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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
/x/ |
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended September 30, 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 0-18902
Health Risk Management, Inc.
(Exact name of registrant as specified in its charter)
Minnesota (State or other jurisdiction of incorporation or organization) |
41-1407404 (I.R.S. Employer Identification Number) |
10900 Hampshire Avenue South, Minneapolis, Minnesota 55438
(Address of principal executive offices, Zip Code)
(612) 829-3500
(Registrant's telephone number, including area code)
(Former
name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /x/ No / /
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
The number of shares of Common Stock par value $.01 per share, outstanding on November 14, 2000 was 4,681,950.
HEALTH RISK MANAGEMENT, INC.
INDEX
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Page Number |
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Part I. Financial Information |
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Item 1. Financial Statements (Unaudited) |
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Consolidated Balance Sheetsat September 30, 2000 and December 31, 1999 |
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3 |
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Consolidated Statements of Operations for the three months ended September 30, 2000 and 1999 and the nine months ended September 30, 2000 and 1999 |
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4 |
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Consolidated Statements of Cash Flows for the nine months ended September 30, 2000 and 1999 |
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5 |
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Notes to Consolidated Financial Statements |
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6-12 |
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations |
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13-18 |
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Item 3. Quantitative and Qualitative Disclosures About Market Risk |
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18 |
Part II. Other Information |
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Item 1. Legal Proceedings |
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19 |
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Item 2. Changes in Securities and Use of Proceeds |
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19 |
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Item 3. Defaults Upon Senior Securities |
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19 |
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Item 4. Submission of Matters to a Vote of Security Holders |
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19 |
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Item 5. Other Information |
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19 |
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Item 6. Exhibits and Reports on Form 8-K |
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19 |
Signatures |
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20 |
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Exhibit Index |
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21 |
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2
PART I. ITEM 1. FINANCIAL INFORMATION
HEALTH RISK MANAGEMENT, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
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September 30, 2000 |
December 31, 1999 |
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(Unaudited) |
(Note 1) |
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ASSETS | |||||||||
Current assets: | |||||||||
Cash and cash equivalents | $ | 407 | $ | 10,577 | |||||
Accounts receivablenet of allowance for doubtful accounts of $257 and $255 at September 30, 2000 and December 31, 1999, respectively | 18,876 | 19,627 | |||||||
Deferred income taxes | | 700 | |||||||
Other | 1,514 | 1,448 | |||||||
Total current assets | 20,797 | 32,352 | |||||||
Fixed maturity investments at fair value | 5,256 | 6,675 | |||||||
Computer software costs, less accumulated amortization of $32,431 and $23,612 at September 30, 2000 and December 31, 1999, respectively | 22,804 | 26,180 | |||||||
Property and equipment, less accumulated depreciation of $19,304 and $16,631 at September 30, 2000 and December 31, 1999, respectively | 11,335 | 11,078 | |||||||
Other assets | 7,810 | 4,552 | |||||||
$ | 68,002 | $ | 80,837 | ||||||
LIABILITIES AND SHAREHOLDERS' EQUITY | |||||||||
Current liabilities: | |||||||||
Accounts payable | $ | 7,119 | $ | 3,084 | |||||
Medical services payable | 14,899 | 22,506 | |||||||
Due to reinsurer | 1,099 | 138 | |||||||
Accrued expenses | 5,438 | 4,226 | |||||||
Unearned revenues | 4,466 | 2,774 | |||||||
Current maturities of notes payable | 10,361 | 6,825 | |||||||
Current portion of capitalized equipment leases | 679 | 380 | |||||||
Total current liabilities | 44,061 | 39,933 | |||||||
Deferred income taxes | | 1,479 | |||||||
Long-term portion of notes payable | | 3,295 | |||||||
Long-term portion of capitalized equipment leases | 1,349 | 529 | |||||||
Surplus note payable | | 2,500 | |||||||
Commitments and contingencies | |||||||||
Shareholders' equity: | |||||||||
Undesignated shares, $.01 par value, 9,700,000 authorized, none issued | |||||||||
Series A preferred shares, $.01 par value, 300,000 authorized, none issued | |||||||||
Common shares, $.01 par value, 20,000,000 authorized, 4,661,801 and 4,641,996 issued and outstanding at September 30, 2000 and December 31, 1999, respectively | 47 | 46 | |||||||
Additional paid-in capital | 32,313 | 32,192 | |||||||
Retained earnings (deficit) | (9,562 | ) | 1,162 | ||||||
Accumulated other comprehensive loss: | |||||||||
Net unrealized loss on fixed maturity investments | (206 | ) | (299 | ) | |||||
Total shareholders' equity | 22,592 | 33,101 | |||||||
$ | 68,002 | $ | 80,837 | ||||||
See accompanying notes.
