<PAGE> 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, 1998
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 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 August 31, 1998
Common Stock, $.01 Par Value 17,407,563 Shares
<PAGE> 2
HEALTH MANAGEMENT SYSTEMS, INC.
INDEX TO FORM 10-Q
QUARTER ENDED JULY 31, 1998
<TABLE>
<CAPTION>
PART I FINANCIAL INFORMATION Page No.
<S> <C>
Item 1 Financial Statements
Consolidated Balance Sheets as of July 31, 1998 (unaudited) and October 1
31, 1997
Consolidated Statements of Operations (unaudited) for the three month 2
and nine month periods ended July 31, 1998 and July 31, 1997
Consolidated Statement of Shareholders' Equity (unaudited) for the nine 3
month period ended July 31, 1998
Consolidated Statement of Cash Flows (unaudited) for the three month 4
and nine month periods ended July 31, 1998 and July 31, 1997
Notes to Interim Consolidated Financial Statements (unaudited) 5
Item 2 Management's Discussion and Analysis of Results of Operations and 8
Financial Condition
PART II OTHER INFORMATION 13
SIGNATURES 15
EXHIBIT INDEX 16
</TABLE>
<PAGE> 3
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
($ IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
July 31, October 31,
1998 1997
--------- ---------
(Unaudited)
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 12,938 20,694
Short-term investments 19,462 18,386
Accounts receivable, net 48,119 39,519
Other current assets 5,094 3,384
--------- ---------
Total current assets 85,613 81,983
Property and equipment, net 6,879 7,988
Goodwill, net 11,990 12,316
Capitalized software costs, net 3,720 3,060
Deferred income taxes 2,717 2,721
Other assets 1,453 1,626
--------- ---------
Total assets $ 112,372 109,694
========= =========
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable and accrued expenses $ 15,737 16,153
Deferred revenue 3,776 5,122
Deferred income taxes 8,964 6,909
--------- ---------
Total current liabilities 28,477 28,184
Other liabilities 1,585 1,704
--------- ---------
Total liabilities 30,062 29,888
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;
18,269,939 shares issued and 17,405,939 shares outstanding at July 31, 1998;
17,773,653 shares issued and 17,459,153 shares outstanding at October 31, 1997 183 178
Capital in excess of par value 70,858 67,304
Retained earnings 16,954 13,506
Unrealized appreciation on short-term investments 775 681
--------- ---------
88,770 81,669
Less treasury stock, at cost
864,000 shares at July 31, 1998 and 314,500 shares at October 31, 1997 (6,460) (1,863)
--------- ---------
Total shareholders' equity 82,310 79,806
Total liabilities and shareholders' equity $ 112,372 109,694
========= =========
</TABLE>
See accompanying notes to unaudited interim consolidated financial statements.
1
<PAGE> 4
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Three months ended Nine months ended
July 31, July 31,
--------------------- ---------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenue:
Trade $ 26,736 22,103 77,412 64,152
Affiliates 0 0 0 331
-------- -------- -------- --------
26,736 22,103 77,412 64,483
Cost of services:
Compensation 15,238 13,784 44,404 38,948
Data processing 2,086 1,739 6,827 5,327
Occupancy 2,312 2,637 6,980 7,196
Other 4,631 4,903 13,094 12,856
-------- -------- -------- --------
24,267 23,063 71,305 64,327
-------- -------- -------- --------
Operating margin (loss) before amortization of intangibles 2,469 (960) 6,107 156
Amortization of intangibles 509 512 1,538 797
-------- -------- -------- --------
Operating income (loss) 1,960 (1,472) 4,569 (641)
Other income (expense):
Net interest and net other income 423 437 1,343 2,209
Merger related costs 0 0 0 (537)
Equity in loss of affiliate 0 0 0 (310)
-------- -------- -------- --------
423 437 1,343 1,362
Income (loss) before income taxes 2,383 (1,035) 5,912 721
Income tax (expense) benefit (995) 432 (2,464) 760
-------- -------- -------- --------
Net income (loss) $ 1,388 (603) 3,448 1,481
======== ======== ======== ========
Earnings per share data:
Basic:
Basic earnings (loss) per share $ 0.08 (0.03) 0.20 0.08
======== ======== ======== ========
Weighted average common shares outstanding 17,468 17,627 17,431 17,648
======== ======== ======== ========
Diluted:
Diluted earnings (loss) per share $ 0.08 (0.03) 0.19 0.08
======== ======== ======== ========
Weighted average common shares and common share equivalents 18,119 17,627 17,950 17,898
======== ======== ======== ========
</TABLE>
See accompanying notes to unaudited interim consolidated financial statements.
