partially offset by decreases in Data Processing and Occupancy expenses.
Compensation expense totaled $47,882,000 for the nine months ended July 31,
1999, an increase of $3,478,000 or 8% over the comparable period in 1998,
principally attributable to increases in personnel associated with the
generation of new revenue and the previously noted acquisition of HRM, and
increases in average salaries to reflect prevailing market conditions. Data
processing expense decreased $1,690,000 to $5,137,000, a decrease of 25% from
the comparable period in 1998. As noted previously, this favorable decrease was
primarily attributable to: the continued consolidation by the Company of its
data processing platforms and reduced support of older versions of the Company's
systems, products and services; the capitalization of additional software
development costs incurred to enhance existing products; and the timing
differences associated with amortization of multiple-period maintenance and
software license fees. Other operating expense for the nine months ended July
31, 1999 was $15,433,000, an increase of $2,339,000 or 18% over the comparable
period in 1998. Also as noted previously, this increase was primarily
attributable to direct project costs for subcontractor expense incurred in
connection with the Company's realization of increased revenue, while an
increase in the allowance for doubtful accounts was in line with increases in
revenue and accounts receivable and was more than offset by the savings in
professional fees and employee related costs, including recruiting fees.
As a result of the above factors, operating margin for the nine months ended
July 31, 1999, before amortization of intangible assets, increased to
$8,699,000, an increase of $2,592,000 or 42% from the comparable period in 1998.
Amortization of intangible assets for the nine months ended July 31, 1999 was
$609,000, a decrease of $929,000 or 60% from the comparable period in 1998. As
previously noted, the decrease was due primarily to completion, in fiscal year
1998, of the amortization of software related to the Company's acquisition of
HSA Managed Care Systems, Inc. (now the Payor Systems group) in 1997.
Net interest and net other income in the nine months ended July 31, 1999 was
$932,000, a decrease of $411,000 or 31% from the comparable period in 1998,
based upon the combination of lower cash balances, execution of the HRM
acquisition transaction and lower interest rates.
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Income tax expense for the nine months ended July 31, 1999 was $3,545,000, an
increase of $1,081,000 or 44% from the comparable period in 1998. The increased
income tax expense was due primarily to the Company's higher pre-tax profit for
the period, offset by a more favorable effective tax rate realized from the
Company's ability to file consolidated state tax returns in specific
jurisdictions and from the newly enacted provision of the tax code pertaining to
utilization of existing net operating tax loss carryforwards, for which the
company had previously provided a valuation allowance.
As a result of the above factors, net income for the nine months ended July 31,
1999 increased to $5,477,000, an increase of $2,029,000 or 59% from the
comparable period in 1998. Resultant fully diluted earnings per share for the
nine months ended July 31, 1999 was $0.31, an increase of $0.12 or 63% from the
comparable period in 1998.
Liquidity and Capital Resources
At July 31, 1999, the Company had $59.0 million in net working capital, an
increase of $2.3 million over the level at October 31, 1998. The Company's
principal sources of liquidity at July 31, 1999 consisted of cash, cash
equivalents, and short-term investments aggregating $29.3 million, net accounts
receivable of $57.3 million and $30 million available under a line of credit
with a major money center bank. Accounts receivable at July 31, 1999 increased
$2.3 million or 4% from the October 31, 1998 balance, of which approximately
$1.9 million is attributable to the previously noted HRM acquisition.
On July 15, 1999, the Company amended its unsecured revolving credit facility to
extend the existing term through September 30, 1999. No other terms of the
existing credit facility have changed. Although the Company intends to further
extend or secure a new credit facility, there can be no assurance that the
Company will be able to do so on acceptable terms.
On May 28, 1997, the Board of Directors authorized the Company to repurchase
such number of shares of its Common Stock that have an aggregate purchase price
not in excess of $10,000,000. The Company may repurchase these shares from time
to time on the open market or in negotiated transactions at prices deemed
appropriate by the Company. Repurchased shares are deposited in the Company's
treasury and used for general corporate purposes. Since the inception of the
repurchase program in June 1997, the Company has repurchased in the open market
1,049,000 shares having an aggregate purchase price of $7,750,000. No shares
were repurchased during the nine months ended July 31, 1999. The Company
utilized a portion of its excess capital to again become an opportunistic
acquirer, having completed the HRM acquisition transaction, and is reassessing
its capital requirements as it seeks to secure a new or renewed credit facility
while reconsidering the further purchase of shares pursuant to the original
authorization by the Board.
Year 2000
In common with many other organizations, the "Year 2000 ("Y2K") computer issue"
creates risks for the Company. To address these Y2K issues, the Company
formulated a plan and began work at the end of 1997. The Company put in place a
working committee to track implementation of the plan. Activities included in
this plan are intended to encompass all major categories of systems in use by
the Company, including those entailed in the performance of product development,
operations, sales, finance, and human resources. Interactions with major
suppliers of products and services have been identified and the Company is
working to ensure uninterrupted delivery to the Company of the requisite
products and services. The Company has purchased and installed Y2K compliant
security, elevator and fire alarm systems in its New York City office and is
currently implementing new financial and human resource information systems
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throughout the enterprise. These management information systems were purchased
in 1998 and were already Y2K compliant.
The Company is working with its clients to ensure a smooth transition to the
next millennium. As well, the Company responded to the enactment of the Y2K
Information and Readiness Disclosure Act ("Y2K Act") on October 19, 1998. The
purpose of the Y2K Act is to encourage and promote disclosure regarding Y2K
issues and to provide limitations for claims on tort liability.