3
HEALTH RISK MANAGEMENT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except per share data)
|
Three Months Ended September 30, |
Nine Months Ended September 30, |
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2000 |
1999 |
2000 |
1999 |
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Revenues: | ||||||||||||||
Premiumsgross | $ | 47,153 | $ | 40,074 | $ | 138,841 | $ | 117,538 | ||||||
Ceding allowance | 955 | 1,161 | 955 | 3,618 | ||||||||||
Management service fees | 9,060 | 12,215 | 29,216 | 36,604 | ||||||||||
QualityFIRST revenues | 1,091 | 1,029 | 3,377 | 3,060 | ||||||||||
Investment income | 183 | 231 | 693 | 783 | ||||||||||
Total revenues | 58,442 | 54,710 | 173,082 | 161,603 | ||||||||||
Less ceded premiums | 15,764 | 19,007 | 15,764 | 56,828 | ||||||||||
Net revenues | 42,678 | 35,703 | 157,318 | 104,775 | ||||||||||
Operating expenses: | ||||||||||||||
Medical costs, net | 31,331 | 16,605 | 108,092 | 48,983 | ||||||||||
Cost of services, net | 17,245 | 14,212 | 48,926 | 41,197 | ||||||||||
Selling, marketing and administration, net | 3,531 | 3,089 | 12,593 | 9,476 | ||||||||||
Interest expense | 321 | 307 | 700 | 907 | ||||||||||
Gain on surplus note | (1,600 | ) | | (1,600 | ) | | ||||||||
Total operating expenses | 50,828 | 34,213 | 168,711 | 100,563 | ||||||||||
Income (loss) before income taxes | (8,150 | ) | 1,490 | (11,393 | ) | 4,212 | ||||||||
Income tax expense (benefit) | 50 | 577 | (669 | ) | 1,594 | |||||||||
Net income (loss) | $ | (8,200 | ) | $ | 913 | $ | (10,724 | ) | $ | 2,618 | ||||
Net income (loss) per share: | ||||||||||||||
Basic | $ | (1.76 | ) | $ | .20 | $ | (2.30 | ) | $ | .56 | ||||
Diluted | $ | (1.76 | ) | $ | .20 | $ | (2.30 | ) | $ | .56 | ||||
Weighted average number of shares outstanding: | ||||||||||||||
Basic | 4,662 | 4,639 | 4,659 | 4,634 | ||||||||||
Diluted | 4,662 | 4,666 | 4,659 | 4,667 | ||||||||||
See accompanying notes.
4
HEALTH RISK MANAGEMENT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
|
Nine Months Ended September 30, |
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2000 |
1999 |
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Cash flows from operating activities: | ||||||||||
Net income (loss) | $ | (10,724 | ) | $ | 2,618 | |||||
Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities: | ||||||||||
Realized loss on investments | 14 | 1 | ||||||||
Loss on disposal of equipment | (10 | ) | | |||||||
Gain on surplus note | (1,600 | ) | | |||||||
Depreciation | 2,753 | 2,653 | ||||||||
Amortization | 9,626 | 5,514 | ||||||||
Provision for deferred income taxes | (779 | ) | 1,575 | |||||||
Changes in operating assets and liabilities: | ||||||||||
Accounts receivable | 2,219 | (167 | ) | |||||||
Other assets | 757 | 545 | ||||||||
Accounts payable | 4,164 | 1,545 | ||||||||
Medical services payable | (14,314 | ) | (7,132 | ) | ||||||
Due to reinsurer | 961 | 787 | ||||||||
Accrued expenses | 297 | 2,369 | ||||||||
Unearned revenues | 1,692 | 1,460 | ||||||||
Net cash (used in) provided by operating activities | (4,944 | ) | 11,768 | |||||||
Cash flows from investing activities: | ||||||||||
Acquisition of net liabilities (assets), net of cash acquired | 1,593 | (7,734 | ) | |||||||
Computer software costs capitalized | (4,400 | ) | (5,149 | ) | ||||||
Property and equipment, net | (227 | ) | (904 | ) | ||||||
Sale of investments | 1,498 | 1,639 | ||||||||
Purchase of investments | | (234 | ) | |||||||
Net cash used in investing activities | (1,536 | ) | (12,382 | ) | ||||||
Cash flows from financing activities: | ||||||||||
Proceeds from notes payable | | 4,000 | ||||||||
Principal payments on notes payable | (3,250 | ) | (1,661 | ) | ||||||
Principal payments on capital leases | (445 | ) | (367 | ) | ||||||
Issuance of common shares | 5 | 120 | ||||||||
Net cash (used in) provided by financing activities | (3,690 | ) | 2,092 | |||||||
(Decrease) increase in cash and cash equivalents | (10,170 | ) | 1,478 | |||||||
Cash and cash equivalents at beginning of period | 10,577 | 6,736 | ||||||||
Cash and cash equivalents at end of period | $ | 407 | $ | 8,214 | ||||||
Supplemental disclosure: | ||||||||||
Equipment and computer software acquired under capital leases | $ | 1,564 | $ | | ||||||
See accompanying notes.
5
HEALTH RISK MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the nine and three month periods ended September 30, 2000 are not necessarily indicative of the results that may be expected for the year ended December 31, 2000.
The balance sheet at December 31, 1999 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Transition Report on Form 10-K for the six month transition period ended December 31, 1999.
During the nine months ended September 30, 2000, the Company experienced a net decrease in cash and cash equivalents of $10,170,000. As discussed in the Liquidity and Capital Resources section of Management's Discussion and Analysis of Financial Condition and Results of Operations, the Company believes that its current cash and the cash flows to be generated from operations will be sufficient to finance the Company's normal operations including the payment of medical claim obligations. However, additional funding of the two new web-based business initiatives in future quarters will be limited until external financing can be obtained. It is expected that the new business will then create positive cash flow back to the Company.
