10-Q 1 y40353e10-q.txt HEALTH MANAGEMENT SYSTEMS, INC. 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, 2000 ------------------------------------------------- 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 8, 2000 ----------------------------------- ----------------------------------- Common Stock, $.01 Par Value 17,501,144 Shares 2 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES INDEX TO FORM 10-Q QUARTER ENDED JULY 31, 2000 PART I FINANCIAL INFORMATION Page No. Item 1 Interim Financial Statements Condensed Consolidated Balance Sheets as of July 31, 2000 1 (unaudited) and October 31, 1999 Condensed Consolidated Statements of Operations 2 (unaudited) for the three month and nine month periods ended July 31, 2000 and July 31, 1999 Consolidated Statements of Comprehensive Income 3 (unaudited) for the three month and nine month periods ended July 31, 2000 and July 31, 1999 Consolidated Statement of Shareholders' Equity 4 (unaudited) for the nine month period ended July 31, 2000 Condensed Consolidated Statements of Cash Flows 5 (unaudited) for the nine month periods ended July 31, 2000 and July 31, 1999 Notes to Interim Consolidated Financial Statements 6 (unaudited) Item 2 Management's Discussion and Analysis of Financial Condition 10 and Results of Operations Item 3 Quantitative and Qualitative Disclosures About Market Risks 13 PART II OTHER INFORMATION 14 SIGNATURES 14 EXHIBIT INDEX 15 3 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS ($ In Thousands)
July 31, October 31, 2000 1999 --------------- --------------- ASSETS (unaudited) Current assets: Cash and cash equivalents $ 6,800 $ 16,310 Short-term investments 10,710 17,507 Accounts receivable, billed, net 18,622 17,001 Accounts receivable, unbilled, net 48,327 41,661 Other current assets 7,502 4,516 --------------- --------------- Total current assets 91,961 96,995 Long term accounts receivable, unbilled, net 783 0 Property and equipment, net 7,601 7,766 Capitalized software costs, net 9,630 7,286 Goodwill, net 12,260 12,762 Notes receivable from officer 1,500 900 Other assets 4,954 5,212 --------------- --------------- Total assets $ 128,689 $ 130,921 =============== =============== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses $ 14,996 $ 18,050 Deferred revenue 3,101 4,541 Deferred income taxes 16,561 15,967 --------------- --------------- Total current liabilities 34,658 38,558 Other liabilities 989 1,131 --------------- --------------- Total liabilities 35,647 39,689 --------------- --------------- 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; 18,550,000 shares issued and 17,501,144 shares outstanding at July 31, 2000 18,450,737 shares issued and 17,401,737 shares outstanding at October 31, 1999 185 184 Capital in excess of par value 72,147 71,714 Retained earnings 28,583 27,078 Accumulated other comprehensive income (loss) (123) 6 --------------- --------------- 100,792 98,982 Less treasury stock, at cost (1,049,000 shares at July 31, 2000 and October 31, 1999) (7,750) (7,750) --------------- --------------- Total shareholders' equity 93,042 91,232 --------------- --------------- Total liabilities and shareholders' equity $ 128,689 $ 130,921 =============== ===============
See accompanying notes to interim consolidated financial statements. 1 4 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, ------------------------ ------------------------ 2000 1999 2000 1999 ----------- ---------- ----------- ---------- Revenue $ 24,660 $ 27,655 $ 78,834 $ 83,881 ----------- ---------- ----------- ---------- Cost of services: Compensation 15,386 16,137 47,553 47,882 Direct project costs 1,787 2,151 8,661 7,998 Data processing 1,173 1,397 4,181 4,936 Occupancy 2,575 2,333 7,623 6,730 Other 3,036 2,584 8,601 7,636 ----------- ---------- ----------- ---------- 23,957 24,602 76,619 75,182 ----------- ---------- ----------- ---------- Operating margin before amortization of intangibles 703 3,053 2,215 8,699 Amortization of intangibles 227 209 682 609 ----------- ---------- ----------- ---------- Operating income 476 2,844 1,533 8,090 Net interest and net other income 335 335 949 932 ----------- ---------- ----------- ---------- Income before income taxes 811 3,179 2,482 9,022 Income tax expense 314 1,111 977 3,545 ----------- ---------- ----------- ---------- Net income $ 497 $ 2,068 $ 1,505 $ 5,477 =========== ========== =========== ========== Earnings per share data: Basic: Basic earnings per share $ 0.03 $ 0.12 $ 0.09 $ 0.32 =========== ========== =========== ========== Weighted average common shares outstanding 17,496 17,376 17,481 17,349 =========== ========== =========== ========== Diluted: Diluted earnings per share $ 0.03 $ 0.12 $ 0.09 $ 0.31 =========== ========== =========== ========== Weighted average common shares and common share equivalents 17,503 17,442 17,513 17,441 =========== ========== =========== ==========
See accompanying notes to interim consolidated financial statements. 2 5 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME ($ IN THOUSANDS) (UNAUDITED)
Three months ended Nine months ended July 31, July 31, -------------------------- ------------------------- 2000 1999 2000 1999 ----------- ------------ ----------- ----------- Net income $ 497 $ 2,068 $ 1,505 $ 5,477 Other comprehensive income (loss), net of tax: Change in net unrealized depreciation on short-term investments (180) (49) (129) (77) ----------- ------------ ----------- ----------- Comprehensive income $ 317 $ 2,019 $ 1,376 $ 5,400 =========== ============ =========== ===========
See accompanying notes to interim consolidated financial statements. 3 6 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES INTERIM CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY ($ In Thousands) (unaudited)
Common Stock -------------------- Capital In Accumulated Total # of Shares Par Excess Of Retained Other Comprehensive Treasury Shareholders' Outstanding Value Par Value Earnings Income (Loss) Stock Equity ----------- ------ ---------- -------- ------------------- -------- ------------- Balance at October 31, 1999 17,401,737 $184 $71,714 $27,078 $6 ($7,750) $91,232 Net income 0 0 0 1,505 0 0 1,505 Stock option activity 66,916 1 308 0 0 0 309 Employee stock purchase plan activity 32,491 0 112 0 0 0 112 Disqualifying dispositions 0 0 13 0 0 0 13 Change in net unrealized depreciation on short-term investments 0 0 0 0 (129) 0 (129) ----------- ------ ---------- -------- ------------------- -------- ------------- Balance at July 31, 2000 17,501,144 $185 $72,147 $28,583 ($123) ($7,750) $93,042 =========== ====== ========== ======== =================== ======== =============
See accompanying notes to interim consolidated financial statements. 4 7 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS ($ In Thousands) (unaudited)
Nine months ended July 31, ------------------------------- 2000 1999 ------------- ------------- Net cash provided by (used in) operating activities $ (9,937) $ 9,128 ------------- ------------- Investing activities: Acquisition of net assets of Health Receivables Management, LLC, net of cash acquired 0 (4,024) Capital asset expenditures (2,194) (1,651) Software capitalization (3,868) (3,048) Increase in note receivable from officer (600) 0 Net proceeds from sales (purchases) of short-term investments 6,668 (1,794) ------------- ------------- Net cash used in investing activities 6 (10,517) ------------- ------------- Financing activities: Proceeds from issuance of common stock 112 206 Proceeds from exercise of stock options 309 286 ------------- ------------- Net cash provided by financing activities 421 492 ------------- ------------- Net decrease in cash and cash equivalents (9,510) (897) Cash and cash equivalents at beginning of period 16,310 13,883 ------------- ------------- Cash and cash equivalents at end of period $ 6,800 $ 12,986 ============= =============