2
<PAGE> 5
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (UNAUDITED)
($ IN THOUSANDS)
<TABLE>
<CAPTION>
Unrealized
Common Stock Capital In Appreciation Total
Par Excess Of Retained on Short-term Treasury Shareholders'
Shares Value Par Value Earnings Investments Stock Equity
------ ----- --------- -------- ----------- ----- ------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at October 31, 1997 17,459,153 $178 67,304 13,506 681 (1,863) 79,806
Net income 0 0 0 3,448 0 0 3,448
Stock option activity 431,229 5 2,663 0 0 0 2,668
Employee stock purchase plan activity 65,057 0 325 0 0 0 325
Treasury stock acquisition (549,500) 0 0 0 0 (4,597) (4,597)
Tax benefit from disqualifying dispositions 0 0 566 0 0 0 566
Appreciation on short-term investments 0 0 0 0 94 0 94
-----------------------------------------------------------------------------------
Balance at July 31, 1998 17,405,939 $183 70,858 16,954 775 (6,460) 82,310
===================================================================================
</TABLE>
See accompanying notes to unaudited interim consolidated financial statements.
3
<PAGE> 6
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
($ IN THOUSANDS)
<TABLE>
<CAPTION>
Three months ended Nine months ended
July 31, July 31,
------------------- ------------------
1998 1997 1998 1997
-------- ------- ------- -------
<S> <C> <C> <C> <C>
Operating activities:
Net income (loss) $ 1,388 (603) 3,448 1,481
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation and amortization 852 1,389 2,650 3,383
Amortization of intangibles 443 0 1,541 0
Provision for doubtful accounts 0 (126) 0 (252)
Deferred tax expense 1,515 754 2,059 383
Equity in loss of affiliate 0 0 0 311
Changes in assets and liabilities:
Decrease (increase) in accounts receivable (3,254) 5,191 (8,600) 7,843
Decrease (increase) in other current assets (1,154) 2,525 (1,710) 3,402
Increase (decrease) in accounts payable and accrued expenses (139) (279) 154 (5,019)
Decrease in amounts payable to affiliates 0 0 0 (747)
Decrease in deferred revenue (1,042) (373) (1,346) (779)
Decrease in other assets and liabilities, net (186) (1,955) (126) (2,509)
-------- ------- ------- -------
Net cash provided by (used in) operating activities (1,577) 6,523 (1,930) 7,497
-------- ------- ------- -------
Investing activities:
Capital asset expenditures (361) (234) (931) (1,055)
Software capitalization (911) (334) (2,266) (1,116)
Acquisition of assets of subsidiaries of GHS, Inc. 0 (2,146) 0 (2,146)
Acquisition of remainder of HISCO, Inc., net of cash acquired 0 0 0 (3,689)
Net increase (decrease) in short-term investments 150 (347) (981) (693)
-------- ------- ------- -------
Net cash used in investing activities (1,122) (3,061) (4,178) (8,699)
-------- ------- ------- -------
Financing activities:
Proceeds from issuance of common stock 80 84 127 637
Proceeds from exercise of stock options 840 142 2,822 375
Common stock repurchases (2,995) (1,258) (4,597) (1,258)
-------- ------- ------- -------
Net cash used by financing activities (2,075) (1,032) (1,648) (246)
-------- ------- ------- -------
Net increase (decrease) in cash and cash equivalents (4,774) 2,430 (7,756) (1,448)
Cash and cash equivalents at beginning of period 17,712 18,462 20,694 22,340
======== ======= ======= =======
Cash and cash equivalents at end of period $ 12,938 20,892 12,938 20,892
======== ======= ======= =======
</TABLE>
See accompanying notes to unaudited interim consolidated financial statements.