2. Uses of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. The most significant items include incurred but not yet reported claims included in medical services payable, recoveries from providers included in medical services payable, performance bonus accruals included in accounts receivable and the deferred tax asset valuation allowance. Such estimates and assumptions could change in the future as more information becomes known, which could impact the amounts reported and disclosed herein. Approximately $4,000,000 of additional reserves were recorded in the third quarter to cover obligations for the first six months of 2000 in that claim experience for the first six months of calendar year 2000 has developed less favorably than expected at June 30, 2000.
6
3. Computer software costs
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September 30, 2000 |
December 31, 1999 |
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(Unaudited) |
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(in thousands) |
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Computer software costs consist of the following: | |||||||||
Care Management Software | |||||||||
Cost | $ | 22,547 | $ | 20,201 | |||||
Less accumulated amortization | 14,625 | 9,161 | |||||||
Net book value | 7,922 | 11,040 | |||||||
Claim Administration Software | |||||||||
Cost | 10,500 | 9,987 | |||||||
Less accumulated amortization | 5,606 | 4,803 | |||||||
Net book value | 4,894 | 5,184 | |||||||
QualityFIRST® Software | |||||||||
Cost | 22,188 | 19,604 | |||||||
Less accumulated amortization | 12,200 | 9,648 | |||||||
Net book value | 9,988 | 9,956 | |||||||
Computer software costs | $ | 22,804 | $ | 26,180 | |||||
The Company capitalizes its internal-use software related to its Care Management software and Claim Administration software in accordance with the American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 98-1 "Accounting for Computer Software Developed For or Obtained For Internal Use" (the SOP).
Effective October 1, 1999, the estimated remaining useful life of the AutoPILOT Care Management software (AutoPILOT) was reduced from seven years to three years and no additional internal costs have been capitalized since that date. On October 13, 2000, the Company announced that its new Care Management software will be operational in January 2001. As a result, AutoPILOT's June 30, 2000, net book will be amortized over the third and fourth quarters of the year ended December 31, 2000. The amortization expense will increase from $720,000 per quarter to $3,600,000 per quarter. The increased amortization is included in cost of services, net.
The Company capitalizes QualityFIRST® computer software costs in accordance with Statement of Financial Accounting Standards (SFAS) No. 86, Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed. The capitalized costs are amortized based on the greater of the amount computed using (a) the ratio of current gross revenues for the product to the total of current and anticipated future gross revenues or (b) a straight-line basis over their estimated useful lives, ranging from three to ten years.
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4. Net Income (Loss) Per Share
The computation of basic and diluted earnings per share for the three months and nine months ended September 30, were as follows (in thousands, except per share data):
|
Three Months Ended September 30, |
Nine Months Ended September 30, |
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2000 |
1999 |
2000 |
1999 |
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Numerator: | ||||||||||||||
Net income (loss) | $ | (8,200 | ) | $ | 913 | $ | (10,724 | ) | $ | 2,618 | ||||
Denominator: | ||||||||||||||
Weighted-average sharesbasic | 4,662 | 4,639 | 4,659 | 4,634 | ||||||||||
Effect of dilutive stock options | | 27 | | 33 | ||||||||||
Weighted-average sharesdiluted | 4,662 | 4,666 | 4,659 | 4,667 | ||||||||||
Net income (loss) per share: | ||||||||||||||
Basic | $ | (1.76 | ) | $ | .20 | $ | (2.30 | ) | $ | .56 | ||||
Diluted | $ | (1.76 | ) | $ | .20 | $ | (2.30 | ) | $ | .56 | ||||
5. Comprehensive Income (Loss)
The comprehensive income (loss) for the Company for the three and nine months ended September 30, were as follows (in thousands):
|
Three Months Ended September 30, |
Nine Months Ended September 30, |
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2000 |
1999 |
2000 |
1999 |
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Net income (loss) | $ | (8,200 | ) | $ | 913 | $ | (10,724 | ) | $ | 2,618 | ||||
Change in net unrealized loss on fixed maturity investments | 85 | (23 | ) | 93 | (231 | ) | ||||||||
Comprehensive income (loss) | $ | (8,115 | ) | $ | 890 | $ | (10,631 | ) | $ | 2,387 | ||||
8
6. Investments
The amortized cost and fair value of available for sale fixed maturity investments consisted of the following (in thousands):
|
September 30, 2000 |
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Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Fair Value |
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U.S. Treasury securities | $ | 4,941 | $ | | $ | 189 | $ | 4,752 | |||||
Corporate bonds | 521 | | 17 | 504 | |||||||||
$ | 5,462 | $ | | $ | 206 | $ | 5,256 | ||||||
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December 31, 1999 |
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Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Fair Value |
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U.S. Treasury securities | $ | 4,941 | $ | | $ | 264 | $ | 4,677 | |||||
Corporate bonds | 2,033 | | 35 | 1,998 | |||||||||
$ | 6,974 | $ | | $ | 299 | $ | 6,675 | ||||||
All fixed maturity investments are due within five years as of September 30, 2000. Actual maturities may differ from contractual maturities because the borrowers may have the right to prepay such obligations without prepayment penalties. Proceeds from sales of investments in bonds during the nine months ended September 30, 2000 and 1999, were $1,498,530 and $1,639,764, respectively. Gross losses realized on sales of investments in bonds during the nine months ended September 30, 2000 were $14,389. Gross gains and losses on sales of investments in bonds during the nine months ended September 30, 1999 were $8,356 and $6,829, respectively.