See accompanying notes to interim consolidated financial statements. 5 8 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, including normal recurring adjustments necessary for the fair presentation of the Company's financial position and results of operations and cash flows for the periods presented. Results of operations for interim periods are not necessarily indicative of the results to be expected for the entire year. These unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements of the Company as of and for the fiscal year ended October 31, 1999 included in the Company's Annual Report on Form 10-K for such year, and the unaudited interim consolidated financial statements as of and for the quarterly periods ended January 31, 2000 and April 30, 2000 included in the Company's Quarterly Reports on Form 10-Q, each as filed with the Securities and Exchange Commission. 2. Reclassifications Certain reclassifications were made to prior amounts to conform to the current presentation. 3. Business Combinations In June 1999, the Company's Quality Standards in Medicine, Inc. ("QSM") subsidiary acquired substantially all of the assets and assumed specified liabilities of Health Receivables Management, LLC ("Old HRM") for $4,024,000, 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" or the "Chicago operations"). HRM currently furnishes Medicaid application services, electronic billing, eligibility verification, accounts receivable management, and collection services to healthcare providers, principally in the State of Illinois. The acquisition was accounted for using the purchase method of accounting. HRM's results are included in the Company's Provider Revenue Services Group. The $1,618,000 excess of the purchase price over the fair market value of the identifiable assets acquired was recorded as goodwill and is being amortized over a period not to exceed 15 years. 4. Long Term Accounts Receivable Certain of the Company's newer offerings have resulted in accounts receivable whose collection cycles are expected to exceed 12 months. Accordingly, these receivables are classified as long term and are recorded at their discounted present value using the Company's borrowing rate of 10.125%, with imputed interest income recognized over the expected period of collection. Interest income during the nine months ended July 31, 2000 was $24,000. 5. Credit Facility The facility is comprised of a $10 million committed revolver and a $20 million advised line of credit with a major money center bank. The facility expires in February 2001, bears interest at LIBOR plus 87.5 basis points, and carries an unused commitment fee of 37.5 basis points. The interest rate and unused commitment fee on the revolver are adjustable, subject to certain earnings thresholds at November 1, 2000 to a maximum rate of LIBOR plus 1.125 percent and 0.625 percent, respectively. 6 9 This revolving facility contains, among other things, restrictions on additional borrowings, capital expenditures, leases, sales of assets, and payments of dividends and contains covenants that require the Company, among other things, to maintain minimum asset, debt coverage, and consolidated tangible shareholders' equity, as defined in the agreement. As of July 31, 2000 and 1999, no amounts were outstanding under this or the predecessor credit facility. 6. Supplemental Cash Flow Disclosures Cash paid for income taxes during the nine months ended July 31, 2000 and 1999 was $170,000 and $486,000, respectively. Cash paid for the unused commitment fee pertaining to the credit facility during the nine months ended July 31, 2000 and 1999 was $49,000 and $80,000, respectively. The Company recorded $13,000 and $29,000 for the nine months ended July 31, 2000 and 1999, respectively, as disqualified dispositions related to the sale of stock acquired through the exercise of certain compensatory stock options, thereby reducing the Company's tax liability and increasing shareholders' equity in like amounts. 7. Earnings Per Share Basic earnings per share is calculated as net income divided by the weighted average common shares outstanding. Diluted earnings per share is calculated as net income divided by the weighted average common shares outstanding including the dilutive effects of potential common shares, which include the Company's stock options. A reconciliation of the numerator and denominator of the calculations for the three-month and nine-month periods ended July 31, 2000 and 1999, respectively, is presented below.