4
<PAGE> 7
HEALTH MANAGEMENT SYSTEMS, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. UNAUDITED INTERIM FINANCIAL INFORMATION
Health Management Systems, Inc. ("HMS" or the "Company") management 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 year ended October 31, 1997 included in the
Company's Annual Report on Form 10-K for such year as filed with the
Securities and Exchange Commission (the "Commission").
2. SUPPLEMENTAL CASH FLOW DISCLOSURES
Cash paid for income taxes during the quarters ended July 31, 1998 and 1997
was $154,000 and $74,000, respectively. Cash paid for income taxes during
the nine months ended July 31, 1998 and 1997 was $2,571,000 and $253,000,
respectively.
The Company recorded $566,000 and $2,042,000 for the nine months ended July
31, 1998 and 1997, respectively, as disqualified dispositions related to
certain compensatory stock option exercises, which had the effect of
reducing the Company's tax liability with an offsetting increase to
shareholders' equity. Additionally, the Company recorded non-cash
transactions during the nine months ended July 31, 1997, which included in
connection with the Company's acquisition of Quality Standards in Medicine,
Inc. ("QSM") the issuance of 87,850 shares of the Company's common stock
(the "Common Stock") to settle $1,435,000 of QSM notes payable plus accrued
interest.
3. EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS
128"). The Company adopted SFAS 128 during the quarter ended January 31,
1998, and earnings per share amounts for all periods presented in the
accompanying unaudited interim consolidated statement of operations are
calculated and presented in accordance with SFAS 128. The statement
specifies new standards for the computation and presentation of earnings
per share, requiring the presentation of both "basic" and "diluted"
earnings per share. Basic earnings per share is calculated as net earnings
divided by the weighted average common shares outstanding. Diluted earnings
per share is calculated as net earnings divided by the weighted average
common shares outstanding including the dilutive effects of potential
common shares, which include the Company's stock options.
5
<PAGE> 8
A reconciliation of the numerator and denominator of the calculations for
the three and nine month periods ended July 31, 1998 and 1997 is presented
below.
<TABLE>
<CAPTION>
Three months ended Nine months ended
JULY 31, JULY 31,
----------------- ------------------
1998 1997 1998 1997
------- ------ ------- -------
<S> <C> <C> <C> <C>
($ in thousands, except per share data)
Numerator:
Net income (loss) $ 1,388 (603) 3,448 1,481
======= ====== ======= =======
Denominator:
Weighted average common shares 17,468 17,627 17,431 17,648
Potential common shares:
Stock options 651 -- 519 250
------- ------ ------- -------
Weighted average common shares and
common share equivalents 18,119 17,627 17,950 17,898
======= ====== ======= =======
Basic earnings (loss) per share $ 0.08 (0.03) 0.20 0.08
======= ====== ======= =======
Diluted earnings (loss) per share $ 0.08 (0.03) 0.19 0.08
======= ====== ======= =======
</TABLE>
4. RELATED PARTIES
In April 1997, the Company guaranteed a loan by The Chase Manhattan Bank
(the "Bank") in the original principal amount of $1,600,000 to Robert V.
Nagelhout, the Chief Operating Officer and a director of the Company. Mr.
Nagelhout granted the Company a security interest in 500,000 shares of
Common Stock as collateral for its guarantee. On June 11, 1998, Mr.