At September 30, 2000 U.S. Treasury Securities with a book value of $100,000 were on deposit with the Commonwealth of Pennsylvania Insurance Department to satisfy regulatory requirements.
The net unrealized loss on fixed maturity investments included in shareholder's equity consisted of the following (in thousands):
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September 30, 2000 |
December 31, 1999 |
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Gross unrealized loss on fixed maturity investments | $ | (206 | ) | $ | (299 | ) | ||
Adjustment for net deferred tax benefit, net of valuation allowance | | | ||||||
Net unrealized loss on fixed maturity investments | $ | (206 | ) | $ | (299 | ) | ||
7. Acquisitions/Reinsurance Agreements
In January 2000, the Company, through its subsidiary HRM Health Plans (PA), Inc. (HRMPA), acquired from Hamilton HealthCenter, Inc. all of the outstanding stock of Pennsylvania HealthMATE, Inc., an 18,000 voluntary member health plan serving the Medicaid population in a six (6) county area. HRMPA assumed ownership of HealthMATE by assuming liabilities in excess of assets of approximately $3,400,000. The $3,400,000 has been recorded as goodwill and will be amortized on a
9
straight line basis over 10 years. It is included in other assets on the consolidated balance sheet. The revenue from HealthMATE is expected to exceed $32,000,000 annually.
On June 29, 2000, effective July 1, 2000, the Company entered into a 33% quota share reinsurance agreement under which the reinsurer has assumed 33% of the Medicaid medical cost risk and certain non-medical expenses in exchange for 33% of the related Medicaid premium. Under this agreement, on July 6, 2000, the Company received a $4,000,000 ceding allowance from the reinsurer. The ceding allowance will be realized in relation to profits ceded to the reinsurer. The Company realized $955,000 in the three month period ended September 30, 2000, of the ceding allowance as a component of net revenue. Amounts ceded under the contract for premiums, medical costs and expenses for the three month period ended September 30, 2000, were $15,764,000, $12,903,000 and $1,762,000, respectively.
During 1999, the Company had in effect a 50% quota share reinsurance agreement under which the reinsurer assumed 50% of the Medicaid medical cost risk and certain non-medical expenses in exchange for 50% of the related Medicaid premium. The ceding allowance was realized in relation to profits ceded to the reinsurer. The Company realized $1,161,000 and $3,618,000 in the three and six month periods ended September 30, 1999, respectively, of the ceding allowance as a component of net revenue. Amounts ceded under the contract for premiums, medical costs and expenses for the three month period ended September 30, 1999, were $19,007,000, $15,986,000 and $1,739,000, respectively and $56,828,000, $47,450,000 and $5,308,000 for the nine month period ended September 30, 1999, respectively.
8. Notes Payable
The Company did not meet certain bank covenants under bank loan agreements during the quarter ended September 30, 2000. As of September 30, 2000, the Company has outstanding a $2,900,000 note payable to the bank under a revolving credit agreement and a term loan which has an unpaid balance of $3,900,000. Subsequent to September 30, 2000, the Company received a waiver for the covenant violations for the quarter ended September 30, 2000. Additionally, the Credit Agreement with the bank was amended to consolidate the note payable and term loan into a single term loan payable in monthly installments of $225,000, including interest, (currently $425,000 per month) with interest at the bank reference rate plus 2.75%.
During the quarter ended September 30, 2000, the Company converted $1,214,000 of accounts payable obligations to notes payable. The notes have terms of less than one year, an interest rate of 10% and some contain equity conversion features.
9. Income Taxes
The effective tax benefit for the three and nine month periods ended September 30, 2000, was less than the statutory rate because the Company was not able to recognize deferred tax assets in excess of deferred tax liabilities in that the utilization of such assets is not reasonably assured.
10. Reclassification
Certain items in the financial statements for the three months ended September 30, 1999 have been reclassified to conform to the 2000 presentations.
10
11. Gain on Surplus Note
In August 2000, the Plan and the Company reached agreement with Oxford Health Plans, Inc. (OHPI) on all post acquisition accounting transactions. Under terms of the agreement, the Company acquired the existing $2,500,000 surplus note owed by the Plan to OHPI for $900,000 in the form of a promissory note bearing 10% interest due March 31, 2001. Additionally, The Plan agreed to remit $1,100,000 to OHPI for post acquisition accounting transactions payable no later than October 31, 2000. As the liability for post acquisition accounting transactions was recorded prior to the agreement, the net settlement gain on the surplus note was $1,600,000.