($ and shares in 000's, except per share data) Three months ended Nine months ended July 31, July 31, ------------------------ -------------------------- 2000 1999 2000 1999 ---------- ----------- ----------- ----------- Numerator: Net income $ 497 $ 2,068 $ 1,505 $ 5,477 ========== =========== =========== =========== Denominator: Weighted average common shares 17,496 17,376 17,481 17,349 Potential common shares: stock options 7 66 32 92 ---------- ----------- ----------- ----------- Weighted average common shares and common share equivalents 17,503 17,442 17,513 17,441 ========== =========== =========== =========== Basic earnings per share $ 0.03 $ 0.12 $ 0.09 $ 0.32 ========== =========== =========== =========== Diluted earnings per share $ 0.03 $ 0.12 $ 0.09 $ 0.31 ========== =========== =========== ===========
8. Segment Information The Company measures the performance of its operating segments utilizing "Operating Income" as defined on the accompanying condensed consolidated statements of operations. Certain reclassifications were made to conform to the current presentation. 7 10
TOTAL Provider Payor REVENUE Revenue Revenue TOTAL Decision Payor TOTAL SERVICES Services Services SOFTWARE Support Systems ($ in Thousands) HMS DIVISION Group Group DIVISION Group Group ------------------------------------------------------------------------------------------------------------------- Three months ended July 31, 2000 Revenue $ 24,660 15,897 10,124 5,773 8,763 5,431 3,332 Operating income (loss) 476 (542) (412) (130) 1,018 1,063 (45) ------------------------------------------------------------------------------------------------------------------- Three months ended July 31, 1999 Revenue 27,655 16,921 10,918 6,003 10,734 5,368 5,366 Operating income 2,844 1,497 418 1,079 1,347 1,014 333 ------------------------------------------------------------------------------------------------------------------- Nine months ended July 31, 2000 Revenue 78,834 52,946 36,181 16,765 25,888 15,399 10,489 Operating income (loss) 1,533 (1,174) (395) (779) 2,707 2,243 464 ------------------------------------------------------------------------------------------------------------------- Nine months ended July 31, 1999 Revenue 83,881 47,390 29,105 18,285 36,491 17,019 19,472 Operating income (loss) $8,090 701 (2,753) 3,454 7,389 3,482 3,907 -------------------------------------------------------------------------------------------------------------------
The difference between "Operating income" and "Income before income taxes" is "Net interest and net other income," which was $335,000 for each of the quarters ended July 31, 2000 and 1999, and $949,000 and $932,000 for the nine months ended July 31, 2000 and 1999, respectively. 9. Legal Proceedings On August 14, 2000, an Order and Final Judgment was entered in the United States District Court for the Southern District of New York approving the proposed settlement of the litigation described below in this paragraph. 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 for the Southern District of New York, which reiterated plaintiffs' allegations in their prior Complaint. On September 11, 1998, the Company and the other defendants filed a motion to dismiss the Second Consolidated Amended Complaint. The motion was fully briefed in late November 1998, at which time the motion was submitted to the Court. The consolidated proceeding was reassigned to another Judge. The Court heard oral argument on the motion to dismiss on June 11, 1999. Prior to rendering its decision on the motion to dismiss, the Court ordered the parties to attempt to settle the case, and meetings toward that end were conducted. On December 20, 1999, the parties reached a tentative agreement on the principal terms of settlement of the litigation against all defendants. 8 11 Pursuant to this understanding, without admitting any wrongdoing, certain of the defendants have agreed to pay, in complete settlement of this lawsuit, the sum of $4,500,000, not less than 75 percent of which will be paid by the Company's insurance carriers. The Company recorded a charge of $845,000 in the quarter ended October 31, 1999 related to this proposed settlement. On March 23, 2000, the Company and plaintiffs entered into a Stipulation and Agreement of Settlement, which was subject to review and approval by the Court. A fairness hearing on the proposed settlement was held before the Court on June 28, 2000. As noted, on August 14, 2000, the Court signed an Order and Final Judgment approving the proposed settlement. 