Nagelhout repaid the loan in its entirety, the Bank released the Company's
guaranty, and the available balance under the Company's line of credit with
the Bank was increased by $1,600,000 to $30,000,000.
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 Company intends to continue to vigorously defend
the lawsuit.
6
<PAGE> 9
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 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 recently 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.
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 intends to oppose plaintiffs' motion for
abstention and to move the Bankruptcy Court to dismiss the Adversary
Proceeding.
7
<PAGE> 10
ITEM 2 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION -- THREE MONTH AND NINE MONTH PERIODS ENDED JULY 31, 1998
AND 1997
OPERATING RESULTS
THREE MONTHS ENDED JULY 31, 1998
Revenue for the third quarter of fiscal year 1998 was $26,736,000, an increase
of $4,633,000 or 21% from the comparable period in 1997. The Company's Transfer
Payment Services ("TPS") division, which includes both Provider and Payor
services, accounted for $14,532,000 (54% of the Company's consolidated revenue
for the third quarter of fiscal year 1998), an increase of $2,276,000 or 19%
from the comparable period in 1997. Revenue from Provider services, comprised of
Retroactive Claims Reprocessing ("RCR"), Comprehensive Account Management
Services ("CAMS"), and Outsourcing, totaled $8,640,000, an increase of $33,000
from the comparable period in 1997. Revenue from Outsourcing included $574,000
attributable to Global Health Systems ("Global"), which was acquired on July 17,
1997, for which there was $69,000 in revenue in the comparable prior year
period. Revenue from Payor services, comprised of Third Party Liability Recovery
("TPLR") services and the Company's CDR Associates, Inc. subsidiary, totaled
$5,892,000, an increase of $2,243,000 or 61% from the comparable period in 1997.
Revenue from the Software Systems and Services ("Software") division, comprised
of Decision Support Software ("DSS"), provided by the Company's Health Care
microsystems, Inc. ("HCm") subsidiary, and Managed Care Information Systems
("MCIS"), provided by the Company's HSA Managed Care Systems, Inc. ("HSA")
subsidiary, totaled $12,204,000 (46% of the Company's consolidated revenue for
the third quarter of fiscal year 1998), an increase of $2,357,000 or 24% from
the comparable period in 1997. Revenue from DSS was $6,358,000, a modest
increase of $44,000 or 1% from the comparable period in 1997. Revenue from MCIS
was $5,846,000, an increase of $2,313,000 or 65% from the comparable prior year
period.
Cost of services for the third quarter of fiscal year 1998 was $24,267,000, an
increase of $1,204,000 or 5% from the comparable period in 1997. The increase
was due primarily to the additional cost of services associated with the Global
acquisition , compensation expense and data processing expense.
Compensation expense (the Company's largest expense component) for the third
quarter of fiscal year 1998 totaled $15,238,000, an increase of $1,454,000 or
11% over the comparable period in 1997. The increase in compensation expense was
primarily due to personnel costs associated with higher headcount for the HSA
subsidiary and the acquisition of Global.
Data processing expense for the third quarter of fiscal year 1998 was
$2,086,000, an increase of $347,000 or 20% from the comparable period in 1997.
This increase was primarily attributable to a decrease in capitalization of
software development expense.
Occupancy expense for the third quarter of fiscal year 1998 was $2,312,000, a
decrease of $325,000 or 12% from the comparable period in 1997. The decrease in
occupancy cost was attributable to the sublease of two floors at the Company's
New York City offices.
Other operating expense for the third quarter of fiscal year 1998 was
$4,631,000, a decrease of $272,000 or 6% from the comparable period in 1997,
primarily due to a decrease in professional service fees.
Operating margin for the third quarter of fiscal year 1998 before amortization
of intangible assets was $2,469,000, an increase of $3,429,000 or 357% from the
comparable period in 1997. The Company's
8
<PAGE> 11
operating margin rate before amortization of intangible assets was 9.2%,
compared with a negative 4.3% in the comparable prior year period.