12. Segment Reporting
Reportable segment information is as follows (in thousands):
|
Management Services Unit |
QualityFIRST Unit |
Risk (HMO) Unit |
Total |
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Nine months ended September 30, 2000: | |||||||||||||
Revenues from external clients | $ | 29,216 | $ | 3,377 | $ | 124,031 | $ | 156,625 | |||||
Intersegment revenues(1) | 19,124 | 851 | | 19,975 | |||||||||
Investment income(2) | 117 | | 576 | 693 | |||||||||
Interest expense(3) | 724 | 172 | (196 | ) | 700 | ||||||||
Depreciation expense | 2,456 | 128 | 169 | 2,753 | |||||||||
Amortization expense | 6,834 | 2,566 | 226 | 9,626 | |||||||||
Segment pretax loss(4) | (8,437 | ) | (2,052 | ) | (904 | ) | (11,393 | ) | |||||
Segment assets(4) | 37,462 | 10,950 | 19,590 | 68,002 | |||||||||
Purchases of property and equipment and computer software | 4,186 | 2,584 | 227 | 6,997 | |||||||||
Nine months ended September 30, 1999: |
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Revenues from external clients | $ | 36,604 | $ | 3,060 | $ | 64,328 | $ | 103,992 | |||||
Intersegment revenues(1) | 19,859 | 904 | 0 | 20,763 | |||||||||
Investment income(2) | 67 | | 716 | 783 | |||||||||
Interest expense(3) | 616 | 147 | 144 | 907 | |||||||||
Depreciation expense | 2,391 | 111 | 151 | 2,653 | |||||||||
Amortization expense | 3,319 | 2,195 | 0 | 5,514 | |||||||||
Segment pretax profit(4) | 4,914 | (1,022 | ) | 320 | 4,212 | ||||||||
Segment assets(4) | 44,966 | 10,963 | 27,060 | 82,989 | |||||||||
Purchases of property and equipment and computer software | 3,917 | 2,391 | 973 | 7,281 |
Intersegment QualityFIRST Unit revenues represents amounts charged by the QualityFIRST Unit to the Management Services Unit ($194,000 and $349,000 for the nine months ended September 30, 2000 and 1999, respectively) and the Risk (HMO) unit ($657,000 and $555,000 for the nine months ended September 30, 2000 and 1999, respectively) for use of the QualityFIRST®
11
software. The revenue is based upon covered members or employees and is eliminated in consolidation.
12
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Overview
The Company's revenues consist primarily of Medicaid premiums for providing administrative services while assuming all the medical cost risk, management service fees for health plan management and QualityFIRST revenues for software licenses and subscription fees.
The Company's operating expenses are comprised of medical costs, net (consisting primarily of the net medical costs after the ceded portion of medical services and reinsurance, net of recoveries), its cost of services, net (consisting primarily of net costs after ceded portions of compensation of personnel, including nurses and physicians, telephone expenses, depreciation and amortization, rent, costs related to the Company's computer operations, costs related to customer service, and costs related to development of new services), and selling, marketing and administration expenses, net (consisting primarily of the net costs after ceded portions of sales commissions, advertising, sales account management personnel, bad debts, administration, professional services, insurance, compensation and depreciation). The medical costs, cost of services and selling, marketing and administration expenses are affected to varying degrees by a 33% quota share agreement related to the Medicaid block of business which was effective July 1, 2000 through September 30, 2000 and the 50% quota share agreement related to the Medicaid block of business which was effective January 1, 1999 through December 31, 1999 (for further discussion of the quota share agreements, see note 7 of the consolidated financial statements enclosed).
A significant portion of the Company's revenue is from the Risk Business Unit which owns two plans serving Medicaid members. This business is subject to regulatory risks such as rate setting, reporting, net worth requirements, government agendas and the general health of the membership served. Service utilization for contracted charges payable to providers of care, pharmacies, vendors, etc. are highly variable and therefore estimates are used to estimate charges incurred but not yet received. The medical loss for the Plan continues to be highly subjective. The Plan has, during the three months ended September 30, 2000, continued the process begun in the second quarter of entering into settlement agreements with providers so as to finalize any liabilities incurred prior to the calendar year 2000. Claim experience for the first six months of calendar year 2000 has developed less favorably than expected at June 30, 2000. Approximately $4,000,000 of additional reserves were recorded in the third quarter to cover obligations for the first six months of the year.
The HMO has estimated receivables from insurance policies for aggregate coverage of excessive medical costs that may result in adjustments in the future. The Company's HMO had a 50% quota share agreement whereby 50% of premiums, investments, medical costs and certain administrative costs were ceded to an insurance company until a certain policy period had passed or there was a recapture as allowed under the policy. Effective January 1, 2000, the Company's HMO recaptured the business ceded for a recapture fee of $300,000 which was accrued at December 31, 1999. Effective July 1, 2000, the Company's HMO entered into a 33% quota share agreement whereby 33% of premiums, investments, medical costs and certain administrative cost were ceded to an insurance company until a certain policy period has passed or there was a recapture as allowed under the policy
Accounts receivable, at times, may include performance bonus accruals which when billed, may result in amounts greater than the accrual or less than the accrual because considerable time may pass between the accrual of the revenue and the actual billing of the performance bonus. The affected parties then require time to prove up the final calculations.
Effective October 1, 1999, the estimated remaining useful life of the AutoPILOT Care Management software (AutoPILOT) was reduced from seven years to three years and no additional internal costs have been capitalized since that date. On October 13, 2000, the Company announced that its new Care Management software will be operational in January 2001. As a result, AutoPILOT's
13
June 30, 2000, net book value will be amortized over the third and fourth quarters of the year ended December 31, 2000. The amortization expense will increase from the previous rate of $720,000 per quarter to $3,600,000 per quarter. Costs capitalized during the quarter ended September 30, 2000, within Care Management Software were for the development of the Company's new Care Management system.