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. Management believes that a loss is not probable and accordingly has not recognized any accrued liability for this matter. Although the outcome of this matter cannot be predicted with certainty, the Company believes that any liability that may result will not, in the aggregate, have a material adverse effect on the Company's financial position or cash flows, although it could be material to the Company's operating results in any one accounting period. In May 2000, the Company commenced an action in the Supreme Court of the State of New York, County of New York ("New York Supreme Court"), for summary judgment in lieu of complaint against The Institutes for Health & Human Services, Inc. ("IHHS") seeking judgment in the amount of $270,000 on an unpaid promissory note. In July 2000, the Court granted the Company judgment in that amount (together with interest and attorneys' fees to be assessed at an inquest), but stayed enforcement of the judgment pending assertion and resolution of claims IHHS represented it had against the Company. Later in July, IHHS asserted such claims against the Company in an action filed in New York Supreme Court. The complaint alleges that the Company fraudulently withheld information from IHHS to induce it to enter into various specified contracts with the Company, and that the Company breached various contractual obligations to IHHS. The complaint seeks an aggregate of $9,100,000 in compensatory damages, and punitive damages in an unspecified amount. The Company believes IHHS's claims to be without merit and intends to contest them vigorously. Management believes a loss is not probable and accordingly has not recognized any accrued liability for this matter. Although the outcome of this matter cannot be predicted with certainty, the Company believes that any liability that may result will not, in the aggregate, have a material adverse effect on the Company's financial position or cash flows, although it could be material to the Company's operating results in any one accounting period. On September 13, 2000, the Company was served with a complaint in a lawsuit commenced by Davis & Associates, Inc. ("D&A") in the United States District Court for the Southern District of New York. The complaint alleges, among other things, that the Company breached contractual obligations to D&A, wrongfully induced D&A to enter into various contracts with the Company, and wrongfully interfered with D&A's ability to perform under several contracts and pursue unspecified business opportunities. D&A seeks compensatory and punitive damages in unspecified amounts and injunctive and other equitable relief. The Company believes D&A's claims to be without merit and intends to contest them vigorously. Management believes that a loss is not probable and accordingly has not recognized any accrued liability for this matter. Although the outcome of this matter cannot be predicted with certainty, the Company believes that any liability that may result will not, in the aggregate, have a material adverse effect on the Company's financial position or cash flows, although it could be material to the Company's operating results in any one accounting period. 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 cash flows. 9 12 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 in view of its revised revenue outlook 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) 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, 2000 Compared to Three Months Ended July 31, 1999 Consolidated revenue for the third quarter of fiscal year 2000 was $24.7 million, a decrease of approximately $3.0 million from the comparable period in 1999. The Revenue Services Division, comprised of the Provider Revenue Services Group and the Payor Revenue Services Group, produced revenue of $15.9 million, a decrease of $1.0 million from the comparable prior year third quarter. The Provider Revenue Services Group, which includes revenue recovery and outsourcing offerings for healthcare providers, generated revenue of $10.1 million, a decrease of $0.8 million from the comparable prior year third quarter. The decrease is principally attributable to the Company's discontinuance of two large but unprofitable engagements in the comparable prior year third quarter and to a one month delay in expected revenue attributable to a changed billing protocol for a large client, partially offset by the increased revenue from the Company's Chicago operations, acquired towards the end of the prior year's third quarter. The Group generated lower than expected sales of additional revenue maximization services and additional revenue relating to existing revenue maximization efforts in the District of Columbia was not recognized (see section on Liquidity and Capital Resources). The Payor Revenue Services Group, which includes recovery activities for third-party payors of healthcare, produced revenue of $5.8 million, a decrease in revenue of approximately $0.2 million from the comparable prior year third quarter. Within the quarter, the Group was successful in overcoming some of the continuing delays in implementation of specific State recovery projects hampering results during the year to date. Revenue from the Software Systems and Services Division, comprised of the Decision Support Group and the Payor Systems Group, was $8.8 million, a decrease of $1.9 million from the comparable prior year third quarter. The Payor Systems Group generated revenue