Net interest income for the third quarter of fiscal year 1998 was $423,000, a
slight decrease of $14,000 or 3% from $437,000 in the comparable period in 1997.
The Company's income tax expense for the third quarter of fiscal year 1998 was
$995,000, compared to an income tax benefit of $432,000 for the comparable
period in 1997. The Company's effective tax rate for the third quarter of fiscal
years 1998 and 1997 was approximately 41.8% and 41.7%, respectively.
Net income for the third quarter of fiscal year 1998 was $1,388,000, an increase
of $1,991,000 or 330% over the net loss of $603,000 in the comparable period in
1997.
The Company's diluted earnings per share for the third quarter of fiscal year
1998 was $0.08, an increase of $0.11 from the $0.03 loss per share in the
comparable period in 1997.
NINE MONTHS ENDED JULY 31, 1998
Revenue for the nine months ended July 31, 1998 was $77,412,000, an increase of
$12,929,000 or 20% from the comparable period in 1997. Revenue from the TPS
division accounted for $41,749,000 (54% of the Company's consolidated revenue
for the fiscal year 1998 year-to-date), an increase of $924,000 or 2% from the
comparable prior year period in 1997. Revenue from Provider services totaled
$25,699,000, a decrease of $3,552,000 or 12% from the comparable nine month
period in 1997. Included in Provider revenue was $1,852,000 attributable to
Global for which there was $69,000 in revenue in the comparable nine month
period in 1997. Revenue from Payor services totaled $16,050,000, an increase of
$4,476,000 or 39% from the comparable nine month period in 1997.
Revenue from the Software division was $35,663,000 (46% of the Company's
consolidated revenue for the fiscal year 1998 year-to-date), an increase of
$12,004,000 or 51% over the comparable nine month period in 1997. Revenue from
DSS was $19,000,000, an increase of $668,000 or 4% from the comparable nine
month period in 1997. Revenue from MCIS was $16,663,000, an increase of
$11,337,000 or 213% from the comparable prior year period. Last year's MCIS
revenue reflected a partial year to date period from March 18, 1997 through July
31, 1997, due to the acquisition of HSA on March 18, 1997.
Cost of services for the nine months ended July 31, 1998 was $71,305,000, an
increase of $6,978,000 or 11% over the comparable nine month period in 1997.
This increase was attributable to the additional costs incurred by the
acquisitions of HSA and Global during the comparable prior year period.
Compensation expense for the nine months ended July 31, 1998 totaled
$44,404,000, an increase of $5,456,000 or 14% over the comparable nine month
period in 1997. This increase in compensation expense was primarily due to the
acquisitions of HSA and Global.
Data processing expense for the nine months ended July 31, 1998 was $6,827,000,
an increase of $1,500,000 or 28% from the comparable nine month period in 1997.
This increase was attributable to data processing expense associated with HSA.
Occupancy expense for the nine months ended July 31, 1998 was $6,980,000, a
decrease of $216,000 or 3% over the comparable nine month period in 1997. This
slight decrease was due to the sublease of
9
<PAGE> 12
two floors in the Company's New York City offices, partially offset by
additional occupancy costs incurred by the Software division.
Other operating expense for the nine months ended July 31, 1998 was $13,094,000,
a slight increase of $238,000 or 2% from the comparable nine month period in
1997. This increase was attributable to direct project costs.
Operating margin for the nine months ended July 31, 1998 before amortization of
intangible assets was $6,107,000, an increase of $5,951,000 or 381% from the
comparable nine month period in 1997. The Company's operating margin rate before
amortization of intangible assets was 7.9%, compared to 0.2% for the comparable
period in 1997. Amortization of intangible expense of $1,538,000 increased by
$741,000 or 93% over the prior year period due to the amortization of intangible
assets associated with the acquisition of HSA on March 18, 1997.