Results of Operations
The following table sets forth certain consolidated financial data as a percentage of revenues for the three and nine months ended September 30, 2000 and 1999.
|
Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2000 |
1999 |
2000 |
1999 |
|||||||
Total revenues | 100 | % | 100 | % | 100 | % | 100 | % | |||
Operating expenses: | |||||||||||
Medical costs, net | 100 | %(1) | 79 | %(1) | 88 | %(1) | 81 | %(1) | |||
Cost of services, net | 40 | (2) | 40 | (2) | 31 | (2) | 39 | (2) | |||
Selling, marketing and administration, net | 8 | (2) | 9 | (2) | 8 | (2) | 9 | (2) | |||
Interest expense | 1 | (2) | 1 | (2) | * | (2) | 1 | (2) | |||
Gain on surplus note | (4) | (2) | | (1) | (2) | | |||||
Total operating expenses | 119 | (2) | 96 | (2) | 107 | (2) | 96 | (2) | |||
Income (loss) before income taxes | (19 | ) | 4 | (7 | )(2) | 4 | |||||
Income tax expense (benefit) | * | 2 | * | 2 | |||||||
Net income (loss) | (19 | ) | 2 | % | (7 | ) | 2 | ||||
Revenues: Total revenues prior to the reduction for ceded premiums increased $3,732,000 (7%) for the quarter ended September 30, 2000 compared to the same period in 1999 (from $54,710,000 to $58,442,000) and increased $11,479,000 (7%) for the nine months ended September 30, 2000 compared to the same period in 1999 (from $161,603,000 to $173,082,000). These increases are primarily attributable to the acquisition of HealthMATE in January 2000 (see note 7 of the financial statements) offset by lower revenues from management service fees. Management service fees were impacted by a net decrease in the number of covered participants enrolled in the Company's management services.
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Following is a breakout of net revenues:
|
Three Months Ended September 30, |
||||||||
---|---|---|---|---|---|---|---|---|---|
|
2000 |
1999 |
|||||||
Premiumsgross | $ | 47,153,000 | $ | 40,074,000 | |||||
Ceding allowance | 955,000 | 1,161,000 | |||||||
Management service fees | 9,060,000 | 12,215,000 | |||||||
QualityFIRST revenues | 1,091,000 | 1,029,000 | |||||||
Investment income | 183,000 | 231,000 | |||||||
Total revenues | 58,442,000 | 54,710,000 | |||||||
Less ceded premiums | (15,764,000 | ) | (19,007,000 | ) | |||||
Net revenues | $ | 42,678,000 | $ | 35,703,000 | |||||
|
Nine Months Ended September 30, |
||||||||
---|---|---|---|---|---|---|---|---|---|
|
2000 |
1999 |
|||||||
Premiumsgross | $ | 138,841,000 | $ | 117,538,000 | |||||
Ceding allowance | 955,000 | 3,618,000 | |||||||
Management service fees | 29,216,000 | 36,604,000 | |||||||
QualityFIRST revenues | 3,377,000 | 3,060,000 | |||||||
Investment income | 693,000 | 783,000 | |||||||
Total revenues | 173,082,000 | 161,603,000 | |||||||
Less ceded premiums | (15,764,000 | ) | (56,828,000 | ) | |||||
Net revenues | $ | 157,318,000 | $ | 104,775,000 | |||||
Premiumsgross are from HMO operations. The premiumsgross increased 18% or $7,079,000, for the quarter ended September 30, 2000 compared to the same period in 1999 (increasing from $40,074,000 to $47,153,000) and increased 18% or $21,303,000, for the nine months ended September 30, 2000 compared to the same period in 1999 (increasing from $117,538,000 to $138,841,000). The increase was the result of the acquisition of HealthMATE as discussed above, membership category changes and rate adjustments effective January 2000. Total revenues include the ceding allowance, and net revenues reflect the premiums that are ceded under the reinsurance agreements for the quarters and nine months ended September 30, 2000 and 1999.
The management services revenue decreased 26% or $3,155,000, for the quarter ended September 30, 2000 compared to the same period in 1999 (decreasing from $12,215,000 to $9,060,000) and decreased 20% or $7,388,000, for the nine months ended September 30, 2000 compared to the same period in 1999 (decreasing from $36,604,000 to $29,216,000) which was the result of the loss of an insurance company, bankruptcy of a health plan, and other decreases in total covered members.
Revenues from QualityFIRST® increased 6% or $62,000 for the quarter ended September 30, 2000 compared to the same period in 1999 (increasing from $1,029,000 to $1,091,000) and increased 10% or $317,000, for the nine months ended September 30, 2000 compared to the same period in 1999 (increasing from $3,060,000 to $3,377,000). The increases were the result of an increased number of clients and expansion of systems with existing clients.
Investment income decreased 21% or $48,000 for the quarter ended September 30, 2000 compared to the same period in 1999 (decreasing from $231,000 to $183,000) and decreased 11% or $90,000, for the nine months ended September 30, 2000 compared to the same period in 1999 (decreasing from
15
$783,000 to $693,000). This decrease is the result of reduced levels of short-term and long-term investments in the periods offset by any increases in interest rates earned.
Medical Costs, Net: Medical costs, net of amounts ceded, for the HMO increased 89% or $14,726,000 for the quarter ended September 30, 2000 and increased 121% or $59,109,000 for the nine months ended September 30, 2000 compared to the same periods in 1999 due mainly to the ceding arrangements described above. As a percentage of net HMO premiums, net medical costs was 99.8% for the quarter ended September 30, 2000 compared to 78.8% for the same period in 1999 and 87.8% for the nine months ended September 30, 2000 compared to 80.7% for the same period in 1999. These increased percentages are the result of the net impact of premium rate increases effective January 1, 2000 and an increase in the estimate for provider recoveries recorded in the second quarter of 2000 offset by the recording of approximately $4,000,000 of medical costs in the third quarter of 2000 to cover greater than estimated obligations for the first six months of 2000, increased pharmacy costs and changes in membership mix into higher cost categories.