of $3.3 million, a decrease of $2.0 million from the comparable prior year third quarter, principally attributable to (1) the winding down of an outsourcing engagement by a Blue Cross client who was acquired and converted to its new affiliate's internal data center, (2) the wind-down of a multi-year project with a single customer, (3) non-recurrence of substantial amounts of Y2K remediation work accomplished for clients during the comparable prior year period, and (4) an elongated sales cycle reflected in delayed purchasing of this Group's systems and software offerings, attributable to 10 13 an industry-wide softness. Revenue generated by the Decision Support Group was $5.4 million, an increase of $0.1 million over the comparable prior year third quarter. The impact of the Decision Support Group's elongated software sales cycle, attributable to prospects' financial constraints and their reluctance to implement new software after expending funds for their own internal Y2K conversions, was offset by both the increase in revenue earned from the Company's recurring base of clients and new installations. Cost of services for the third fiscal quarter ended July 31, 2000 was $24.0 million, a decrease of $0.6 million from the comparable prior year third quarter. Compensation expense, the largest component of cost of services, was $15.4 million for the third fiscal quarter ended July 31, 2000, a decrease of $0.7 million from the comparable prior year third quarter as the cost of the approximately 100 employees associated with the Company's Chicago operations acquired at the end of June 1999 was more than offset by reductions in the Software Division and reduced employee performance bonuses and temporary help throughout the organization. Direct project costs were $1.8 million for the fiscal quarter ended July 31, 2000, a decrease of $0.4 million from the comparable prior year third quarter, reflective of the lower cost reporting and audit settlement revenue generated in the Revenue Services Division. Data processing costs were $1.2 million for the fiscal quarter ended July 31, 2000, a decrease of $0.2 million from the comparable prior year third quarter, reflective of the wind-down of the engagement by a Blue Cross client who was acquired and converted to its affiliate's internal data center, the wind-down of a multi-year project with a single client, and other project work being brought in-house. Occupancy costs were $2.6 million for the fiscal quarter ended July 31, 2000, an increase of $0.2 million from the comparable prior year third quarter, principally attributable to the Chicago operations acquired last year. Other indirect expenses were $3.0 million for the quarter ended July 31, 2000, an increase of $0.5 million from the comparable prior year third quarter, reflecting a full quarter of the costs of the Chicago operations and increased marketing, advertising, travel, and allowance for doubtful accounts, partially offset by savings in consulting and employee related costs. Nine Months Ended July 31, 2000 Compared to Nine Months Ended July 31, 1999 Consolidated revenue for the nine months ended July 31, 2000 of $78.8 million represented a decrease of $5.0 million from the comparable period in 1999. The Revenue Services Division achieved revenues of $52.9 million for the nine months ended July 31, 2000, an increase of $5.6 million from the comparable period in 1999. Of these amounts, the Provider Revenue Services Group produced revenue of $36.2 million, an increase of $7.1 million from the comparable period in 1999, including $6.0 million in additional revenue attributable to the Chicago operations acquired last year and its subsequent growth. The additional revenue increase realized by the Provider Revenue Services Group was generated from internal growth attributable to both (1) new clients and (2) delivery of services of expanded scope to existing clients. The Payor Revenue Services Group produced revenue of $16.8 million, a decrease of $1.5 million from the comparable period in 1999, principally reflective of the successful commencement of new recovery projects for multiple states in the comparable prior period and of delays in obtaining client data, securing client approvals to bill, and executing certain field work in the current fiscal year. Revenue from the Software Systems and Services Division totaled $25.9 million, a decrease of $10.6 million from the comparable period in 1999. The Payor Systems Group produced revenue of $10.5 million, a decrease of $9.0 million from the comparable period in 1999, principally attributable to a combination of (1) the winding down of an outsourcing engagement by a Blue Cross client who was acquired and converted to its affiliate's internal data center, (2) non-recurrence of substantial amounts of Y2K remediation work accomplished for clients during the comparable prior year period, (3) a non-recurring revenue incentive bonus received in the comparable prior year period, (4) the wind-down of a multi-year project with a single