Net interest income for the nine months ended July 31, 1998 was $1,343,000, a
decrease of $866,000 attributable to the reversal of an accrued interest expense
of $887,000 as a consequence of an Internal Revenue Service audit resolution
("IRS audit resolution") concluded in the comparable period in 1997. The Company
did not incur any merger related costs for the nine months ended July 31, 1998,
compared to $537,000 incurred in the comparable prior year period related to the
merger with QSM in November 1996. The Company did not report any equity in the
loss of affiliates for the nine months ended July 31, 1998, compared to a loss
of $310,000 in the comparable nine month period in 1997.
The Company's income tax expense for the nine months ended July 31, 1998 was
$2,464,000, compared to an income tax benefit of $760,000 in the comparable nine
month period in 1997 due to the $1,093,000 benefit derived from the IRS audit
resolution. The Company's effective tax rate for the nine months ended July 31,
1998 was approximately 41.7%, compared to an effective tax rate of 46.2% (before
the income tax effect of the IRS audit resolution) in the comparable nine month
period in 1997. The fluctuation in the effective tax rate between the nine
months ended July 31, 1998 and 1997 was primarily attributable to certain
merger related costs in 1997 and higher state taxation costs for 1997.
Net income for the nine month period ended July 31, 1998 was $3,448,000, an
increase of $1,967,000 or 133% from the comparable nine month period in 1997.
Excluding all one-time events in the comparable prior nine month period, the
Company's net income increased $3,017,000.
The Company's diluted earnings per share for the nine month period ended July
31, 1998 was $0.19, an increase of $0.11 or 138% from the comparable nine month
period in 1997. Excluding all one-time events from the comparable nine month
period in 1997, the Company's diluted earnings per share increased $0.16.
10
<PAGE> 13
LIQUIDITY AND CAPITAL RESOURCES
At July 31, 1998, the Company had $57,136,000 in net working capital, an
increase of $3,337,000 or 6% from the level at October 31, 1997. The Company's
principal sources of liquidity at July 31, 1998 consisted of cash, cash
equivalents, and short-term investments aggregating $32,400,000, net accounts
receivable of $48,119,000, and an available balance of $30,000,000 under its
Bank line of credit. On June 11, 1998, an officer and director of the Company
repaid a loan guaranteed by the Company to the Bank and the available balance
under the Company's line of credit with the Bank was increased by $1,600,000
from $28,400,000 to $30,000,000. See Note 4 to unaudited interim consolidated
financial statements. Accounts receivable at July 31, 1998 reflected an increase
of $8,600,000 or 22% from the October 31, 1997 balance. There has been no
significant change in the nature, age, or composition of the Company's accounts
receivable portfolio.
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 is authorized to 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. In the third
quarter of fiscal year 1998, the Company repurchased 300,000 shares of Common
Stock in the open market at an average price of $9.98 per share for an aggregate
purchase price of $2,995,000. Since the close of the third quarter of fiscal
year 1998, the Company repurchased an additional 185,000 shares of Common Stock
at an average price of $6.97 per share, using an additional $1,290,000. Since
the inception of the repurchase program in June 1997, the Company has
repurchased in the open market 1,049,000 shares of Common Stock at an average
price of $7.39 per share having an aggregate purchase price of $7,750,000.