Cost of Services, Net: Cost of services, net of amounts ceded, increased 21% or $3,033,000 for the quarter ending September 30, 2000 compared to the same period in 1999 (increasing from $14,212,000 to $17,245,000) and increased 19% or $7,729,000 for the nine months ending September 30, 2000 compared to the same period in 1999 (increasing from $41,197,000 to $48,926,000). The increases were primarily due to the ceding arrangements described above, increased payroll and expenses related to the HMO acquisition and implementing management services for new covered lives. As a percentage of net revenues, the cost of service, net of amounts ceded, was 40.4% in the quarter ending September 30, 2000 compared to 39.8% for the same period in 1999 and 31.1% in the nine months ending June 30, 2000 compared to 39.3% for the same period in 1999.
Selling, Marketing and Administration, Net: Selling, marketing and administration, net of amounts ceded, increased 14% or $442,000 for the quarter ended September 30, 2000 compared to the same period in 1999 (increasing from $3,089,000 to $3,531,000) and increased 33% or $3,117,000 for the nine months ending September 30, 2000 compared to the same period in 1999 (increasing from $9,476,000 to $12,593,000). The increases were due primarily to the ceding arrangements described above, settlement of a provider dispute (including legal fees), network development in the HealthMATE service area, development costs related to the two new business initiatives, additions or decreases to staff, travel, commission, bad debts, insurance, training programs and other expenses. This expense as a percentage of net revenues was 8.3% and 8.7% for the quarter ended September 30, 2000 compared to the same period in 1999 and 8.0% in the nine months ending September 30, 2000 compared to 9.0% for the same period in 1999.
Interest Expense: Interest expense increased 5% or $14,000 for the quarter ended September 30, 2000 compared to the same period in 1999 (increasing from $307,000 to $321,000) and decreased 23% or $207,000 for the nine months ending September 30, 2000 compared to the same period in 1999 (decreasing from $907,000 to $700,000). In fiscal 1999, additional loans were obtained to acquire the HMO. In the quarter ended June 30, 2000, the Company reversed interest accrued on the surplus note to Oxford Health Plans, Inc. in the amount of $303,000. In the quarter ended September 30, 2000, the Company converted $1,214,000 of accounts payable obligations to notes payable. The notes have terms of less than one year with an interest rate of 10%.
Gain on Surplus Note: In August 2000, the Plan and the Company reached agreement with Oxford Health Plans, Inc. (OHPI) on all post acquisition accounting transactions. Under terms of the agreement, the Company acquired the existing $2,500,000 surplus note owed by the Plan to OHPI for $900,000 in the form of a promissory note bearing 10% interest due March 31, 2001. The Plan agreed to remit $1,100,000 to OHPI for post acquisition accounting transactions. A payment of $500,000 was remitted to OHPI on November 1, 2000. The balance of the note is to be paid no later than November 30, 2000. The net settlement gain on the surplus note was $1,600,000.
16
Income Taxes: Income tax expense decreased in the quarter ended September 30, 2000 from the same period a year ago by $527,000, or 91% (from a tax expense of $577,000 to a tax expense of $50,000) and decreased in the nine months ended September 30, 2000 from the same period a year ago by $2,263,000, or 142% (from a tax expense of $1,594,000 to a tax benefit of $669,000) primarily due to fluctuations in levels of income or loss before income taxes. The net income or loss has been reported as fully taxed in the periods at the federal tax rate of 34% with the effective tax rate varying due to state income taxes, expired NOL's, nondeductible expenses and the excess of deferred tax assets over deferred tax liabilities. See note 9 of the financial statements enclosed.
Liquidity and Capital Resources
The Company's cash flow used in operations was $4,944,000 and provided from operations was $11,768,000 for the nine months ended September 30, 2000 and 1999, respectively. In 2000, cash used in operations was less than the net loss primarily due to net changes in operating assets and liabilities including the medical services payable in excess of non-cash charges such as depreciation and amortization and deferred income taxes. In 1999, cash flow from operations exceeded net income primarily due to non-cash charges such as depreciation and amortization, deferred income taxes, and net changes in operating assets and liabilities including the medical services payable.
Cash of $1,593,000 was provided by net liabilities, net of cash, from companies acquired in the nine months ended September 30, 2000 and cash of $7,734,000, net of cash acquired, was used in the nine months ended September 30, 1999 to purchase Oxford Health Plans (PA), Inc., now named HRM Health Plans (PA), Inc., on January 27, 1999. Cash has been used to invest in software and program enhancements ($4,400,000 and $5,149,000 for the nine months ended September 30, 2000 and 1999, respectively). The Company also used cash to acquire property and equipment ($227,000 and $904,000 for the nine months ended September 30, 2000 and 1999, respectively). Cash of $1,498,000 and $1,639,000 was provided in the nine months ended September 30, 2000 and 1999, respectively, from the sale of fixed maturity investments. Cash of $234,000 was used in the nine months ended September 30, 1999 for the purchase of fixed maturity investments. The Company expects to continue to acquire property and equipment and enhance software and products.
HRM also used approximately $3,695,000 and $2,028,000 for the nine months ended September 30, 2000 and 1999, respectively, to repay principal on notes payable and capital leases. The Company borrowed $4,000,000 in the first quarter of calendar 1999. The Company received cash proceeds of $5,000 and $120,000 for the nine months ended September 30, 2000 and 1999, respectively, from stock option exercises for common stock by current or former employees and directors.