customer, and (5) an elongated software sales cycle reflected in delayed purchasing of this Group's systems and software offerings attributable to an industry-wide softness. Revenue generated by the Decision Support Group was $15.4 million, a decrease of $1.6 million from the 11 14 comparable period in 1999, principally attributable to prospects' financial constraints and their reluctance to implement new software so quickly after expending funds for their own internal Y2K conversions, partially offset by the increase in revenue earned from the Company's recurring base of clients. Cost of services for the nine months ended July 31, 2000 of $76.6 million, increased $1.4 million from the comparable period in 1999. Compensation expense totaled $47.6 million for the nine months ended July 31, 2000, a decrease of $0.3 million from the comparable period in 1999, as the increase in personnel to support the increased revenue in the Revenue Services Division, including the approximately 100 employees added through the acquisition of the Company's Chicago operation in June 1999, was more than offset by reduced compensation expense in the Software Division and reduced employee performance bonuses and temporary help throughout the organization. Direct project costs were $8.7 million for the nine months ended July 31, 2000, an increase of $0.7 million from the comparable prior year nine-month period, primarily attributable to the Company's increased use of revenue-generating subcontractors and related project consulting services in the first half of the year. Data processing costs were $4.2 million for the nine months ended July 31, 2000, a decrease of $0.8 million from the comparable prior year nine-month period, primarily attributable to the (1) Company's reallocation of resources to develop additional service offerings and major systems enhancements, as reflected by increased capitalized software costs and (2) reduced data costs reflective of the wind-down of the engagement by a Blue Cross client who was acquired and converted to its affiliate's internal data center, the wind-down of a multi-year project with a single client, and other project work being brought in-house. Occupancy costs were $7.6 million for the nine months ended July 31, 2000, an increase of $0.9 million from the comparable prior year nine-month period, principally attributable to the Chicago operations acquired last year. Other indirect expenses were $8.6 million for the nine months ended July 31, 2000, an increase of $965,000 from the comparable prior year third quarter, primarily attributable to the Company's increased marketing, advertising, travel, and strategic planning costs. Liquidity and Capital Resources At July 31, 2000 and October 31, 1999, the Company had net working capital of $57.3 million and $58.4 million, respectively. The Company's principal sources of liquidity at July 31, 2000 consisted of cash, cash equivalents, and short-term investments aggregating $17.5 million, net accounts receivable of $67.7 million, of which $783,000 is classified as long term, and a $10.0 million committed revolver and $20.0 million advised line of credit from a major money center bank, expiring in February 2001 and under which no amounts are currently outstanding. Accounts receivable at July 31, 2000 reflected an increase of $9.1 million from the balance at October 31, 1999, primarily attributable to (1) a significant increase in the portion of the Company's revenue being generated by the Revenue Services Division, whose receivables conversion cycle is more elongated than that of the Software Division, and (2) delays in the timing of receipts and governmental appropriation processes. Included in accounts receivable at July 31, 2000 are approximately $3.5 million for several revenue enhancement efforts undertaken by the Company in conjunction with a subcontractor, on behalf of the District of Columbia government, its schools, and the public benefit corporation operating its healthcare facilities, with related subcontractor costs fully accrued. As of July 31, 2000, the Company has provided the subcontractor $2.6 million of funding in relation to several revenue enhancement efforts, to be repaid from the proceeds of these efforts. The Company has been disappointed by the pace at which it has been able to resolve various audit, contract, and appropriations issues with the District of Columbia agencies for whom it has performed the subject revenue enhancement activities. In the face of these difficulties and the subcontractor's failure to secure anticipated engagements outside of the District of Columbia, the Company has suspended further advances to the subcontractor and is seeking to negotiate a mutually acceptable plan of withdrawal from that relationship. On September 13, 2000, the Company was served with a complaint, as further described in Note 9 of the Notes to Interim Consolidated Financial Statements. In view of the difficulties encountered by the Company in its use of subcontractors, the Company intends