* * * *
In common with many other companies, the Year 2000 computer issue creates risks
for the Company. If internal systems do not correctly recognize and process date
information beyond the year 1999, there could be an adverse impact on the
Company's operations. There are two other related issues which could also lead
to incorrect calculations or failures: i) some systems programming assigns
special meaning to certain dates, such as 9/9/99, and ii) the Year 2000 is a
leap year. To address these Year 2000 issues with its internal systems, the
Company has initiated a comprehensive program which is designed to deal with the
most critical systems first. Assessment and remediation are proceeding in
tandem, and the Company currently plans to have changes to critical systems
completed and tested by mid-1999. These activities are intended to encompass all
major categories of systems in use by the Company, including product
development, sales, finance and human resources. The Company is also actively
working with critical suppliers of products and services to determine that the
suppliers' operations and the products and services they provide are Year 2000
capable or to monitor their progress toward Year 2000 capability. In addition,
the Company has commenced work on various types of contingency planning to
address potential problem areas with internal systems and with suppliers and
other third parties. It is expected that assessment and remediation will be
completed by May 1, 1999, and contingency planning activities will be completed
by August 1, 1999, with the goal of appropriately resolving all material
internal systems and third party issues by such dates.
The Company also has designed and tested the most current versions of its
products for Year 2000 compliance. A significant number of the Company's
customers are running product versions that are not Year 2000 compliant. While
the Company has been encouraging such customers to migrate to current product
versions, it is possible that the Company may experience increased expenses in
11
<PAGE> 14
addressing migration issues and may lose customers. Moreover, the revenue stream
and financial stability of existing customers may be adversely impacted by Year
2000 problems, which could cause fluctuations 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 Year 2000 date functions
that may result in the material costs to the Company. Moreover, the assessment
of whether a complete system will operate correctly depends on the hardware
capability of the system and software design and integration, and 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
their Year 2000 capability. Nevertheless, the Company is incurring various costs
to provide customer support and customer satisfaction services regarding Year
2000 issues, and it is anticipated that these expenditures will continue through
1999 and thereafter.
The costs incurred to date related to these programs are estimated at less than
$1,000,000. The Company currently expects that the total cost of these programs,
including both incremental spending and redeployed resources, will not exceed
$2,000,000. The total cost estimate does not include potential costs related to
any customer or other claims or the cost of internal software and hardware
replaced in the normal course of business. In some instances, the installation
schedule of new software and hardware in the normal course of business is being
accelerated to also afford a solution to Year 2000 capability issues. The total
cost estimate is based on the current assessment of the projects and is subject
to change as the projects progress.
The expenses incurred by the Company to identify and address the Year 2000
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 the failure to ensure Year 2000
capability by a supplier or another third party would not have a material
adverse effect on the Company.
Certain statements in this document constitute "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995. 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 health care 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.
12
<PAGE> 15
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
PART II -- OTHER INFORMATION
Item 1 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. The Company intends to continue to vigorously defend the
lawsuit. On September 11, 1998, the Company and the other defendants
filed a motion to dismiss the new Complaint.
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 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 recently developed for
the Company by certain former employees of plaintiff, who are also
defendants in the action, acting as independent contractors. Plaintiff
seeks, among other relief, (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.
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 million (the unpaid amount of the Notes)
plus interest. Plaintiffs have moved in the Bankruptcy Court to have
the Court abstain from
13
<PAGE> 16
hearing the Adversary Proceeding in deference to the New York State
Court action. The Company intends to oppose plaintiffs' motion for
abstention and to move the Bankruptcy Court to dismiss the Adversary
Proceeding.
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 --
On May 27, 1998 the Board of Directors elected Randolph G. Brown as a
director of the Company to fill the vacancy created by the resignation
of Mr. Russell Carson on March 18, 1998. Mr. Brown will be a nominee
for election as a director at the Company's 1999 Annual Meeting of
Shareholders.
Proposals by shareholders intended to be presented at the 1999 Annual
Meeting must be forwarded in writing and received at the principal
executive office of the Company no later than October 3, 1998,
directed to the attention of the Secretary, for consideration for
inclusion in the Company's proxy statement for the Annual Meeting of
Shareholders to be held in 1999. Moreover, with regard to any proposal
by a shareholder not seeking to have such proposal included in the
proxy statement but seeking to have such proposal considered at the
1999 Annual Meeting, if such shareholder fails to notify the Company
in the manner set forth above of such proposal no later than December
16, 1998, then the persons appointed as proxies may exercise their
discretionary voting authority if the proposal is considered at the
1999 Annual Meeting notwithstanding that shareholders have not been
advised of the proposal in the proxy statement for the 1999 Annual
Meeting. Any proposals submitted by shareholders must comply in all
respects with (i) the rules and regulations of the Securities and
Exchange Commission, (ii) the provisions of the Company's Certificate
of Incorporation and Bylaws and (iii) New York law.