The Company had a working capital deficit of $23,264,000 and $7,581,000 at September 30, 2000 and December 31, 1999, respectively. The medical services payables reduced working capital by $14,899,000 and $22,506,000 at September 30, 2000 and December 31, 1999, respectively. The Company has fixed maturity investments of $5,256,000 and $6,675,000 available at September 30, 2000 and December 31, 1999, respectively, to be used to pay medical services payables, if the need arises.
The Company has a net operating loss carryforward of approximately $30,000,000 for income tax purposes at December 31, 1999, which can be used to reduce taxable income and cash flow necessary to pay taxes. The Company changed its tax accounting treatment to one of capitalizing computer software costs versus expensing them when incurred. This change should protect carry forward net operating loss (NOLs) for tax purposes going forward.
The Company believes that its current cash and the cash flows to be generated from operations, together with revisions to current credit facilities as described in note 8 of the financial statements enclosed, will be sufficient to finance the Company's anticipated normal operations for the balance of calendar year 2000, but, on a near-term basis, additional financing of its two new web-based business initiatives needs to be obtained. The Company anticipates raising a minimum of $8,000,000 of external
17
financing in future quarters in the form of cash or accounts payable obligations converted into convertible debentures. The two new web-based business plans will require on-going support from the Company until external financing is obtained. The quarters ended June 30, 2000 and September 30, 2000, included approximately $1,000,000 and $400,000 of expenses related to the new web-based business initiatives, respectively. Investment in future quarters will be limited until they are financed and it is expected that the new business will then create positive cash flow back to the Company.
The Company has a term loan and a revolving credit facility having principal balances of $3,900,000 and $2,900,000, respectively, outstanding as of September 30, 2000. The Company has no additional funds available under the revolving credit facility at September 30, 2000. The term loan and revolving credit facility are secured by liens on the assets of the Company. Subsequent to September 30, 2000, the term loan and revolving credit agreement were amended as described in note 8 of the financial statements enclosed.
During the quarter ended March 31, 2000, the Company acquired approximately $32,000,000 of annual premium in its risk business unit by assuming approximately $3,500,000 of liabilities in excess of cash and other assets. These excess liabilities will impact the net worth of the HMO entity, but it is believed that the HMO's net worth, the earnings of the HMO and the new quota share insurance arrangement, will allow the HMO to meet state statutory net worth requirements. The Company continues to evaluate possible state risk based capital requirements. The acquisition has been immediately profitable to the Company, because the Company has been able to leverage its equipment, systems and employees in the Medicaid business in the same state.
Forward Looking Statements
Forward looking statements in this report reflected as expectations, plans, anticipations, prospects or future estimates are subject to the risks and the uncertainties present in the Company's business and the competitive healthcare marketplace including, but not limited to clients and vendors commonly experiencing mergers or acquisitions, use of estimates for incurred but not yet reported claims including medical services payable, use of estimates of bonus accruals including accounts receivable, reconciliations, volume fluctuations, provider relations and contracting, participant enrollment fluctuations, changes in member mix or utilization levels, fixed price contracts, contract disputes, contract modifications, contract renewals and non-renewals, regulatory issues and requirements, various business reasons for delaying contract closings, and the operational challenges of matching case volume with optimum staffing, having fully trained staff, having computer and telephonic supported operations and managing turnover of key employees and outsourced services to performance standards. While occurrences of these risks, and others periodically detailed in the Company's SEC reports, cannot be predicted exactly, such occurrences can be expected to have an impact on the Company's anticipated level of revenue growth or profitability.
Quantitative and Qualitative Disclosure About Market Risk
There have been no material changes in the Company's interest rate market risk disclosures since December 31, 1999. For further information, refer to Item 7A in the Company's Transition Report on Form 10-K for the six months ended December 31, 1999.
18
A dispute, previously reported, with a provider, that was submitted to arbitration in September 1999 was settled by the Company and the provider in August 2000. Under terms of the settlement, the Plan agreed to pay the provider $500,000. This obligation has been included in accrued expenses in the consolidated balance sheet as of June 30, 2000, and in selling, marketing and administration, net, in the consolidated statement of operations. The plan incurred approximately $450,000 in legal expenses related to the dispute during the third quarter. The expenses have also been included in selling, marketing and administration, net in the third quarter.
Item 2. Changes in Securities and Use of Proceeds
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
19
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.
HEALTH RISK MANAGEMENT, INC. | ||||
Dated: November 14, 2000 |
|
By: |
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/s/ GARY T. MCILROY Gary T. McIlroy, M.D. Chief Executive Officer |
Dated: November 14, 2000 |
|
By: |
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/s/ THOMAS P. CLARK Thomas P. Clark Executive Vice President, Acquisitions and Business Development (principal financial officer during quarter covered by this report) |
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
EXHIBIT INDEX
to
FORM 10-Q
For Quarter Ended September 30, 2000
HEALTH RISK MANAGEMENT, INC.
(SEC File No. 0-18902)
Exhibit Number |
Exhibit Description |
|
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10.1 |
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Fifth Amendment to Credit Agreement between Health Risk Management, Inc. and U.S. National Bank dated July 31, 2000 |
27 |
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Financial Data Schedule (filed in electronic format only) |
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21
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