Contingency plans for all potential single points of disruption have been or are
being developed and implemented. It is expected that assessment and redemption
will be completed in sufficient time to ensure the Company's provision of
service without interruption due to the onset of the year 2000. The Company is
seeking to complete its Y2K remediation work in accordance with a schedule which
is responsive to the time sensitivity of the clients, seeking first to complete
work on engagements where the Company's interactions with the clients are on a
concurrent (in contrast to a retrospective) basis. To the extent that the
Company has not developed an adequate plan for any particular contingency, the
Company believes its capacity to stage, resequence and reschedule much of its
operational processing work should enable mitigation, in whole or part, of the
potential long-term negative impact on its clients and the Company.
The Company has designed and tested the most current versions of its products
for Y2K compliance. The Company is now migrating to its most current versions
those of the Company's products running on versions not Y2K compliant. The
Company is utilizing the migration to Y2K compliant systems as the catalyst for
a consolidation of various of the Company's disparate systems -- thereby
reducing the number of product versions which require updating for the Y2K
problem. Each business group is scheduled to have Y2K remediation tested before
the Company's fiscal year end, with the exception of the Provider Revenue
Services Group. Progress continues to be made in the substantial conversion work
for the Provider Revenue Services Group, though not all of it must be concluded
by the end of 1999. As well, a number of the Company's customers are running
product versions that are not Y2K compliant. While the Company has provided its
clients with viable plans for migration to Y2K compliant versions and has been
encouraging such customers to adopt such plans, it is possible that various of
the Company's clients will not adopt the recommended plan of migration,
potentially entailing either increased costs to the Company or loss of revenue
by the Company. Moreover, the revenue stream and financial stability of existing
customers may be adversely impacted by Y2K problems, which could cause
fluctuations or diminution in the Company's revenue. In addition, there can be
no assurances that the Company's current products do not contain undetected
errors or defects associated with Y2K date functions that could result in
material, additional future costs to the Company. Moreover, assessment of
whether a complete system will operate correctly depends on the capabilities and
interoperability of the hardware and software components comprising the system;
for most end-users, this will include hardware and software provided by
companies other than the Company. Except as specifically provided for in the
limited warranty accompanying the current versions of its products, the Company
does not believe it is legally responsible for costs incurred by customers
related to ensuring customers Y2K capability. Nevertheless, the Company is
incurring various costs to provide customer support and customer satisfaction
services regarding Y2K issues and it is anticipated that these expenditures will
continue through 1999 and thereafter.
The costs incurred to date related to these programs are difficult to isolate
but are estimated at approximately $1,650,000. The Company currently expects
that the total cost of these programs, including both incremental spending and
redeployed resources, will not exceed $2,500,000. The total cost estimate does
not include potential costs related to any customer claims, other claims or the
cost of internal software and hardware replaced in the normal course of
business, nor does this estimate include the costs associated with the
consolidation (to the maximum practicable extent) by the two Revenue Services
groups of their respective product versions into a consolidated version for each
group. In some instances, the installation schedule of new software and hardware
in the normal course of business is being accelerated to afford a timely
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solution to Y2K capability issues. Because the factors involved are complex and
frequently not readily separable, it is difficult to determine which of the
Company's multiple development activities are properly allocable to the solution
of Y2K problems. The Company's cost estimates are based on an assessment of the
current situation and are subject to future revision.
The expenses incurred by the Company to identify and address the Y2K matters
discussed above, or the expenses or liabilities to which the Company may become
subject as a result of such matters, could have a material adverse effect on the
Company's business, financial condition and results of operation. In addition,
there can be no assurance that failure to ensure Y2K capability by a supplier,
client or another third party would not have a material adverse effect on the
Company.
Item 3. Quantitative and Qualitative Disclosures About Market Risk -- None
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HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings -- See Note 5 of the Notes to Interim Consolidated
Financial Statements for discussion of certain pending legal
proceedings
Item 2. Changes in Securities -- None
Item 3. Defaults Upon Senior Securities -- Not applicable
Item 4. Submission of Matters to a Vote of Security Holders -- None
Item 5. Other Information -- None
Item 6. Exhibits and Reports on Form 8-K -- None
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: September 14, 1999 HEALTH MANAGEMENT SYSTEMS, INC.
(Registrant)
By: /s/ Paul J. Kerz
--------------------
Paul J. Kerz
President and Chief Executive Officer
By: /s/ Alan L. Bendes
--------------------
Alan L. Bendes
Senior Vice President and
Chief Financial Officer
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HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
EXHIBIT INDEX
Exhibit Number DESCRIPTION OF EXHIBIT TO INTERIM CONSOLIDATED FINANCIAL
STATEMENTS
2 Asset Purchase Agreement, dated as of June 30, 1999, by and
among ARC Ventures, LLC, and Health Receivables Management, LLC
and Health Management Systems, Inc., and Quality Standards In
Medicine, Inc.
10 Fourth Amendment To Credit Agreement And Guaranty, dated as of
July 15, 1999 among Health Management Systems, Inc.,
Accelerated Claims Processing, Inc., Quality Medi-Cal
Adjudication, Incorporated, Health Care Microsystems, Inc., CDR
Associates Inc., HSA Managed Care Systems, Inc., Quality
Standards In Medicine, Inc. and The Chase Manhattan Bank
27 Financial Data Schedule (Submitted for informational purposes
only and not deemed to be filed)
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