Item 6 Exhibits and Reports on Form 8-K -- None
a) Reports on Form 8-K -- None
b) Exhibits -- See Exhibit Index
14
<PAGE> 17
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, 1998 HEALTH MANAGEMENT SYSTEMS, INC.
(Registrant)
/s/ Paul J. Kerz
-------------------------------------
Paul J. Kerz
President and Chief Executive Officer
15
<PAGE> 18
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
11 Computations of Earnings Per Share
27 Financial Data Schedule (Submitted for informational purposes only
and not deemed to be filed)
16
<PAGE> 1
HEALTH MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
EXHIBIT 11 -- COMPUTATIONS OF EARNINGS PER SHARE
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Three months ended Nine months ended
July 31, July 31,
-------------------- --------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Basic and Diluted Earnings Per Share:
Earnings data:
Net income (loss) $ 1,388 $ (603) 3,448 1,481
======== ======== ======== ========
Weighted average shares outstanding:
Average shares of common stock outstanding 17,468 17,627 17,431 17,648
Net effect of dilutive stock options -- based on the
treasury stock method using average market price 651 0 519 250
-------- -------- -------- --------
Weighted average common shares and common share
equivalents outstanding 18,119 17,627 17,950 17,898
======== ======== ======== ========
Earnings per common share:
Basic earnings (loss) per share $ 0.08 (0.03) 0.20 0.08
======== ======== ======== ========
Diluted earnings (loss) per share $ 0.08 (0.03) 0.19 0.08
======== ======== ======== ========
</TABLE>
17
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AT JULY 31, 1998 (UNAUDITED) AND 1997 (UNAUDITED)
AND THE CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE NINE MONTHS ENDED JULY 31,
1998 (UNAUDITED) AND 1997 (UNAUDITED) AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0000861179
<NAME> HEALTH MANAGEMENT SYSTEMS, INC.
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C> <C>
<PERIOD-TYPE> 9-MOS 9-MOS
<FISCAL-YEAR-END> OCT-31-1998 OCT-31-1997
<PERIOD-START> NOV-01-1997 NOV-01-1996
<PERIOD-END> JUL-31-1998 JUL-31-1997
<EXCHANGE-RATE> 1 1
<CASH> 12,938 20,892
<SECURITIES> 19,462 18,109
<RECEIVABLES> 48,119 38,112
<ALLOWANCES> 1,273 1,430
<INVENTORY> 0 0
<CURRENT-ASSETS> 85,613 79,655
<PP&E> 26,136 24,054
<DEPRECIATION> 19,257 16,617
<TOTAL-ASSETS> 112,372 107,798
<CURRENT-LIABILITIES> 28,477 26,525
<BONDS> 0 0
0 0
0 0
<COMMON> 183 177
<OTHER-SE> 82,310 79,352
<TOTAL-LIABILITY-AND-EQUITY> 112,372 107,793
<SALES> 77,412 64,403
<TOTAL-REVENUES> 77,412 64,483
<CGS> 77,301 64,327
<TOTAL-COSTS> 0 0
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 86 184
<INTEREST-EXPENSE> 0 0
<INCOME-PRETAX> 5,912 721
<INCOME-TAX> 2,464 (760)
<INCOME-CONTINUING> 3,448 (641)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 3,448 1,481
<EPS-PRIMARY> 0.20 0.08
<EPS-DILUTED> 0.19 0.08
</TABLE>