to build its own capacity to respond to future opportunities for revenue maximization work. 12 15 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, 2000. The Company expects to continue to use a portion of its working capital to finance product and systems development, system enhancements, and revenue growth. The Company also continues to seek to acquire companies that supply healthcare providers and/or payors with information management software, systems, or services if the offerings of the Company or such companies would benefit from access to the other's technology, software applications, or client base. The Company believes that such acquisition opportunities exist due, in part, to competitive pressures on local service businesses that lack adequate capital, technical, and management resources. The Company expects to divest specific components of its business exhibiting lack of growth and constituting unacceptably high opportunity cost to the Company, reconfigure its multiple business office operations across the nation to improve quality (including yield) and reduce costs, and continue to explore a number of possible partnering and joint marketing situations. Item 3. Quantitative and Qualitative Disclosures About Market Risks The Company's holdings of financial instruments are comprised of federal, state, and local government debt, and corporate debt. All such instruments are classified as securities available for sale. The Company does not invest in portfolio equity securities or commodities or use financial derivatives for trading purposes. The Company's debt security portfolio represents funds held temporarily, pending use in the Company's business and operations. The Company manages these funds accordingly. The Company seeks reasonable assuredness of the safety of principal and market liquidity by investing in rated fixed income securities while, at the same time, seeking to achieve a favorable rate of return. The Company's market risk exposure consists principally of exposure to changes in interest rates. The Company's holdings are also exposed to the risks of changes in the credit quality of issuers. The Company typically invests in the shorter-end of the maturity spectrum or highly liquid investments. The table below presents the historic cost basis, and the fair value for the Company's investment portfolio as of July 31, 2000, and the related weighted average interest rates by fiscal year of maturity:
Maturity Dates ------------------------ ($ in thousands) 2000 2001 2002 Total Fair value -------------------------------------------------------------------------------- Cash equivalents: Money Market Fund $ 5,576 $ -- $ -- $ 5,576 $ 5,576 Average interest rate 6.1% Short-term investments: Fixed income assets Governmental Securities $ -- $9,747 $1,140 $10,887 $10,710 Average interest rate 5.34% 5.78% 5.23%
13 16 PART II -- OTHER INFORMATION Item 1. Legal Proceedings -- See Note 9 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 Exhibits - See exhibit index Reports on Form 8-K - None 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, 2000 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 14 17 HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES EXHIBIT INDEX
Exhibit Number Description of Exhibit to Interim Consolidated Financial Statements -------------- ------------------------------------------------------------------- 10.1 Fifth Amendment, dated May 30, 2000 to the lease for the entire eighth, ninth, and tenth floors and part of the eleventh and twelfth floor between 401 Park Avenue South Associates, LLC and Health Management Systems, Inc. 10.2 Sixth Amendment, dated May 1, 2000 to the lease for the entire eighth, ninth, and tenth floors and part of the eleventh and twelfth floor between 401 Park Avenue South Associates, LLC and Health Management Systems, Inc. 10.3 Third Amendment, dated May 30, 2000 to the lease for a portion of the eleventh floor between 401 Park Avenue South Associates, LLC and Health Management Systems, Inc. 10.4 Fourth Amendment, dated May 1, 2000 to the lease for a portion of the eleventh floor between 401 Park Avenue South Associates, LLC and Health Management Systems, Inc. 10.5 Sixth Amendment, dated May 30, 2000 to the lease for a portion of the twelfth floor between 401 Park Avenue South Associates, LLC and Health Management Systems, Inc. 10.6 Seventh Amendment, dated May 1, 2000 to the lease for a portion of the twelfth floor between 401 Park Avenue South Associates, LLC and Health Management Systems, Inc. 10.7 Fifth Amendment, dated May 30, 2000 to the lease for the fourth floor and the penthouse between 401 Park Avenue South Associates, LLC and Health Management Systems, Inc. 10.8 Sixth Amendment, dated May 1, 2000 to the lease for the fourth floor and the penthouse between 401 Park Avenue South Associates, LLC and Health Management Systems, Inc. 27 Financial Data Schedule (Submitted for informational purposes only and not deemed to be filed)
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